```

[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]

IMPACT OF COMPLEXITY IN THE TAX CODE ON INDIVIDUAL TAXPAYERS AND SMALL 
                               BUSINESSES

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

                                HEARING

                               before the

                       SUBCOMMITTEE ON OVERSIGHT

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             FIRST SESSION

                               __________

                              MAY 25, 1999

                               __________

                             Serial 106-83

                               __________

         Printed for the use of the Committee on Ways and Means

                    U.S. GOVERNMENT PRINTING OFFICE
67-314 CC                   WASHINGTON : 2001

_______________________________________________________________________
            For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 
                                 20402

                      COMMITTEE ON WAYS AND MEANS

                      BILL ARCHER, Texas, Chairman

PHILIP M. CRANE, Illinois            CHARLES B. RANGEL, New York
BILL THOMAS, California              FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida           ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut        WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York               SANDER M. LEVIN, Michigan
WALLY HERGER, California             BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana               JIM McDERMOTT, Washington
DAVE CAMP, Michigan                  GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota               JOHN LEWIS, Georgia
JIM NUSSLE, Iowa                     RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas                   MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington            WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia                 JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio                    XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania      KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma                LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida

                     A.L. Singleton, Chief of Staff

                  Janice Mays, Minority Chief Counsel

                                 ______

                       Subcommittee on Oversight

                    AMO HOUGHTON, New York, Chairman

ROB PORTMAN, Ohio                    WILLIAM J. COYNE, Pennsylvania
JENNIFER DUNN, Washington            MICHAEL R. McNULTY, New York
WES WATKINS, Oklahoma                JIM McDERMOTT, Washington
JERRY WELLER, Illinois               JOHN LEWIS, Georgia
KENNY HULSHOF, Missouri              RICHARD E. NEAL, Massachusetts
J.D. HAYWORTH, Arizona
SCOTT McINNIS, Colorado

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public 
hearing records of the Committee on Ways and Means are also published 
in electronic form. The printed hearing record remains the official 
version. Because electronic submissions are used to prepare both 
printed and electronic versions of the hearing record, the process of 
converting between various electronic formats may introduce 
unintentional errors or omissions. Such occurrences are inherent in the 
current publication process and should diminish as the process is 
further refined.

                            C O N T E N T S

                               __________

                                                                   Page

Advisory of May 18, 1999, announcing the hearing.................     2

                               WITNESSES

Internal Revenue Service, W. Val Oveson, National Taxpayer 
  Advocate.......................................................    12

                                 ______

American Bar Association, Stefan F. Tucker.......................    35
American Institute of Certified Public Accountants, David A. 
  Lifson.........................................................    52
KPMG LLP, Harry L. Gutman........................................    70
National Federation of Independent Business, and Southern Pan 
  Services Company, Gerry P. Harkins.............................    75
National Tax Association, and Urban Institute, C. Eugene Steuerle    80
New York State Society of Certified Public Accountants, and 
  Mengel, Metzger, Barr & Co., LLP, P. Gerard Sokolski...........    23
Williams-Keepers CPA's LLP, Stephen B. Smith.....................    28

                       SUBMISSIONS FOR THE RECORD

American Network of Community Options and Resources, Annandale, 
  VA, statement..................................................    98
Associated General Contractors of America, statement.............   100
Bond, Hon. Christopher S. ``Kit,'' a United States Senator from 
  the State of Missouri, statement...............................   103
Kleczka, Hon. Gerald D., a Representative in Congress from the 
  State of Wisconsin, statement..................................   107
National Association of Home Builders, statement.................   108
National Conference of CPA Practitioners, Lake Success, NY, 
  Steven Greenberg, letter.......................................   111
Washington Counsel, P.C., LaBrenda Garrett-Nelson, and Robert J. 
  Leonard, statement.............................................   113

 
IMPACT OF COMPLEXITY IN THE TAX CODE ON INDIVIDUAL TAXPAYERS AND SMALL 
                               BUSINESSES

                              ----------                              

                         TUESDAY, MAY 25, 1999

                  House of Representatives,
                       Committee on Ways and Means,
                                Subcommittees on Oversight,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 2:06 p.m., in 
room 1100, Longworth House Office Building, Hon. Amo Houghton 
(Chairman of the Subcommittee) presiding.
    [The advisory announcing the hearing follows:]

ADVISORY

FROM THE 
COMMITTEE
 ON WAYS 
AND 
MEANS

                       SUBCOMMITTEE ON OVERSIGHT

                                                CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE

May 18, 1999

No. OV-7

                     Houghton Announces Hearing on

                the Impact of Complexity in the Tax Code

              on Individual Taxpayers and Small Businesses

    Congressman Amo Houghton (R-NY), Chairman, Subcommittee on 
Oversight of the Committee on Ways and Means, today announced that the 
Subcommittee will hold a hearing on the impact of complexity in the tax 
code for individual taxpayers and small businesses. The hearing will 
take place on Tuesday, May 25, 1999, in the main Committee hearing 
room, 1100 Longworth House Office Building, beginning at 2 p.m.
      
    In view of the limited time available to hear witnesses, oral 
testimony at this hearing will be from invited witnesses only. 
Witnesses will include representatives of the U.S. Department of the 
Treasury, the Office of the Taxpayer Advocate, tax professional 
organizations, and individual tax practitioners. However, any 
individual or organization not scheduled for an oral appearance may 
submit a written statement for consideration by the Committee and for 
inclusion in the printed record of the hearing.
      

BACKGROUND:

      
    When the Federal income tax system was established in 1913, the 
legislation was only 19 pages long. Today, the Internal Revenue Code 
covers 2,300 pages, not counting regulations. The resulting compliance 
burden for taxpayers is enormous, especially for lower- and middle-
income taxpayers and small businesses.
      
    Many studies have documented the impact of complexity. For example, 
one study showed that U.S. taxpayers spent more than five billion hours 
preparing tax returns with compliance costs of more than $200 billion 
in 1998. Two-thirds of compliance costs were borne by small businesses. 
Another study has shown that some small businesses pay more than seven 
dollars in compliance costs for every dollar they pay in taxes.
      
    Because of the problems caused by the complexity of the current tax 
code, there are several efforts in Congress to replace the tax code. 
However, in the interim, simplification of the most complex provisions 
of the Code may help to reduce significantly the burden on individual 
taxpayers and small businesses.
      
    In announcing the hearing, Chairman Houghton stated: ``Sixty-six 
percent of respondents in a recent Associated Press poll said that the 
Federal tax system is too complicated. The same poll showed that over 
half of those surveyed, 56 percent, pay someone else to complete their 
returns. When you consider that only 30 percent of taxpayers itemize, 
that is a good number of people who are paying someone else to fill out 
their income tax forms. Something is wrong when so many taxpayers with 
relatively straightforward returns lack confidence in their ability to 
fill them out.''
      

FOCUS OF THE HEARING:

      
    The Subcommittee will review current tax law to identify the impact 
of complexity, along with a number of proposals to simplify the tax 
code.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Any person or organization wishing to submit a written statement 
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch 
diskette in WordPerfect 5.1 format, with their name, address, and 
hearing date noted on a label, by the close of business, Tuesday, June 
8, 1999, to A.L. Singleton, Chief of Staff, Committee on Ways and 
Means, U.S. House of Representatives, 1102 Longworth House Office 
Building, Washington, D.C. 20515. If those filing written statements 
wish to have their statements distributed to the press and interested 
public at the hearing, they may deliver 200 additional copies for this 
purpose to the Subcommittee on Oversight office, room 1136 Longworth 
House Office Building, by close of business the day before the hearing.
      

FORMATTING REQUIREMENTS:

      
    Each statement presented for printing to the Committee by a 
witness, any written statement or exhibit submitted for the printed 
record or any written comments in response to a request for written 
comments must conform to the guidelines listed below. Any statement or 
exhibit not in compliance with these guidelines will not be printed, 
but will be maintained in the Committee files for review and use by the 
Committee.
      
    1. All statements and any accompanying exhibits for printing must 
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect 5.1 
format, typed in single space and may not exceed a total of 10 pages 
including attachments. Witnesses are advised that the Committee will 
rely on electronic submissions for printing the official hearing 
record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. A witness appearing at a public hearing, or submitting a 
statement for the record of a public hearing, or submitting written 
comments in response to a published request for comments by the 
Committee, must include on his statement or submission a list of all 
clients, persons, or organizations on whose behalf the witness appears.
      
    4. A supplemental sheet must accompany each statement listing the 
name, company, address, telephone and fax numbers where the witness or 
the designated representative may be reached. This supplemental sheet 
will not be included in the printed record.
      
    The above restrictions and limitations apply only to material being 
submitted for printing. Statements and exhibits or supplementary 
material submitted solely for distribution to the Members, the press, 
and the public during the course of a public hearing may be submitted 
in other forms.
      

    Note: All Committee advisories and news releases are available on 
the World Wide Web at `HTTP://WWW.HOUSE.GOV/WAYS__MEANS/'.
      

    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four 
business days notice is requested). Questions with regard to special 
accommodation needs in general (including availability of Committee 
materials in alternative formats) may be directed to the Committee as 
noted above.

                                

    Chairman Houghton [presiding]. Ladies and gentlemen, I 
think we will begin the hearing if we could.
    Val, it is nice to have you here.
    I would like to make a statement, and then I know Mr. Neal 
would like to make one and then Mr. Coyne would also.
    Anyway, Mr. Albert Einstein once remarked, ``the hardest 
thing in the world to understand is the income tax.'' And in 
trying to prepare his own return, he said, ``This is too 
difficult for a mathematician. It takes a philosopher.'' So 
these troubling words were spoken long before the enactment of 
what is named the individual Alternative Minimum Tax. The AMT 
is computed on Form 6251. And it is a baffling calculation of 
adjustments and preferences.
    They were also spoken long before the notorious Schedule D, 
which you have here. This schedule is used to calculate capital 
gains and losses, a form which is 2 pages and 54 lines long. 
According to the IRS, it takes an average of 6 hours and 41 
minutes to fill out schedule D. It is required even if a 
taxpayer receives as little as $10 in capital gains income from 
a mutual fund.
    The whole process began many years ago with a simple 
constitutional amendment. And it consisted of 32 words and here 
they are: ``The Congress shall have the power to lay and 
collect taxes on incomes, from whatever source derived, without 
apportionment among the several States, and without regard to 
any census or enumeration.'' Incidentally, the Revenue Act of 
1913, which enacted the income tax, was 15 pages long.
    Now, here is a copy of the Internal Revenue Code and it is 
printed on very, very thin paper. It covers over 2,300 pages 
and the regulations springing from this particular code fill, 
obviously, many volumes. The court cases--I am told--would fill 
a whole library.
    As we all know, our tax system is unique. It relies on 
voluntary compliance with our tax laws. Now they must be 
intelligible. No one should have to skip a day of work to 
complete any tax form, nor should 56 percent of taxpayers have 
to pay someone else to complete their returns.
    Two of my Subcommittee Colleagues, Mr. Coyne and Mr. Neal, 
have introduced bills to help simplify the Tax Code. Mr. 
Portman, sitting on my right, has introduced a bill to simplify 
the pension provisions of tax law. He also helped bring about 
enactment last year of key changes in the way we consider tax 
legislation in order to help reduce complexity. Today, I will 
be introducing a tax simplification bill as well.
    Now, we have a great deal of talent and many good ideas 
springing from this Subcommittee and its staff. Today's 
witnesses have some important thoughts to share with us as 
well. But before calling on the first witness, I would like to 
yield to our Ranking Democrat, Mr. Neal, for his opening 
statement.
    Mr. Neal. Thank you, Mr. Chairman. I have a brief opening 
statement. I want to thank you for holding this hearing to 
address some of the complexities of the Federal Income Tax 
Code, especially for individual taxpayers. And I certainly want 
to compliment you on the bill you are introducing that contains 
a series of proposals to make life easier for average 
taxpayers. I also want to note the key role of Mr. Coyne, our 
Ranking Member, in efforts to change and to simplify the 
current method of taxing capital gains. His is a common sense 
approach that I hope we can all share in the appropriate 
moment.
    As you know, my bill, H.R. 1420, eliminates about 200 lines 
from individual tax forms, work sheets, and schedules. It does 
this in essentially a revenue-neutral manner and without moving 
money between economic income groups. Other members have other 
ideas about simplification, such as Mr. Hulshof's SAVE Act. Mr. 
Chairman, this hearing can be an important step forward in the 
effort to reform the Federal income tax by raising simplicity 
to a competing value with all the other things we want to 
accomplish.
    The income tax code will always be complex because we live 
in a complex society with a complex economy. To achieve 
fairness, our Tax Code must mirror that economic reality. But 
for those who do not engage in complex transactions, who have, 
indeed, a simple economic life, then the Tax Code should also 
mirror that reality.
    In this instance, fairness means simplicity and, to that 
end, a taxpayer should not have to fill out dozens of lines 
simply because they received a small capital gains 
distribution. Nor should a taxpayer have to worry about 
alternative minimum tax because they want to take the child 
care credit or the education credits. Nor should those credits 
be cut back after we have promised them to the American people. 
Lifting at least these two burdens would go a long way toward 
helping taxpayers.
    But that is just the least that we can do. We can also 
accomplish by direct means that which we are now accomplishing 
by indirect means. I think of the phaseouts of the personal 
exemption and itemized deductions as examples of needless 
paperwork. But how to jump start this process of simplification 
is a question that I am struggling with and certainly would 
welcome suggestions from other members of this panel. That is 
the critical role that we play today: how to jump start this 
process.
    Simplification is like the weather, everybody talks about 
it, but nobody does anything. To put it in this context, 
simplification is an idea that everybody supports and, during 
normal times, is low enough on everyone's list so that it never 
quite gets done. I have concluded that it will be all but 
impossible to find the revenue by the means we normally apply 
to offset the cost of significant simplification. While the 
budget surplus is coming, it seems to have already been spent 
two or three times on ideas of differing merit, but which have 
significant political support behind them.
    We could develop a series of small revenue raisers and 
dedicate the revenue to tax simplification. But the CQ Daily 
Monitor laid that notion to rest yesterday by pointing out that 
the tax and trade bills that are currently moving all use many 
of the same offsets to fund different bills. A simplification 
package is bound to lose out in such a game.
    Again, I have concluded that the only realistic chance a 
major simplification bill has of being enacted is to be 
revenue-neutral as a free-standing proposal. That is why my 
bill is essentially revenue-neutral and, in fact, all three 
titles to the bill are revenue-neutral in and of themselves. I 
have also come to the conclusion that simplification cannot 
move money between economic income groups because that may be 
seen as a back-door way of advancing the agenda of one 
political party or the other. That is why my bill upholds the 
principle that those who benefit from simplification ought to 
pay for it to keep the focus purely on simplification.
    I, for one, seriously doubt that a major tax cut is going 
to make it into law this year. But if it does, a major 
simplification title would fit nicely into that package. But if 
it doesn't, a major simplification package might be even more 
attractive because it would be a real accomplishment in an era 
of diminishing accomplishments for both parties.
    In conclusion, Mr. Chairman, I hope this hearing will 
produce a number of technical suggestions to improve our 
efforts to date, but I also hope today is the first step toward 
bringing some well-
deserved simplification to the American people. And I would 
close on a note that I offer in the middle of my statement, and 
that is I think the broader question for all of us today is how 
do we jump start this process.
    Chairman Houghton. Thanks very much, Mr. Neal. Mr. Coyne.
    Mr. Coyne. Thank you, Mr. Chairman. I apologize for being 
late. I knew, however, that the minority party's position was 
going to be strongly upheld by the very distinguished gentleman 
from Massachusetts. So, with that, I would like to just submit 
my statement for the record.
    [The prepared statement follows:]

Statement of Hon. William J. Coyne, a Representative in Congress from 
the 
State of Pennsylvania

    Mr. Chairman, I want to thank you for holding today's hearing on a 
topic that is a source of concern for millions of Americans--
simplification of our tax laws.
    At nearly 2300 pages, with hundreds of forms and publications, the 
Federal Tax Code confuses and intimidates most Americans. They fear the 
consequences of making a mistake and dread the prospect of spending 
hours or days preparing their returns.
    The debate on fundamental tax reform appears to be one which will 
continue indefinitely. Therefore, we must proceed to simplify the Tax 
Code wherever and whenever we can. We should start with the provisions 
which affect the greatest number of individual taxpayers and which are 
unnecessarily complex.
    There are several proposals that the Subcommittee will hear about 
today. These are proposals that have bi-partisan support in the 
Congress and great appeal to the taxpaying public.
    I have introduced H.R. 1407, the Capital Gains Tax Simplification 
Act of 1999. This bill would simplify capital gains calculations for 
all taxpayers and provide a modest capital gains tax reduction for 
most. I have attached for the record a copy of my recent ``Dear 
Colleague'' on H.R. 1407, as well as a copy of the current Schedule D, 
a tax form which millions of taxpayers would no longer need to fill out 
under my bill.
    Importantly, H.R. 1407 would be revenue neutral. Simplification 
proposals which cost millions or billions in lost revenues are 
politically attractive. However, given the fiscal constraints facing 
this Congress, it is doubly important that simplification proposals 
have small--or even better--positive fiscal impacts.
    I also support Congressman Neal's simplification bill, H.R. 1420, 
the Individual Tax Simplification Act of 1999. This bill incorporates 
capital gains simplification and significant alternative minimum tax 
relief, along with other reforms.
    I understand that you, Mr. Chairman, are introducing tax 
simplification legislation, and I look forward to working with you and 
the other Members of the Subcommittee to make tax simplification a 
reality.
    Today's hearing will provide an excellent forum for discussing 
individual and small business tax simplification proposals. I thank 
each of the witnesses for participating in this hearing.

                                

                              Congress of the United States
                                    Washington, DC, April 15, 1999.

Re: Capital Gains Tax Simplification

    Dear Colleague:

    As you know, the 1997 Taxpayer Relief Act has resulted in a 
significant increase in complexity for ordinary taxpayers with capital 
gains. We urge you to become a cosponsor of H.R. 1407, the Capital 
Gains Tax Simplification Act of 1999, which would simplify the 
calculation of the individual capital gains tax.
    The current capital gains tax schedule and the underlying rules for 
taxation of capital gains are unnecessarily complex, as illustrated by 
the attached 1998 Schedule D, Capital Gains and Losses. The IRS 
estimates that these provisions will force taxpayers (with more than 
four sales) to spend, on average, more than 6 hours and 41 minutes 
filling out these forms (over 3 hours more than in 1994). 
Unfortunately, the problem will only get worse in the coming years as 
two additional tax rate categories established by the Taxpayer Relief 
Act of 1997 take effect in tax years 2001 and 2006. In addition, 
increasingly large numbers of taxpayers will have to fill out this 
complex schedule twice--once for the regular tax and once for the 
alternative minimum tax.
    The complexity of the current law may fall hardest on mutual fund 
investors, many of whom are low- and middle-income taxpayers, because 
they now are required in all cases to fill out Schedule D to report 
capital gain distributions from their mutual fund. It has been 
estimated that nearly half of all U.S. households now own mutual funds. 
Under H.R. 1407, taxpayers whose only capital gains come from mutual 
funds would not have to fill out even a simplified capital gains 
schedule. They would simply total up their capital gains distributions, 
figure out what 62 percent of that total would be, and then write that 
amount on the appropriate line of their tax return form.
    Some have also asserted that the current law's complexity was due 
to the previous 18-month holding period requirement (repealed by the 
IRS Restructuring and Reform Act). That is not correct. The repeal of 
the 18-month holding period requirement did not eliminate one line of 
Schedule D since the various capital gains tax rates will remain.
    The bill that we have introduced would substitute a simple 38-
percent capital gains exclusion for the confusing array of five capital 
gains tax rates provided in the 1997 Act. It also would permit 
individuals selling real estate to receive the full benefit of the 
capital gains tax reduction. We have not received a revenue estimate 
for H.R. 1407 yet, but the Joint Committee on Taxation determined that 
an identical bill last year would have raised $600 million over a 10-
year period.
    H.R. 1407 would simplify the computation of capital gains taxes for 
all individual taxpayers. In addition, more than 98 percent of 
individual taxpayers would be eligible for modest capital gains tax 
reductions. Many of the remaining 2 percent of taxpayers could also 
receive modest tax reductions under this bill. The following chart 
shows the impact of this legislation on capital gains tax rates.

----------------------------------------------------------------------------------------------------------------
                                                            Rate Under Current Law                  Rate Under
------------------------------------------------------------------------------------------------     Proposed
                                                                                                   Legislation
                                                                                                ----------------
                                                Assets Held                                        All Capital
                                                More than 12     Real Estate      Collectibles    Assets (Other
 Rate Bracket  (No. of Taxpayers in Bracket)   Months and Not    Depreciation    Held At Least         Than
                                              Collectibles or   Recapture Gain     12 Months      Collectibles)
                                               Recapture Gain                                     Held More Than
                                                                                                    12 Months
----------------------------------------------------------------------------------------------------------------
15 percent (61.58 million)..................              10               15               15              9.3
28 percent (24.0 million)...................              20               25               28            17.36
31 percent (2.3 million)....................              20               25               28            19.22
36 percent (1.0 million)....................              20               25               28            22.32
39.6 percent (0.5 million)..................              20               25               28            24.55
----------------------------------------------------------------------------------------------------------------

    If you have any questions about this legislation or if you desire 
to be a cosponsor, please feel free to contact Matt Dinkel at extension 
5-2301.
            Sincerely,
                                           Robert T. Matsui
                                                Member of Congress.

                                           William J. Coyne
                                                Member of Congress.
[GRAPHIC] [TIFF OMITTED] T7314.001

[GRAPHIC] [TIFF OMITTED] T7314.002

                                

    Chairman Houghton. Thank you very much. Mr. Portman.
    Mr. Portman. Mr. Chairman, I will be brief. I just want to 
congratulate you for shining the light on the issue of 
complexity. We have spent a year with the IRS Commission 
looking at the inner workings of the IRS and figuring out how 
to change the mission of the IRS, which was discussed at length 
by Commissioner Rossotti this morning. But at the end of the 
day, there was a consensus among all commissioners, and it was 
actually a consensus that was formulated in terms of specific 
recommendations, that we needed to simplify the Tax Code if the 
IRS is truly going to be the kind of taxpayer service 
organization that we all hoped for. So this does not just 
affect the taxpayer, Mr. Chairman, as you know, it affects the 
administration of taxes and I commend you for your proposal 
today and for holding a hearing today.
    The pension reforms are also another example where we can 
move forward with regard to simplification and almost everyone 
on this Subcommittee is now working toward that goal on the 
legislation and I think this is, indeed, a good first step. 
Short of fundamental tax reform, we need to figure out ways to 
get under the hood as another great philosopher, not Einstein, 
said at one point. Get under the hood and figure out how to 
change aspects of our Tax Code to make it simpler for both the 
taxpayer and the tax administration. I commend you for having 
the hearing.
    Chairman Houghton. Who was that? Henry Ford.
    Mr. Portman. H. Ross Perot. [Laughter.]
    Chairman Houghton. Thanks, Mr. Portman. Mrs. Dunn.
    Ms. Dunn. Mr. Chairman, thank you very much. I applaud you 
for holding this hearing. As I go home to my districts and 
speak to the people I represent in town hall meetings or in 
other meetings, they ask first and foremost that we do 
something to effectively simplify the Tax Code. Those of us who 
believe in tax relief would really like the first step of that 
to be tax simplification. And so I think the fact that you are 
holding this hearing today and that we are hearing from 
organizations that have to deal with the complicated Tax Code 
and also from our very able new taxpayer advocate, that speaks 
very well of your oversight capabilities and I think we are 
going to do a lot in this hearing. Thank you.
    Chairman Houghton. Thanks, Ms. Dunn. Mr. Watkins.
    Mr. Watkins. Thank you, Mr. Chairman, again, for your work 
and the Committee's work. And I still have got a couple of 
comments. One about the national taxpayer advocate. I utilized 
their assistance a couple of different times and they have been 
a great help in getting focused on a problem that was hard for 
our office to be able to get that done and that has been a 
great help.
    Second, I guess about the overall tax, I think all of us 
would like to have, you know, tax simplification, but I have 
always felt like our national priority should dictate our tax 
policy. And, you know, is a domestic food basket important for 
this country? And, if we do, we have got to have the incentives 
to produce in this country a domestic food basket. Is a 
domestic oil supply important to the national security of this 
country? If it is, then we have got to have the type of 
incentives that let us produce the energy and the oil 
production for this country in order to have that.
    So as we look at trying to say how we simplify, there are 
certain things that we have got to have incentives to produce, 
so I am one who feels that very strongly that we have got to 
have those kind of economic impacts if we are going to have a 
future we want here in this country and, especially, in that 
global competitive world.
    Chairman Houghton. Thank you, Mr. Watkins.
    Now, I would like to call our first witness, the Honorable 
W. Val Oveson, Taxpayer Advocate. Val, again, great to have you 
here.

    STATEMENT OF W. VAL OVESON, NATIONAL TAXPAYER ADVOCATE, 
                    INTERNAL REVENUE SERVICE

    Mr. Oveson. Thank you very much, Mr. Chairman and 
distinguished Members of the Subcommittee. I am pleased to be 
with you once again and very pleased to be addressing this very 
critical, important topic of simplification and, on the 
converse side, complexity of the Tax Code.
    Complexity, in my opinion, is the No. 1 problem facing the 
American taxpayer and the tax administrators in the Government 
in general. It is not just one-sided. All of us are dealing 
with this complexity problem.
    I use several factors as my basis for saying that it is the 
No. 1 problem--it popped up in my annual report this year, as I 
testified earlier this year to you and had done in that report 
for the 2 years running that had been presented to you. 
Analyzing the cases that come up from the field is one of the 
sources of identification that complexity is the No. 1 problem. 
Actually, the casework that we deal with, as well as surveys of 
taxpayers, tax practitioners, and small business groups that we 
conducted over the last year and a half, also tell us that it 
is a No. 1 problem. Surveys of our own taxpayer advocates in 
the field and their feelings of the work that they have 
conducted also identify it as the No. 1 problem.
    As is written in my testimony, which I have submitted for 
the record, my opinion is that the following three issues are 
the most critical components of this complexity that, if you 
want to address, you need to solve. No. 1 is the frequency and 
the number of tax law changes. No. 2 is targeted tax relief for 
groups of taxpayers, including income phaseouts on deductions. 
And No. 3 is the alternative minimum tax.
    Now let me go briefly into these areas. In the last 10 
years, there have been 6,500 changes in the tax law in 61 
bills. In the last 2 years alone, there have been approximately 
1,260 changes of individual code sections. It is difficult for 
taxpayers to understand why the law changes so much and for 
them to assimilate it and to understand why; it is hard for 
them to deal with it.
    Programming changes into the brittle computer system at the 
IRS is extremely expensive and fraught with risks in getting it 
right. The magnitude of the changes makes it hard to convey the 
changes to the taxpayer in forms and publications and the 
communications effort gets more and more difficult every day at 
the IRS. And it is difficult to train employees and the service 
level suffers. And I might add training the private sector, not 
only the taxpayers, but tax practitioners is also a major, 
major problem. For those reasons, again, the frequency and 
number of tax law changes, I rate as No. 1.
    Second is targeted relief for groups of taxpayers, 
including income phaseouts. These would be items such as the 
child care credit, the adoption credit, educational credits 
that are on top of other credits that are very similar. There 
are different qualifications for each of these credits. There 
are definitions that sound similar but they are really not and 
they are different among the credits, making it more 
complicated and difficult to sort through them. And then the 
income phaseouts are different and complicated in each of these 
areas.
    I want you to know and understand that I am not commenting 
on the merits of the policy issues surrounding these issues. 
You need to sort through those policy issues. What I am telling 
you is that these are the areas that, in my opinion, are 
creating complication in the tax law.
    Third is the alternative minimum tax. Again, you are well 
familiar with this issue of requiring taxpayers to actually 
compute their tax under two separate systems and to evaluate 
the two against each other. It is not indexed. AMT is affecting 
more and more people every day as more credits in the system 
come into play.
    In conclusion, don't change the laws so much. If you are 
going to change the laws, make sure that they are actually less 
complex and not more complex. Thank you very much.
    [The prepared statement follows:]

Statement of W. Val Oveson, National Taxpayer Advocate, 
Internal Revenue Service

    Mr. Chairman and Distinguished Members of the Subcommittee: I am 
pleased to appear before this Subcommittee to address the subject of 
the complexity of the tax law. As you know, my role is to be the voice 
of the taxpayer and the advocate of a more equitable and balanced 
approach to tax administration. As my FY 1998 Annual Report to Congress 
describes, complexity of the tax laws is the number one problem facing 
taxpayers. This conclusion is supported by those groups directly 
impacted by such complexity--individual and small business taxpayers, 
tax practitioners and professional associations and IRS Field Taxpayer 
Advocates. I take great hope in the fact that Congress, by inviting the 
panelists you will have before you today for hearings like this, is 
acknowledging the problems complexity is causing and is prepared to 
help America's taxpayers. I am here today to lend my hand in easing 
that burden.

             I. Frequency and Number of Changes to Tax Law

    As I just suggested, I believe that Congress is serious about 
wanting to reduce the complexity of the tax laws. Section 4022 of RRA 
98, which calls for complexity studies to be conducted by the IRS and 
the Joint Committee on Taxation, is a good place to start. As I 
mentioned last month before the Senate Finance Committee, I am 
confident that the two studies the law mandates will identify for the 
Congress and Federal tax administrators specific sources of complexity. 
The Commissioner's study will provide you empirical data on how 
existing law affects taxpayers and a window into how the tax laws you 
pass get translated into what the public experiences. I continue to be 
optimistic that you can use the information to reduce existing 
complexity. The study by the Joint Committee on Taxation will estimate 
the ``complexity factor'' of legislation and what that means to 
taxpayers. I hope that you can use that information to affect what I 
believe to be the single most complicating factor in tax 
administration--the frequency and number of changes to the tax laws.
    In 1986, Congress drastically changed the tax laws by enacting the 
Tax Reform Act (TRA 86). The goal of TRA 86 was to create a simpler, 
fairer and more efficient tax system. In TRA 86, Congress made 
approximately 1850 separate amendments to the Internal Revenue Code. It 
reduced the number of tax brackets, modified the standard deduction and 
made many other changes that greatly reduced complexity.
    Since TRA 86 and ending in 1998, Congress made approximately 6,500 
changes to Title 26 in 61 different pieces of legislation. In fact, the 
Taxpayer Relief Act of 1997 and RRA 98 alone made 1,260 changes to the 
tax code. The magnitude of the changes made by those two pieces of 
legislation resulted in revisions of at least 100 separate IRS forms.
    This translates into additional burden for taxpayers in several 
significant ways. First, it is difficult for taxpayers to understand 
why the law changes so much. As Ben Franklin said, ``Nothing is certain 
but death and taxes.'' Taxpayers may not necessarily like the certainty 
of paying taxes, but certainty and familiarity at least lead to an 
understanding of expectations. An uncertain tax system leads to 
cynicism and unintentional noncompliance. Second, programming the 
changes into brittle computer systems is expensive and fraught with 
risks. Third, the magnitude of the changes, particularly recently, 
makes it hard for the IRS to convey those changes most effectively to 
taxpayers. The nature of changes can be difficult for the IRS to 
explain simply enough in forms, instructions and publications for 
taxpayers. The frequency of the changes means that IRS publishes 
guidance reacting largely to the most pressing issues, such as those 
for the next filing season, resulting in fewer resources to address 
longer standing questions. Finally, such frequent changes make it 
difficult for the IRS to adequately train its employees, which inhibits 
the service IRS employees can provide to taxpayers. Every taxpayer has 
a right to expect that, in every encounter with an IRS employee, 
whether it is a phone call asking a question about how to fill out a 
return or a meeting with a revenue agent in an audit, the employee 
understands the current tax laws and has the skills to apply the laws 
to the facts and circumstances of that taxpayer. When our employees do 
not understand the complex and frequent changes to the laws, we cannot 
explain the laws to the taxpayer. Failing to understand the law results 
in frustration on both ends.
    For example, TRA 97 changed the law regarding capital gains. It 
lowered the rates, but it provided different brackets based on the type 
of property and the length of the holding period. There are 10 percent, 
20 percent, 25 percent and 28 percent brackets. It resulted in the IRS 
completely overhauling Schedule D and in a marked increase in the 
amount of time and information required to complete that schedule. As a 
matter of fact, the burden estimate for the 1998 Schedule D is 6 hours 
and 41 minutes. These changes also resulted in a great deal of 
frustration for taxpayers who had difficulty calculating their capital 
gains and could not get through when calling the IRS for help. What 
could make things even more confusing is that this will become even 
more complicated in the relatively near future. A new 8 percent rate 
becomes effective in 2001 for capital gains on assets held longer than 
five years, that otherwise would have been subject to the 10 percent 
rate. Also in 2001, yet another rate--18 percent--will apply to capital 
gains otherwise subject to the current 20 percent rate with respect to 
assets held longer than five years.
    Cumulatively, the changes over the last 13 years, but particularly 
TRA 97 and RRA 98, have greatly increased complexity. In conjunction 
with the complexity studies, I hope that you will simplify the tax 
code. If not, then I suggest that you can alleviate the burden of 
complexity on taxpayers, practitioners and tax administrators, as well 
as our tax system, by not changing the tax laws so frequently.

              II. Targeted Relief for Groups of Taxpayers

    Frequency and number of changes to the laws are obviously not the 
only causes of complexity in the tax code. I believe that targeted 
relief or incentives for groups of taxpayers significantly adds to the 
complexity of the tax law and the difficulty these taxpayers have in 
understanding and complying with the law. As I did before the Senate 
Finance Committee, I would like to take a moment to point out that I am 
not commenting on the merits of the policy reasons for targeted relief. 
Those in a position to make policy decisions may conclude that a 
certain subsidy is best or most simply delivered through the tax code. 
My goal here, like the RRA 98 studies, is to point out where the laws 
cause problems for taxpayers.
    Recently, the Administration and Congress enacted into law many 
credits to help families, such as the child tax credit, the adoption 
credit and the education credits. These are in addition to the already-
existing credits such as the child and dependent care credit, the 
credit for the elderly and the earned income tax credit. While these 
credits have resulted in lower taxes for taxpayers, they have also 
increased the complications these same taxpayers experience. Some of 
these credits sound like they involve similar concepts, but the tax law 
has defined them differently. For example, the definition of a 
``qualifying child'' or ``qualifying individual,'' used to determine 
eligibility to claim the child and dependent care tax credit, the child 
tax credit and the earned income tax credit, is different in each case. 
So, taxpayers who sit down to prepare their returns must fill out 
different worksheets or schedules and look to different instructions 
each time they claim similar sounding credits to determine which 
definition applies and whether their circumstances meet the 
requirements in every situation.
    Further, the interaction of these targeted provisions, with each 
other and with those currently existing, creates a great deal of 
complexity. The credits mentioned above must be claimed in a specific 
order. In addition, the child tax credit, adoption credit, the 
education credits and the earned income tax credit are each subject to 
different income phase outs. These phase outs are equivalent to 
marginal rate increases and require a taxpayer to perform additional 
calculations on a separate worksheet, rather than simply entering a 
standard credit amount on a tax form. The combination of these credits, 
along with exemptions and deductions, can also cause unintended 
consequences for taxpayers if they become subject to the Alternative 
Minimum Tax (AMT).
    I am not suggesting that we should or should not employ targeted 
relief or incentives. Rather, I am advising you that certain 
legislation increases the complexity of the tax laws and the burden on 
taxpayers and the system. You must weigh the desire for simplicity 
against the policy reasons for the legislation. Going forward, you can 
help to reduce complexity by harmonizing the provisions to the extent 
possible. In this way, you can take steps to minimize the burden 
taxpayers experience in taking advantage of relief they expect from the 
laws that you passed.

                           III. Other Issues

    I am certain that the other panels today will discuss some very 
specific areas in which you can reduce complexity and proposals to 
accomplish that result. I would like to take this opportunity to 
mention very briefly a couple of places in the tax code that could 
benefit from your attention.
    Based on several articles this past filing season, I think the AMT 
is probably one of the most discussed and least understood areas in the 
tax code with good reason for both. Taxpayers that Congress never 
intended to subject to the AMT are and will increasingly be required to 
calculate the AMT. That means having to calculate taxes twice, once 
under the standard rules and once under the AMT rules, which requires 
taxpayers to understand the basics of the two regimes. Considering that 
taxpayers can be intimidated by preparing their returns under the one, 
more common, set of rules, I cannot imagine that subjecting more of 
them to the AMT will increase their comfort or compliance level.
    I also believe that the penalty and interest regimes are 
unnecessarily complex and, as a result, misunderstood by taxpayers. 
With regard to the complexity of the regimes, I hope that the RRA 98 
studies will provide you an important tool in improving interest and 
penalty administration. With regard to taxpayers' understanding of the 
interest provisions, I think the RRA 98 provision requiring the IRS, 
beginning in 2001, to provide taxpayers with interest computations and 
Internal Revenue Code citations imposing the interest will help 
taxpayers better comprehend their tax situations.

                               Conclusion

    Mr. Chairman, it is important that we continue to discuss our tax 
laws and the effect of our laws on taxpayers. It is my hope that you 
will carry through the difficult task of reducing complexity. If not, I 
recommend that you not add to the complexity and slow down the 
frequency of change to the tax laws.

                                

    Chairman Houghton. Thank you, Mr. Oveson. I would like to 
ask one question, and then I will turn it over to the rest of 
the members of the panel. You know, we constantly get tripped 
up on who does what. I have said this to Mr. Rosotti at times. 
Why don't you do this? Why don't you do that? And he said, 
``Well, that is a policy issue; it is not mine.'' I am trying 
to work out the mechanics and the structure of the IRS. But, I 
just wonder whether the Internal Revenue Service, just taking 
this meeting as a key, couldn't do an awful lot through the 
administrative function, rather than waiting for the change in 
the law.
    Mr. Oveson. Well, first of all, there are many things that 
the IRS can do and many of those things are being addressed. 
But none of that can compensate for the tax law that you 
described, Mr. Chairman, in your opening remarks. It is 
essential if we are going to get simplification, that we get 
true simplification in the code.
    But there are things that the IRS can do and let me mention 
a couple. Forms and publications. Again, we need to make those 
as simple and as clear in plain English as possible and a 
project has been underway for some time to do that. By the way, 
the issue popping up as about the third or fourth most serious 
problem is clarity of the forms and letters that go out to 
taxpayers. So there is a lot more that we can do with forms and 
letters and publications.
    With customer service, there is a lot that we have done 
and, interestingly, have we gone too far with customer service? 
I think not, but there are those that would say that we have. 
But, certainly in the customer service area, there is more that 
we can do to help people, taxpayers, negotiate the tax system. 
So, yes, there is more that needs to be done, but we really 
need your help in simplifying the code to make that really 
meaningful.
    Chairman Houghton. I will ask you a question. You don't 
have to answer this if it is too sensitive for you, but I want 
to ask it anyway. Prior to the State of the Union, does the 
President ever ask the Internal Revenue Service to come in? 
When he talked about the 28 tax credits that he had, did he 
ever say to you, you know, I would like to do this and I think 
it is going to reduce--or is this something that is really 
handled at the Treasury level?
    Mr. Oveson. I don't know. He didn't ever ask me and I have 
no knowledge of whether he asked the Commissioner or others at 
the IRS.
    Chairman Houghton. All right. Thanks. Mr. Coyne.
    Mr. Coyne. Thank you, Mr. Chairman. Mr. Oveson, with the 
tax laws getting more complicated with each year that passes 
by, what comments do you have about the Taxpayer Relief Act of 
1997 now that we have had a year or so of experience with it?
    Mr. Oveson. Again, I have commented in my testimony and I 
would comment again that the targeted credits are a 
complicating factor in the code. Again, the policy decisions of 
why you do credits of that type versus something else is 
something you need to work out in the policy side of the 
business between you and the Treasury and the White House. But 
it complicates the code.
    Mr. Coyne. Is that the only offering that you could give 
from that particular Act?
    Mr. Oveson. I think that is pretty strong, actually. There 
were approximately 1,260 changes between the 2 years. There 
were just a lot of changes and a lot of complications and we 
hear that through the casework. We hear it through 
practitioners and then the other work that we do in the field.
    Mr. Coyne. What complexity problems has the current tax 
return season yielded that you would be concerned about? The 
one that just has passed, for individual taxpayers?
    Mr. Oveson. The biggest complication I see from this past 
tax season is the sheer size and momentum of the changes of the 
bill that passed last summer. Again, much of that bill--I would 
say most of that bill--was taxpayer friendly and provided 
additional rights to taxpayers. Since you would have to say 
that was good, I would say it was good. I think it was a great 
piece of legislation. But you can't escape the fact that there 
was a lot of change and a lot to assimilate, certainly within 
the IRS. We are reeling and struggling to train employees, to 
change the systems, and to get all of the features that were in 
that bill implemented and get them working. And I think the 
same would be true from the outside.
    Mr. Coyne. On the EITC issue, given the fact that both 
practitioners and taxpayers have had trouble calculating the 
earned income tax credit, do you have any recommendations in 
that area?
    Mr. Oveson. Yes. The report to Congress that I presented in 
December has about four suggestions on the EITC. The top two: 
One is really a refund offset issue that the earned income tax 
credit should not be subject to offset by other debts. In a 
hardship kind of basis, we see that issue come up a lot. The 
other one that we see on EITC is the top wage-earner issue 
where only the top wage-earner in a household can be eligible 
for the credit. And we recommended that that be changed. And we 
have also recommended that you change the definition of 
qualifying individual and make that consistent with the 
exemption. That causes a lot of confusion as people are trying 
to claim the credit and comply with the law.
    Mr. Coyne. Thank you.
    Chairman Houghton. Thanks, Mr. Coyne. Mr. Portman.
    Mr. Portman. Thanks, Mr. Chairman. Let me look back to the 
report language from the IRS Restructuring and Reform Act which 
just passed last summer, as you say. With regard to Mr. 
Houghton's earlier question to follow up on that, I think what 
Chairman Houghton was getting at is the sense that we want to 
have an independent view from the IRS on our process of 
developing tax legislation. And he took it a step further by 
saying, wouldn't it be great if the President actually 
consulted with his Internal Revenue Service before coming out 
with the Administration proposals, whether it was attractive 
new tax credits or other changes in the law that added 
complexity.
    And I guess all I can say is that, under this law, we made 
two requirements. One was that there be a new complexity 
analysis done by the Joint Tax Committee as legislation is 
considered by this Committee or by the Finance Committee. We 
are waiting this year to see how that is going to work. I know 
Joint Tax is hard at work on it. And I would hope that the IRS, 
as intended in the law, would work with the Joint Tax Committee 
in providing input to the Joint Tax Committee as to the burden 
on the system. But that is new and that is a complexity 
analysis that will bear fruit even next month and the month 
after as we get into tax writing with this Committee. There you 
have a role to play because you, I hope, will be givin input to 
the IRS, as taxpayer advocate, which then will go into the 
process.
    Second is that there is a new requirement, as you know, 
that the IRS send us, in addition to your report, an IRS report 
every year. And that report is regarding sources of complexity 
in the administration and the Federal tax laws. And then we 
would list all the factors and take them into account, 
including many of the things you take into account: frequently 
asked questions and so on. And there, again, I hope that you 
will provide input that you are getting.
    My point is that this new law we passed last summer is 
intended to reduce complexity prospectively. And it comes out 
of the commission's work of over a year's worth of effort 
looking at this and deciding that, if you are really going to 
have the tax laws work, you have got to reduce the complexity.
    There is also in the report language, though, this Sense of 
Congress that the IRS should provide the Congress--and I am 
reading the report language here--``with an independent view of 
tax administration.'' And I guess part of what my frustration 
has been in my short time here in the last 6 years is that we 
often get an administration position and we don't get an IRS 
position on tax complexity.
    And I would just pose the question to you, do you feel as 
though your input going into the system, whether it is to the 
IRS and then to the Joint Tax Committee or directly from the 
IRS to the Congress in terms of these two reports or in your 
report to us, do you feel as though you are able to give us an 
independent, unvarnished, apolitical, non-tax ideology or tax 
policy view as to administration? Do you feel comfortable 
giving us that input and do you feel as though you are giving 
adequate input?
    Mr. Oveson. To answer your question directly, yes I do. And 
the fact that I would be here today talking about the 
alternative minimum tax as directly as I am is, I think, a 
testament to that independence and to that directness.
    Mr. Portman. And talking about the EITC takes some courage 
also.
    Mr. Oveson. Yes.
    Mr. Portman. Although some of your suggestions would 
broaden the EITC in an area where we have already got a 
tremendous amount of mispayment and some would say fraud.
    Mr. Oveson. Thank you. One of my concerns with the EITC is 
that it is there. It is in the law. And we see taxpayers that 
would qualify that are being excluded from it. And that our 
position, as you have put into the statute, is to look at the 
taxpayers point of view with EITC and not, necessarily, from 
the compliance point of view.
    On the other issues, we do have the study internally within 
the IRS, on complexity and I will be a player. I will be on the 
Committee. I will be working with them and advising the group 
that is working on complexity within the IRS. I will be a 
contributor to it.
    With regard to the Joint Committee work, I look forward to 
the outcome of that work and, hopefully, it will be extremely 
valuable to you as you evaluate proposals against that 
complexity analysis. And I would be happy to help any way you 
or the Joint Committee would like.
    Mr. Portman. Thank you. Thank you, Val.
    Chairman Houghton. Thank you, Mr. Portman. Mr. Neal.
    Mr. Neal. Thank you, Mr. Chairman. In your written 
statement, you raised the question of AMT and you suggest that 
you can't imagine subjecting more and more taxpayers to the AMT 
will increase ``their comfort or compliance level.'' The most 
immediate problem is the nonrefundable credits and the AMT. 
Would you be willing to give us a better idea about your 
thoughts of what will happen to compliance and taxpayer 
frustration in general if we don't fix the problem with AMT and 
nonrefunable credits?
    Mr. Oveson. That is a bit speculative. The question asks 
for a speculative answer. My personal opinion is that, as the 
law gets more complex, people choose to drop out of the system, 
to not comply, because it is so complex, out of frustration or 
out of other kinds of feelings. And that it is not conducive to 
good tax compliance to have the law get more and more complex. 
And this alternative minimum tax, as you suggest, is an area 
that kind of creeps up and grabs people by the back of the neck 
and creates a lot of anger.
    Mr. Neal. Well, as you know, my legislation would collapse 
the three phaseout ranges for the adoption, education, and 
child credits into one phaseout range. Do you think that is a 
useful suggestion?
    Mr. Oveson. I have read your proposals and your bill, and, 
in general, the simplification that it would create, I think, 
would be great.
    Mr. Neal. Thank you. Thanks, Mr. Chairman.
    Chairman Houghton. Thanks, Mr. Neal. Mr. Watkins.
    Mr. Watkins. Thank you. The third line on your testimony, 
you basically said, you know, you see yourself as your role 
would be to be the voice of the taxpayer and the advocate of 
more equitable and balanced approach to tax administration. Do 
you see that more in policy or do you see that more dealing 
with the compliances that the taxpayers run into?
    Mr. Oveson. I see it more with the administration of the 
tax law and the day-to-day field work that we have got 
taxpayers out there working in every area of the country and 
every State----
    Mr. Watkins. I am glad to hear you say that because I think 
that is where many of us need help out there. As I said in my 
opening statement, I have turned to the taxpayer advocacy group 
a couple of times and they have been able to be on the ground 
and been able to intercede in working with giving some 
confidence in working with the IRS with some of the problems 
that they have had and I have felt like it was really a plus in 
that area. And I know we have a lot of changes, you know, as we 
go about looking at the tax policy and I know the great one we 
would like to have would be sort of simplified that one could 
probably do their own taxes. And I don't know that if we will 
ever see that.
    But, again, I have stated, you know, as I have tried to 
analyze it and reflect on it, I think our national priorities 
shouldn't dictate our tax priorities. And I don't know how we 
maintain certain positions economically around the world, 
especially in this competitive global economy we are in unless 
we have certain incentives in place.
    And that is like a national food basket for this country. 
Food is important and we need to have the kind of tax policies 
that make it feasible to do so. In the same way as we look at 
the national security and the need of energy, we have got to 
have tax incentives to produce the type of oil production that 
quantity and all that we need to have, especially when you see, 
if we analyze our national policy as we deal with Kosovo and 
all concerning oil embargoes and the other things that has 
turned against us, we are going to find that we are in a world 
of hurt, literally.
    So I think we have to look at our priorities and say, what 
are our incentives? What is necessary for us to have that 
national security and what do we have to have in the way of 
trying to secure the future for our children and our 
grandchildren? So I appreciate your being on the ground and 
your groups trying to help many of the families out there and 
individuals and small businesses that are running into 
complication. I think it is a great assistance. Thank you.
    Chairman Houghton. Thanks very much. Mr. Weller.
    Mr. Weller. Thank you, Mr. Chairman. And, Mr. Oveson, thank 
you for your testimony. And I am glad to see you here today. I 
represent the southside of Chicago and the south suburbs and 
whether I am at a union hall or the VFW or the local coffee 
shop or a grain elevator in some of the rural areas I 
represent, everyone complains about their taxes are too high, 
but they also complain about how they are too complicated, too 
unfair, they are frustrated that over half of them tell me they 
have to hire someone else to do their taxes. They are afraid of 
being audited if someone else doesn't fill out their tax forms.
    But they really focus on the unfairness of the Tax Code and 
the complexity of the Tax Code is part of the unfairness. But 
they are frustrated that the Tax Code unfairly treats married 
working couples. They are frustrated that the Tax Code unfairly 
treats family farms and family businesses because of the estate 
tax. They are frustrated that the alternative minimum tax is 
now goring middle-class working families. They are frustrated 
that senior citizens who want to work longer after the age of 
65 are stuck with the work penalty, the earnings limit, which 
confiscates much of their social security benefits. And the 
self-employed are also frustrated that the big corporations can 
deduct 100 percent of their health insurance premiums, but the 
little guys and the little gals that are self-employed can't.
    And Jennifer Dunn and I have put together a package of what 
we call tax simplification that addresses the unfairness in 
these areas as a solution, not only of lowering the tax burden, 
but also to address the complexity of the code by simplifying 
the unfair aspects of the code. And I would like to focus on a 
couple of these just to ask your perspective. Particularly the 
marrieds tax penalty which I consider to be the most unfair 
complication in the Tax Code which affects 21 million married 
working couples who pay an average of $1,400 more in higher 
taxes just because they are married.
    Do you consider, you know, the consequences of our Tax Code 
where our joint filers pay higher taxes, joint filers with an 
identical income pay higher taxes than two single filers, 
perhaps living together, with identical incomes--that married 
couple pays $1,400 more--do you consider that fair?
    Mr. Oveson. Boy, you put it to me so directly. The fairness 
issue of the marriage penalty, I think, cuts both ways and 
certainly there are some that get caught one way and some that 
get caught the other way and I think that is a policy issue 
that you need to grapple with. There are certainly some 
complexity issues related to the marriage penalty, but I don't 
think it is a clear-cut complexity issue.
    Mr. Weller. So you really feel that, for 21 million couples 
that pay $1,400 more, it is not really unfair that they do? 
Now, as a taxpayer advocate, I would think that you would want 
them treated more fairly.
    Mr. Oveson. If you fixed it in that direction, you are 
going to have a whole group of other taxpayers that are going 
to go the other direction, depending on how you fix that issue.
    Mr. Weller. Well, if you have a man and woman with 
identical incomes who are living together, have the same 
household income as a married couple, should the married couple 
pay more in taxes just because they are married?
    Mr. Oveson. And that is a policy issue that I am not going 
to comment on.
    Mr. Weller. All righty. Well, I certainly believe it is 
unfair and I know 21 million couples, 42 million people, who do 
and certainly feel our Tax Code should be marriage neutral so 
that you should not pay more just because you are married, 
under our Tax Code. And, you know, the CPAs were before us a 
year ago and we were talking about the marriage tax penalty in 
testimony and they pointed out that, you know, once you get 
beyond the marriage tax penalty, the big one that exists for 
joint filers, that there are 63 other marriage tax penalties. 
And most of them are the result of the so-called targeted tax 
cuts.
    Mr. Oveson. Yes.
    Mr. Weller. You know, where there is various means testing 
and so forth and the means testing is never double for joint 
filers what it is for single filers. Do you feel that it would 
help simplify the code if we eliminated those 63 different 
marriage penalties----
    Mr. Oveson. Yes.
    Mr. Weller [continuing]. So that joint filers would be able 
to earn twice as much as single filers?
    Mr. Oveson. Definitely.
    Mr. Weller. Well, how about for the larger marriage tax 
penalty for joint filers? Do you feel it would simplify the 
code if joint filers would be able to earn twice as much as a 
single filer with the same burden as two single filers?
    Mr. Oveson. Again, my concern with your question is that 
there are some tax policy elements to your question and to the 
issue. There are some simplification issues. And it is hard to 
separate those out. And, certainly, the deal with the phaseouts 
and the credits and the others would be extremely helpful in 
solving the complexity issue. Again, there are some tax policy 
questions implicit in all that I would prefer not to get into.
    Mr. Weller. Well, I would like to work with you. I think it 
is really wrong that under our Tax Code our society's most 
basic institution is punished by our Tax Code and I believe one 
of the best ways we can help families is to simplify the code 
by eliminating that unfair aspect called the marriage tax 
penalty. Thank you, Mr. Chairman.
    Chairman Houghton. Thank you very much. I would like to 
just ask a final question, unless other people have continued 
questions. These are not up-to-date figures, but a few years 
ago, we had a regional meeting of the Oversight Committee, when 
Mr. Pickle was chairman of it, and I think we figured at that 
time that it cost something like $400 billion for people to 
make out their taxes. I mean, it was that expensive.
    So, I look at your testimony here and you talk about the 
frequency and the number of the changes to the tax laws. 
Suppose we froze that for 1 year--had no changes. The same 
thing as far target relief for groups of taxpayers. There would 
be no credits, no exemptions, and no deduction changes at all. 
We would do the same thing as far as the alternative minimum 
tax is concerned. What sort of impact would this have on the 
country?
    I mean, you obviously wrote this thing and you have a sort 
of a composite view. Tell me how you feel about it.
    Mr. Oveson. I think in a large view of the situation, that 
it would be helpful to have a multi-year commitment not to 
change the Tax Code. You would have to forego some solutions: 
the marriage-tax penalty, the alternative minimum tax, other 
kinds of issues that you feel would help simplify the code. You 
would have to forego those. But the impact that that would have 
on the taxpayers themselves, certainly the impact that it would 
have within the IRS, particularly during these times when we 
are rebuilding and redoing the computer systems and having to, 
as Commissioner Rosotti explained earlier today and has said 
many times, redesign and rebuild the home while you are living 
in it; it is even worse when you talk about redesigning an 
airplane while you are flying it. While you are making these 
changes, it is extremely difficult and fraught with risk.
    So my suggestion, No. 1, less changes, less frequent 
changes to the Tax Code, was implying just what you suggested 
here, that there would be some tremendous benefits in freezing 
that for a period of time.
    Chairman Houghton. Well, I think that there are two 
categories--the internal and the external. Internal, obviously 
it helps the IRS, you know, in terms of the transition in using 
your new computer system and trying to get more electronic 
filing and things like that. But what does it do for the 
ordinary American? Suppose you did this, which you suggest, 
what would it do, in a year, if that happened?
    Mr. Oveson. I think the longer you do it, the more benefits 
there are. In a year, certainly all of the tax software vendors 
won't have to scramble to do that, although they may lose some 
market in terms of making the changes and selling them. But, 
from what I hear from practitioners and having been one in the 
past, there is just a lot of things you don't catch as you go 
through and it is difficult and you have got to go really 
scramble to learn the changes that go on. And there would be a 
benefit throughout the economy, throughout the taxpaying world 
to not having the level of changes that we have had recently.
    Chairman Houghton. OK. Mr. Coyne, have you got any 
questions?
    Mr. Coyne. No, Mr. Chairman.
    Chairman Houghton. And, Mr. Weller, have you got any other?
    Mr. Weller. No.
    Chairman Houghton. Well, Val, let me ask if you have some 
thoughts on this as a followup to your statement; you might 
want to send them along to us. You talk about this multi-year 
program. Some of the impacts it would have inside, specifically 
stating those things which you do for the ordinary taxpayer. I 
think it would be an interesting followup to this meeting if 
you could do that. And thank you. Thank you very much.
    Mr. Oveson. Thank you.
    Chairman Houghton. We certainly appreciate your not only 
being here, but also the wonderful work you are doing.
    All right. Now we have the tax practitioner panel. Mr. 
Gerard Sokolski, who is a CPA partner in a firm in the great 
city of Rochester, New York, and Stephen B. Smith, who is a 
general partner in a CPA firm in Columbia, Missouri. Would you 
please come to the stand. OK, good. Thank you.
    Gentlemen, how are you? Good to have you here.
    Mr. Sokolski, would you like to start with your testimony?

  STATEMENT OF P. GERARD SOKOLSKI, CPA, TAX PARTNER, MENGEL, 
METZGER, BARR & CO., LLP, ROCHESTER, NY; ON BEHALF OF NEW YORK 
         STATE SOCIETY OF CERTIFIED PUBLIC ACCOUNTANTS

    Mr. Sokolski. Certainly. Thank you. Good afternoon, Mr. 
Chairman, and Members of the Oversight Subcommittee. I am Gerry 
Sokolski, CPA, a tax partner with the regional upstate New York 
firm of Mengel, Metzger, Barr, and Company and, as of June 1, I 
will be president-elect of the New York State Society of CPAs. 
I am honored to testify before you today on tax simplification. 
My written testimony contains several points which I will not 
be able to address in the time allotted. I therefore 
respectfully request that my written testimony be admitted to 
the record.
    Let me first offer my opinion as to the chief causes of 
unnecessary complexity. If we face those causes, stare at them 
eyeball-to-eyeball, perhaps we can take some steps to eliminate 
unnecessary complexity in the future.
    Ladies and gentlemen, in the words of Pogo, ``I have met 
the enemy and they is us.'' By they, I mean taxpayers and tax 
advisers who obtain special provisions for their clients. They 
include legislative staff, many of whom are fresh out of school 
and have never worked out there in the real world. And, with 
utmost respect, they also means you. I know that you all have 
very busy schedules, but sometimes the tax laws look as though 
you haven't thought them through sufficiently. Perhaps it is 
unreasonable to expect legislators to understand their 
legislation in this complex society. Still a key element of tax 
law draftsmanship, going back to Adam Smith, is that tax law 
should be understandable.
    Now on to specifics. Recent changes to the IRA rules have 
made this area extremely complicated. The complexity results 
from many different phaseouts applicable to the IRAs. Not just 
IRA phaseouts need reform. In 1998, child credits, tuition tax 
credits, and education loan interest deductions dramatically 
highlighted the problem with the so-called middle income 
phaseouts. Who would have thought that a young married couple 
just out of school and making $37,500 each would not be able to 
deduct student loan interest because their combined income was 
too high? I suggest that you use a uniform phaseout schedule 
that kicks in at a higher income level if phaseout is necessary 
at all. This would make the tax system simpler, if not more 
palatable.
    Also needing reform are the minimum distribution rules from 
qualified retirement plans. The current rules were designed in 
the early 1960's. In the 1990's, they are hurting the working 
elderly and also widows. They feel they may need more money in 
their accounts later in their lives. Also the unisex tables 
used to compute minimum distributions discriminate against 
women because of their higher life expectancy.
    Capital gains rules are another area of unnecessary 
complexity. In 1996, the schedule D was a single page with 19 
lines. Taxpayers whose only capital gains came from mutual fund 
dividends reported their gains on the first page of form 1040 
and were excused from filing schedule D. No longer. After the 
1997 Taxpayer Relief Act, schedule D ballooned to 54 lines on 2 
pages.
    Now on to the AMT. The AMT is now taxing taxpayers whom it 
was never intended to affect. One of my colleagues faxed me a 
startling example. It involves a divorced mother of two who 
received $102,000 of alimony and had AGI of $108,000. She paid 
nearly $7,800 of additional tax due to AMT because $14,000 of 
mostly real estate taxes and $10,000 of home mortgage interest 
was not deductible for AMT purposes.
    This also highlights that AMT discriminates against 
taxpayers in high-tax States such as New York and California. 
Personally, I would like to see you repeal the AMT. But if you 
cannot, our written testimony suggests a number of reforms you 
should explore.
    Another area of unnecessary and unexpected complexity is 
the so-called kiddie tax. Often kiddie tax situations require 
the running and rerunning of a family's tax returns to arrive 
at the correct tax.
    I sincerely thank you for the opportunity to testify here 
today. It is an experience I will always cherish. Let me end by 
reminding you of one of Adam Smith's four maxims of taxation: 
Certainty. Specifically, Smith advised the tax which each 
individual is bound to pay ought to be certain and not 
arbitrary. The time of payment, the manner of payment, the 
quantity to be paid ought all to be clear and plain to the 
contributor and to every other person. If we regain that sense 
that taxes need to be clear and plain to every contributor, tax 
complexity will never be an issue. Thank you.
    [The prepared statement follows:]

Statement of P. Gerard Sokolski, CPA, Tax Partner Mengel, Metzger, Barr 
& Co., LLP, Rochester, New York; on Behalf of New York State Society of 
Certified Public Accountants

    Good afternoon, Mr. Chairman and distinguished members of the 
Oversight Subcommittee. I am P. Gerard Sokolski, CPA, a tax partner 
with the regional CPA firm of Mengel, Metzger, Barr & Co. LLP, which 
has four offices in upstate New York. Also, as of June 1, I will be the 
President-Elect of the New York State Society of Certified Public 
Accountants. The NYSSCPA represents more than 31,000 CPAs, who 
collectively serve literally millions of taxpayers, ranging from 
individuals and corner grocery stores to multinational 
megacorporations. My firm serves a variety of individual and small 
business clients in central and western New York State.
    I am honored to testify before you today to give you a 
practitioner's views on the complexity of the Internal Revenue Code and 
the hardships it imposes on individual taxpayers and small businesses. 
Although many areas are too complex and require simplification, I will 
limit my comments today to six issues:
      Tax-advantaged savings accounts,
     Phase-outs,
     Retirement plan distribution reform,
     Capital gains and the Schedule D,
     Alternative minimum tax, and
     The ``kiddie tax''.
    It is no wonder that Americans are burdened with an overly complex 
tax law. There have been significant tax-law changes in eight of the 
last 14 years--1986, 1987, 1988, 1989, 1990, 1993, 1996 and 1997. The 
1997 Taxpayer Relief Act alone contains
     36 retroactive changes,
     114 changes effective August 5, 1997,
     69 changes effective January 1, 1998, and five changes 
effective thereafter,
     285 new Code sections, and
     824 Internal Revenue Code amendments.
    Because of the average taxpayer's inability to understand the 
requirements of the tax laws as interpreted in the tax forms, many are 
forced to pay a tax preparer to help them meet their tax obligations. 
This may be appropriate for wealthier taxpayers for whom tax advice is 
a necessary part of their financial planning, but I am hard-pressed to 
justify tax rules that also create a need for lower-income taxpayers to 
hire paid preparers.
    Before turning to specific instances of tax complexity, let me 
offer my opinion as to the chief causes of unnecessary complexity. If 
we face those chief causes--stare at them eyeball to eyeball--perhaps 
we can take some steps to eliminate unnecessary complexity in the 
future.
    Ladies and gentlemen, in the words of Pogo, ``I have met the enemy 
and they is us!'' By ``they'' I mean that the causes of complexity 
include taxpayers and tax advisors who obtain special provisions for 
their clients. ``They'' includes legislative staff, many of whom are 
fresh out of school or have never worked ``out there'' in the real 
world. Some staff members latch on to trendy economic theories and 
craft statutes that are simply impractical. And, with utmost respect, 
``they'' also means you. I know that you all have very busy schedules, 
but sometimes the tax laws look as though you haven't thought them 
through sufficiently. Perhaps it is unreasonable to expect legislators 
to understand their legislation in this complex society.
    Still, I submit to you that a key element to tax-law draftsmanship 
going back to the days of Adam Smith is that tax law should be 
understandable. If it is unreasonable to expect you to understand your 
own work product, how much more unreasonable is it to expect the 
average taxpayer to understand it?
    Now to specifics.

                    Tax-Advantaged Savings Accounts

    We are very supportive of tax-advantaged savings accounts. 
Nevertheless, recent changes to the IRA rules have made this area 
extremely complicated. In 1998, individual taxpayers could choose from 
among the
     Traditional IRA
     Spousal IRA
     Nondeductible IRA
     The Roth IRA
     The Education IRA (EDIRA)
     The SEP IRA, and
     The Simple IRA.
    Availability of many of these phase out as incomes rise. But the 
phase-outs are not consistent. For instance, the income phase-out 
ranges from $30,000 to $40,000 for a single taxpayer in a traditional 
IRA to $150,000 to $160,000 for joint return filers for a spousal IRA 
where the spouse is not covered by a qualified plan. The nondeductible 
IRA has no income phase-out range at all. The phase-out range for the 
Roth IRA is between $95,000 and $110,000 for a single taxpayer and 
$150,000 and $160,000 for joint filers. The same phase-out rules apply 
for the Education IRA.
    Perhaps a little uniformity is in order.
    While discussing the area of retirement saving choices, I would be 
remiss if I did not mention the complexity of Keogh plans. These are 
the retirement plans for the self-employed. Because an algebraic 
formula must be used to calculate the maximum Keogh contribution, an 
individual owning an unincorporated business and filing a Schedule C is 
generally not capable of calculating his or her own self-employed 
contribution deduction. Thank goodness for computers!
    With all of the current effort to save the Social Security program, 
it makes sense to encourage taxpayers to put more into retirement 
plans. In the case of the self-employed individual, the deduction 
should be a straight percentage of the individual's Schedule C income. 
An individual owner of a corporation merely has to multiply his or her 
salary by a maximum percentage to determine his or her annual 
deduction. Why not the self-employed?
    You can also encourage additional contributions to IRAs if you 
eliminate or raise the income phase-out ranges. But please make them 
uniform throughout the various IRA vehicles.

                               Phase-Outs

    It is not just IRA phase-outs that cry out for reform. This past 
year child credits, tuition tax credits and education loan interest 
deductions dramatically highlighted the problem with so-called middle-
income phase-outs. Numerous middle class taxpayers who thought Congress 
had done something for them with the Taxpayer Relief Act of 1997 were 
disappointed, some even angry, to find out that the credits or 
deduction didn't apply to them. Who would have thought that a young 
married couple just out of school and making $37,500 each would not be 
able to deduct student loan interest because their combined income was 
too high? Presumably the intended effect was to show middle-income 
families that their member in Congress cared about them. The actual 
effect for many was disillusionment and even anger. My suggestion would 
be to use uniform phase-out schedules that kick in at a higher income 
level, if phase-out is necessary at all. This would make the tax system 
simpler if not palatable

                  Retirement Plan Distribution Reform

    Another area that needs simplification and reform is Internal 
Revenue Code section 401(a)(9), which governs distributions from 
qualified retirement plans. Where do you come up with numbers like 
59\1/2\ and 70\1/2\? These are the respective ages at which qualified 
plan distributions may begin and must begin.
    I need to digress a moment and talk about half-years. I always 
assumed that \1/2\-year increments are the result of congressional 
compromise. They also pop up, for instance, in the depreciation rules, 
where the cost of certain buildings must be recovered over 31\1/2\ 
years. Talk about unnecessary complexity! Ladies and gentlemen, please 
stay away from 6-month increments in your compromise discussions.
    The current qualified plan distribution rules were first designed 
in the early 1960s. In the 1990s they are hurting the elderly who want 
or have to work past the traditional retirement age and also widows and 
widowers. With ever-greater life expectancies, it is worrisome to the 
elderly to require minimum distributions. They feel they may need the 
money later in their lives. Also, the tables used to compute minimum 
distributions are unisex tables. Because women have a higher life 
expectancy, their minimum required distributions are higher than they 
should be to match their life expectancies.
    This area of the tax law is both overly complex and past its prime 
demographically.

                      Capital Gains and Schedule D

    The capital gains rules are another area of unnecessary complexity. 
In 1996, the Form 1040, Schedule D, was a single page with 19 lines. 
Taxpayers whose only capital gains transactions came from mutual fund 
dividends were even excused from filing a Schedule D and could report 
their mutual funds capital gain on page 1 of the Form 1040. No longer!
    After the 1997 Taxpayer ``Relief '' Act, Schedule D ballooned to 54 
lines on two pages. The form became very confusing to the average 
taxpayer, not only because of the variety of tax rates--10%, 20%, 25%, 
and 28%--but also because it is sometimes so hard to determine what 
assets qualify for each of these rates.

                     Alternative Minimum Tax (AMT)

    We have two federal income tax systems, the regular tax and the 
alternative minimum tax, or AMT. Theoretically, the AMT is very similar 
to the flat tax one hears touted in tax policy circles. What makes the 
AMT so complicated, however, is its need to interface with the regular 
tax.
    The individual AMT is now taxing taxpayers whom it was never 
intended to affect. Among the most important reasons for this is that 
tax brackets and exemptions are not indexed for the AMT as they are for 
the regular income tax. Furthermore, some important credits are either 
directly or effectively not allowed against the AMT.\1\
---------------------------------------------------------------------------
    \1\ Congress passed legislation last year allowing these credits 
against the AMT for 1998 only, creating the need to extend this 
palliative in future years. The legislative technique of annual 
extenders is very unfortunate. An extender bill introduces unnecessary 
uncertainty into the tax law and significantly increases tax compliance 
costs when the extender bill is passed late and taxpayers have to file 
amended returns. We strongly discourage you from resorting to short-
term extenders.
---------------------------------------------------------------------------
    In my firm we had several cases during the past filing season where 
taxpayers with adjusted gross incomes below $100,000 were subject to 
the AMT. Many taxpayers are not sophisticated in tax matters and have 
no idea that they may be subject to the AMT. It is easy to understand 
why many taxpayers fail to notice their AMT obligations when filing 
their return--it is so unexpected.
    The disallowance of certain itemized deductions in the calculation 
of the AMT is another AMT feature that surprises taxpayers in the 
middle-income group. For AMT purposes, taxpayers lose itemized 
deductions, which are already reduced by the 3% AGI adjustment as well 
as the 2% miscellaneous deduction floor. Furthermore, medical expenses 
are disallowed to the extent that they do not exceed 10% of AGI. Under 
the regular tax, medical expenses are permitted to the extent they 
exceed 7\1/2\% of AGI. One of my colleagues faxed me a startling 
example. It involves a divorced mother of two who received $102,000 of 
alimony and had an AGI of $108,000. She paid nearly $7,800 of 
additional tax due to the AMT because $14,000 of state tax\2\ and 
$10,000 of home mortgage interest was not deductible for AMT purposes.
---------------------------------------------------------------------------
    \2\ $12,426 of real estate taxes and $1,619 of state income taxes. 
All numbers used in the example above are rounded.
---------------------------------------------------------------------------
    I should also note that the AMT is rather unfair to taxpayers in 
high tax states such as New York and California. Taxpayers with the 
same AGI often will pay AMT if they live in high-tax states, but not 
trigger the AMT if they live in low-tax states.
    Small businesses are also adversely affected by the Alternative 
Minimum Tax. One component of the AMT calculation, the ACE adjustment, 
requires the calculation of depreciation three different ways. Small 
business taxpayers who are not subject to the alternative tax must 
still make this calculation because a negative ACE adjustment could be 
of benefit to them in future years if they become subject to the 
Alternative Minimum Tax. Although the ACE adjustment for depreciation 
has been eliminated prospectively, those with assets placed in service 
prior to the enactment of that legislation are still required to 
calculate the ACE adjustment depreciation.

                 Recommendations for Change in the AMT

    The easiest way to eliminate the complexity of the Alternative 
Minimum Tax would be to repeal it. I understand this is a very 
political issue and is much easier said than done. However, if 
repealing the AMT is not a possibility, there are several changes that 
can be made to the individual Alternative Minimum Tax that would help 
reduce its complexity. These include the following:
     Index the AMT brackets and exemption amounts.
     Eliminate any add-back of itemized deductions and personal 
exemptions in calculating alternative minimum taxable income.
     Permanently allow certain regular tax credits as credits 
against the AMT.
     Exclude low- and middle-income taxpayers from being 
subject to the AMT by providing an exemption when adjusted gross income 
(AGI) is less than $100,000 (indexed).
    Small business relief from the Alternative Minimum Tax could be 
accomplished by eliminating the ACE calculation completely and 
increasing the corporate exemption from AMT to eliminate small 
businesses under an indexed dollar amount of annual sales (higher than 
the current exemption).

                           The ``Kiddie Tax''

    The ``kiddie tax'' was enacted to keep parents from shifting income 
to lower-tax children. It was passed along with several other measures 
to curtail this practice, including the elimination of ``Clifford 
trusts'' and the prohibition against a child taking a full personal 
exemption while the parents take the dependency deduction. The lowering 
of the top tax bracket also reduced the incentive to shift income. I 
believe the kiddie tax was overkill and these other provisions were 
sufficient to curtail abuse.
    In any event the kiddie tax is very complicated, requiring the 
running and rerunning of a family's tax return to arrive at the correct 
tax. Also, it is not designed quite correctly and can result in a 
higher tax than if the income were kept with the parent. Two examples 
in which this occurs are where the parents have capital losses while 
the children have capital gains and where the parents have investment 
interest limitations.

                         Administrative Reforms

    We would also like to suggest two administrative reforms that would 
greatly simplify representation of individuals and small businesses. 
First interim extensions (July 15 for partnerships and trusts and 
August for individuals) should be eliminated and the initial extensions 
should be for six months. And second, powers of attorney are a 
perennial source of irritation in relations between the IRS and the 
practitioner community. Consideration should be given to a ``check the 
box'' power of attorney or ``tax information authorization,'' whereby 
the taxpayer can check a box on the tax return at the time of filing 
giving the IRS permission to discuss the contents of the tax return 
with the preparer who has signed the tax return.

                               Conclusion

    I sincerely thank you for the opportunity to testify here today. It 
is an experience I will always cherish. Let me end by reminding you of 
one of Adam Smith's four ``maxims'' of taxation--certainty. 
Specifically, Smith advised, ``The tax which each individual is bound 
to pay ought to be certain, and not arbitrary. The time of payment, the 
manner of payment, the quantity to be paid ought all to be clear and 
plain to the contributor, and to every other person.'' This is good 
advice as you move to amend the Internal Revenue Code. If we regain the 
sense that taxes need to be ``clear and plain to every contributor,'' 
tax complexity will never be an issue.

                                

    Chairman Houghton. Thanks very much, Mr. Sokolski.
    Mr. Smith.

 STATEMENT OF STEPHEN B. SMITH, CPA, GENERAL PARTNER, WILLIAMS-
             KEEPERS CPA'S LLP, COLUMBIA, MISSOURI

    Mr. Smith. Thank you, Mr. Chairman. Mr. Chairman and 
Members of this distinguished Subcommittee, I am Stephen B. 
Smith. I am a practicing CPA from Columbia, Missouri. And I 
appear before you today with observations from the viewpoint of 
a practitioner with 30 years experience in the field of 
taxation.
    Before drawing your attention to a few aspects of my 
prepared testimony and at the risk of appearing to curry favor, 
I would like to refer to the chairman's Tax Simplification and 
Burden Reduction Act. I did not have the benefit of the 
chairman's May 12 statement concerning that Act when I prepared 
my testimony prior to going on vacation. In summary, and 
without exception, it is an excellent start on the road to tax 
simplification. I believe it does not go far enough in the 
alternative minimum tax area, however.
    Referring to my prepared statement, I draw your attention 
to the fact that my comments are divided into two areas: those 
requiring statutory changes, the logical province of this 
Subcommittee, and those requiring administrative action.
    Dealing first with what I perceive to be the largest 
problem and, perhaps, somewhat repeatedly, the alternative 
minimum tax needs to be repealed outright. As I recall, this 
tax was conceived 20 years ago as a political reaction to a 
very limited number of high-income individuals who paid no 
income tax. It was instituted in order to collect taxes on 
fewer than 500 returns out of something on the order now of 
about 90 million returns that would be filed. It is to be 
repealed outright, as I said.
    However, it traps more taxpayers each succeeding year and 
thereby generates revenue, the ability to repeal it in a 
revenue-neutral environment gets successively difficult. I am 
reminded of the commercial, one of the punchlines of which was 
you can pay me now or you can pay me later, but every year it 
gets to be more expensive to consider repealing this. This is a 
stealth tax. It is a parallel tax universe with significant 
impact and almost no ability to be predicted with any degree of 
certainty and economy of effort.
    Few taxpayers can describe it at all. A substantial number 
of tax professionals such as Mr. Sokolski and I cannot 
accurately describe it. And I would throw myself into that 
group also. If it is politically impossible to abolish it 
outright, the bare minimum changes should be to exempt State 
and local income taxes from the calculations and to index the 
brackets for change.
    The cumulative effects of complexity affect all of us. 
Although each individual rule may be capable of explanation, 
the cumulative effect of many different provisions, each 
requiring a unique understanding of income levels, facts, and 
circumstances to which they do apply, they don't apply, or they 
might apply causes many taxpayers to simply give up any attempt 
at preparing their own returns. This failure to prepare their 
own return produces a citizenry which is more removed from the 
tax laws of our country and more removed, more importantly, 
from the details of their own finances. Both are detrimental to 
our society.
    The current code is so complex that many taxpayers are 
suspicious that someone else is gaining an unknown advantage on 
them. The result of this is a compensation for the perceived 
inequity and voluntary compliance goes down. This is a 
euphemism for the process whereby individual taxpayers don't 
report income or overstate deductions in order to decrease the 
amount of tax paid and, therefore, be fair. Even ignoring 
fairness completely, we believe that a significant minority of 
taxpayers' actions are influenced by alternating attacks of 
greed and fear. And with few or no IRS field audits to worry 
about, fear is the less dominant concern and compliance goes 
down.
    A simplified filing process would be greatly to the 
advantage of all. The perceived complexity unnecessarily scares 
millions of taxpayers into hiring others to prepare a return 
which should be easy to self-prepare and the exclusion of a de 
minimis amount of interest and dividends from taxation, such as 
those that have been proposed on more than one occasion, would 
serve to remove many returns from the realm of the paid 
preparer.
    Although I prefer the chairman's proposal for capital 
gains, the Coyne-Matsui Capital Gains Tax Simplification Bill 
would also solve the problem. And many parts of Mr. Neal's 
Individual Tax Simplification Act of 1999 addressed complexity 
which need attention. Thank you for the privilege of appearing 
before you today and I would be pleased to answer any questions 
you might have.
    [The prepared statement follows:]

Statement of Stephen B. Smith, CPA, General Partner, Williams-Keeper 
CPA's LLP, Columbia, Missouri

                         Introductory Comments

    Mr. Chairman, and members of this distinguished subcommittee: My 
name is Stephen B. Smith, and I am a general partner in Williams-
Keepers CPA's LLP. Our firm is located in Mid-Missouri and encompasses 
the talents and efforts of more than 80 of my colleagues in our three 
offices. We assist over two thousand clients in their dealings with 
various taxing authorities. I am not notable for any historic interest 
in tax policy or lobbying for or against specific Internal Revenue Code 
changes. My comments are contributed as ``observations from the 
Heartland.''
    Speaking personally from the perspective of thirty years of tax 
practice I have seen the Internal Revenue Code become increasingly 
complex, more expensive to comply with and viewed as unfair in many 
material aspects. The disdain of many taxpayers for the societal 
engineering which permeates the tax law is palpable. In addition, with 
reduced personal contact between taxpayers and the Internal Revenue 
Service, many taxpayers now view compliance as a lottery; and, 
voluntary compliance has declined. Many have no faith in the system and 
believe it to be inherently unfair. The significant majority of high-
income taxpayers have never had an IRS field audit.
    To be viewed as fair, we believe any tax system must be:
    1. Uniform
    2. Understandable
    3. Administered impartially
    4. Reasonable in relation to the income of the payer
    5. Not unduly burdensome with which to comply
    At the moment, we believe only #3 would be generally acclaimed to 
be present. Our experiences with the vast bulk of Internal Revenue 
Service employees prove them to be dedicated to their jobs. Many of 
them feel they do not have adequate support or adequate tools to do 
their job, but they do the best they can. There clearly is room for 
improvement and we refer below to some of the most-needed areas based 
on our day-to-day experiences.
    We firmly believe a small group of trained tax practitioners could 
materially simplify the Internal Revenue Code, on a revenue-neutral 
basis, if exempted from the lobbying process. The Alternative Minimum 
Tax solution, referred to below, might require an exemption from the 
charge to make all changes on a revenue-neutral basis. I have divided 
my comments below into two areas: first, those requiring legislative 
change; second, those requiring administrative action alone.

Suggestions for Internal Revenue Code Changes

    Repeal or drastically amend the Alternative Minimum Tax (AMT). This 
tax was conceived twenty years ago as a political reaction to a very 
limited number of high income individuals who paid no income tax. My 
recollection is that it was instituted in order to collect taxes on 
fewer than 500 returns. Originally designed to apply to a handful of 
wealthy taxpayers, it can reasonably be expected to apply to millions 
of taxpayers in the very near future. It ought to be repealed outright. 
However, it traps more taxpayers each succeeding year and thereby 
generates revenue. The ability to repeal it in a ``revenue-neutral'' 
environment gets more difficult each year. It is, practically speaking, 
impossible to determine without an unreasonable effort. Generally the 
only time the true amount of AMT tax can be calculated, if indeed it 
can be calculated at all, is annually during the tax preparation 
process. It is a ``stealth'' tax. It is a parallel tax universe with 
significant impact and almost no ability to be predicted with any 
degree of certainty and economy of effort. Few taxpayers can describe 
it at all. A substantial number of professional tax practitioners 
cannot accurately describe it. It would be far preferable, nationally, 
for the tax to be wiped out and to allow a relatively few persons to 
pay no tax at all than to cause the pain and suffering on the scale it 
currently produces. The AMT may be the single most unknown or 
unexpected tax and strikes taxpayers in many cases solely because of 
their state of residence. High-tax-state taxpayers are thus treated 
differently, nationally, solely because of the tax burden of a 
political subdivision below the Federal level. If it is politically 
impossible to abolish the tax, the minimum changes should be to exempt 
state and local income taxes from the calculations and index the 
brackets for inflation.
    Change underpayment rules for the individual estimated tax safe 
harbor. For many years the underpayment of individual income tax safe 
harbor rules provided a simple test permitting 100 percent of the prior 
year's tax liability to serve as a safe harbor for avoiding penalties 
for failure to ``quarterly'' pay enough income tax. As a revenue-
raising measure the safe harbor was initially raised for several years, 
then subsequently structured to fluctuate up and down over a period of 
years, again solely as a revenue-balancing measure. The old rule was 
simple, effective and economical to compute and follow. The new rules 
are unduly complicated and for many taxpayers very expensive to 
compute. The new rules do not, in the end, change the amount of the 
tax. In many cases taxpayers are required to make elaborate 
calculations as many as three times a year. A return to the original 
safe harbor would be a significant simplification for many taxpayers 
who do not otherwise have complex returns, but have incomes which 
fluctuate from year to year.
    Coordinate phaseout rules. Different rules for phaseouts should be 
coordinated. The lack of coordination among phaseouts that apply to 
different provisions should be remedied. Recent years have produced a 
plethora of ``targeted'' credits and special provisions that are phased 
in or out at different levels of income. Although the various levels 
may well have been set at different times based on fiscal cost 
estimates, the lack of a small group of homogenous rules for 
determining phase-in or phase-out produces a degree of complexity that 
cannot be overemphasized. Breaking phaseouts into two or three 
categories and applying uniform rules to each category would ease the 
ability to increase the utilization of all credits and phaseouts.
    Reverse the effects of cumulative complexity. Although each 
individual rule may be capable of explanation, the cumulative effect of 
many different provisions, each requiring unique understanding of the 
income levels, facts and circumstances to which they apply, or don't 
apply, causes many taxpayers to simply give up any attempt at preparing 
their own returns. This failure to prepare their own return produces a 
citizenry which is more removed from the tax laws of our country and 
more removed from the details of their own finances. Both are 
detrimental to our society. The current Internal Revenue Code can be 
analogized to a family home which has been much remodeled over the 
years. Each successive remodeling ``chopped up'' the house into smaller 
and smaller unique spaces. Moving about the house increased in 
difficulty. New owners ``gut'' the house, opening it up, restoring the 
simplicity and beauty which was originally present. The current 
Internal Revenue Code needs new owners, statesmen who are prepared to 
withstand the lobbyists' incessant pressure, in order to return the tax 
code to a system which once again is sufficiently comprehensible as to 
inspire confidence and permit an economical system of self-assessment 
with a high degree of compliance. The Code is currently so complex that 
many taxpayers are suspicious that ``someone else'' is gaining an 
unknown advantage on them. In order to compensate for the perceived 
inequity, voluntary compliance goes down. This is a polite euphemism 
for the process whereby income is not reported and/or deductions are 
increased in order to cause the tax amount to be less, and, therefore, 
``fair.'' Even ignoring fairness completely, we believe a significant 
minority of taxpayers' actions are influenced by alternating attacks of 
``greed'' and ``fear.'' With few or no IRS field audits to worry about, 
fear is the less dominant concern. Compliance goes down.
    Increase the number of taxpayers qualifying for a simplified filing 
process. An additional goal should be to remove taxpayers from the 
complexities of the filing process, to the maximum extent possible. 
Perceived complexity unnecessarily scares millions of taxpayers into 
hiring others to prepare a tax return which should be easy to self-
prepare. Many taxpayers have only Forms W-2 and a relatively small 
amount of interest or dividends to report. The inclusion of the 
interest or dividend statements frequently causes an outside preparer 
to be engaged. In many cases, that is unnecessary. The exclusion of a 
de minimis amount of interest and dividends from taxation, such as 
proposed by The Savings Advancement and Enhancement Act, would serve to 
remove many returns from the realm of the paid preparer and at the same 
time encourage savings and investment.
    The ``marriage penalty.'' Those sections of the Code which produce 
a marriage penalty should be repealed and a married couple should be 
treated no worse than two single individuals who cohabit. Although this 
is a policy issue, computer software currently available at mass-market 
prices provides a diagnostic which alerts the user to the fact that a 
Married Filing Separately status may save a married couple money. Since 
this diagnostic is generated only after the completion of a MFJ return, 
the inefficiencies of dividing and re-entering information to capture 
the savings possible in MFS are notorious. The Marriage Penalty should 
be eliminated and two married individuals should individually be 
treated on a par with single individuals.

Suggestions for Administrative Changes Within the IRS

    Filing by electronic means. The current process which permits the 
filing of tax returns by telephone for simpler returns should be 
expanded. Filing using the Internet, email and other electronic media 
should be developed and implemented as quickly as possible. In 
addition, sufficient taxpayer education should be undertaken in order 
to inform the public about the availability of alternatives to mailed 
paper forms.
    The IRS budget. Reverse the erosion of the IRS budget. Incredibly, 
as tax returns have grown exponentially more complicated, the IRS has 
constantly reduced face-to-face taxpayer contact opportunities, closed 
IRS offices and consolidated IRS personnel in increasingly isolated 
surroundings and generally removed the human factor from the tax 
collection process. Although this can and does reduce the nominal costs 
of collection, the toll it exacts in the form of expenses for hired 
professional help, confusion about tax law, reduced compliance and 
other more intangible detriments reduce the efficiencies claimed. Most 
taxpayers are not trained tax professionals. There is a significant 
need for increased opportunities for face-to-face contact with IRS 
professionals. Most individuals are visual learners. We need help in 
understanding that which we cannot understand. Telephone contacts will 
not replace human interaction for many of those taxpayers most in need 
of special assistance.
    Increase investment in technology. As tax practitioners one of the 
greatest hindrances we face is the lack of good technology on the part 
of the IRS when we need to interact with them concerning a taxpayer's 
account. At the present time we believe that IRS accounts are updated 
on a weekly basis to reflect changes in a taxpayer's account. In a 
virtual Windows World we are forced to deal with a system based on 
Worse-Than-DOS computers and accounts that are only updated weekly. 
Powers of Attorney which permit a CPA to represent a client are 
regularly unable to be documented online, requiring a continuous stream 
of faxes in order to document our ability to speak for the taxpayer as 
we wind our way through the telephone maze. We are respectful of the 
needs to secure privacy, but the current system is inadequate for 
telephone contacts. Lengthy lag times following contact between the 
taxpayer (or his/her professional representative) and inclusion of any 
results in the IRS database guarantees significant confusion about 
whether a particular telephone or mail contact actually accomplished 
the promised results. This generates additional correspondence/contacts 
which further degrade efficiency. Increased reliance on other forms of 
electronic communications such as email as a substitute for taxpayer 
contact should be investigated and implemented at the earliest possible 
date. In addition, the IRS should consider adopting that portion of the 
airlines' reservations database technology which permits each IRS 
employee who deals with an account to record substantial detail as to 
the steps taken. Frequently repeated contacts are necessary because 
telephonic contacts are not documented or not capable of being 
documented. Subsequent contacts then re-commence from ``square one.''
    Errors in overpayments. The number of tax overpayments applied to 
future tax periods which are refunded in error appear to be out of 
proportion to the expected number of such errors. In addition, it is 
clear that IRS computers do not adequately capture information on Form 
2210 pertaining to the exceptions from penalty for underpayment of 
estimated tax utilizing annualization of income over 3, 5 and 8-month 
periods. This failure generates notices of penalty which should never 
be generated based on the information filed with the return.
    Thank you for the opportunity to provide perspective on these 
matters.

                                

    Chairman Houghton. Thank you, gentlemen, very much. We have 
to vote now, so let us try to go through the questions--I will 
hold off on my questions--and see whether we can do this so you 
won't have to wait. Then we will have a recess and go back to 
the next panel.
    Mr. Coyne.
    Mr. Coyne. No, Mr. Chairman.
    Chairman Houghton. No questions. Mr. Neal.
    Mr. Neal. Thank you, Mr. Chairman.
    Mr. Smith, you touched upon it in your testimony. You spoke 
about a growing complexity of the Tax Code and the disgusting 
reaction from your clients. Would you elaborate on that a bit 
more?
    Mr. Smith. I think the disgust comes from the fact that 
several of us have alluded today. The code should not be beyond 
the province of an average American. It doesn't mean that every 
single one of our citizens should be able to understand it 
completely, but certainly the average American should be able 
to understand how to prepare their own income taxes.
    When they cannot and they can do nothing about it, they 
have only one reaction left and that is frustration. That is 
the last avenue. I can't fight it and I can't flee it. And, 
unfortunately, some of them don't flow it very well, either.
    Mr. Neal. Thank you. Thanks, Mr. Chairman.
    Chairman Houghton. Mr. Weller.
    Mr. Weller. Thank you, Mr. Chairman. And, Mr. Smith, I 
would like to direct my question to you. By the way, you have a 
fine representative in Kenny Hulshof, my seatmate here. He does 
a great job as a Member of this Committee.
    You had, in your testimony, of course you focused as all of 
us are today, on the need to simplify the code and the 
taxpayers' frustration and you as a tax practitioner with the 
complications in the Tax Code. Over the last few years in 
particular, there has been the desire by some to focus every 
time there is a new initiative to provide tax relief, to target 
it. And I once had a gentleman say, you know what targeted tax 
cut means? That means very few get very little. And, as a 
result of that, you know, the various targeted tax relief that 
has been adopted by Congress and the initiative of the White 
House in the last few years has created quite a few targeted 
tax cuts.
    What, from a general standpoint, in your view as a tax 
practitioner, how has this made your job more difficult? Or has 
it made it more easy, having so-called targeted tax cuts?
    Mr. Smith. First of all, it clearly has not made it more 
easy. So we can dispense with that side of it, immediately. And 
I am sure Mr. Sokolski would join me in saying that.
    Second, targeted tax credits produce two reactions amongst 
my clients. One is palpable disdain for societal engineering.
    The second is a little more complex. Essentially--and I 
address that in my prepared testimony--because if you are going 
to have--and that, of course, is a policy decision beyond my 
purview--if you are going to have them at all, targeted 
legislation should be subjected to phaseouts that are 
appropriate for high-income taxpayers, perhaps medium-income 
taxpayers, and a low-income group of taxpayers.
    And I would urge this Committee to conform the definitions 
so that the same definition applies for ``individual'' and 
``exemption'' and the other things, for example, in the ITC and 
HOPE credit and some of these. And to take the income levels 
that they apply and rationalize them so that they all apply at 
the same level. And if, in a revenue-neutral environment, you 
have to change those amounts a little bit in order to get the 
CBO numbers to come out right, then do it.
    But there are something like 15 different phaseout levels 
and I can go to a book and find them, but I have the book. How 
many of the 90-million returns have people that have a book 
that is 2 inches thick right at their right hand where they can 
go look at it or have some chance of knowing it offhand? They 
don't. And they really have no real easy way to get it, 
although with the advent of the Internet, I think we are going 
to find that some information will, be easier to obtain than it 
has been in the past.
    Mr. Weller. OK.
    Mr. Smith. And in my administrative comments, which I, in 
the interest of time, skipped over, I believe the IRS should 
clearly be making steps and plans now to utilize the Internet. 
It is extremely efficient. It can be dealt with once for a lot 
of people and it can be accessed millions of times, at no cost, 
as opposed to the rather unsatisfactory telephone contacts that 
have to be made now.
    Mr. Weller. Thank you. Mr. Chairman, I know Mr. Hulshof 
would like to ask questions so I will yield back.
    Chairman Houghton. Thanks. Mr. Hulshof.
    Mr. Hulshof. Thanks, Mr. Chairman. And let me just say how 
much I appreciate you allowing me to invite a constituent here 
to provide this testimony. And, Mr. Smith, let me just say, you 
need not worry about an attempt to curry favor with the 
chairman. Those of us on this side of the dais attempt to do 
the same thing on a daily basis, so we welcome you here. Just a 
couple of quick questions. And I want to associate myself with 
the remarks of Mr. Neal earlier today regarding the SAVE Act.
    And you make reference to the fact that many returns would 
be removed from the realm of the paid preparer, to paraphrase 
your testimony. I think the actual numbers are 7-million 
taxpayers would no longer have to file a schedule B tax form if 
we were to enact the $200, $400 exclusion, and an additional 
10-million taxpayers would be able to file the 1040 EZ form 
were we to implement this one change in the Tax Code.
    You touched on this briefly, Mr. Smith. I want to give you 
a chance to expand just a bit. How well acquainted do you think 
that the average American citizen is with his or her finances?
    Mr. Smith. I think I have been quoted as saying that many 
of them are about as well acquainted with them as the father 
salmon is with one of their offspring. Not very, in other 
words. [Laughter.]
    Mr. Hulshof. And, as a result of that, not to have you run 
afoul of members of your profession of certified public 
accountants or paid preparers, but, I mean, how does this lack 
of acquaintanceship with one's own finances, how does that 
affect whether or not you involve a paid preparer?
    Mr. Smith. Well, frankly, it causes people to spend money 
with us unnecessarily. And, in doing so, many taxpayers take 
the position that it is in a box, the old, classic shoe box, 
and they hand it to us, at least at my level of practice they 
do, and that is sort of the end of it. It is sort of like 
putting the body in a bag and shipping it off. And then they 
come back and sign the return at the very end. It is a sort of 
casual process of dealing with the largest expense that many 
people have.
    If you think about it, Federal and State taxes are larger 
for many people, although not for all, obviously, than any 
other expense, including their home. And yet, annually, they 
turn over their calculation of that tax to me, a relative 
complete stranger. I think many of them would be much better 
off to do it themselves. And I am sure my union will have some 
chat with me in the locker room afterward.
    But, truthfully, for the good of the country, we would be a 
lot better off if we got 10 million or 15 million people just 
flat out of the system and head some way to turn it into a 
telephone filing system or an Internet filing system or, less 
acceptably, a mail filing system that is capable of even having 
the service match up their very good reports of wages and other 
income and then sending me a bill. And I think, hopefully, it 
will come to that someday.
    Mr. Hulshof. And I think that, probably, Mr. Chairman, is a 
good note to end on, recognizing our time is drawing close for 
a vote. Thank both of you gentlemen for being here.
    Chairman Houghton. Yes. Thanks very much, gentlemen. 
Certainly appreciate it.
    [Recess.]
    Chairman Houghton. We will begin our next panel. We have 
Mr. Tucker, chairman of the Section on Taxation of the American 
Bar Association; David Lifson, chairman of the Tax Executive 
Committee, the American Institute of Certified Public 
Accountants in New York; the famous Mr. Harry L. Gutman, a 
partner with KPMG; Mr. Gerry Harkins, general manager and owner 
and operator of Southern Pan Services Company in Conley, 
Georgia; and, Mr. Eugene Steuerle, senior fellow of the Urban 
Institute, National Tax Association.
    Gentlemen, thanks very much for being here.
    Mr. Tucker, would you begin?

  STATEMENT OF STEFAN F. TUCKER, CHAIR, SECTION OF TAXATION, 
                    AMERICAN BAR ASSOCIATION

    Mr. Tucker. Yes, Sir, Mr. Chairman and Members of the 
Subcommittee. My name is Stefan Tucker. I am appearing today in 
my capacity as chair of the American Bar Association Section of 
Taxation and my testimony is presented on behalf of the Tax 
Section. As you probably know, we are comprised of 
approximately 18,000 tax lawyers. We are the largest and 
broadest-based professional organization of tax lawyers in the 
country, and we are the national representatives of the legal 
profession with regard to the tax system.
    On behalf of the section, I would like to thank the 
Chairman and the Members of this Subcommittee for their focus 
on eliminating complexity in the Tax Code. Mr. Chairman, we are 
looking forward to your introduction of the Tax Simplification 
and Burden Reduction Act of 1999 and, frankly, we are quite 
pleased that the proposed legislation will include several of 
the Tax Section's proposals.
    We are also pleased to have read Congressman Neal's Act and 
noted that, both as to the AMT and as to a number of other 
provisions, you have focused on items that we have focused on. 
And, Congressman Coyne, we were pleased to see, has taken a 
very careful look with Congressman Matsui at the capital gains 
provisions and their complexity. And, finally, Congressman 
Portman has looked at the pension and profit sharing 
complexities which are, in my mind, extraordinary. And we think 
that we really do need to focus on these complexities.
    We have said for a long time in the ABA Tax Section, we 
have testified during my tenure as chairman of the ABA Tax 
Section on complexity and simplification and we believe very 
strongly in the same. Now you may wonder why would tax lawyers 
want to see simplification? I can tell you that our membership 
in the Tax Section has gone down by 10,000 persons over the 
last 12 years. Complexity is not something that engenders 
confidence in either the taxpayers or the practitioners and we 
think that is something to know.
    I think it is interesting to see that a number of our 
younger members are now specialists in anywhere from three to 
six provisions of the entire Internal Revenue Code. Whereas 
when I started 36 years ago, we were able to focus on the 
Internal Revenue Code as a code. You noted that there is one 
thick volume with very thin pages. The regulations are six 
volumes with very thin pages and there are virtually no 
regulations yet on the 1997 or 1998 legislation. And the more 
that we do, the more complex it becomes, the more we enhance 
people looking at ways to get around the system and to avoid 
the system and that does none of us any good.
    Earlier this year, in February, I wrote a letter to 
Secretary Rubin with a concern and a great deal of 
disappointment that the President's budget proposals had added 
a multitude of proposed new tax credits to the income tax 
system. And we think that does none of us any good either. So 
we were very concerned in that, in particular on phaseouts. And 
we really think that, as Congressman Neal said before, you need 
to jump start the system of simplification. I learned a long 
time ago that a journey of 1,000 miles starts with one small 
step. Of course, it was stated by somebody whose political 
philosophy may not have been the most desirable, but it still 
does start with one small step.
    We have a number of specific tax proposals in our written 
testimony. We would note that a number of them are the same as 
the AICPA and others have noted to you. We have a number of the 
same concerns. The first and foremost is the AMT, the 
alternative minimum tax. There are at least four significant 
tax problems with the AMT. No. 1, it no longer is necessary to 
fulfill its original intended purpose.
    No. 2, it increasingly affects an unintended class of 
taxpayers, middle-class taxpayers who are not engaged in tax 
shelter or deferral strategies. As someone said, we started 
with a few people who were not paying any tax and we have 
broadened to the remainder of the world. It is too complex. It 
creates too much of a compliance burden. And a number of the 
adjustments and preference items are inappropriate from both a 
policy and a technical perspective.
    We think you ought to repeal the individual AMT. If you 
don't repeal it, we think you need to raise the threshold so 
that people below an average AGI, for example, of $200,000 are 
not subject to the AMT. Or partially repeal it. We have noted 
before, time and again, that itemized deductions create AMT. 
Mortgage interest creates AMT. That is a very strange result. 
Real estate taxes and State and local income taxes create AMT. 
That is not an intended result. We think you ought to focus on 
at least, at the very least, indexing, which was never done and 
at least would pick up something.
    We note there are problems with the phaseout of itemized 
deductions and personal exemptions. We concur with what was 
said before that people are more interested in eliminating 
these hidden taxes and seeing the real tax rates.
    And then, finally, there are a number of items in our 
specific proposals that have come from our committees and we 
would just note three of them to you. One is we think you ought 
to repeal the 2 percent floor on miscellaneous itemized 
deductions. Second, we think you ought to simplify alternatives 
for family status issues. And, third, we think you ought to 
simplify subchapter S and maybe even consider, in light of 
limited liability companies, eliminating subchapter S and just 
recognize that for small business there ought to be a single 
tax regime. Thank you.
    [The prepared statement follows:]

Statement of Stefan F. Tucker, Chair, Section of Taxation, American 
Bar Association

    Mr. Chairman and Members of the Subcommittee: My name is Stefan F. 
Tucker. I appear before you today in my capacity as Chair of the 
American Bar Association Section of Taxation. This testimony is 
presented on behalf of the Tax Section. Accordingly, except as 
otherwise indicated, it has not been approved by the House of Delegates 
or the Board of Governors of the American Bar Association and, 
accordingly, should not be construed as representing the policy of the 
Association.
    As you know, the ABA Tax Section is comprised of approximately 
18,000 tax lawyers. As the largest and broadest-based professional 
organization of tax lawyers in the country, we serve as the national 
representative of the legal profession with regard to the tax system. 
We regularly and continuously advise individuals, trusts and estates 
and small businesses, as well as exempt organizations and major 
national and multi-national corporations. We serve as attorneys in law 
firms, as in-house counsel, and as advisors in other, multidisciplinary 
practices. Many of the Section's members have served on the staffs of 
the Congressional tax-writing Committees, in the Treasury Department 
and the Internal Revenue Service, and the Tax Division of the 
Department of Justice. Virtually every former Assistant Secretary of 
the Treasury for Tax Policy, Commissioner of Internal Revenue, Chief 
Counsel of the Internal Revenue Service and Chief of Staff of the Joint 
Committee on Taxation is a member of the Section.
    The Section appreciates the opportunity to appear before the 
Subcommittee today to discuss simplification. On behalf of the Section, 
I want to thank the Chairman and the Members of this Subcommittee for 
their focus on eliminating complexity in the tax code. We are truly 
looking forward to the introduction by the Chairman of The Tax 
Simplification and Burden Reduction Act; we are very pleased that the 
proposed legislation will include several of the Tax Section's 
proposals. As you are aware, we consider the elimination of complexity 
to be of the utmost importance, and the Section and its members are 
ready, willing and able to work with you in order to accomplish needed 
change.

                     Simplification and Complexity

    The ABA and its Tax Section have long been forceful advocates for 
simplification of the Internal Revenue Code. In resolutions proposed by 
the Tax Section and passed by the full ABA in 1976 and 1985, the ABA 
went on record urging tax law simplicity, a broad tax base and lower 
tax rates. We have reiterated this position in testimony before the 
House Ways and Means and Senate Finance Committees on numerous 
occasions.
    In recent years, the Code has become more and more complex, as 
Congress and various administrations have sought to address difficult 
issues, target various tax incentives and raise revenue without 
explicit rate increases. As the complexity of the Code has increased, 
so has the complexity of the regulations that the IRS and Treasury have 
issued interpreting the Code. Moreover, the sheer volume of tax law 
changes has made learning and understanding these new provisions 
difficult for taxpayers, tax practitioners and Service personnel alike.
    The volume of changes, especially recent changes affecting average 
taxpayers, has created the impression of instability and unmanageable 
tax complexity. This takes a tremendous toll on taxpayer confidence. 
This Subcommittee often hears how our tax system relies heavily on the 
willingness of the average taxpayer voluntarily to comply with his or 
her tax obligations. Members of the Tax Section can attest to the 
widespread disaffection among taxpayers with the current Code. The 
willingness and ability of taxpayers to keep up with the pace and 
complexity of changes is now under serious stress.
    Tax law changes are again under discussion. The Tax Section does 
not take a position with respect to the wisdom of particular levels of 
taxation or of particular broad-based tax reduction proposals. We do 
urge, however, that the members of this Subcommittee keep 
simplification and avoidance of complexity uppermost in their minds as 
any tax reduction packages are fashioned. Tax relief can be delivered 
in ways that avoid new, complicated rules, such as phase-outs, multiple 
choice elections and highly detailed conditions. While simple, broad-
based tax reductions may not have the cachet of the newer style, more 
targeted provisions, they will avoid the layering of new complexity 
over old. If Congress chooses to reduce taxes, we urge you to do no 
harm.
    To this end, I, on behalf of the Tax Section, earlier this year 
sent to Secretary Rubin a letter expressing our disappointment that the 
President's budget proposes to add a multitude of new tax credits to 
the Federal income tax system. Our point in that letter was that, 
although each credit taken in isolation could be viewed as meritorious, 
that kind of micro-balancing inevitably leads to the type of tax system 
that is, in total, overly complex and undeserving of public respect. 
Particularly in light of the various, complicated provisions added by 
the Taxpayer Relief Act of 1997, Congress and the Administration must 
focus on the cumulative impact of all new provisions sought to be 
added. We continue to urge that the leaders of the tax legislative 
process--including this Subcommittee--resist the accretion of income 
tax benefits and penalties that are unrelated to the administrable 
measurement of annual taxable income and ability to pay.
    My letter to Secretary Rubin also urged that particularly close 
scrutiny be given to any proposals that include income phaseouts. These 
phaseouts have gained popularity in the last two decades and are 
responsible for a significant amount of the complexity imposed on 
individual taxpayers. Phaseouts create the effect of a marginal rate 
increase as a taxpayer's income moves through the phaseout range, and 
the effects of multiple phaseouts on the same taxpayer can create 
capricious results. Phaseouts also blunt the intended incentive effect, 
because taxpayers cannot predict whether benefits will be available to 
them. Phaseouts also play a significant role in the creation of 
marriage tax ``penalties,'' and add to the difficulty in addressing 
that set of issues. We urge you to resist their continued use in the 
enactment of additional tax incentives.
    We do not claim to have all the answers. The Tax Section will 
continue to point out opportunities to achieve simplification whenever 
possible, including several ideas that we will discuss later in this 
testimony. However, it is also necessary that we point out that 
simplification necessitates hard choices and a willingness to embrace 
proposals that are often dull and without passionate political 
constituencies. Simplification also requires that easy, politically 
popular, proposals be avoided if they would add significant new 
complexity. Simplification--and preventing greater complexity--may not 
garner political capital or headlines, but it is crucial. It requires 
leadership from the Administration and from the tax-writing committees.
    To date, simplification has not achieved the commitment that we 
believe is required. Too often, other objectives have tended to crowd 
simplification out as a priority. We urge the members of this 
Subcommittee to adjust this balance by endorsing simplification as a 
bedrock principle and communicating that principle to all involved in 
the tax-writing process.
    To that end, the Congress adopted as part of the IRS Restructuring 
and Reform Act of 1998 a procedure to analyze the complexity of 
proposals with widespread applicability to individuals or small 
business. By means of this complexity analysis, the Joint Committee on 
Taxation will call attention to provisions that could result in 
substantial increases in complexity, and will suggest ways in which the 
goals of those proposals can be achieved in simpler ways. We strongly 
support this increased focus on complexity and urge the members of this 
Committee, and especially this Subcommittee, to pay heed to the JCT 
analyses. Only by raising awareness of problems with proposals before 
they become law will Congress make substantial inroads into the 
problem.

                           Specific Proposals

    We would now like to address certain specific areas in which the 
Tax Section considers the need for simplification immediate. We begin 
with the alternative minimum tax, which is an area that we believe 
demands the immediate attention of this Congress. As this Subcommittee 
is well aware, there is an inherent problem with the individual AMT 
which, if not dealt with in one way or another, will result in 
approximately 9 million additional taxpayers becoming AMT taxpayers 
within the next decade. Many have referred to this problem as a 
``ticking time bomb.'' Most of these additional taxpayers are not of 
the type envisioned as being subject to the AMT when it was revised in 
1986. Moreover, many of these individuals will not even be aware they 
are subject to the AMT until completing their returns or, worse, 
receiving deficiency notices from the IRS. We are continuing to confer 
with our counterparts at the Tax Division of the AICPA concerning our 
respective positions on the AMT, and we have found that our two groups 
are in accord on the importance of addressing the AMT issue promptly.
    We wish to acknowledge the Chairman's understanding of the problems 
attendant to the AMT, as reflected in the first three items of his list 
of provisions for his proposed legislation, and for his leadership in 
seeking to reduce complexity. We are pleased that Congressman Coyne (D-
PA) has introduced a simplification bill. (See H.R. 1407 (106th 
Cong.).) We also would like to commend Congressman Neal (D-MA) for his 
recognition of the problems that the Tax Section perceives as 
associated with the individual AMT and for his proposal to repeal the 
personal exemption phaseout and the overall limitation on miscellanous 
itemized deductions--an issue which I will discuss in more detail later 
in this testimony. (See H.R. 1420 (106th Cong., 1st Session, 1999.)

                       A. Alternative Minimum Tax

1. Background

    Individuals first became subject to an ``add-on'' minimum tax in 
1969, enactment of which was precipitated by concerns that some 
taxpayers with significant economic income were paying little or no tax 
because of excessive investments in tax shelters. This add-on tax 
ultimately was repealed and replaced with a minimum tax payable to the 
extent that an individual's AMT liability exceeded his or her regular 
tax liability. This minimum tax--which eventually morphed into an 
entirely separate, parallel, tax system--has been modified several 
times since enacted.
    The current law version of the minimum tax generally involves 
computing AMT liability by multiplying an AMT rate that is lower than 
the regular tax rate against a tax base that is broader than the 
regular tax base. Subject to year-by-year exceptions that have been 
made, most nonrefundable credits cannot be used to reduce AMT 
liability. This has the effect of making many credits unavailable to 
otherwise eligible individuals in cases where use of the credit would 
cause the amount of the regular tax liability to be less than the 
tentative AMT liability. The AMT rate brackets are mildly progressive, 
but are not indexed for inflation.
    The base for the AMT is an individual's alternative minimum taxable 
income (AMTI). An individual's AMTI is determined by adding certain 
``preference items'' to taxable income (such as tax-exempt interest on 
certain private activity bonds and a portion of the amount excluded 
from regular taxable income on sales of certain small business stock) 
and ``adjusting'' the treatment of certain items to eliminate or reduce 
benefits associated with the regular tax treatment of those items. Some 
of these adjustments relate to ``business'' type items--such as the 
requirement that depreciation be computed for AMT purposes using a 
separate system that provides for less accelerated depreciation 
deductions than under the regular tax system. Other adjustments are 
purely ``personal.'' For example, adjustments for individuals include: 
(1) disallowing deductions for State and local taxes; (2) disallowing 
medical expenses except to the extent they exceed 10 percent of the 
taxpayer's adjusted gross income (AGI), and (3) disallowing standard 
deductions and personal exemptions. Other adjustments that affect 
individuals relate to investment or employment items. For example, (1) 
miscellaneous itemized deductions are not allowed, and (2) the special 
regular tax rules relating to incentive stock options (ISOs) are not 
allowed. Although an individual is allowed an exemption against his or 
her AMTI, the exemption amount is not indexed for inflation.

2. Problems with the AMT

    As explained below, we believe that there are at least four 
significant problems with the individual AMT.
    First, the AMT no longer is necessary to fulfill its intended 
purpose. As indicated above, the original AMT was enacted to address 
concerns that persons with significant economic income were paying 
little or no Federal taxes due to investments in tax shelters. This 
reason is no longer compelling in light of numerous changes that have 
been made to the Tax Code to specifically limit tax-shelter deductions 
and credits. For example, the Tax Reform Act of 1986 expanded the 
application of the at-risk rules and enacted rules limiting deductions 
and credits for passive activity losses, which greatly reduced shelter 
opportunities.
    Second, the AMT increasingly is affecting an unintended class of 
taxpayers--middle class taxpayers who are not engaged in tax-shelter or 
deferral strategies. Studies indicate that the AMT increasingly is 
becoming the tax system for middle-income individuals. For example, a 
pamphlet prepared last year by the Joint Committee on Taxation 
(``JCT'') indicates that, by 2008, 19.7 percent of taxpayers in the 
$75,000 to $100,000 bracket will be paying the AMT and that almost 1.75 
million AMT returns will be filed by individuals in the $30,000 to 
$75,000 bracket. Joint Committee on Taxation, Present Law and Issues 
Relating to the Individual Alternative Minimum Tax (``AMT'') (JCX-3-
98), February 2, 1998. Another study indicates that, by 2007, almost 95 
percent of the revenue from AMT preferences and adjustments will be 
derived from four items that are ``personal'' in nature and are not the 
product of any tax planning strategies--the personal exemption, the 
standard deduction, state and local taxes, and miscellaneous itemized 
deductions. In fact, the same study indicates that, in 1994, the 
disallowance of the deduction for state and local taxes accounted for 
approximately 47 percent of total AMT preferences; we expect this 
percentage is even larger today. Harvey and Tempalski, ``The Individual 
AMT: Why It Matters,'' National Tax Journal, Vol. L, No. 3, September 
1997. Further, even those individuals who ultimately do not pay any AMT 
liability increasingly will lose the benefits of credits that Congress 
decided were necessary and appropriate and, in some cases, may have 
been targeted to specific classes of taxpayers. For example, the 1998 
JCT pamphlet projects that, by 2008, 7.9 million returns will receive 
zero or less than the full child care credit due to AMT limitations.
    Third, the AMT is too complex and imposes too great a compliance 
burden. The existence of the AMT system literally requires all people 
to compute their taxes under two different sets of rules--the regular 
rules and the AMT rules. Given the complexity associated with the 
regular tax system, even a small amount of additional complexity from 
an additional tax system may be too much. However, the AMT involves 
more than a small amount of additional complexity. Even individuals who 
ultimately do not end up paying the AMT have to perform calculations to 
determine whether or not they need to pay it or whether they are 
restricted in their use of credits. For example, taxpayers trying to 
determine whether or not they owe the AMT must complete a 12-line 
worksheet first, then a 43-line form (and another 22-lines if they have 
long-term capital gains). Further, some of the adjustments (such as 
those for depreciation and net operating losses) require the taxpayer 
to keep two sets of records, one for regular tax purposes and the other 
for AMT purposes so that proper alternative calculations may be made in 
the future, even if there is no AMT liability currently. It is no 
wonder that many individuals fail to make the statutorily required 
calculations, either because they cannot imagine the AMT would apply to 
them, or because they simply cannot deal with the excessive complexity.
    Fourth, some of the adjustments and preference items are 
inappropriate from both a policy and a technical perspective. While 
virtually all of the adjustments and preferences can be, and have been, 
sharply criticized from a policy standpoint, two adjustments that apply 
only to individuals seem particularly inappropriate for technical 
reasons as well. Neither the adjustment to disallow miscellaneous 
itemized deductions nor the adjustment for ISOs seems supportable from 
a policy or technical standpoint. The AMT's main purpose is to blunt 
the use of tax shelter or uneconomic deductions incurred to reduce 
income tax excessively. The regular tax system permits as a 
miscellaneous itemized deduction those expenditures that are employment 
related or are clearly related to the production of income or the 
management or maintenance of income-producing property. There is no AMT 
objective to deny a deduction for the remaining, clearly employment--or 
income-related, expenses. Certainly they are not the sort of deductions 
that individuals incur as tax-shelter items or ``trump up'' 
artificially to eliminate income tax.
    The AMT system also denies regular tax benefits accorded to 
incentive stock options by requiring that the excess of the fair market 
value of the stock over the exercise price (i.e., the ``bargain'' 
element) be included in income in the year the option is exercised. 
However, this adjustment improperly taxes the ISO gain at a 28% rate 
rather than the top capital gain rate of 20%, the rate applicable under 
the regular tax system. There seems no justification for this denial of 
capital-gain character of the bargain element now that Congress has 
expressed its intention in the Taxpayer Relief Act of 1997 that long-
term capital gain be taxed under the AMT system at no higher rate than 
under the regular system.

3. Recommendations

    We respectfully suggest that the Subcommittee consider the 
following alternatives, which we state in our order of preference.
    a. Repeal the Individual AMT. As indicated above, the individual 
AMT is no longer necessary to serve its intended purpose and, if kept 
in place, will become the regular tax system for more and more 
individuals. Further, the additional burdens it imposes are not 
justified by a sufficiently clear policy objective and, if left 
unchecked, almost certainly will engender further dissatisfaction with 
the tax system. We realize that repealing the individual AMT is 
expensive and may raise a political problem if repeal is perceived as 
aiding people with economic income to avoid paying their fair share of 
taxes. However, we respectfully submit that, even though it may be 
expensive to repeal the individual AMT in its entirety now, the cost of 
repeal will only increase in the future as more people are affected. 
Further, it is doubtful that repealing the individual AMT will result 
in a significant ``perception'' problem akin to that which precipitated 
the enactment of the original add-on tax in 1969, given the reforms to 
the Tax Code that have been made in the interim and Congressional 
willingness to legislate against shelter transactions in general. 
Indeed, we believe there will be a much worse political problem if the 
AMT is not repealed and more and more Americans become subject to the 
AMT, lose credits to which they otherwise would be entitled, or are 
forced to endure the frustration of spending even more time and effort 
on filing their income tax returns.
    b. Exclude Taxpayers with Average AGI Below a Certain Threshold 
from the AMT System Entirely. In the Taxpayer Relief Act of 1987, 
Congress struck a blow in favor of simplicity by excluding certain 
small corporations from the burden of AMT calculations. This was done 
on the basis of the average gross receipts of the corporation for the 
prior three years. Applying a similar approach to individuals could 
exclude many taxpayers from the individual AMT system while still 
retaining much of the revenue. For example, based on income 
distribution tables as of 1994, it might be possible to exclude 
approximately two-thirds of taxpayers from the AMT system, while 
retaining nearly two-thirds of the revenue, by excluding entirely from 
the AMT system any individuals whose average AGI for the prior three 
years was under $200,000, adjusted for inflation. See Harvey and 
Tempalski, Table 3 at p. 463. We emphasize, however, that this approach 
alone does not fully respond to the significant substantive problems 
with the AMT.
    c. Partial Repeal. Another alternative would be to examine each 
preference and adjustment item separately and to determine whether it 
should be retained in the AMT system. However, in our view, proper 
analysis of each item of adjustment and preference would result in the 
AMT system being repealed. There is little, if any, justification for 
the ``business'' adjustments and preferences, and clearly is no 
justification for any of the personal adjustments and preferences. 
Still, if full repeal is not possible, major simplification could be 
achieved by (1) allowing all credits to reduce the individual's 
liability, without regard to the AMT (i.e., making the temporary 
measure for 1998 returns permanent); (2) removing most of the 
adjustments and preferences, which are mostly ``cats and dogs'' anyway, 
while retaining at most the four or five ``core'' items that account 
for almost all the revenue; and (3) removing some of these core items 
depending upon revenue constraints. As indicated above, however, we 
strongly urge the Subcommittee to consider repealing the entire system. 
Individual items can be addressed directly under the regular tax rules, 
if necessary for revenue purposes.
    d. Fix Problems with the Existing Adjustments and Preferences. Even 
if Congress decides to retain all or most of the existing preferences 
and adjustments for perception or revenue reasons, we recommend that 
Congress correct the glaring problems with two preference items that 
affect only individuals. First, the denial for AMT purposes of any 
deduction for miscellaneous itemized deductions should be repealed. The 
regular tax system already denies a deduction for a portion of those 
expenses, i.e., the portion equal to two percent of AGI. The remaining 
portion is either an employment-related expense or is clearly related 
to the production of income or the maintenance of income-producing 
property. It cannot be said that these deductions are ``excessive,'' 
uneconomic or otherwise incurred primarily to reduce income tax. There 
is no reason for these items to be denied under the alternative system 
when they are sufficiently ``income related'' to be allowed under the 
regular tax system. Second, the adjustment for ISO stock should be 
modified or eliminated as it inappropriately taxes a portion of the 
gain at a rate in excess of the maximum 20% that Congress intended be 
applied to long-term capital gain. As noted earlier, because the entire 
gain will be treated as capital gain if the stock is held for more than 
12 months after the option is exercised, the so-called bargain element 
should also be treated as capital gain under the AMT system and taxed 
at a top rate of 20%.
    e. Index the Rate Brackets and the Exemption Amount. Studies have 
shown that indexing the rate brackets and exemption amount would solve 
a significant part of the second problem highlighted above--that more 
and more people will be affected by the AMT each year. For example, the 
above-cited article by Harvey and Tempalski indicates that, if the AMT 
exemption, the income level at which the phaseout of the AMT exemption 
begins, and the income level at which the AMT marginal rate switches 
from 26 to 28 percent were indexed, approximately 8.2 million fewer 
taxpayers would be affected by the AMT in 2007 than if nothing were 
done. Indexing the parameters of the AMT is less optimal than full 
repeal, however, because it will do little to alleviate the compliance 
burden associated with the AMT system. That is, people will still have 
to make the calculations to determine whether they must pay the AMT or 
whether they will lose the benefit of certain credits. For these 
reasons, we view indexing as our last choice and as only a partial 
response to the problem.
    We urge this Subcommittee in the strongest possible terms to solve 
the problems with the AMT once and for all. There is universal 
acknowledgement that the effects we have described are unintended and 
unjustified. It is also acknowledged that the revenue cost associated 
with a permanent solution will only increase over time and may 
eventually become prohibitive. It would be a travesty if a permanent 
solution to the AMT became caught on the merry-go-round of expiring 
provisions. A permanent solution should not be deferred merely because 
it competes with other, more popular proposals for tax reduction.

       B. Phaseout of Itemized Deductions and Personal Exemptions

    At the urging of the Tax Section, the American Bar Association 
earlier this year adopted a recommendation that the Congress repeal the 
phaseout for itemized deductions (the so-called ``Pease provision'') 
and the phaseout for personal exemptions (the ``PEP provision''). The 
ABA also recommends that the revenue that would be lost by repeal be 
made up with explicit rate increases. This would address any revenue 
neutrality concern, as well as any concern with respect to the 
distributional effects of repeal.
    It may be difficult for members of Congress to appreciate the level 
of cynicism engendered by these two phaseouts. Countless times, 
taxpayers who might not otherwise be troubled by the amount of tax they 
are paying have reacted in anger when confronted with the fact that 
they have lost--either wholly or partially--their itemized deductions 
and personal exemptions. They are no more comforted when told that 
these phaseouts should really be viewed as substituting for an explicit 
rate increase. Almost without exception, they react by asking why 
Congress refuses to impose the additional rate rather than trying to 
pull the wool over their eyes.
    We have no answer to that question. We take pride in the fact that 
the ABA is willing to recommend a simplification proposal funded by a 
marginal rate increase on the same taxpayers benefiting from the 
simplification. We urge this Subcommittee to give serious consideration 
to the ABA's recommendation.

                 C. Additional Simplification Proposals

    Although the alternative minimum tax certainly causes great 
complexity in the Code (and its application is much more widespread 
than ever envisioned), the Code is replete with numerous other 
provisions, the complexity of which are much greater than the perceived 
abuse to which the provision was directed or the benefit that was 
deemed gained by its addition. Furthermore, the Code contains many 
provisions which at the time of enactment may well have been desirable, 
but with the passage of time or the enactment of other changes, have 
truly become ``deadwood.'' However, despite the lack of utility of such 
provisions (whether in a relative or absolute sense) analysis of the 
same may well be required either in the preparation of the tax return 
or in the consummation of a proposed transaction. The elimination of 
such provisions would greatly simplify the law. The following are 
examples of such provisions, that when analyzed do not justify their 
continuation in the law. Obviously, these are but a few such examples, 
and an extensive analysis of the Code would undoubtedly uncover a 
legion of the same. We have separated our recommendations into 
categories for individual, business, and administrative items.

1. Individual Tax Provisions

    a. Simplify Phaseouts. Numerous sections in the Code 
provide for the phaseout of benefits from certain deductions or 
credits over various ranges of income based on various measures 
of the taxpayer's income. There is no consistency among these 
phaseouts in either the measure of income, the range of income 
over which the phaseouts apply or the method of applying the 
phaseouts. Even without the inconsistencies, the phaseouts 
cause problems. They add significantly to the length of tax 
returns, increase the potential for errors, are difficult to 
comprehend, and make it extraordinarily difficult for families 
to know whether the benefits the provisions confer will be 
available. The inconsistencies exacerbate these problems, 
causing inordinate complexity, particularly for taxpayers 
attempting to prepare their tax returns manually. Simplicity 
would be achieved by (a) eliminating phaseouts altogether, (b) 
substituting cliffs for the phaseouts, or (c) providing 
consistency in the measure of income, the range of phaseout and 
the method of phaseout.
    b. Rationalize Estimated Tax Safe Harbors. Section 6654 
imposes an interest charge on underpayments by individuals of 
estimated income taxes, which generally are paid by self-
employed individuals. This interest charge generally does not 
apply if the individual made estimated tax payments equal to 
the lesser of (x) 90 percent of the tax actually due for the 
year or (y) 100 percent of the tax due for the immediately 
prior year. The availability and computation of the prior year 
safe harbor has been adjusted regularly by the Congress over 
the past decade. Presently, for individuals with adjusted gross 
income exceeding $150,000, the prior year safe harbor 
percentage increases and decreases from year to year over a 
range from 105 to 112 percent. The purpose of these increases 
and decreases is to shift revenues from year to year within the 
five and ten year budget windows used for estimating the 
revenue effects of tax legislation. Congress should determine 
an appropriate safe harbor percentage and apply that amount for 
all years, avoiding the complexity the increasing and 
decreasing percentages bring.
    c. Repeal the Two Percent Floor on Miscellaneous Itemized 
Deductions. The two percent floor on miscellaneous itemized 
deductions contained in Section 67 was enacted as a 
simplification measure intended to relieve taxpayers of 
recordkeeping burdens and the Internal Revenue Service 
(``IRS'') of the burden of auditing deductions insignificant in 
amount. Experience indicates that taxpayers continue to keep 
records of such expenses to determine deductible amounts in 
excess of two percent of adjusted gross income. Moreover, the 
existence of the limitation and the need to identify the 
deductions to which it applies introduces needless 
computational and substantive complexity to the preparation of 
tax returns.
    d. Increase the Floor for Itemized Deductions for Medical 
Expenses and Increase the Personal Exemption Amount for 
Taxpayers 65 or Over. A deduction is allowed for medical 
expenses in excess of 7.5 percent of adjusted gross income. 
Despite the current 7.5 percent floor, which limits the 
deduction to extraordinary unreimbursed medical expenses, the 
existence of the deduction requires taxpayers to identify 
medical as compared to personal expenses and to maintain 
detailed records of the former. An increase in the floor to 10 
percent of adjusted gross income would reduce the number of 
returns claiming the medical expense deduction and alleviate 
substantiation and audit verification problems and numerous 
definitional issues. An increase in the floor to a catastrophic 
level would also likely reduce the number of taxpayers 
maintaining medical records. The personal exemption amount for 
taxpayers 65 and older could be increased to offset any adverse 
effect on elderly taxpayers.
    e. Reduce Family Unit Tax Complexity. A number of 
provisions make the filing of tax returns and computation of 
tax liability particularly complicated for low and moderate 
income taxpayers. Certain provisions necessitate the filing of 
returns by individuals who would otherwise have no tax 
liability and no need to file. The complexity of the 
calculations coupled with definitional issues make it extremely 
difficult for low and moderate income taxpayers to complete 
their returns without paid assistance, which they cannot 
afford. These provisions result in a significant number of 
adjustments to tax returns, causing considerable administrative 
difficulties for the IRS in making the adjustments and 
collecting the amounts due. In addition, the adjustments result 
in additional liability for interest and penalties on the part 
of a group of taxpayers that has difficulty satisfying the tax 
liability, let alone additional sums.
    f. Earned Income Credit. The Earned Income Credit (EIC) 
contained in Section 32 provides a substantial, refundable tax 
credit to low income workers, both with and without children. 
The EIC, as presently designed, creates several layers of 
complexity.
     The EIC requires many taxpayers to file a return 
whose income would otherwise fall below filing thresholds.
     The definition of a ``qualifying child'' under 
Section 32(c)(3) differs from the definition of a dependent 
child, and treats foster children differently from biological 
or adoptive children.
     The AGI tie-breaker rule does not resolve the 
perceived abuse it targets while its application often 
incorrectly denies the credit to people who should be eligible, 
insofar as it does not focus on a clear and reasonable 
definition of what constitutes a ``household''.
    g. Child Credit. The Child Credit, contained in Section 24, 
on account of its multiple calculations and ``integration'' 
with the child and dependent care credit, the earned income 
credit, the alternative minimum tax, and social security tax 
creates unnecessary complexity for taxpayers who would 
otherwise be able to file simple returns.
    h. Dependent Care Credit. The Dependent Care Credit, 
contained in Section 21, is of limited benefit to low income 
working families because it is not refundable. Further, it does 
not benefit higher-income working families because the credit 
rate caps at relatively low income levels and does not reflect 
the true cost of child or dependent care.
    i. Nondeductibility of Child Support Payments. The 
treatment of child support payments as a nondeductible expense 
creates confusion and leads to many noncustodial parents 
claiming dependency exemptions for children without obtaining 
the required Form 8332. It places the burden on the IRS 
administratively to identify and audit such claims, and makes 
the dependency exemption an element of horse-trading in 
domestic relations disputes, catching taxpayers in a conflict 
between state domestic relations orders and Federal income tax 
laws. The disparate treatment of alimony and child support adds 
the complexity of the tax law to negotiations that are often 
difficult and unpleasant.
    j. Dependency Definition. The current definition of 
``dependent'' under Sections 151 and 152 is confusing and 
difficult to administer. In particular, problems arise with 
regard to the treatment of (1) children of separated or 
divorced spouses; (2) other ``custodians'' of dependent 
children; and (3) ``custodians'' of disabled or elderly 
individuals. Further, as noted previously, the definition of a 
dependent child is not harmonized with the definition of a 
``qualifying child'' under the earned income credit, nor is the 
concept of ``support'' identical to the concept of 
``maintaining a household'' for purposes of head of household 
status under Section 2(b). Finally, foster children are treated 
differently from biological or adopted children.
    k. Simplification Alternatives for Family Status Issues. 
Simplification for low and moderate income taxpayers could be 
pursued at a macro level, with a wholesale revision of the 
provisions intended to provide benefits to this group of 
taxpayers, or at a micro level by addressing individual issues 
described above. On the macro level, replacing ``head of 
household'' status, dependent child exemptions, and the child 
credit with one ``mega-'' program that provides the economic 
value of these benefits to taxpayers with children, with the 
same overall distribution of benefits as under current law 
could result in significant simplification for low and moderate 
income taxpayers. Definitions would be coordinated with those 
utilized in the EIC program. The exemption amount could differ 
depending on whether the taxpayer is single or married (or 
married filing separately). With this kind of macro revision, 
taxpayers would only have to walk through two sets of 
coordinated rules--the mega-exemption and the EIC.
    On a micro level, the following alternatives address 
particular problems and could significantly reduce complexity 
in those areas.
     Apply one standard for qualification as a 
dependent child, qualifying child for purposes of the EIC, and 
head of household status (if retained) that equates support 
with the cost of maintaining a taxpayer's household and is 
based on the child residing in the taxpayer's home for more 
than half the tax year. Provide safe harbors for taxpayers 
awarded custody by court order or other agreement. (Taxpayers 
could check a box signifying the existence of such an order or 
agreement.)
     Define dependent to include foster children 
residing in a home for more than half the tax year. In the case 
of a court order or other official ``placement'' of the child 
(e.g., by order of the local Department of Social Services, a 
child welfare agency, or other placement agency), qualification 
could be established by attaching a copy of the order to the 
return or checking a box signifying the existence of such an 
order. In the case of the informal placement of a foster child, 
the taxpayer would have to establish residence for more than 
half the tax year.
     Equalize the treatment of alimony and child 
support by making child support deductible by the payor and 
included in income by the payee. This will remove much of the 
``gaming'' involved with duplicate claims for dependency 
exemptions, the earned income credit and head of household 
status, and problems arising from state domestic relations 
orders, since it gives taxpayers who pay child support some tax 
benefit for their payments. Since dependent exemptions will 
only be claimed by custodial parents or other custodial 
individuals, nonworking custodial parents will usually not have 
to file. Those custodial parents who do file will claim 
dependency exemptions and other child-related credits.
     Increase the dependency exemption to ensure it 
reflects the cost of maintaining a home for a child. An 
increase in the amount of the dependency exemption in 
conjunction with standard deductions that more accurately 
reflect minimum cost of living would reduce the number of 
taxpayers who must file returns.
     Replace the ``AGI tie-breaker'' rule in the EIC 
with a definition of ``household'' that more accurately targets 
the perceived abuse of two unmarried taxpayers living together 
and gaming the system.
     Facilitating or mandating advance EIC payments 
through integration of Forms W-4 and W-5 and employee 
withholding systems would eliminate the need for many taxpayers 
to file returns.
     Establish a uniform credit rate for the dependent 
care credit and make the credit refundable so it truly benefits 
lower income working families.
    l. Simplify the Capital Gains Provisions. The capital gains 
regime applicable to individuals is frighteningly and 
unnecessarily complex. As a result of Congressional 
determinations that some assets are worthier of tax benefits 
than others and that investment in capital assets should be 
encouraged but only if the tax benefits affect revenue some 
time in the future, the Code contains a bewildering variety of 
rules under which different types of assets are subject to 
different rates and the rates applicable to long-term gains 
vary depending on the holding period. This system imposes 
difficult record-keeping burdens on taxpayers and encourages 
taxpayers to try to manipulate the system through investments 
in derivatives, short sales, and similar techniques. In 
addition, taxpayers holding property acquired before 2001 can 
elect to have the property treated as if it had been sold on 
the first business day after January 1, 2001, thereby becoming 
eligible for the special 18% rate if it is held for another 
five years. Determining whether to make this election will 
require taxpayers to make economic assumptions and do difficult 
present value calculations. While there may be some 
justification for each item of fine-tuning in this area, their 
cumulative effect has been to create a structure that is 
incomprehensible to taxpayers and to the people who prepare 
their tax returns.
    Simplification can take several forms. First, different 
rates for different types of assets (e.g., collectibles) should 
be eliminated. Second, different rates for long-term assets 
held for different holding periods should be eliminated; there 
is no reason to have a special ultra-low rate for assets held 
for more than five years. Third, to assure that any benefit is 
extended to all taxpayers regardless of their tax brackets, the 
concept of special capital gain rates might be replaced by an 
exclusion for a percentage of long-term capital gains.
    m. Harmonize and Rationalize Education Incentives. The Code 
contains a variety of provisions granting taxpayers educational 
incentives. These provisions include education IRAs, the Hope 
Credit, the Lifetime Learning Credit, exclusions for employer-
provided educational assistance, and interest deductions on 
student loans. The sheer number of alternatives creates 
complication. Moreover, the targeting of the provisions makes 
them particularly complicated and difficult to comprehend. The 
restrictions on their use can mean that taxpayers unexpectedly 
find they have lost the benefit of a particular incentive. The 
education incentives should be harmonized and rationalized so 
that taxpayers have a simple and clear menu of options from 
which to choose in planning for educational expenses that 
yields predictable results.
    n. Eliminate Elections. Many provisions allow taxpayers to 
elect special treatment. While some elections are necessary and 
appropriate (e.g., election to be treated as an S corporation), 
it is often the case that elections and safe harbors, even 
those enacted in the name of simplification, increase 
complexity. The availability of an election oftentimes requires 
taxpayers to make multiple computations to determine the best 
result, thereby adding significant complexity. For example, the 
various elections available under recently enacted Section 6015 
with respect to innocent spouse relief increase planning and 
procedural complexity significantly. Likewise, some recent 
proposals for eliminating or reducing the so-called marriage 
penalty would effectively require married couples to compute 
their income twice to determine which approach yielded a lower 
tax payment. In lieu of providing multiple approaches to the 
same goal, Congress should develop a single legislative 
solution to address a specific problem, and should make such a 
solution as simple and fair as possible.
    o. Increase the Estate and Gift Tax Unified Credit. The 
Code requires the estates of decedents with gross estates in 
excess of the exclusion amount ($650,000 in 1999) to file 
estate tax returns. According to the latest published IRS 
statistics (calendar year 1996), approximately 79,346 estate 
tax returns were filed that year. Fewer than half of the 
returns filed (47.5 percent) reported estates that were subject 
to tax. Of those subject to tax, the largest 14 percent of 
estates (over $2.5 million gross estate) bore 69 percent of the 
total estate tax paid. Conversely, the lowest 86 percent of 
gross estates paid only 31 percent of the total estate tax 
revenues received ($4.51 billion out of $14.49 billion). In 
1997, Congress put in place a gradual phase-up of the exclusion 
amount to $1 million in 2006, which will eliminate the filing 
requirements for a substantial number of estates otherwise 
required to file returns and reduce to zero the tax owed by 
many of those estates. An additional increase in the unified 
credit (beyond $1 million) would further relieve an additional 
significant number of decedents' estates from the burden of 
filing returns and paying estate tax without a significant 
decrease in Federal revenue. More importantly, such a change 
would relieve many such individuals during their lifetimes of 
the burden of estate planning oriented almost entirely toward 
minimizing their estate tax liability, rather than family and 
business succession considerations.
    p. Repeal Sections 2032A and 2057. Section 2032A (enacted 
in 1976) provides special valuation rules for farms and real 
property used in a trade or business. Section 2057 (enacted in 
1997) provides a deduction for a limited amount of the value of 
a closely held business. The maximum reduction in the value of 
a decedent's estate from use of Section 2032A is $750,000; the 
maximum deduction under Section 2057 is $675,000 (not taking 
into account the interaction with the unified credit). The 
limited benefits provided by these Sections, which is limited 
to a select group of taxpayers, should be contrasted with the 
substantial complexity they produce. In addition to their 
statutory and administrative complexity, the provisions 
encourage extensive tax planning and invite manipulation of 
ownership interests and asset use.
    q. Simplify Transfer Tax Valuation of Minority Interests in 
Non-Publicly Traded Family-Owned Businesses. Significant 
taxpayer planning and government administrative expenses are 
incurred when a discount is claimed with respect to the value 
of ownership interests in non-publicly traded business 
enterprises controlled by a family. Significant simplification 
could be achieved if the value of stock in a non-publicly 
traded corporation were deemed to be equal to its pro rata 
share of all the stock of the same class in such corporation, 
unless a different value is established by clear and convincing 
evidence. Under this test, all stock held, directly or 
indirectly, by an individual or by members of such individual's 
family will be treated as held by one person. Similar rules 
would apply to ownership interests in other entities.

2. Small Business Tax Provisions

    a. Simplify the Minimum Distribution Requirements. Under Section 
401(a)(9), qualified retirement plan benefits must be distributed to a 
participant or his or her beneficiary(ies) within a prescribed period 
of time that is dependent upon a number of variables, including the 
identity of the participant's beneficiary(ies) and the circumstances 
under which benefits are paid. Section 408(a)(6) extends these 
distribution requirements to IRA benefits. The distribution rules in 
Section 401(a)(9) complicate the administration of qualified retirement 
plans and IRAs, and present conceptual difficulties for participants. 
Moreover, although intended to preclude the unreasonable deferral of 
benefits, benefits deferred are subject to income taxation upon 
eventual distribution and may be subject to estate taxation upon a 
participant's death. The provisions of Section 401(a)(9), other than 
those dealing with the required beginning date for distribution of 
retirement benefits, should be replaced with the incidental death 
benefit rule in effect prior to the enactment of the Employee 
Retirement Income Security Act of 1974 (hereafter ``ERISA'').
    b. Eliminate the Half-Year Age Conventions. Section 401(a)(9) 
provides that retirement plan benefits must commence, with respect to 
certain employees, by April 1 of the calendar year following that in 
which the employee attains 70\1/2\. Section 401(k) states that plan 
benefits may not be distributed before certain stated events, including 
attainment of age 59\1/2\. Further, Section 72(t) provides that 
premature distributions from a qualified retirement plan, including 
most in-service distributions occurring before an employee's attainment 
of age 59\1/2\, are subject to an additional 10% tax. Changing these 
age requirements to age 70 and age 59, respectively, would simplify 
plan administration.
    c. Repeal or Modify the Top Heavy Rules. Section 416 was enacted to 
limit the ability of a plan sponsor to maintain a qualified retirement 
plan benefiting primarily the highly paid. Section 416 is both 
administratively complex and difficult to understand. Furthermore, 
under current law, there are limitations on the compensation with 
respect to which qualified retirement plan benefits can be provided, 
there are overall limitations on qualified retirement plan benefits, 
and non-discrimination requirements limit the ability of sponsors to 
adopt benefit formulas favoring the highly paid. Given the other 
limitations in the Code, Section 416 adds an unnecessary layer of 
complexity to employee plan administration.
    If Section 416 is retained, the rule attributing to a participant 
stock owned by a member of the participant's family for purposes of 
determining whether or not the participant is a key employee should be 
eliminated. This change would be consistent with the recent repeal of 
the family aggregation rules under Sections 401(a)(17) and 414(q).
    d. Replace the Affiliated Service Group and Employee Leasing Rules. 
Sections 414(b) and 414(c) treat businesses under common control as a 
single employer for purposes of determining whether a retirement plan 
maintained by one or more of these businesses qualifies under Section 
401. Two other Code provisions adopt an aggregation concept as well. 
Specifically, Section 414(m) generally treats all employees of members 
of an affiliated service group as though they were employed by a single 
employer, and Section 414(n) states that, under certain circumstances, 
a so-called leased employee will be deemed to be employed by the person 
for whom the employee performs services. No regulations have been 
finalized under these provisions. They are difficult to comprehend and 
to apply.
    Sections 414(m) and 414(n) should be replaced with provisions 
explicitly describing and limiting the circumstances under which 
employees of businesses that are not under common control must be taken 
into account for purposes of determining the qualified status of a 
sponsor's retirement plan, and the discretion granted under Section 
414(o) to develop different rules should be repealed.
    e. Worker Classification. Determining whether a worker is an 
employee or independent contractor is a particularly complex 
undertaking because it is based on a 20-factor common law test. The 
factors are subjective and given to varying interpretations and no 
guidance exists on how or whether to weight them. In addition, the 
factors are not applicable in all work situations, and, in some work 
situations, the factors do not provide a meaningful indication of 
whether the worker is an employee or independent contractor. The 
consequences of misclassification are significant for both the worker 
and employer, including retroactive tax assessments, imposition of 
penalties, disqualification of benefit plans, and loss of deductions.
    Complexity would be significantly reduced by enactment of an 
objective test to replace the subjective 20-factor test and making it 
applicable for Federal income tax and ERISA purposes. In the 
alternative, changes could be made to reduce the differences between 
the tax treatment of employees and independent contractors. Efforts to 
make the tax law more neutral with respect to whether a worker is an 
employee or independent contractor would reduce the importance of the 
worker classification rules because the consequences of 
misclassification would be less significant.
    f. Expand the Use of the Cash Method of Accounting. Small C 
corporations, qualified personal service corporations, sole proprietors 
and certain passthrough entities are excepted from the required use of 
the accrual method under Section 448. This exception does not cover 
more than de minimis amounts of inventory, however, and there are no 
specific rules delineating when inventory is de minimis. In addition, 
the applicability of the inventory rules, which were written for the 
industrial age, is not at all clear for businesses operating in the 
information age. For example, it is not clear whether a business 
developing software sold via the Internet is required to use an 
inventory method. Thus, some businesses cannot easily determine if they 
have inventory that requires the use of the accrual method of 
accounting. Moreover, many of these businesses otherwise use the cash 
method of accounting, so that requiring the use of the accrual method 
and the keeping of inventories subjects them to complex rules and 
recordkeeping.
    Considerable simplification could be achieved by amending Sections 
446 and 448 to allow small taxpayers to use the cash method of 
accounting. Consistent with Section 448, small taxpayers (even those 
with inventory) could be defined as those with average annual gross 
receipts in the three prior years of $5 million or less. This rule 
would enable small businesses (even those with inventory) to use the 
cash method should they find it simpler. This proposal should not 
result in taxpayers manipulating their income because such businesses 
generally cannot afford to maintain large quantities of inventory on 
hand and the inventory levels of small businesses, in particular, would 
not be extensive. Further simplification could be achieved by 
increasing the Section 448 gross receipts threshold to $10 million.
    g. Provide Clear Rules Governing the Capitalization and Expensing 
of Costs and Recovery of Capitalized Costs. Although the IRS clearly 
stated that the Supreme Court's decision in INDOPCO v. Commissioner, 
503 U.S. 79 (1992), did not change fundamental legal principles for 
determining whether a particular expense may be deducted or must be 
capitalized, nonetheless, since INDOPCO, whether an expense must be 
capitalized has become the most contested audit issue for businesses. A 
future benefit test derived from the INDOPCO decision has been used by 
the IRS to support capitalization of numerous expenditures, many of 
which have long been viewed as clearly deductible. Almost any ongoing 
business expenditure arguably has some future benefit. The distinction 
between an ``incidental'' future benefit, which would not bar deduction 
of the expenditure, and a ``more than incidental'' future benefit, 
which might require capitalization, generally is neither apparent nor 
easy to establish to the satisfaction of parties with differing 
objectives. In addition, the administrative burden associated with 
maintaining the records necessary to permit the capitalization of 
regular and recurring expenditures is significant. Development of 
objective, administrable tests governing the deduction of expenses or 
the capitalization of categories of expenditures would significantly 
reduce controversy, just as the enactment of Section 197 significantly 
reduced controversy regarding the amortization of intangible assets. 
For example, repair allowance percentages such as those previously 
provided under the Class Life Asset Depreciation Range (CLADR) System 
would significantly reduce controversy regarding capitalization of 
repair expenditures. See Rev. Proc. 83-35, 1983-1 C.B. 745 (CLADR 
repair allowance percentages); see alsoSection 263(d) (repair allowance 
percentage for railroad rolling stock).
    h. Modify the Uniform Capitalization Rules. The uniform 
capitalization (``UNICAP'') rules in Section 263A are extraordinarily 
complex. Compliance with the UNICAP rules consumes significant taxpayer 
resources; yet, for many taxpayers, the UNICAP rules do not result in 
capitalization of any significant amounts not capitalized under prior 
law. Modification of the UNICAP rules to limit their application to 
categories of expenditures not addressed comprehensively under prior 
law (e.g., self-constructed assets) or to large taxpayers would reduce 
complexity for many taxpayers.
    i. Simplify S Corporation Qualification Criteria. The definition of 
an ``S corporation'' contained in Section 1361 establishes a number of 
qualification criteria. To qualify, the corporation may have only one 
class of stock and no more than 75 shareholders. Complex rules provide 
that the shareholders must be entirely composed of qualified 
individuals or entities. On account of state statutory changes and the 
check-the-box Regulations, S corporations are disadvantaged relative to 
other limited liability entities, which qualify for a single level of 
Federal income taxation without the restrictions. The repeal of many of 
the restrictions would simplify the law and prevent inadvertent 
disqualifications of S corporation elections.
    j. Modify the S Corporation Election Requirement. Section 
1362(a)(2) requires all shareholders to consent to an S corporation 
election, as well as that the election be made on or before the 15th 
day of the third month of the taxable year. There are also election 
deadlines for qualified subchapter S subsidiaries and qualified 
subchapter S trusts, which adds complexity. Late elections are common 
occurrences because taxpayers are unaware of or simply miss the 
election deadline. If the election is filed late, Section 1362(b)(5) 
permits the IRS to treat the late election as timely if the IRS finds 
reasonable cause for the late election. This provision has saved 
hundreds of taxpayers from the consequences of a procedural mistake; it 
has also generated considerable administrative work for the IRS as is 
evidenced by the hundreds of rulings granting relief. The election 
deadline was intended to prevent taxpayers from waiting until income 
and expenses for the taxable year were known before deciding whether to 
make an S corporation election. The differences that exist between the 
taxation of S and C corporations are so significant, however, that it 
is unlikely a taxpayer's decision over whether to make an S corporation 
election would be determined by the events during a single taxable 
year. Even if that were the case, it is difficult to understand the 
compelling policy reason to require taxpayers to guess at their 
financial operations for the year in determining whether to make an S 
corporation election at the beginning of the year rather than making an 
informed decision. The ability to pass through losses has been 
substantially restricted by various provisions of the Code. Thus, 
concerns about passing through losses are likely more theoretical than 
real. In addition, as a practical matter, taxpayers cannot wait until 
the end of the taxable year to make a decision because the need to make 
estimated tax payments compels a decision before the date the first 
estimated tax payment is due. Thus, the separate filing of the election 
itself is a mere procedural requirement leading to frequent procedural 
foot faults, but little else.
    The most obvious time for the filing of an election is with a 
filing that is otherwise required. Significant simplification could be 
achieved by requiring the election to be made on the corporation's 
timely filed (including extensions) Federal income tax return for the 
year of the election. The same rule should apply to the qualified 
subchapter S subsidiary and qualified subchapter S trust elections.
    k. Repeal or Simplify the Personal Holding Company Rules. The 
personal holding company rules were enacted in 1934 to tax the so-
called ``incorporated pocketbook.'' With differentials in the corporate 
and individual tax rates, individuals could, for example, place their 
investments in a corporation and substantially lower the Federal income 
tax paid on income generated by those investments, especially if the 
income was held in the corporation and reinvested for a long period of 
time. The personal holding company provisions attack this plan by 
imposing a surtax on certain types of passive income earned by closely 
held corporations that is not distributed (and thus taxed) annually.
    Over time, the personal holding company rules have been broadened 
to include many closely held corporations, both large and small, with 
passive income (whether or not such corporations are, in effect, 
``incorporated pocketbooks'') and, thus, may create a trap for the 
unwary. In addition, the rules have become very complex and difficult 
for the IRS to administer and for taxpayers to comply with, and 
sometimes require taxpayers to rearrange asset ownership to comply with 
the rules. With maximum corporate and individual rates coming closer 
together and the repeal of General Utilities, it is questionable 
whether the personal holding company rules should remain in the tax 
code at all. Regardless of this debate, however, the rules should be 
significantly simplified in order to eliminate the substantial burden 
they impose on closely held corporations.
    l. Repeal the Collapsible Corporation Provision. Since the repeal 
of the General Utilities doctrine in 1986, Section 341--the 
``collapsible corporation'' provision--is essentially deadwood. By 
definition, a collapsible corporation is a corporation availed of with 
a view to a sale of stock before a substantial amount of the corporate 
income has been recognized. After 1986, a sale of corporate stock or a 
sale of all of a corporation's assets prior to the realization of 
corporate income cannot escape corporate taxation. Section 384 assures 
that a purchaser of stock of a corporation with built-in gain property 
cannot utilize its losses to shelter that gain. Since 1964, a 
corporation could escape the rigors of Section 341 by effecting a 
Section 341(f) election, i.e., the corporation agrees to recognize gain 
on the disposition of subsection (f) assets, notwithstanding any 
otherwise applicable non-recognition provisions of the Code. The repeal 
of General Utilities renders Section 341(f) redundant. More accurately, 
it renders Section 341(a) redundant because no corporate gain can now 
escape corporate tax. Since it was that avoidance or potential 
avoidance that gave birth to Section 341, it is now deadwood and should 
be repealed. Its repeal would result in the interment of the longest 
sentence in the Internal Revenue Code--Section 341(e).
    m. Simplify the Attribution Rules. The attribution rules throughout 
the Code contain myriad distinctions, many of which may have been 
reasonably fashioned in light of the particular concern of the 
underlying provision. For example, should siblings be included in the 
rules? Should the ownership test be 80% or 50%? Whatever the reasons 
originally driving the differences among the attribution rules, those 
reasons may simply be outweighed by the need to simplify the Code. 
Consequently, the attribution rules and the concerns underlying them 
should be reexamined in light of concerns about complexity with a view 
to harmonizing and standardizing the rules, unless there are truly 
compelling reasons to do otherwise. At a minimum, and without 
reexamination, it is clear the rules could be simplified by 
standardizing whether the percentage is equal to or greater than and 
not have both.
    n. Simplify the Loss Limitation Rules. The Code contains multiple 
rules limiting the availability of a taxpayer claim to use losses. 
These include Section 465, which limits the deductibility of losses of 
individuals and certain C corporations to the amount at risk--that is, 
generally, the amount of the investment that could be lost plus the 
taxpayer's personal liability for additional losses; Section 469, which 
limits losses incurred in ``passive activities'' Section 704(d), which 
limits a partner's distributive share of a partnership's losses to the 
partner's basis in the partnership interest; and Section 1366(d), which 
limits an S corporation shareholder's loss in similar fashion.
    There are numerous limitations and qualifications layered on each 
of these rules and definitions, and Sections 465 and 469, in 
particular, are extremely complicated and difficult to comprehend. 
Section 465 originally applied only to certain types of activities 
deemed especially prone to abuse, such as the production and 
distribution of films and video tapes, but, in 1978, it was extended to 
virtually all other income-producing activities. Since the enactment of 
Section 469, Section 465 has become superfluous because there are very 
few situations in which a deduction would be denied because of the 
applicability of Section 465 that would not also be denied because of 
the applicability of Section 469.
    Substantial simplification could be achieved by combining, 
rationalizing and harmonizing the loss limitation provisions.
    o. Simplify Section 355. Section 355 permits a corporation or an 
affiliated group of corporations to divide on a tax-free basis into two 
or more separate entities with separate businesses. Under Section 
355(b)(2)(A), which currently provides an attribution or 
``lookthrough'' rule for groups of corporations that operate active 
businesses under a holding company, ``substantially all'' of the assets 
of the holding company must consist of stock of active controlled 
subsidiaries. Under this rule, holding companies that, for very sound 
business reasons, own assets other than the stock of active controlled 
subsidiaries are required to undertake one or more preliminary (and 
costly) reorganizations solely for the purpose of complying with this 
provision. Treating members of an affiliated group as a single 
corporation for purposes of the active trade or business requirement 
will simplify numerous corporate transactions.
    p. Simplify the Consolidated Return Rules. Affiliated groups of 
corporations can elect to file a single consolidated income tax return. 
The dominant theory governing the development of the consolidated 
return regulations is that the consolidated group should be treated as 
a single entity. As evidenced by the hundreds of pages of regulations 
and excruciating detail, this seemingly simple concept has evolved into 
one of the most complex and burdensome areas of the tax law. These 
rules, which are laced with numerous traps for the unwary, are 
virtually incomprehensible, even to experienced tax practitioners if 
they do not spend an entire career in the consolidated return area. 
With the advent of single-member limited liability companies (LLCs) and 
the check-the-box regulations, many companies may be able to avoid or 
ameliorate the complexity of the consolidated return rules by simply 
inserting single-member LLCs into their corporate structure. For 
companies that desire or are required to use a C corporation, however, 
the consolidated return rules still present a major stumbling block in 
terms of complexity. Accordingly, simplification of the consolidated 
return rules would be a major step towards the ultimate goal of 
simplifying the tax laws.
    q. Simplify the PFIC Rules. In 1997, the passive foreign investment 
company (``PFIC'') rules were greatly simplified by the elimination of 
the controlled foreign corporation-PFIC overlap and by allowing for a 
mark-to-market election for marketable stock. However, a great deal of 
complication remains in the PFIC area, suggesting that further 
simplification is necessary. Considerable simplification could be 
achieved by eliminating the application of the PFIC rules for smaller 
investments in foreign companies whose stock is not marketable.
    r. Simplify the Foreign Tax Credit Rules. The foreign tax credit 
area is subject to significant complication, particularly because of 
the nine separate baskets for allocating income and credits set forth 
in Section 904(d)(1). Consolidating these baskets for businesses that 
are either starting up abroad or that constitute small investments 
would provide some relief from the complexity. In addition, treating 
the European Union as a single country would eliminate another 
complication faced by US taxpayers competing in this newly unified 
marketplace. Lastly, the elimination of the alternative minimum tax 
credit limitations on the use of foreign tax credits would greatly 
simplify this area for all US taxpayers operating abroad without 
permitting tax motivated behavior.
    s. Simplify the Subpart F Rules. The Subpart F rules present a host 
of difficulties in their application. While the rules may be necessary 
to prevent tax avoidance by large and sophisticated taxpayers, smaller 
taxpayers or smaller foreign investments could be excepted from the 
application of these rules, which would greatly simplify the tax 
system, without creating the potential for the tax avoidance the rules 
were intended to prevent.
    t. Clarify Treatment of Check-the-Box Entities for Subpart F 
Purposes. Notices 98-11 and 98-35 caused considerable confusion in 
planning with respect to international tax matters. Notice 98-35 
suggests potential rules that, once implemented, could adversely affect 
the use of so-called ``check-the-box'' entities (that is, entities that 
are either disregarded or treated as partnerships for Federal income 
tax purposes but are treated as taxable entities under local law) in 
international transactions. The suggested rules are leaving many 
taxpayers with uncertainly in their international planning. 
Congressional clarification of what factors should be relevant in 
computing ``foreign personal holding company'' income under Subpart F 
would greatly simplify the task of international tax compliance.
    u. Repeal Section 514(c)(9)(E). In general, income of a tax exempt 
organization from debt financed property is treated as unrelated 
business taxable income. Debt financed property is defined in Section 
514 as income producing property subject to ``acquisition 
indebtedness,'' which generally does not include debt incurred to 
acquire or improve real property. Section 514(c)(9)(E) (the ``fractions 
rule'') provides, in general, that debt of a partnership will not be 
treated as acquisition indebtedness if the allocation of income and 
loss items to a tax exempt partner cannot result in the share of the 
overall taxable income of that organization for any year exceeding the 
smallest share of loss that will ever be allocated to that 
organization. This provision was enacted to prevent disproportionate 
allocations of income to tax exempt partners and disproportionate 
allocations of loss items to taxable partners. The provision has become 
a trap for the unwary as well as a tremendous source of planning 
complexity even for those familiar with it. Anecdotal evidence suggests 
that few practitioners understand the provision completely, and almost 
no IRS agents or auditors raise it as an issue on audits. Instead, 
because of its daunting complexity, it has become a barrier to 
legitimate investment in real estate by exempt organizations. At the 
same time, other provisions in the tax law (such as the requirement of 
substantial economic effect under Section 704(b)) substantially limit 
the ability to shift tax benefits among partners. Therefore, Section 
514(c)(9)(E) could be repealed without substantial risk of abuse.
3. Administrative Provisions

    a. Deposit Penalty. The failure to timely deposit taxes is subject 
to penalty, pursuant to Section 6656, in amounts ranging from 2 percent 
to 15 percent of the underdeposit, depending on the lateness of the 
deposit. The deposit rules are unnecessarily complex and adversely 
affect small businesses as they move from one payroll deposit category 
to another.
    For example, professional corporations may be severely impacted 
where their payroll deposit is normally less than $100,000 per pay 
period which permits at least semi-weekly deposits (i.e., a three-day 
deposit rule). However, at each year end, in order to pay out all, or 
almost all, of the corporation's income, bonus compensation 
distributions are frequently required. The amount of the bonus 
distributions for each employee, a prerequisite to determining 
appropriate withholding tax, cannot be ascertained until the annual 
books are closed. Closing of the books requires receipts, expenses, 
etc. for the last day of the taxable year to be considered. Bonuses 
must also be paid by the last day of the taxable year (often December 
31) to be tax deductible for such year.
    Financial intermediaries generally require at least one day's 
advance notice to make electronic federal withholding tax deposits. 
Banks and taxpayer businesses are frequently shorthanded at year end 
and find it difficult to determine the amount of the Federal tax 
deposit due until after the financial intermediaries' cutoff time to 
make withholding tax deposits on the next business day. This is 
particularly true for taxpayers in the western U.S. time zones. A 2 
percent penalty is excessive for a deposit that is only one day late, 
particularly where the depositor is normally a semi-weekly depositor 
but is required to make a one-day deposit.
    Congress recently recognized that the changing of deposit 
requirement time frames is a complexity that causes great confusion and 
that waiver of the penalty should be permitted for the first change 
period. See Section 6656(c)(2)(B). While this solution helps, it does 
not fully address the problem. The current provision requires an 
administrative waiver request that may be expensive and time consuming 
and applies only to the first instance of a problem which by nature is 
likely to occur annually. Section 6302 (or the regulations) should be 
modified to require next day electronic depositing only in those 
instances where next day depositing (i.e., $100,000 or more deposit) is 
required of that taxpayer with respect to 10 percent or more of its 
deposits. Alternatively, taxpayers could be given a minimum of two days 
to make deposits of $250,000 or less.
    b. Information Returns. Sections 6041 and 6041A generally require 
reporting of all payments made in connection with a trade or business 
that exceed $600 per year. The $600 per year has never been adjusted 
for inflation. Section 6045(f) now requires reporting of all gross 
payments to attorneys (includes law firms and professional 
corporations) where the portion constituting the legal fee is unknown 
even if the payment is less than $600. Many Form 1099 information 
returns from non-financial institutions cannot be processed by the IRS 
or do not provide truly useable information. Anecdotal evidence 
suggests the information on these information returns may not be used 
in examinations of the taxpayers and cannot be reconciled to tax 
returns. The reporting threshold should be increased to $5,000 (which 
harmonizes with Section 6041A(b)) and adjusted for inflation in full 
$1,000 increments.
    c. Penalty Reform. The 1998 IRS Restructuring Act instructs both 
the Joint Committee on Taxation and the Treasury Department to conduct 
separate studies of the penalty and interest provisions of the Code and 
to make recommendations for the reform of the same.
    The Tax Section believes that reform of the penalty and interest 
provisions is appropriate at this time and looks forward to working 
with the JCT and Treasury. There are many cases in which the 
application of penalty and interest provisions takes on greater 
significance to taxpayers than the original tax liability itself. The 
Tax Section is concerned that these provisions often catch individuals 
unaware, and that the system lacks adequate flexibility to achieve 
equitable results. In light of the significant changes being made by 
the IRS, the completion of this study and eventual enactment of the 
recommendations will be welcome.
    The Tax Section has submitted preliminary comments to the staff of 
the Joint Committee on Taxation that we hope will be useful in 
developing alternatives.

                               Conclusion

    Thank you again for the opportunity to testify at this very 
important hearing. We wish you, and concomitantly all individual and 
small business taxpayers, success in your endeavors. We would be happy 
to work with the Committee and this Subcommittee as legislation is 
developed to address the twin tasks of simplification and avoidance of 
complexity.

                                

    Chairman Houghton. Thank you very much. We are having to 
work on our mechanics here because we have another vote. We 
will get around to some questions, Mr. Tucker. Thanks very 
much.
    Mr. Lifson.

 STATEMENT OF DAVID A. LIFSON, CHAIR, TAX EXECUTIVE COMMITTEE, 
       AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS

    Mr. Lifson. Mr. Chairman and Members of this Distinguished 
Committee, my name is David Lifson and I speak to you 
representing over 330,000 certified public accountants, as the 
chair of the Tax Executive Committee of the American Institute 
of CPAs.
    Many of our members provide comprehensive tax services for 
all types of taxpayers, including businesses and individuals in 
various financial situations. They work daily with the tax 
provisions you enact and we are committed to helping make our 
tax system as simple yet as fair as possible. These days, the 
process of obeying the tax law is more daunting than ever. Our 
tax laws are too complicated. The current outcry for tax 
simplification is not new. In fact the AICPA has warned 
Congress for more than a decade that the tax law is growing so 
dense that it threatens to undermine voluntary compliance.
    Chairman Houghton, I commend you on your commitment to 
reducing the complexity of the tax law. Your Tax Simplification 
and Burden Reduction Act represents an excellent starting point 
for reducing the tax compliance burden imposed on many 
individual taxpayers and small businesses.
    In our written statement submitted for the record, we have 
included our top 10 list of tax law complexities, designed for 
individuals and small businesses. We share concerns about such 
areas of law as the individual AMT and the estimated tax safe 
harbor. We urge you to place a high tax policy value on tax 
simplification and would be pleased to work with you to try to 
make your tax legislative proposals as simple and as complete 
and as effective as possible.
    Complexity has already led to a growing perception by 
taxpayers that the tax law is unfair, increased costs in 
funding the IRS to administer the tax law, increased taxpayer 
compliance costs, and, perhaps, most importantly, undue 
interference with business decisionmaking. Our tradition of 
voluntary tax compliance and self-assessment is a national 
treasure. By and large, our citizens obey the law, but it is 
only human to disobey a law if you do not or cannot understand 
the rules.
    There are various types of simplification, such as 
simplification that reduces calculation complexity, like the 
earned income credit calculation. Simplification that reduces 
the filing burden such as electronic filing. Perhaps most 
importantly, simplification that reduces the chances of a 
dispute between the Internal Revenue Service and the taxpayer, 
such as worker classification reform.
    The first two types of simplification are sometimes the 
easiest to identify, yet, politically, they may not be the 
easiest to address. But they should be the low fruit on the tax 
tree that you can see and capture most readily. The last type, 
adding certainty to the law and thereby reducing the likelihood 
of disputes is the most difficult to effectuate, yet perhaps it 
is the most important. Please help us find simplification in 
all three areas. Clarifying law that is hard to understand must 
be a priority if we are to achieve a simpler system and to 
avoid unnecessary taxpayer unrest.
    Our written submission offers a start. Inside are the 10 
areas that require serious revisions. There are, in fact, 
hundreds of areas that could be improved. Because of their 
importance, I will simply mention four areas of particular 
interest today. I hope you will look into our full explanation 
in our submission for the record.
    The alternative minimum tax is one of the most complex 
parts of the tax system. It should be eliminated or 
substantially simplified. The earned income credit has long 
been identified as an area in great need of simplification. The 
rules are so complex that the targeted taxpayers are often not 
always effectively able to claim the credit. Worker 
classification issues often paralyze startup businesses with 
uncertainty which leads to resentment of the tax system. Until 
taxpayers are provided with clear-cut rules by Congress, this 
area will continue to provide unintended traps for small 
business owners as well as a continuation of the many battles 
between the taxpayers and the IRS. Phaseouts should also be 
simplified and we have provided you with a comprehensive, 
detailed starting point for legislative action.
    There is a good bit more detail in my written statement, 
both on the items I have mentioned here and in a number of 
other areas. We would only ask that you review that statement 
carefully. The AICPA thanks you for the opportunity to help. We 
want to simplify the system for everyone's benefit.
    [The prepared statement follows:]

Statement of David A. Lifson, Chair, Tax Executive Committee, American 
Institute of Certified Public Accountants

    Mr. Chairman, and members of this distinguished committee: My name 
is David A. Lifson, and I am the chair of the Tax Executive Committee 
of the American Institute of Certified Public Accountants (AICPA). The 
AICPA is the professional association of certified public accountants, 
with more than 330,000 members, many of who provide comprehensive tax 
services to all types of taxpayers including businesses and 
individuals, in various financial situations. Our members work daily 
with the tax provisions you enact, and we are committed to helping make 
our tax system as simple and fair as possible.
    The AICPA has long been an advocate of simplification of the tax 
system. The complexity of our tax law has reached the point where many 
taxpayers and practitioners believe that it is undermining voluntary 
compliance. Frequent change, the lack of deliberation in the 
legislative process, and the increasing magnitude and complexity of the 
Internal Revenue Code are serious concerns for tax professionals.
    Chairman Houghton, I commend you on your commitment to reducing the 
complexity of the tax law. The pending Tax Simplification and Burden 
Reduction Act represents an excellent starting point for reducing the 
tax compliance burden imposed on many individual taxpayers and small 
businesses. As you can see from the Top Ten List of Tax Law 
Complexities, we share concerns about such areas of law as the 
individual alternative minimum tax and the estimated tax safe harbor.
    Many of our comments urge simpler solutions, particularly in the 
area of the individual alternative minimum tax and the proliferation of 
individual credits with complex income phase-out rules for families. We 
urge you to place a high tax policy value on tax simplification and 
would be pleased to work with you to try to make your tax legislative 
proposals as simple and as effective as possible.
    There are various types of simplification such as: simplification 
that reduces calculation complexity, like the AMT calculation; 
simplification that reduces the filing burden, such as electronic 
filing; and, simplification that reduces the chances of a dispute 
between the Internal Revenue Service and the taxpayer. The first two 
types are sometimes the easiest to identify and accomplish--the ``low 
fruit'' on the tax tree that you can see and capture most easily. The 
last type, adding certainty to the law and thereby reducing the 
likelihood of disputes, is the most difficult to effectuate yet, 
perhaps, the most important.
    Clarifying law that is hard to understand must be a priority if we 
are to achieve a simpler system. There are numerous areas of the Code 
where this type of simplification is needed. One example is in the area 
of worker classification. The AICPA is on record as supporting S.344, 
the Independent Contractor Simplification and Relief Act of 1999, which 
was introduced by Senator Christopher Bond on February 9, 1999. At this 
time we are examining other proposed legislation in this area. It is 
our hope that the proper elements can be pulled together so that worker 
classification simplification can be accomplished. We welcome the 
opportunity to work with legislators and staffs to design an approach 
that provides certainty, while balancing the needs of service 
recipients and the rights of service providers.
    Significant problems arise from the increasing complexity of the 
tax law. For example:
     a growing number of taxpayers perceive the tax law to be 
unfair;
     it becomes increasingly more difficult for the Internal 
Revenue Service to administer the tax law;
     the cost of compliance for all taxpayers is increasing (of 
particular concern are the many taxpayers with unsophisticated 
financial affairs who are forced to seek professional tax return 
preparation assistance); and,
     complexity interferes with economic decision making.
    The end result is erosion of voluntary compliance. By and large, 
our citizens obey the law, but it is only human to disobey a law if you 
do not or can not understand the rules. In a recent Associated Press 
(AP) poll, 66 percent of the respondents said that the federal tax 
system is too complicated. Three years ago, just under one-half of 
respondents in a similar AP poll said that the tax system was too 
complicated.
    The poll also showed that more than half of those surveyed, 56 
percent, now pay someone else to prepare their tax returns. This is a 
serious indictment of our tax system. When over half our individual 
taxpayers have so little comprehension of (or faith in) their tax 
system that they have to hire another party to prepare their returns, 
something is not right. Consider, too, that only about 30% of 
individual returns claim itemized deductions. Thus, a significant 
segment of those paying to have returns prepared are standard deduction 
filers. The AICPA firmly believes that taxpayers with relatively simple 
financial affairs should not have to seek professional preparation 
services in order to comply with the tax law.
    To maintain a viable voluntary tax system, simplification must have 
a prominent position in the tax process. Although it should not take 
precedence over revenue and tax policy objectives, simplification must 
be an integral part of the tax legislative, regulatory, and 
administrative process. While a tax system that is simple for all 
taxpayers may never be designed, a ``simpler'' system is attainable, 
both through new legislative proposals and a review of existing tax 
law.

      AICPA Blueprint for Tax Simplification and Complexity Index

    The AICPA in the Blueprint for Tax Simplification, issued in 1992, 
identified four elements necessary to create a simpler tax system: (1) 
a visible constituency to communicate the need for simplification to 
Congress and the Administration; (2) identification of guiding 
principles for tax simplification; (3) identification of factors that 
contribute to complexity to be used in the development of a framework 
for analyzing the balance among equity, policy, revenue, and 
simplification objectives; and, (4) consideration of simplification at 
all stages of the legislative and regulatory process.
    The Blueprint also outlined guiding principles in pursuing a 
simpler tax law. These are:
     the legislative process should consider the objectives of 
equity, efficiency and revenue needs, balancing them with 
simplification;
     once tax policy objectives have been identified, 
alternative approaches to implementing the policy should be considered 
to provide the simplest possible design and administration;
     the long-term benefit of any change made to simplify the 
tax law should more than offset any transitory complexity that results 
by a change;
     the law and regulations should be drafted within a 
rational, consistent framework;
     there should be a balance between simple general rules and 
more complex detailed rules;
     the benefit of a provision should be weighed against the 
cost of compliance; and
     tax rules should build on common industry record keeping 
and business practices.
    The Blueprint concluded with the identification of the leading 
factors that create complexity: the effects of change; subjectivity; 
lack of consistent concepts; structural complexity; the effect on 
taxpayers not targeted by a particular provision; communication 
complexity; computations; complexity of forms; administrative issues; 
legal complexity; transactional application and business dynamics; 
diffusion of responsibility; inconsistent application of rules; and the 
legislative process.
    From these factors, the AICPA then developed and released the 
Complexity Index. The Index is a tool for measuring complexity factors 
to assess the complexity, or simplification, of proposed tax law 
changes relative to existing law or competing legislative proposals. 
The Index is used by AICPA committees when developing legislative 
proposals and comments. Although we understand that complexity is a 
multidimensional concept and acknowledge that no single index can 
measure complexity in an absolute sense, the AICPA has encouraged 
Congressional tax writing committees and staffs to use the same or a 
similar index when considering and drafting proposed legislation.

     Internal Revenue Service Restructuring and Reform Act of 1998

    The AICPA was greatly pleased when many of the concepts and factors 
contained in the Blueprint and Index were incorporated into the tax law 
complexity analysis mandated by the Internal Revenue Service 
Restructuring and Reform Act of 1998.
    The Act requires an annual tax law analysis of sources of 
complexity in administration of the Federal tax laws to be conducted by 
the Commissioner of Internal Revenue. This analysis will draw on such 
information as: questions frequently asked by taxpayers; common errors 
on tax returns; areas of law which frequently result in disagreements 
between taxpayers and the IRS; and areas of law lacking published 
guidance.
    The Act also requires the Joint Committee on Taxation, in 
conjunction with the IRS and the Treasury Department, to develop a 
complexity analysis of any proposed legislation that has widespread 
applicability to individuals or small business. This analysis will draw 
on such information as: an estimate of the number of taxpayers affected 
by a provision; the income level of affected taxpayers; the effect of a 
proposed change on tax forms and published guidance; any additional 
record keeping requirements imposed on taxpayers; and an estimated cost 
to taxpayers to comply with the provision.
    Now that a framework for analyzing complexity has been established 
and tools are being developed to measure a proposal's effect on the 
complexity of the law, steps must be taken to ensure that the tools are 
used and that the information obtained is formally considered in the 
legislative and regulatory process. This final element is critical to 
achieving a simpler tax system for many taxpayers.

                      Recent Legislative Proposals

    In recent years, tax legislation has increasingly included complex 
thresholds, ceilings, phase-ins, phase-outs, effective dates, and 
sunset dates in an effort to provide benefits to numerous specific 
groups within the limits of revenue neutrality. For example, the 
President's Fiscal Year 2000 Budget tax proposals, as drafted, continue 
this trend through numerous, additional targeted credits. While these 
credits are well-intentioned, cumulatively they would further weigh 
down our tax system with complexity. Many average taxpayers do not 
understand the benefits to which they are currently entitled. While it 
is still early, we believe that taxpayers will, all too frequently, 
omit from their 1998 tax returns some of the benefits intended for 
them. In fact the Wall Street Journal just reported on April 12 that 
the IRS had discovered that 30,000 filers eligible for the child tax 
credit had filled out their tax return wrong. Other taxpayers will be 
disappointed to learn that they do not qualify for benefits that they 
have heard about because of complex phase-out rules written in fine-
print. Taxpayers will have difficulty in complying, much less planning 
for, and this level of complexity.
    We understand that delivering politically popular benefits within 
budget constraints often results in simplification being sacrificed. 
However, the Administration's current proposals are only the 
continuation of a growing trend to complicate our tax structure through 
targeted benefits. For example, the 1997 Taxpayer Relief Act enacted 
the new dependent child credit (up to $400 in 1998 for dependent 
children under 17 years of age) that had strong political support from 
both political parties. The AICPA opposed the proposal, not on policy 
grounds but solely based on simplification of the law. Rather than 
introduce a new form, a new set of calculations and a new set of income 
phase-outs, a rough equivalent of the desired objective could have been 
achieved by increasing the dependency exemption available for children 
under 17. Since exemption deductions already phase-out for the wealthy, 
the increased amount would not have been available for our most 
affluent taxpayers. Obviously, we were politically incorrect. But, we 
think we were correct in the context of tax simplification.
    The Administration's revenue proposals contain numerous provisions 
affecting individuals, such as: a new long-term care credit, a new 
disabled workers tax credit, the child and dependent care tax credit 
expansion, the employer-provided educational assistance exclusion 
extension, a new energy efficient new homes credit, the electric 
vehicles credit extension, AMT relief extension, a new D.C. homebuyers 
credit, optional self-employment contributions computations, a new 
severance pay exemption, a new rental income inclusion, etc. While we 
are not commenting on the policy need for these provisions, we note 
that Congress must consider the general administrability of these 
provisions.
    We are very concerned about the increasing complexity of the tax 
law as a result of targeted individual tax cuts. The 1997 Taxpayer 
Relief Act contained several targeted individual tax cuts that were 
first effective for 1998 individual income tax returns. As discussed in 
the Wall Street Journal of February 17, 1999, these provisions, while 
providing tax relief to certain individuals, have greatly increased the 
complexity of the preparation of individual income tax returns. This 
increased compliance burden is born mostly by lower income taxpayers 
who can least afford the cost of hiring a professional income tax 
return preparer.
    IRS National Taxpayer Advocate W. Val Oveson, in his first report 
to Congress, stated that increasing tax law complexity is imposing 
significant compliance and administrative burdens on the IRS and 
taxpayers. The report also cited the increasing complexity caused by 
the targeted individual tax cuts contained in the 1997 Taxpayer Relief 
Act.
    The Administration's tax proposals contain 28 new targeted tax 
cuts. Many of these provisions have limited applicability; none are 
available to high-income taxpayers. Unfortunately, the way these 
provisions are drafted with different income limits for each provision, 
taxpayers need to make many additional tax calculations just to 
determine if they are eligible for the tax benefit. The 
Administration's tax proposals will add several additional income 
limits to the Internal Revenue Code.
    Below are a few examples of provisions in the Administration's tax 
proposals that have different phase-out limits:
     The long-term care credit and disabled workers tax credit 
would be phased out ``by $50 for each $1,000 (or fraction thereof) by 
which the taxpayer's modified AGI exceeds'' $110,000 (married filing a 
joint return taxpayers), $75,000 (single/head of household), or $55,000 
married filing separate.
     The first-time D.C. homebuyers credit phases out for 
individuals with AGI between $70,000 and $90,000 ($110,000 to $130,000 
for joint filers).
     The severance pay exemption would not apply if the total 
severance payments received exceed $75,000.
     The expanded child and dependent care credit proposal 
would allow taxpayers the 50 percent credit rate if their AGI is 
$300,000 or less, then the credit rate would be reduced by one 
percentage point for each additional $1,000 of AGI in excess of 
$300,000, and taxpayers with AGI over $59,000 would be eligible for a 
20 percent credit rate.
     The student loan interest deduction (to which the 
President's proposal would eliminate the current 60-month limit) phases 
out ratably for single taxpayers with AGI between $40,000 and $55,000 
and between $60,000 and $75,000 for married filing a joint return 
taxpayers.
    This type of law, with so many different phase-out limits, provides 
incredible challenges for middle-income taxpayers, in determining how 
much of what benefit they are entitled to. We suggest common phase-out 
limits among all individual tax provisions in order to target benefits 
to one of three uniform groups and simplify the law. Our phase-out 
simplification proposal is attached.
    Another problem with these targeted tax cuts is that the impact of 
the alternative minimum tax (AMT) on these cuts is not adequately 
addressed. This is evidenced by the provision in the 1998 IRS 
Restructuring and Return Act and the provision in the Administration's 
tax proposals that provide temporary relief from the AMT for 
individuals qualifying for some of the targeted tax credits. We believe 
that the individual alternative minimum tax needs to be simplified; our 
proposal is attached.
    Finally, much of the complexity in the individual income tax system 
is the result of recent efforts to provide meaningful tax relief to 
medium and low-income taxpayers. In order to aid simplification, we 
believe that Congress should consider alternatives to targeted tax 
cuts, including the new ones proposed by the Administration, with 
provisions such as the following:
     Increased standard deduction.
     Increased amount for personal exemptions.
     Increasing the taxable income level where the 28 percent 
tax and the 31 percent tax rate begins.
     Marriage penalty relief.
    The AICPA would like to further study the complexity caused by the 
proliferation of credits with their complex provisions, and hopes to 
provide further specific comments as this legislation progresses.

                      AICPA Simplification Efforts

    Over the years the AICPA has made numerous, regular submissions of 
specific tax simplification recommendations. Examples include the 
annual release of ``The AICPA Top Ten List of Tax Law Complexities'' 
and the April 1997 comprehensive package of simplification proposals 
which included recommendations to simplify the tax law for individuals, 
small businesses, employee benefit taxation, trust and estate taxation, 
corporation and shareholder taxation, financial service and product 
institutions taxation, and international taxation. The AICPA is once 
again initiating a project to develop a comprehensive package of tax 
simplification recommendations that we hope to share with this 
committee later in the year.
    In the meanwhile, our statement below contains the AICPA 1999 Top 
Ten List of Tax Laws Complexities that would significantly simplify the 
tax law for individuals. We also encourage this committee to consider 
alternatives to targeted tax credits and cuts, including an increased 
standard deduction, increased personal exemption amount, reduction of 
the income level at which current rates apply, and relief from the 
marriage penalty.

   Specific Simplification Recommendations--Top Ten List of Tax Law 
       Complexities for Individual Taxpayers and Small Businesses

     Simplification of the Individual Alternative Minimum Tax (AMT)

Present Law

    Complexity of AMT. The AMT is one of the most complex parts of the 
tax system. Each of the adjustments of Internal Revenue Code (IRC) 
section 56, and preferences of IRC Section 57, requires computation of 
the income or expense item under the separate AMT system. The 
supplementary schedules used to compute many of the necessary 
adjustments and preferences must be maintained for many years to allow 
the computation of future AMT as items turn around.
    Generally, the fact that AMT cannot always be calculated directly 
from information on the tax return makes the computation extremely 
difficult for taxpayers preparing their own returns. This complexity 
also calls into question the ability of the Internal Revenue Service to 
audit compliance with the AMT. The inclusion of adjustments and 
preferences from pass-through entities also contributes to the 
complexity of the AMT system.
    Effects of the Taxpayer Relief Act of 1997 and AMT on Individual 
Taxpayers. If the Administration's budget proposal on temporary AMT 
relief expansion is not enacted, several tax credits included in the 
Taxpayer Relief Act of 1997 will have a dramatic impact on the number 
of individuals who will find themselves subject to the AMT. For many, 
this will come as a real surprise and, in all likelihood, will cause 
substantial problems for the Internal Revenue Service, which will have 
to redirect significant resources to this area in the future to ensure 
compliance, educate taxpayers, and handle taxpayer questions. We 
believe the Administration's proposal should be for permanent AMT 
relief rather than just temporary two-year relief.
    Most sophisticated taxpayers understand that there is an 
alternative tax system, and that they may sometimes wind up in its 
clutches; unsophisticated taxpayers, however, may never have even heard 
of the AMT, certainly do not understand it, and do not expect to ever 
have to worry about it. Unfortunately, that is changing--and fairly 
rapidly--because a number of the more popular items, such as the 
education and child credits that were recently enacted, offset only 
regular tax and not AMT. While Congress changed the law--for 1998 
only--to allow these credits against AMT, it is now faced with the need 
to continue revisiting this issue if there is to be continuing relief. 
Thus, the question of nonrefundable credits as an AMT offset has joined 
the unenvied list of ``expiring provisions'' or ``extenders'' for which 
it becomes necessary to continue finding revenues to pay for another 
year or two of what should be a matter of simplicity and equity.
    Indexing of AMT Brackets and Exemption. Numerous anecdotal examples 
now indicate the likelihood that taxpayers with adjusted gross incomes 
in the $60,000-$70,000 range (or below) will be subject to AMT in the 
next few years. Aside from the fairness issues involved--this is not 
the group that the AMT has ever been targeted to hit--we see some 
potentially serious compliance and administration problems. Many of 
these taxpayers have no idea that they may be subject to the AMT (if, 
indeed, they are even aware that there is an AMT). Thus, we anticipate 
large numbers of taxpayers not filling out a Form 6251 or paying the 
AMT who may be required to do so, thus requiring extra enforcement 
efforts on the part of the IRS to make these individuals (most of whom 
will otherwise be filing in absolute good faith) aware of their added 
tax obligations. Further, IRS notices to these taxpayers assessing the 
proper AMT may well be perceived as unfair, subjecting the IRS to 
unwarranted criticism that should be directed elsewhere.

Recommended Changes

    Due to the increasing complexity, compliance problems, and a 
perceived lack of fairness towards the intended target, the AICPA 
supports eliminating the individual AMT altogether. These provisions 
have been in the law since 1978 (with amendments from time to time), 
and substantive changes to the regular tax regime in the past 20 years 
have resulted in much of the AMT impact now coming from disallowance of 
itemized deductions, with a slowly growing secondary effect from the 
failure to index tax brackets and exemptions. Thus, the policy 
underpinning of the AMT which was present in 1978 has been greatly 
diluted.
    While we are concerned with those who have to pay the AMT based 
upon mechanical rules that leave a lot to be desired from a policy 
perspective, we also note that many non-AMT payers must still be AMT 
filers. We would be interested in seeing statistics as to the number of 
individual taxpayers who struggle to fill out Form 6251 just to show 
they do not have an AMT liability. To fill this form out correctly is 
one of the most baffling experiences a taxpayer can go through -not 
because the IRS can't design forms (they do a terrific job overall), 
but because the law is so incomprehensible it defies being reduced to a 
set of easily derived numbers and simple instructions.
    For these reasons, and others described above, we believe the 
individual AMT is an appropriate candidate for repeal. We do, however, 
recognize that there is no simple solution to the AMT problem given the 
likely revenue loss to the government. If repeal is not possible, 
Congress should consider the following:
    1. Increasing and/or indexing the AMT brackets and exemption 
amounts.
    2. Eliminating itemized deductions and personal exemptions as 
adjustments to regular taxable income in arriving at alternative 
minimum taxable income (AMTI) (e.g., all--or possibly a percentage of--
itemized deductions would be deductible for AMTI purposes).
    A. At the very least, state income taxes should no longer be an 
adjustment. There is very little fairness in concluding that a resident 
of California, the District of Columbia, or New York should have a 
higher likelihood of incurring the AMT than a resident of Texas, solely 
for making a choice of state in which to live or work.
    3. Eliminating many of the AMT preferences by reducing for all 
taxpayers the regular tax benefits of AMT preferences (e.g., require 
longer lives for regular tax depreciation).
    4. Allowing certain regular tax credits against AMT (e.g., low-
income tax credit, tuition tax credits)--permanently, rather than just 
for the next two years.
    5. Providing an exemption from AMT for low and middle-income 
taxpayers with regular tax AGI of less than $100,000.
    6. The impact of AMT in all future tax legislation.

Contribution to Simplification

    The fairness goal of the AMT has created hardship and complexity 
for many taxpayers who have not used preferences to lower their taxes. 
Many of these individuals are not aware of these rules and complete 
their return themselves, causing confusion and errors. The 1997 law and 
the impact of inflation on indexed tax brackets and the AMT exemption 
are causing more lower-income taxpayers to be inadvertently subject to 
AMT. Increasing and/or indexing the AMT brackets and exemption 
(recommendation 1) would solve this problem.
    Under recommendation 2, those individuals who are affected only by 
itemized deductions and personal exemption adjustments would no longer 
have to compute the AMT. Itemized deductions are already reduced by the 
phase out for high income taxpayers, 2 percent AGI miscellaneous 
itemized deduction disallowance, 7.5 percent AGI medical expense 
disallowance, $100 and 10 percent AGI casualty loss disallowance, and 
the 50 percent disallowance for meals and entertainment. Similarly, the 
phase out of exemptions already affects high-income taxpayers. It is 
also worth noting that because state income taxes vary, taxpayers in 
high income tax states may incur AMT solely based on the state in which 
they live, while other taxpayers with the same AGI, but who live in 
states with lower or no state income taxes, would not pay AMT. This 
unintentionally works to the disadvantage of residents of high tax 
states.
    In addition, under recommendation 3, many of the AMT preferences 
could be eliminated by reducing for all taxpayers the regular tax 
benefits of present law AMT preferences (e.g., require longer lives for 
regular tax depreciation). This would add substantial simplification to 
the Code, recordkeeping and tax returns.
    Under recommendation 4, those who are allowed regular tax credits, 
such as the low income or tuition tax credits, would be allowed to 
decrease their AMT liability by the credits. This would increase 
simplicity and create fairness. Compliance would also be improved.
    Under recommendation 5, fewer taxpayers will be subject to AMT and 
its associated problems. By increasing the AMT exemption to exclude low 
and middle income taxpayers, the AMT will again be aimed at its 
original target--the high-income taxpayer.
    In conclusion, we see the AMT as becoming more prevalent and 
causing considerable disillusion to many taxpayers whom do not see 
themselves as wealthy and who will believe they are being punished 
unfairly. The AMT will apply to many taxpayers it was not originally 
intended to affect. We believe our proposals offer a wide range of ways 
to help address this problem.

               Simplification of Earned Income Tax Credit

Present Law

    The refundable earned income tax credit (EITC) was enacted in 1975 
with the policy goals of providing relief to low-income families from 
the regressive effect of social security taxes, and improving work 
incentives among this group. According to the IRS, EITC rules affect 
almost 15 million individual taxpayers.
    Over the last few years, the most common individual tax return 
error discovered by the IRS during return processing has been the EITC, 
including the failure of eligible taxpayers to claim the EITC, and the 
use of the wrong income figures when computing the EITC.
    The frequent changes made over the past twenty years contribute 
greatly to the credit's high error and noncompliance rates. Some 
examples of frequent changes and complexities follow. As part of the 
health insurance deduction act that Congress passed in 1995, a new 
factor was added to determining eligibility--the amount of interest 
(taxable and tax-exempt), dividends, and net rental and royalty income 
(if greater than zero) received by a taxpayer, even if total income is 
low enough to otherwise warrant eligibility for the EITC. A threshold 
of this type of disqualified income was set at $2,350 in 1995, was then 
altered as part of the Personal Responsibility and Work Opportunity 
Reconciliation Act of 1996 to be $2,200, and goes to $2,300 for 1998. 
In addition, in 1996, capital gain net income and net passive income 
(if greater than zero) that is not self-employment income were added to 
this disqualified income test.
    In 1996, the credit computation became even more complicated, with 
the introduction of a modified AGI definition for phasing out the 
credit, wherein certain types of nontaxable income need to be 
considered and certain losses are disregarded. Specifically, nontaxable 
items to be included are: tax-exempt interest, and nontaxable 
distributions from pensions, annuities, and individual retirement 
arrangements (but only if not rolled over into similar vehicles during 
the applicable rollover period). The losses that are to be disregarded 
are:
     net capital losses (if greater than zero);
     net losses from trusts and estates;
     net losses from non-business rents and royalties; and
     50 (changed to 75% in 1997) percent of net losses from 
businesses, computed separately with respect to sole proprietorships 
(other than in farming), sole proprietorships in farming, and other 
businesses--but amounts attributable to business that consist of 
performance of services by an individual as an employee are not taken 
into account.
    In addition to the prior requirement that a taxpayer identification 
number (TIN) be supplied for all qualifying children, starting in 1996, 
individuals are also required to be authorized to be employed in the 
U.S. in order to claim the credit. Failure to provide a correct TIN is 
now treated as a mathematical or clerical error.
    In 1997, as part of the Taxpayer Relief Act of 1997 (TRA 97), new 
restrictions are placed on the availability of the EITC. For example, 
taxpayers who improperly claimed the credit in earlier years are denied 
the credit for a period of years. If the improper claim was due to 
fraud, the disallowance period is ten years after the most recent tax 
year for which the final determination is made. If it was due to 
reckless or intentional disregard of the rules, the disallowance period 
is two tax years after the most recent tax year for which the final 
determination was made. Taxpayers who are denied the EITC for any tax 
year as a result of tax deficiency procedures must demonstrate 
eligibility for the credit and provide additional information to the 
IRS in order to claim the credit in any later tax year.
    In addition, the 1997 law increases from 50% to 75% the amount of 
net losses from carrying on trades or businesses that is disregarded in 
determining modified AGI. The 1997 legislation also includes the 
following items in determining modified AGI for the credit: tax-exempt 
interest received or accrued during the tax year; and non-taxable 
distributions from pensions, annuities, or individual retirement plans 
(if not rolled over into similar vehicles during the rollover period). 
The 1997 law provides that workfare payments are not earned income for 
EITC purposes.
    The credit has been changed 13 times (1976, 1977, 1978, 1979, 1984, 
1986, 1988, 1990, 1993, 1994, 1995, 1996 and 1997) and now is a 
nightmare of eligibility tests, requiring a maze of worksheets. 
Computation of the credit currently requires the taxpayer to consider 9 
eligibility requirements:
     the number of qualifying children--taking into account 
relationship;
     residency test;
     age test;
     the taxpayer's earned income--taxable and non-taxable;
     the taxpayer's AGI;
     the taxpayer's modified AGI;
     threshold amounts;
     phase out rates; and,
     varying credit rates.
    To claim the credit, the taxpayer may need to complete:
     a checklist (containing 9 complicated questions);
     a worksheet (which has 10 steps);
     another worksheet (if there is self-employment income); 
and
     a schedule with 6 lines and 2 columns (if qualifying 
children are claimed).
    For guidance, the taxpayer may refer to 7 pages of instructions 
(and 28 pages of IRS Publication 596). The credit is determined by 
multiplying the relevant credit rate by the taxpayer's earned income up 
to an earned income threshold. The credit is reduced by a phase-out 
rate multiplied by the amount of earned income (or AGI, if less) in 
excess of the phase-out threshold.
    While Congress and the IRS may expect that the AICPA and its 
members can comprehend the EITC intricacies and the many pages of 
instructions and worksheets, it is unreasonable to expect those 
individuals entitled to the credit (who will almost certainly NOT be 
expert in tax matters) to deal with this complexity. Even our members, 
who tend to calculate the credit for taxpayers as part of their 
volunteer work, find this area to be extremely challenging.
    Our analysis suggests that most of the EITC complexity arises from 
the definitional distinctions in this area. While each departure from 
definitions used elsewhere in the Code can be understood in a context 
of accomplishing a specific legislative purpose, the sum of all the 
definitional variances causes this IRC Section to be unmanageable by 
taxpayers and even the IRS. We recognize that many of the additions and 
restrictions to the credit over the years were well intended. However, 
the rules are so complex that the group of taxpayers to be benefited 
finds them incomprehensible and are not effectively able to claim the 
credit to which they are entitled.

Recommended Changes

    We recommend that Congress adopt the following changes to the EITC.
    1. Simplify definitions and the calculation.
    2. Define ``earned income'' as taxable wages (Form 1040, line 7) 
and self-employment income (Form 1040, line 12).
    3. Modify the ``qualifying child'' rules.
    A. Replace the ``qualifying child'' definition with the existing 
``dependent child'' definition.
    B. Increase the incremental amount of credit provided for two 
children versus one child.
    C. Use the dependency exemption rather than the EITC to provide 
benefits relating to children.
    4. Combine and expand the denial provision.
    A. Deny the credit for taxpayers with: foreign earned income, 
alternative minimum tax liability, and AGI that exceeds earned income 
by $2,200 or more.

Contribution to Simplification

    Instructions and computations would be greatly simplified. The 
error rate should be dramatically reduced.

           Simplification of Phase-Outs Based on Income Level

Present Law

    Numerous sections in the tax law provide for the phase-out of 
benefits from certain deductions or credits over various ranges of 
income based on various measures of the taxpayer's income. There is 
currently no consistency among these phase-outs in either the level of 
income, the range of income over which the phase-outs apply, or the 
method of applying the phase-outs. Furthermore, the ranges for a 
particular phase-out often differ depending on filing status, but even 
these differences are not consistent. For example, the traditional IRA 
deduction phases out over a different range of income for single filers 
than it does for married-joint filers; whereas the $25,000 allowance 
for passive losses from rental activities for active participants 
phases out over the same range of income for both single and married-
joint filers. Consequently, these phase-outs cause inordinate 
complexity, particularly for taxpayers attempting to prepare their tax 
returns by hand; and the instructions for applying the phase-outs are 
of relatively little help. See the attached Exhibits for a listing of 
most current phase-outs, including their respective income 
measurements, phase-out ranges (for 1998) and phase-out methods.
    Note that currently many the phase-out ranges for married-filing-
separate (MFS) taxpayers are 50 percent of the range for married-
filing-joint (MFJ), while many of the phase-out ranges for single and 
head of household (HOH) taxpayers are 75 percent of married-joint. That 
causes a marriage penalty when the spouses' incomes are relatively 
equal.

Recommended Changes

    Simplification could easily be accomplished by eliminating phase-
outs altogether. However, if that is considered either unfair 
(simplicity is often at odds with equity) or bad tax policy, 
significant simplification can be achieved by creating consistency in 
the level of income, the income range of phase-out and the method of 
phase-out.
    Instead of the approximately 20 different phase-out ranges (shown 
in attached Exhibit A), we recommend only three--at levels representing 
low, middle, and high income taxpayers.
    If there are revenue concerns, the ranges and percentages could be 
adjusted, as long as the phase-outs for each income level group (i.e., 
low, middle, high income) stayed consistent across all relevant 
provisions. In addition, marriage penalty impact should be considered 
in adjusting phase-out ranges for revenue needs.
    We propose that all phase-out ranges for MFS taxpayers should be 
the same as those for single and HOH taxpayers, which would be 50 
percent of the range for MFJ taxpayers.
    The benefits that are specifically targeted to low-income 
taxpayers, such as the earned income credit, elderly credit, and 
dependent care credit, would phase-out under the low-income taxpayer 
phase-out range. The benefits that are targeted to low and middle 
income taxpayers, such as the traditional IRA deduction and education 
loan interest expense deduction, would phase-out under the middle-
income taxpayer phase-out range. Likewise, those benefits that are 
targeted not to exceed high income levels, such as the new child 
credit, the new education credits and education IRA, and the new Roth 
IRA, as well as the existing law AMT exemption, itemized deductions, 
personal exemptions, adoption credit and exclusion, series EE bond 
exclusion, and section 469 $25,000 rental exclusion and credit, would 
phase-out under the high-income taxpayer phase-out range.
    Additionally, instead of the differing methods of phase-outs (shown 
in attached Exhibit B), the phase-out methodology for all phase-outs 
would be the same, such that the benefit phases out evenly over the 
phase-out range. Every phase-out should be based on adjusted gross 
income (AGI).

       Proposed Adjusted Gross Income Level Range for Beginning to End of Phase-Out for Each Filing Status
----------------------------------------------------------------------------------------------------------------
                     Category of Taxpayer                         Married Filing Joint      Single & HOH & MFS
----------------------------------------------------------------------------------------------------------------
Low-Income....................................................          $15,000-$37,500           $7,500-$18,750
Middle-Income.................................................            60,000-75,000            30,000-37,500
High-Income...................................................          225,000-450,000          112,500-225,000
----------------------------------------------------------------------------------------------------------------

Contribution to Simplification

    The current law phase-outs complicate tax returns immensely and 
impose marriage penalties. The instructions related to these phase-outs 
are difficult to understand and the computations often cannot be done 
by the average taxpayer by hand. The differences among the various 
phase-out income levels are tremendous. Either the phase-outs should be 
eliminated and the same goal accomplished with a lot less complexity by 
adjusting rates, or at least the phase-outs should be made applicable 
at consistent income levels (only three) and applied to consistent 
ranges using a consistent methodology. This would ease the compliance 
burden on many individuals. If there were only three ranges and only 
one methodology, it would be much easier to recognize when and how a 
phase-out applies. Portions of numerous Internal Revenue IRC Sections 
could be eliminated. By also making the MFJ phase-out ranges double the 
ranges applicable to single individuals, and by making the MFS ranges 
the same as single individuals, the marriage penalty associated with 
phase-out ranges would be eliminated. (See Exhibit A for selected AGI 
phase-out amounts and Exhibit B for current methods of phase-out.)

                     Eliminate the Marriage Penalty

Present Law

    Under the current tax system, a marriage penalty and marriage bonus 
exist. The marriage penalty/bonus results when two married individuals 
have a greater (penalty) or smaller (bonus) tax liability as compared 
to two similarly situated single individuals (i.e., individuals with 
the same total incomes). The marriage penalty is likely an unintended 
result from prior legislative efforts to be equitable. As each Congress 
introduces changes to the Code, complexity and unintended tax effects 
often result. There are at least 63 provisions in the Internal Revenue 
Code where tax liability depends on whether a taxpayer is married or 
single. Most of these differences were created to be fair; to target 
benefits to specific taxpayers, or to prevent abuses. Some examples are 
the tax rates, standard deduction, and earned income tax credit, as 
well as social security benefits taxation, capital loss limits, IRAs, 
dependent care credit, child credit, and education tax incentives.
    The two major factors that have created the marriage penalty 
problems are:
    1. The ``stacking of income'' problem, resulting from the different 
and progressive tax rate/bracket schedules applicable to different 
filing statuses, and
    2. Different income thresholds and phase-outs of deductions and 
credits for single versus married taxpayers.
    The progressive tax rate/bracket schedules impose a higher marginal 
tax on combined spousal earnings, as compared to two single persons. 
Additionally, the tax brackets for married filing joint are not twice 
as wide as the brackets for single taxpayers, and the tax brackets for 
married filing separately do not equate to the tax brackets for single 
taxpayers. We refer to this phenomenon as the ``stacking of income'' 
problem and there are a variety of ways to address it.
    The second factor contributing to the marriage penalty is the large 
number of provisions that phase-out based on income levels that may or 
may not differ based on marital/filing status. The TRA 97 significantly 
increased the provisions with different phase-outs for different filing 
status (i.e., based on joint, single, or married filing separately).

Recommended Changes

    The AICPA has been studying this area for many years and 
recommends that the marriage penalty be eliminated or reduced. 
There are a number of possible approaches to address the 
marriage penalty problem.
    1. Provide a deduction to reduce the marriage penalty, such 
as the two-earner deduction. This would be the simplest 
solution to implement, and would eliminate some, but not 
necessarily all, of the marriage penalty and could add to 
marriage bonuses. It would have to apply for both regular tax 
and alternative minimum tax (AMT) and not be subject to an AGI 
phase-out to be fully effective.
    2. Provide on one return, a separate calculation of each 
spouse's taxable income and use one tax rate schedule that 
would apply to all individuals. The income and deductions of 
each spouse could be allocated in a variety of ways, e.g., by 
property ownership, by AGI, by percentage of earned income, 50/
50, or in the parties' discretion. In our opinion, 
conceptually, this one-return, separate calculation proposal 
could produce the most equitable system. However, any 
allocation of income and deductions adds complexity in return 
filing and tax administration. The total increase in complexity 
will depend on the allocation methods used. Many states that 
have an income tax, such as Virginia, use this approach.
    3. Provide a tax credit to reduce the marriage penalty. 
This would eliminate some, but not necessarily all, of the 
penalty and could add to the marriage bonus. It would have to 
apply for both regular tax and AMT to be fully effective. 
Several considerations would have to be taken into account, 
such as the complexity in the calculation, the treatment of 
carryovers and carrybacks, and the priority ordering of the 
many tax credits that could apply.
    4. Adjust/broaden the current rate/bracket schedules 
applicable to married individuals. The joint schedule could be 
modified to eliminate the marriage penalty (by increasing the 
joint brackets to twice the single brackets) or to reduce the 
penalty. Another approach would be to conform the married 
filing separate and single rate/bracket schedules (such as in 
Arizona). This approach would be better than the current system 
and could be viewed as elective complexity for those couples 
that chose to file separately.
    5. Adopt standard phase-outs for three income levels--low, 
middle, and high-income taxpayers (rather than the 20 current 
levels), and adopt one standard phase-out method. This would 
eliminate marriage penalties related to phase-outs, since the 
joint amounts would be twice the single ranges, and the phase-
out ranges applicable to married filing separate taxpayers 
would be the same as those for single taxpayers.
    In addition, there are related tax problems that arise 
because of marriage and divorce, and we urge the Committee to 
give these matters consideration. For example, the treatment of 
carryover tax attribute rules and NOL computations in divorce 
situations need modification. We also note that various IRC 
regulations (i.e., under IRC Sections 108, 121, 154, 163, 1041, 
and 6013) regarding spouses and divorce situations need to be 
amended.
    This recommendation discusses a number of possible 
approaches to address the marriage penalty problem. However, 
each of these provisions needs to be thoroughly analyzed in 
order to provide the economic, tax, and social benefits that 
Congress determines is appropriate. Further, to eliminate 
marriage penalties and improve simplification, standard phase-
outs (with joint ranges being twice the single and married 
filing separate ranges) for three income levels--low, middle, 
and high-income taxpayers (rather than the 20 current levels)--
and one standard phase-out method should be adopted.

Contribution to Simplification

    By eliminating or reducing the marriage penalty and marriage bonus, 
the tax system would become ``marriage neutral.'' Tax complexities 
arising out of marriage and divorce would be reduced and the tax system 
would be made more rational and equitable.

         Simplification of Employee vs. Independent Contractor

Present Law

    The rules relating to classification of a worker as an employee or 
independent contractor are unclear. This results in needless confusion 
and potentially large tax assessments for businesses that are 
attempting to comply with the law.

Recommended Changes

    A bill (S. 344 Independent Contractor Simplification and Relief Act 
of 1999) simplifying the classification of workers was introduced in 
the Senate on February 9, 1999 by Senator Christopher Bond (R-MO). This 
bill establishes a safe harbor for businesses classifying workers as 
independent contractors when either of the following two criteria are 
met:
     A worker demonstrates economic and workplace independence 
meeting a set of stipulated criteria, and a written agreement exists 
between the parties; or
     A worker conducts business through a corporation or 
limited liability company, the worker does not receive benefits from 
the service recipient, and a written agreement exists between the 
parties.
    At this time the AICPA is examining other proposed legislation in 
this area. It is our hope that the proper elements can be pulled 
together so that worker classification simplification can be 
accomplished through an approach that provides certainty, while 
balancing the needs of service recipients and the rights of service 
providers.

Contribution to Simplification

    Until taxpayers are provided with clear-cut rules by Congress, this 
area will continue to provide many uncertainties for small business 
owners, as well as a continuation of the many battles between taxpayers 
and the Internal Revenue Service. This issue is a top priority of many 
small business organizations, including the 1995 White House Conference 
on Small Business and the U.S. Chamber of Commerce. Even the Treasury 
Department has testified that the 20-factor test, historically used by 
the Internal Revenue Service to classify workers, is confusing and does 
not yield ``clear, consistent, or even satisfactory answers, and 
reasonable persons may differ as to the correct classification.''

                    Simplification of the Kiddie Tax

Present Law

    The 1986 Tax Reform Act introduced the so-called ``kiddie tax'' 
which taxes the net unearned income of children under the age of 14 at 
the parents' tax rate. While at first this seems to be straight-forward 
approach, it has evolved into a very complicated calculation. When 
first enacted in 1986, there was not a preferential tax rate for 
capital gains. The introduction of the maximum 28% (now 20%) capital 
gain rate has further complicated the situation. Under certain limited 
circumstances, parents can elect to include their children's income on 
their return. However, the election in not available for parents of a 
child with any earned income, unearned income in excess of $5,000, 
capital gains, withholding or estimated tax payments.
    Instructions for utilization of Form 8615, ``Tax for Children Under 
Age 14 Having Investment Income of More Than $1,200,'' cannot be 
contained on the reverse of the form. Instead, the IRS has issued 
Publication 929, a 20-page booklet which provides the ``hidden 
worksheets'' that allow the taxpayer, or the return preparer, to 
calculate the child's taxable income, as well as the tax. In situations 
in which there are multiple siblings falling within this provision, the 
complexity expands. Similarly, if a child is subject to the AMT, 
additional calculations are required. In the overwhelming majority of 
situations, the additional tax revenue generated by the ``kiddie tax'' 
appears to be insignificant when compared to the complexity of the 
calculations. Also, the kiddie tax provision only considers the regular 
tax of section 1 and not the AMT of section 55. Therefore, the way the 
current rules are written, if a parent must pay AMT, the children's 
income is still taxed at the parent's regular marginal tax rate, while 
the parent is taxed at the AMT rate without taking into account the 
child's income or the child's regular tax liability. This results in 
taxpayers paying more tax than if the parent and children's income are 
both included in the parent's AMT calculation.

Recommended Changes

    The linkage of a child's taxable income to parents' and other 
siblings' taxable income should be repealed. Income (other than capital 
gains) subject to kiddie tax should be taxed at a separate rate 
schedule (e.g., fiduciary income tax rates). The child's capital gains 
should be taxed at the capital gains rates. The election to include a 
child's income on the parent's return should be expanded to allow all 
income, regardless of its nature or amount, to be included. The 
election could apply whether or not the child has withholding or 
estimated payments. There could be a check-off, similar to the current 
nominee interest check-off, or column added to the Form 1040 Schedules 
B and D so as to indicate whether the item applies to another social 
security number, to avoid any matching problems.

Contribution to Simplification

    The suggested change would allow children's returns to stand on 
their own. Issues regarding missing information on one return, 
matrimonial issues, and unintended AMT problems would be eliminated. 
The perceived loophole of shifting income to minors would remain closed 
since fiduciary income moves to higher tax brackets at significantly 
lower income levels than individuals.
    Allowing across-the-board inclusion of a child's income on a 
parent's return could eliminate many children's returns and their 
associated compliance burdens for taxpayers and the government.

       Simplification of the Individual Estimated Tax Safe Harbor

Present Law

    Individuals with adjusted gross incomes of $150,000 or less may 
base their current year estimated taxes on 100 percent of their prior 
year tax. As changed by TRA 97, individuals with adjusted gross incomes 
in excess of $150,000 may base their current year estimated taxes on a 
percentage of their taxes for the prior year as follows:

------------------------------------------------------------------------
                                                              Percentage
                 Current Estimated Tax Year                    of Prior
                                                               Year Tax
------------------------------------------------------------------------
1998........................................................        100
1999........................................................        105
2000........................................................        106
2001........................................................        106
2002........................................................        112
2003 and thereafter.........................................        110
------------------------------------------------------------------------

Recommended Changes

    The percentage of prior year tax should be 100 percent for all 
years.

Contribution to Simplification

    In general, the estimated tax rules are complex. Prior to TRA 97, 
the provisions for basing individual estimated taxes on their prior 
year taxes were straight-forward and simple. To change to different 
percentages for different years results in poor tax policy, and adds 
needless complexity. By basing all estimates on the same percentage for 
all years, such as 100 percent of the prior year tax, the complex 
calculations that are made quarterly by taxpayers are reduced and 
simplicity and year-by-year consistency is added to the Code.

                    Simplification of Child Credits

Present Law

    Effective for years beginning in 1998, taxpayers can claim 
a $400 ($500 in 1999 and later) credit for each qualifying 
child. The credit is phased out by $50 for each $1,000 of 
adjusted gross income over a threshold amount. The threshold 
amounts are $110,000 for married persons filing jointly, 
$55,000 for married taxpayers filing separately and $75,000 for 
single taxpayers.
    The basic child credit is a non-refundable credit that is 
limited to the excess of regular tax liability over alternative 
minimum tax liability. (A special provision treats alternative 
minimum tax as equal to zero for 1998 only.) However, to the 
extent that the child credit is disallowed because of other 
refundable credits, a portion of the credit is converted into a 
supplemental refundable credit. Further, an additional 
refundable credit for taxpayers with three or more children is 
allowed.

Recommended Changes

    We recognize that there is no one solution that will both continue 
to target the credit to its intended beneficiaries and limit the cost 
associated with its benefits. However, we recommend the following 
legislative changes.
    1. Replace the three-tier child credit system (basic, supplemental 
and additional) with one universal, refundable credit.
    2. Consider increasing the credit amount and eliminating the 
exemption amount for children eligible for the credit.
    3. Change the phase out levels to correspond to one of the three 
levels included in the AICPA Phase out Simplification proposal.
    4. Make permanent the provision that allows the credit against both 
regular and alternative minimum tax.

Contribution to Simplification

    The purpose of the child credit is to allow a reduction in tax 
liability in excess of that provided by the existing exemption 
deduction amount. The use of an additional credit amount rather than a 
combined credit and exemption mechanism would allow additional use of 
credits to be provided to low income taxpayers without the significant 
revenue drain associated with providing benefits to high income 
taxpayers.
    Combining the three-tier credit into one refundable credit would 
eliminate confusing computations for taxpayers with low income. The 
current system either fosters a system prone to errors or forces 
taxpayers with otherwise simple returns to seek professional advice 
whose cost would offset a portion of the benefit of the credit.
Simplification of the Generation Skipping Transfer Tax

                              Present Law

    In 1986, Congress enacted the generation skipping transfer 
tax (GST tax), which is imposed on transfers to beneficiaries 
more than one generation below the transferor's generation at 
the maximum gift and estate tax rate (55%). To determine the 
rate applicable to a particular transfer, the 55% rate is 
multiplied by the inclusion ratio (a fraction based on the GST 
exemption amount allocated to the transfer). A trust with a 
zero inclusion ratio is exempt from GST tax. Every individual 
is allowed a $1 million GST exemption (indexed for inflation), 
that may be allocated to any property subject to estate or gift 
tax. Married couples may treat transfers as made one-half by 
each spouse, in effect giving them a combined $2 million GST 
tax exemption. While direct transfers to grandchildren qualify 
for an automatic allocation of the GST exemption, transfers to 
a trust do not. If a GST exemption is allocated to a lifetime 
transfer to a trust on a timely filed gift tax return, the 
portion of the trust protected is generally based on the 
property's value at the time of the transfer. However, if the 
allocation is not made on a timely filed gift tax return, the 
portion of the trust protected is based on the value at the 
time of allocation. The planning necessitated by the GST tax 
exemption rules is very complex and fraught with traps for 
taxpayers and their advisors.

Recommended Changes

    We propose the following legislative changes:
    1. Extend the automatic GST exemption allocation rule (that 
currently applies to direct skips) to transfers in trust where 
skips are generally expected. Those taxpayers that do not want 
the automatic allocation to apply could elect out.
    2. Provide relief for GST tax exemption allocations for 
those taxpayers who do not make an election because of an 
inadvertent failure to timely file an appropriate return and 
for those who demonstrate intent to have a zero inclusion ratio 
for a trust (substantial compliance).
    3. Provide a trust severance rule.
    4. Allow retroactive allocations of GST exemption when 
there is an unnatural order of death.

Contribution to Simplification

    The following examples demonstrate some of the common 
problems faced by taxpayers as a result of the current GST tax 
rules:
    1. P, a parent, transfers $10,000 a year for 10 years to a 
discretionary trust for a child, C, and such descendants of C, 
which will terminate and distribute to C when C reaches age 35. 
If C dies before attaining age 35, the trust is distributable 
to the descendants of C. If C dies before age 35 with issue 
when the trust assets are worth $100,000, a taxable termination 
occurs. Unless P allocates a GST tax exemption before C dies, 
the GST tax would be $55,000.
    2. P transfers $1 million of stock to a trust to pay income 
to C for life, remainder to P's grandchild, G. If the full $1 
million GST exemption is allocated to this transfer on a timely 
filed gift tax return, and the stock's value is $5 million at 
the time the property passes to G, no GST tax results. However, 
if the GST tax exemption is not allocated until the property 
has grown to $5 million, a $2.2 million GST tax would result if 
the property that passes is still worth $5 million when it 
passes to G.
    3. P transfers $1 million to a trust to pay income to C 
until C's 35th birthday, at which time the trust property will 
be paid to C. If C dies before his 35th birthday, the trust 
property is paid to C's children. If C dies before attaining 
age 35 at a time when the trust property is worth $5 million, 
and there was no GST tax exemption allocation before C's death, 
there would be no opportunity to allocate such exemption and a 
$2.75 million GST tax would be imposed.
    4. P transfers $5 million to a trust for the benefit of his 
five children. If one child dies, current regulations do not 
allow the trust to be severed so that a GST tax exemption can 
be allocated to the one-fifth of the trust that will primarily 
benefit the deceased child's children. (If five separate trusts 
had been created instead of one, this problem could have been 
avoided).
    Simplification would be achieved by making automatic an 
allocation of GST tax exemption to those taxpayers likely to 
benefit, rather than requiring taxpayers to elect such an 
allocation. The planning necessary to take advantage of the GST 
tax exemption allowed by law is overly complex and often leads 
to errors by taxpayers. These simplification proposals would 
allow some relief to taxpayers that fail to make timely 
allocations and allow retroactive allocation in situations 
involving an unnatural order of death. In addition, the trust 
severance rule would simplify the drafting of trusts and 
minimize the need for creating multiple trusts simply for GST 
tax planning purposes.

Simplification of Half Year Requirements

                              Present Law

    The Internal Revenue Code uses &;-year age requirements to 
allow individual taxpayers to begin to withdraw from their 
pension plans without penalty. (Example, distribution must be 
made after the taxpayer reaches age 59 &; to avoid penalty).

                           Recommended Change

    Change the Internal Revenue Code by eliminating the various 
IRC Sections that use &; year requirements: A) Age 70 &; for 
mandatory IRA distributions and B) Age 59 &; for penalty free 
retirement plan withdrawals. Instead, use whole years: Age 70 
and Age 59.

                     Contribution to Simplification

    Many taxpayers, employers and banks are confused when 
calculating this part of the requirement. It would be easier to 
remember, calculate and administer, and be more user-friendly 
if the ages were changed.

                                                        EXHIBIT A--Selected AGI Phase-out Amounts
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                            Current Single &                                           Proposed Single &
   IRC Section         Provision           Ft Nt.         Current Joint           HOH          Current Married/Sep    Proposed Joint       HOH & MFS
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                        PHASE-OUT LEVELS FOR LOW-INCOME TAXPAYERS
21...............  30 Percent        (3)..............    $10,000-$20,000    $10,000-$20,000  No credit...........    $15,000-$37,500     $7,500-$18,750
                    Dependent Care
                    Credit.
22...............  Elderly Credit..  (4)..............    $10,000-$25,000     $7,500-$17,500
                                                                              $5,000-$12,500
                                                                           $15,000-$37,500$7
                                                                                ,500-$18,750
32...............  EITC (No Child).  (2,3,4)..........     $5,570-$10,030             10,030  No credit...........    $15,000-$37,500     $7,500-$18,750
32...............  EITC (1 Child)..  (2,3,4)..........    $12,260-$26,473    $12,260-$26,473  No credit...........    $15,000-$37,500     $7,500-$18,750
32...............  EITC (2 or More   (2,3,4)..........    $12,260-$30,095    $12,260-$30,095  No credit...........    $15,000-$37,500     $7,500-$18,750
                    Children).
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                      PHASE-OUT LEVELS FOR MIDDLE-INCOME TAXPAYERS
219..............  IRA Deduction w/  (1,7,9)..........    $50,000-$60,000    $30,000-$40,000  No deduction........    $60,000-$75,000    $30,000-$37,500
                    retirement plan.
221..............  Education Loan    (1,2,6)..........    $60,000-$75,000    $40,000-$55,000  No deduction........    $60,000-$75,000    $30,000-$37,500
                    Interest Exp..
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                       PHASE-OUT LEVELS FOR HIGH-INCOME TAXPAYERS
24...............  Child Credit....  (1,5,6)..........          $110,000-           $75,000-  $55,000-............  $225,000-$450,000  $112,500-$225,000
25A..............  Hope Credit &     (1,2,6)..........   $80,000-$100,000    $40,000-$50,000  No credit...........  $225,000-$450,000  $112,500-$225,000
                    Lifetm. Lrng.
                    Cr..
23 & 137.........  Adoption Credit/  (1,7)............   $75,000-$115,000   $75,000-$115,000  No benefit..........  $225,000-$450,000  $112,500-$225,000
                    Exclusion.
55(d)............  AMT Exemption...  (1,8)............  $150,000-$330,000  $112,500-$247,500  $75,000-$165,000....  $225,000-$450,000  $112,500-$225,000
68...............  Itemized          (2)..............          $124,500-          $124,500-  $62,250-............  $225,000-$450,000  $112,500-$225,000
                    Deduction level.
135..............  EE Bond int.      (1,2,7)..........  $78,350-$108,350-    $52,250-$67,250  No exclusion........  $225,000-$450,000  $112,500-$225,000
                    Exclusion.
151..............  Personal          (2)..............  $186,800-$309,300  $124,500-$247,000  $93,400-$154,650....  $225,000-$450,000  $112,500-$225,000
                    Exemption.                                             HOH$155,650-$278,
                                                                                         150
219-(g)(7).......  IRAw/spouse w/    (1,6,7)..........  $150,000-$160,000     Not applicable  No deduction........  $225,000-$450,000  $112,500-$225,000
                    retrmt.plan.
408A.............  Roth IRA          (1,6)............  $150,000-$160,000   $95,000-$110,000  No deduction........  $225,000-$450,000  $112,500-$225,000
                    Deduction.
408A.............  IRA to Roth IRA   (1,6,7)..........           $100,000           $100,000  No rollover.........  $225,000-$450,000  $112,500-$225,000
                    Rollover.
469 (i)..........  $25,000 Rent      (1,7)............  $100,000-$150,000  $100,000-$150,000  $50,000-$75,000.....  $225,000-$450,000  $112,500-$225,000
                    Passive Loss.
469 (i)..........  Passive Rehab.    (1,7)............  $200,000-$250,000  $200,000-$250,000  $100,000-$125,000...  $225,000-$450,000  $112,500-$225,000
                    Credit.
530..............  Education IRA     (1,6)............  $150,000-$160,000   $95,000-$110,000  No deduction........  $225,000-$450,000  $112,500-$225,000
                    Deduction.
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Modifications to AGI apply; (2) Inflation indexed; (3) Earned income limitations; (4) Low income only; (5) Phase-out range depends on number of
  children; (6) Newly enacted in 1997; (7) Also see section 221(b)(2); (8) Phase-out applies to alternative minimum taxable income rather than AGI; (9)
  Increases for future years are specifically provided in the statute.

                 EXHIBIT B--Current Method of Phase-Out
------------------------------------------------------------------------
                                                Current Methodology for
    Code Section(s)         Tax Provision        Phase-outs Application
------------------------------------------------------------------------
21....................  Dependent Care Credit  Credit percent reduced
                                                from 30 percent to 20
                                                percent in AGI range
                                                noted by 1 percent
                                                credit for each $2,000
                                                in income
22....................  Elderly Credit.......  Credit amount reduced by
                                                excess over AGI range
23 & 137..............  Adoption Credit &      Benefit reduced by excess
                         Exclusion.             of modified AGI over
                                                lowest amount noted
                                                divided by 40,000
24....................  Child Credit.........  Credit reduced by $50 for
                                                each $1,000 in modified
                                                AGI over lowest amount
                                                divided by 10,000
                                                (single) and 20,000
                                                (joint)
25A...................  Education Credits      Credits reduced by excess
                         (Hope/Lifetime         of modified AGI over
                         Learning).             lowest amount divided by
                                                10,000 (single) and
                                                20,000 (joint)
32....................  Earned Income Credit.  Credit determined by
                                                earned income and AGI
                                                levels
55....................  AMT Exemption........  Exemption reduced by 1/4
                                                of AGI in excess of
                                                lowest amount noted
68....................  Itemized Deductions..  Itemized deductions
                                                reduced by 3 percent of
                                                excess AGI over amount
                                                noted
135...................  Series EE Bonds......  Excess of modified AGI
                                                over lowest amount
                                                divided by 15,000
                                                (single), 30,000 (joint)
                                                reduces excludable
                                                amount
151...................  Personal Exemption...  AGI in excess of lowest
                                                amount, Exemption
                                                divided by 2,500,
                                                rounded to nearest whole
                                                number, multiplied by 2,
                                                equals the percentage
                                                reduction in the
                                                exemption amounts
219...................  Traditional IRA w/     Individual retirement
                         Retiremt. Plan.        account (IRA) IRA
                                                limitation ($2,000/
                                                $4,000) reduced by
                                                excess of AGI over
                                                lowest amount noted
                                                divided by $10,000
219(g)(7).............  IRA w/Spouse w/        Deduction for not active
                         Retiremt. Plan.        spouse reduced by excess
                                                of modified AGI over
                                                lowest amount noted
                                                divided by 10,000
221...................  Education Loan         Deduction reduced by
                         Interest Expense       excess of modified AGI
                         Deduction.             over lowest amount noted
                                                divided by 15,000
408A..................  Roth IRA.............  Contribution reduced by
                                                excess of modified AGI
                                                over lowest amount noted
                                                divided by 15,000
                                                (single) and 10,000
                                                (joint)
408A..................  IRA Rollover-Roth IRA  Rollover not permitted if
                                                AGI exceeds 100,000 or
                                                if MFS
469(i)................  Passive Loss Rental    Benefit reduced by 50
                         $25,000 Rule.          percent of AGI over
                                                lowest amount noted
530...................  Education IRA          Contribution reduced by
                         Deduction.             excess of modified AGI
                                                over lowest amount noted
                                                divided by 15,000
                                                (single) and 10,000
                                                (joint)
------------------------------------------------------------------------

                                

    Chairman Houghton. Thank you very much, Mr. Lifson.
    Mr. Gutman.

        STATEMENT OF HARRY L. GUTMAN, PARTNER, KPMG LLP

    Mr. Gutman. Thank you, Mr. Chairman. It is a pleasure to be 
sitting as a witness, I must say, as compared to other 
capacities I have been here. I appreciate the opportunity to 
appear before you and ask that my statement be included in the 
record. Before I get to the substance of my remarks, I want to 
commend you and Mr. Coyne and Mr. Neal for doing something 
tangible in the simplification area. Too often, we have simply 
heard words from those who have the responsibility to enact and 
administer the tax laws and you have taken some action and put 
some concrete proposals on the table and I think you need to be 
commended for that. This process, as has been said before, has 
to start somewhere.
    I wish I had some good advice for Mr. Neal about how to 
jump start the process. That is extremely difficult. Revenue-
neutrality is a key component. He has achieved that with his 
bill. And while a bill could get out of this committee and pass 
the House, unfortunately, as we know, the risk is not here, but 
rather on the other side of the Capitol. And, unfortunately, I 
think, as a practical matter, until one gets satisfied by what 
might happen to a tax bill when it goes over to the Senate, a 
free-standing bill is a problem. So I appreciate the 
difficulty, but urge you to continue to try to move forward 
with this legislation in a free-standing or whatever other 
capacity you are able to get it out of the committee and onto 
the floor.
    Tax complexity causes serious systemic costs. Focusing on 
the taxpayer side of the equation, the most obvious is the cost 
of 
compliance. But complexity also affects planning and certainty. 
If complex rules are viewed as unfair or unnecessary, respect 
for the system is undermined. And the story doesn't end with 
taxpayers, complex rules also affect the administration of the 
tax system, requiring more guidance, training, and enforcement.
    Understanding that inordinate complexity imposes 
unacceptable costs on the system and those who are affected by 
it does not, however, provide us with solutions. We are tempted 
to say, make the system simple and all our problems will 
disappear. But that is not really the case.
    Tax simplification is considerably more subtle and tricky 
because it means a lot of different things to a lot of 
different people. For example, to some, simplification means a 
system that is easy to understand. To others, it is a system 
that requires little record keeping. To still others, it is a 
system that allows for ease of computation and return 
preparation. And, finally, to others, simplification means a 
system that is easy to administer. In truth, it is all of those 
things. But it is important to recognize that achieving 
simplification objectives involves real tradeoffs and that 
simplification cannot occur in a vacuum. Simplification needs 
to take place within the context of creating a tax system that 
is, and is perceived as, equitable, neutral, and administrable.
    Complexity comes in many different forms and we must 
recognize that complex rules are often necessary to deal with 
complex transactions undertaken by sophisticated taxpayers. 
That complexity is not what we are talking about today. There 
are many other forms and sources of complexity that need not 
and should not be tolerated and those provisions are the 
subject of the bills that are under consideration today.
    In addressing the problem, we need to recognize that 
complexity often occurs because of the desire to use the Tax 
Code to achieve social or political goals rather than simply 
collect revenue on an equitable and neutral basis. The history 
of the Tax Code is replete with efforts to use the code to 
achieve particular objectives and they are the principal 
sources, I believe, of the complexity that was identified in a 
Joint Committe print prepared for a similar hearing in the 
Finance Committee.
    Another source of complexity is congressional attempts to 
tailor provisions to benefit specific taxpayers. The complexity 
of the law is also increased when Congress, for political 
expediency, disguises the substance of its legislative changes. 
Personal exemption and itemized deduction phaseouts, commonly 
known as PEP and Pease are prime examples of this. Mr. Neal's 
bill would repeal these provisions and substitute explicit rate 
increases. That is to be commended.
    Turning to the bills that are under consideration today, I 
would like to review very briefly the provisions of H.R. 1407 
and H.R. 1420. Title I of H.R. 1420, which is Mr. Neal's bill, 
and Chairman Houghton's proposed legislation would permanently 
waive the minimum tax limitations on nonrefundable credits and 
Mr. Neal's bill would also create a single phaseout range for 
the adoption credit, the family credit, and the education 
credits. These are sensible provisions and they should be 
enacted.
    Title II of the bill, which is Mr. Coyne's provision as 
well as Mr. Neal's, would replace the present melange of 
capital gains provisions with a 38-percent deduction and would 
treat gain or loss from the sale of a collectible as short-term 
gain. Mr. Houghton's legislation would provide a 50-percent 
deduction. Both of these would be simplifying provisions. The 
question of the appropriate exclusion amount is a political 
issue, but the question of how to compute the tax is not and 
these would both be very favorably received.
    Title III of Mr. Neal's bill would repeal PEP and Pease and 
that makes perfect sense. The provision repealing the 
individual minimum tax isn't quite as simple. It is clear that 
more taxpayers than ever anticipated will shortly become 
subject to the tax unless something is done. Moreover, many 
taxpayers who are not ultimately subject to the tax must make 
calculations to determine whether the tax applies to them. 
These facts argue for some adjustment. Mr. Neal would repeal 
the tax. Chairman Houghton would increase the alternative 
minimum tax exemption.
    As currently structured, the minimum tax does not achieve 
the objectives for which it was originally designed. The 
passive loss rules have largely eliminated the real and 
perceived sheltering and fairness issues that previously 
existed. The current minimum tax base does not correspond in 
any meaningful way to economic income. Indeed, it is 
questionable whether a number of the preferences are 
conceptually correct. And, finally, it is shortly going to 
affect too many taxpayers. Chairman Houghton's solution limits 
the damage. Mr. Neal eliminates the problem. Unless the minimum 
tax base is expanded to measure economic income, I prefer Mr. 
Neal's solution. No taxpayer should have to bother with the 
minimum tax in its current form.
    I am pleased to have had the opportunity to share some 
ideas with you. And I will be happy to answer any questions. 
Thank you.
    [The prepared statement follows:]

Statement of Harry L. Gutman, Partner, KPMG LLP

    Mr. Chairman and Members of the Subcommittee: I am honored to 
appear before the Subcommittee today as an invited witness to discuss 
tax simplification for individuals and small businesses, in general, 
and the Tax Simplification and Burden Reduction Act that is to be 
introduced by Chairman Houghton, H.R. 1407 introduced by Mr. Coyne, and 
H.R. 1420 introduced by Mr. Neal, in particular. This statement is made 
in my individual capacity and expresses my personal views. Nothing in 
this statement should be attributed to KPMG or to any of its clients.

                   Tax Complexity and Simplification

    Inordinate tax complexity creates serious systemic costs. Focusing 
on the taxpayer side of the equation, the most obvious is the cost of 
compliance. Complex rules and requirements mean that affected taxpayers 
need to take more time to understand, prepare, and substantiate tax 
returns. Complexity also affects planning and certainty. Time is 
required to master the rules so that the consequences of anticipated 
acts or transactions can be evaluated. If complex rules are also viewed 
as unfair or unnecessary, respect for the system is undermined. But the 
story does not end with taxpayers. Complex rules also affect the 
administration of the tax system, requiring more guidance, training, 
and enforcement.
    Understanding that inordinate complexity imposes unacceptable costs 
on the system (and those affected by it) does not, however, provide us 
with solutions. We are tempted to say, ``Make the system simple and all 
our problems will disappear.'' That, however, is not the case. Tax 
simplification is a considerably more subtle and tricky topic because 
it means different things to different people. For example, to some, 
simplification means a tax system that is simple to understand. To 
others, it means a system that requires little record keeping. To still 
others, it means a system that allows for ease of computation and 
return preparation. Finally, to others, tax simplification means a tax 
system that is easy to administer. In truth, it is all of these 
things--and more.
    It is important to recognize that achieving simplification 
objectives involves real trade-offs and that simplification cannot 
occur in a vacuum. Simplification needs to take place within the 
context of creating a tax system that is, and is perceived as, 
equitable, neutral, and administerable. An equitable tax system treats 
all similarly situated taxpayers the same. A neutral tax system is one 
that does not affect economic decisions. A tax system is administerable 
if the costs of administering the law and collecting revenue are 
comparatively low. Arguably, our tax system is none of the above.

                 Sources of Current Tax Law Complexity

    Complexity comes in many different forms. Complex rules are often 
necessary to deal with complex transactions undertaken by sophisticated 
taxpayers. They are not the provisions under consideration today. But 
there are many other forms and sources of complexity that need not--and 
should not--be tolerated, and many of those are addressed by the bills 
under consideration today.
    In large measure, the complexity we are addressing today is the 
result of using the tax code to achieve social or political goals 
rather than simply to collect revenue on an equitable and neutral 
basis. The principal sources of complexity in our tax system--described 
by the Joint Committee on Taxation\1\ as elections provided to 
taxpayers, definitional issues that taxpayers must consider, record-
keeping and reporting requirements, limitations on the availability of 
tax benefits, and frequent changes in the tax laws--are often the 
consequences of congressional attempts to tailor tax provisions to 
benefit specific taxpayers.
---------------------------------------------------------------------------
    \1\ JCX-18-99, Overview of Present Law and Issues Relating to 
Individual Income Taxes, April 14, 1999.
---------------------------------------------------------------------------
    The complexity of the tax laws is also increased when Congress, for 
political expediency, disguises the substance of its legislative 
changes. The personal exemption and itemized deduction phase-outs--
commonly known as ``PEP and Pease''--are prime examples. Rather than 
providing explicitly for a marginal rate increase when these provisions 
were added in 1990, Congress hid the real nature of these provisions as 
rate increases by calling them ``phase-outs.'' Mr. Neal's bill would 
repeal these complex provisions and substitute explicit rate increases.

                         Simplicity Trade-Offs

    Attempts to achieve tax simplification require trade-offs. Simple 
rules often create inequalities because in real life, there are many 
disparate situations that cannot be dealt with by applying simple 
rules. Attempts to tailor tax rules to address disparate situations 
generally give rise to greater complexity in the system. Thus, 
ironically, complex rules generally promote greater equality in a tax 
system. The original issue discount rules as applied to zero coupon 
bonds held by individuals are a case in point.
    The proposal to make all mortgage points paid in connection with a 
refinancing currently deductible is designed to add simplicity to the 
tax code, but it will result in trade-offs. Current deductibility of 
refinancing points would not reflect economic reality and would create 
abuse potential that should be addressed statutorily, thus complicating 
the proposed simple rules. If mortgage points are paid in connection 
with a 10-year refinancing loan, why does it make sense for the points 
to be deducted in the first year of the loan, rather than being 
allocated to and deducted over the course of the 10-year period? Would 
a simple rule of deductibility encourage refinancing, rather than 
allowing taxpayers to make refinancing decisions based on their 
personal economics? What would stop taxpayers from front-loading 
interest or points to obtain an accelerated interest deduction? Is it 
not a more sound approach--an approach in line with economic 
realities--to apply the costs of the refinancing over the life of the 
loan?

              Two Areas Where Simplification Is Necessary

    The array of education assistance programs now available in the tax 
code, from Lifetime Learning credits, to HOPE credits, to Education 
IRAs, to prepaid tuition plans and student loan interest deductions, 
are hopelessly intertwined, complex, difficult to understand, and 
difficult to compute--even for a person who has taken advantage of any 
of these programs to attain a good education. No rational individual 
could have concocted this scheme. Rather, it is the result of the 
political process. The program should be rationalized.
    Another prime example of tax law complexity is the earned income 
tax credit (EITC). The EITC is, of course, a government subsidy 
programs for low-income taxpayers who are gainfully employed. The goal 
of the EITC is laudable; however, the complexity of the provisions is 
regrettable. Simplification is plainly necessary to reduce the burden 
on taxpayers least able to afford the compliance costs.
    Recent testimony before the Senate Finance Committee by 
representatives of the American Bar Association and the American 
Institute of Certified Public Accountants, among others, described many 
other instances of tax complexity. These statements, and the bills 
under consideration today, suggest that the road to tax simplification 
is an incremental one. I agree. It is unreasonable to expect a complete 
revision of the Internal Revenue Code--to achieve simplification or 
otherwise. Consequently, simplification efforts should be devoted to 
identifying major areas of complexity for a large number of taxpayers 
and simplifying those provisions. I cited two examples above. The bills 
under consideration today identify a number of others. Accordingly, I 
now turn to the bills before the Subcommittee.

                        H.R. 1407 and H.R. 1420

    The basic substance of H.R. 1407 is included in Title II of H.R. 
1420. Therefore, I will discuss the bills together.

Title I--Simplification Relating to Nonrefundable Personal 
Credits

    Title I of H.R. 1420, and Chairman Houghton's proposed legislation, 
would permanently waive the minimum tax limitations on nonrefundable 
credits. H.R. 1420 would also create a single phase-out range for the 
adoption credit, the family credit, and the education credits. Both are 
sensible provisions and should be enacted.

Title II--Simplification of Capital Gains Tax

    Title II would replace the present melange of capital gain 
provisions with a 38 percent deduction and would treat gain or loss 
from the sale of a collectible as short term. Chairman Houghton's 
legislation would provide a 50-percent deduction. The question of the 
amount of the preference to be accorded capital gain income is a 
political issue. The structure of the preference is not. The complexity 
of the current provisions reflects a number of political 
accommodations. They make little policy sense when originally adopted, 
and they make less sense today. The bills restore simplicity to the 
calculation of capital gain income, even if they fail to address the 
question of why the preference is required at all.

Title III--Repeal of Certain Hidden Marginal Rate Increases; 
Repeal of Individual Minimum Tax

    As noted above, Title III of the bill would repeal PEP and Pease 
and replace them with a straightforward rate increase. I strongly 
support these changes, both from a simplicity and ``truth in 
advertising'' perspective. I am not as comfortable with the provision 
that increases the floor on itemized deductions for higher income 
taxpayers. I never understood the policy justification for the floor in 
the first place.
    The provision repealing the individual minimum tax is not quite as 
simple. It is clear that more taxpayers than ever anticipated will 
shortly become subject to the minimum tax unless something is done. 
Moreover, many taxpayers who are not ultimately subject to the tax must 
make the calculations to determine whether the tax applies to them. 
These facts argue for some adjustment. Mr. Neal would repeal the tax. 
Chairman Houghton would increase the alternative minimum tax exemption.
    What to do about the minimum tax depends in large measure on one's 
view of why the tax exists in the first place. Almost 15 years ago, in 
1985, I testified about this very issue before the Senate Finance 
Committee. The discussion at that time focused on the fact that high-
income taxpayers were able to use tax preferences to reduce 
substantially, or even eliminate, their income tax liabilities. At the 
1985 hearing, I noted there were three reasons why a minimum tax should 
be enacted. The first was revenue. In my testimony, I stated that while 
a need for revenue could lead to a search for an alternative source of 
tax receipts, this alone was not a compelling reason to adopt a minimum 
tax. Moreover, even with revenue as the principal justification for the 
tax, the structure of the tax was not provided.
    The second reason for a minimum tax dealt with perceptions of 
fairness. Because of the existence of tax preference items, different 
taxpayers with similar economic income were allowed to pay different 
amounts of tax. The use of tax preference items by some taxpayers to 
minimize their tax liabilities fostered public resentment, and this 
resentment had two notable consequences: a loss of respect for the tax 
system; and pressure on the political process to do ``something'' about 
the problem. As I said at the time, while it was not perfectly clear 
what the ``something'' was, it appeared to be that steps should be 
taken to ensure that all taxpayers pay some tax.
    The third reason for invoking a minimum tax was to broaden the 
income tax base. If broadening the tax base was the ultimate goal, a 
minimum tax was the appropriate vehicle. The tax base should 
approximate economic income.
    I also noted that a minimum tax designed solely to assure that all 
taxpayers paid some tax created what I referred to as tax system 
``schizophrenia.'' On the one hand, a minimum tax had the effect of 
reducing the after-tax value of the preferences that are a part of the 
minimum tax base. On the other hand, the congressional objective that 
prompted the enactment of the preference in the first place would be 
undermined. I asked why the value of the preference should be reduced 
when a taxpayer did precisely what Congress intended.
    Now, some 15 years later, we return to visit some of the same 
issues. As currently structured, the minimum tax does not achieve the 
objectives for which it was originally designed. The passive loss rules 
have largely eliminated the real and perceived sheltering and fairness 
issues I addressed in 1985. The current minimum tax base does not 
correspond in any meaningful way to economic income. Indeed, it is 
questionable whether a number of the preference items are conceptually 
correct. Finally, it will shortly affect too many taxpayers.
    Chairman Houghton's solution limits the damage. Mr. Neal eliminates 
the problem. Unless the minimum tax base is expanded to measure 
economic income, I prefer Mr. Neal's solution. No taxpayer should have 
to bother with the minimum tax in its current form.

              Tax Simplification and Burden Reduction Act

    I have discussed a number of the provisions in Chairman Houghton's 
proposed legislation earlier in this statement. In the absence of 
legislative language, it is difficult to comment more than generally on 
the other proposals. However, I think it makes good sense to simplify 
the estimated tax safe harbors and to treat the postmark date as the 
filing date for all returns. Further Subchapter'S simplification is 
appealing, but the details are critical. The same is true with respect 
to reducing record-keeping requirements.

                               Conclusion

    I am pleased to have had the opportunity to share my views on tax 
simplification with you. I am prepared to answer any questions you may 
have.

                                

    Chairman Houghton. Thank you, Mr. Gutman.
    Mr. Harkins.

STATEMENT OF GERRY HARKINS, OWNER AND GENERAL MANAGER, SOUTHERN 
 PAN SERVICES COMPANY, CONLEY, GEORGIA, ON BEHALF OF NATIONAL 
               FEDERATION OF INDEPENDENT BUSINESS

    Mr. Harkins. Thank you, Mr. Chairman, Committee Members. I 
am here to speak on behalf of the National Federation of 
Independent Business and its 600,000 small business owner 
members.
    I am the owner and operator of Southern Pan Services 
Company in Conley, Georgia. Southern Pan Services was started 
in 1987. It is a construction subcontractor specializing in 
concrete form work. We employ approximately 400 workers in the 
Southeast. I have been an adviser to the Internal Revenue 
Service for 9 years as chairman of the Commissioner's Advisory 
Group, and as a member of the District Director's Liaison 
Committee and as a member of the National Commission on 
Restructuring the Internal Revenue Service, of which Mr. Coyne 
served ably. I spent a year investigating the Internal Revenue 
Service.
    I am here today to talk about several things and I would 
like to ask that my statement be entered into the record. 
First, tax simplification. Small business owners might best be 
described as the poster child for tax complexity victims. We 
could be compared to the slowest buffalo in the herd and the 
IRS as the lion. And, as tough as the IRS code is on everybody 
else, it is doubly tough on America's small businessmen and 
women. It has been estimated that tax-related paperwork costs 
are twice as high for small business, compared to large 
business.
    About the chairman's bill, Chairman Houghton's bill, the 
NFIB has advocated a long list of items that would simplify the 
Tax Code for small businesses. I am pleased to say that many of 
these items are contained in the Tax Simplification and Burden 
Reduction Act proposed by Chairman Houghton. These provisions 
include: alternative minimum tax relief, expanded expensing 
opportunities, and pension simplification. Other legislation to 
be introduced by Congressman Talent also contains many of these 
provisions as does legislation introduced by Congressman Neal.
    The chairman's proposals regarding AMT are targeted 
specifically at small businesses and represent a significant 
relief from the AMT. On behalf of small business, I would like 
to thank the chairman for including this provision in his bill. 
While the NFIB obviously would prefer the outright elimination 
of the AMT, which is the Neal approach, the Houghton bill would 
address the worst aspects of the tax.
    Another pet peeve of small business and all property owners 
is the elimination of the death tax. One provision not 
addressed by the chairman's bill that would provide significant 
relief to small businesses is repeal of the death tax. For a 
family business like mine, the death tax is a storm on the 
horizon. It threatens everything I have accomplished over the 
past 19 years.
    Death tax supporters argue that the tax only affects a 
small percentage of estates, but the costs are much deeper than 
that. I recently completed a series of lengthy meetings with my 
attorney and CPA to determine how my estate would be affected 
by my death. To my horror, I found out that my heirs would have 
to liquidate my business under duress to pay the estate taxes 
due upon my death. There is no way to avoid this tax upon a 
successful business. In my company's case, we would endanger 
the livelihood of all our employees and suppliers. The negative 
economic impact goes far beyond the business owner's heirs.
    The death tax may provide government revenue in the short-
run but, in the long-run, costs far outweigh the gains. Studies 
by the Joint Economic Committee and the Institute for Policy 
Innovation show the death tax actually costs the Federal 
Government in the long-run. NFIB supports eliminating the death 
tax. Two bills have been introduced in the House that we 
support. H.R. 8, introduced by Representatives Dunn and Tanner 
and H.R. 86, introduced by Representative Cox.
    Another area ripe for simplification is the Federal 
Unemployment Tax or FUTA. For small businesses, FUTA presents 
two problems. First, the rate is too high. Second, employers 
are required to pay two unemployment taxes, the Federal tax and 
the State tax. That means twice the collection points, twice 
the payments, and twice the complexity. NFIB supports reforming 
the nation's unemployment system, including cutting the rate 
and having just one point of collection. Once again, I am 
pleased to see that the chairman and other Members of the 
Committee have supported such reforms in the past. This week, 
Congressman McInnis plans to introduce legislation to eliminate 
the FUTA surtax, which is .2 percent or one-fourth of the tax 
and I hope the Committee will support his efforts.
    Another area is the clarification of the definition of 
independent contractor. I understand the chairman has joined 
others in introducing legislation to address the independent 
contractor issue. We applaud the chairman for seeking to create 
objective standards to define who is and who is not an 
independent contractor. At the same time, I understand the 
chairman is aware that the NFIB has serious concerns about the 
direction this legislation takes. That said, something needs to 
be done to create a bright line between employee and an 
independent contractor. The current 20 common law factor test 
has handcuffed small business for too long. We need an 
objective standard that is simple and easily understood.
    Mr. Chairman, Committee Members, I thank you for your 
attention and for inviting me to be here today. I will answer 
any questions.
    [The prepared statement follows:]

Statement of Gerry Harkins, Owner and General Manager, Southern Pan 
Services Company, Conley, Georgia, on Behalf of National Federation of 
Independent Business

    Good afternoon. On behalf of the 600,000 members of the National 
Federation of Independent Business (NFIB), I appreciate the opportunity 
to present the views of small business owners on the subject of tax 
simplification.
    My name is Gerry Harkins. I am an owner and operator of Southern 
Pan Services Company of Conley, Georgia. Southern Pan Services was 
started in 1987 and is a construction subcontractor specializing in 
concrete formwork. We employ approximately 400 workers in the 
Southeast.
    I have been an advisor to the IRS for 9 years as Chairman of the 
Commissioner's Advisory Group and a member of the District Director's 
Liaison Committee. As a member of the Commission on Restructuring the 
IRS, I spent a year investigating the Internal Revenue Service.

                           Tax Simplification

    Small business owners might best be described as the poster child 
of tax complexity victims. As tough as the IRS Code is on everyone 
else, it is doubly tough on America's small businessmen and women. It 
has been estimated that the tax-related paperwork costs are twice as 
high for a small business compared to a large business.
    While economists differ as to the actual cost of compliance, 
Professor Joel Slemrod, in testimony before the IRS Restructuring 
Commission, very conservatively estimated the cost to the taxpayers of 
complying with the current tax code is $75 billion annually. Other 
estimates put the cost closer to $200 billion. This is particularly 
staggering when compared to the IRS budget of $7.5 billion.
    For that reason, NFIB believes the best solution for a fairer, 
simpler tax code is to scrap the current code and replace it with one 
that promotes investment and savings. This new system must be broad 
based. That is our long-term goal and we will continue to work towards 
it.
    In the short term, however, there are specific tax provisions that 
are particularly onerous to small business. I believe addressing these 
issues would move us towards the fairer, simpler tax code we would all 
like to see. I am pleased to say that many of these items are contained 
in the proposed legislation outlined by Chairman Houghton, including 
Alternative Minimum Tax Relief, expanded expensing opportunities, and 
pension simplification. Other legislation to be introduced by 
Congressman Talent also includes many of these provisions.

                        Eliminate the Death Tax

    If you want to simplify the tax code and raise revenues at the same 
time, eliminate the death tax? Eliminating the death tax would remove 
an enormous source of compliance cost and complexity and remove an 
entire Subtitle of the IRS Code all at the same time.
    For a family business like mine, the death tax is a storm on the 
horizon. It threatens everything I have accomplished over the past 
nineteen years. Death tax supporters argue that the tax only affects a 
small percentage of estates, but the costs are much deeper than that.
    I recently completed a series of lengthy meetings with my attorney 
and CPA to determine how my estate would be affected by the death tax. 
To my horror, I found out that my heirs would have to liquidate my 
business under duress to pay the estate taxes due upon my death. There 
is no way to avoid this tax upon a successful business. In my company's 
case, we would endanger the livelihood of all our employees and 
suppliers. The negative economic effect goes far beyond the business 
owner's heirs.
    The death tax is bad for family businesses, it is bad for 
employees, and if you take the economic and compliance costs into 
account, it is bad for the federal government too. The death tax may 
provide government revenue in the short run, but the long-run costs far 
outweigh the gains. Studies by the Joint Economic Committee and the 
Institute for Policy Innovation show the death tax actually costs the 
federal government in the long run.
    NFIB supports eliminating the death tax. Two bills have been 
introduced in the House that we support--HR 8, introduced by 
Representatives Dunn and Tanner, and HR 86, introduced by 
Representative Cox. Either one of these bills would provide significant 
relief to millions of small business owners and dramatically simplify 
the IRS Code. I am pleased to see that many members of this panel, 
including the Chairman, are cosponsors of one or both of these bills.

                          Reform Payroll Taxes

    Another area ripe for simplification is the federal unemployment 
tax, or FUTA. For small business, FUTA presents two problems. First, 
the rate is too high. Federal payroll taxes have never been cut--they 
only go up. Since their inception, federal payroll taxes--including 
FUTA and Social Security taxes--have risen from 2 cents of the first 
dollar earned to over 16 cents. This represents an increase of 800 
percent.
    Second, employers are required to pay two unemployment taxes--the 
federal tax and the state tax. That means twice the collection points, 
twice the payments, and twice the complexity. Payroll taxes were listed 
as the most costly tax in an NFIB tax survey, just ahead of personal 
income taxes. And 53 percent of those surveyed said payroll taxes are 
less fair or much less fair than business income taxes.
    NFIB supports making the following changes to our nation's 
unemployment system:
     Eliminate the Surtax: The temporary FUTA surtax was put in 
place in 1976 in order to repay loans from the federal unemployment 
trust fund. Even though this money was fully repaid in 1987, Congress 
has extended this temporary tax four times, imposing an annual $1.4 
billion tax burden on America's workers and employers. The surtax 
should be eliminated. Repeal of the surtax is long overdue.
     Cut FUTA Taxes: Even if the surtax is eliminated, FUTA 
still collects far more than it needs. FUTA raised $6.1 billion last 
year, but only $3.5 billion was spent on FUTA-related expenses. The 
rest was used to pay for non-related government programs. Permanent 
FUTA taxes should be cut to reflect the lower costs of the program.
     Send the Program to the States: The current system is 
duplicative and inefficient, costing the federal government, state 
governments, and private employers hundreds of millions in unnecessary 
administrative costs annually. Unemployment taxes should be collected 
by the states alone to eliminate these unnecessary costs.
    Once again, I am pleased to note that the Chairman and other 
members of this Committee have supported such reforms. This week, 
Congressman McInnis plans to introduce legislation to eliminate the 
FUTA surtax.

                        Small Business Expensing

    Another positive step taken by Congress recently was to increase 
the annual limit on business expensing to $25,000 by the year 2003. 
Legislation has been introduced by Congressman English to increase this 
limit further, to $60,000.
    The purpose of small business expensing is twofold. First, it 
simplifies tax calculations--deducting investments immediately is 
simpler than depreciating them over a number of years. Second, it 
encourages small businesses to invest by reducing their tax liability 
and increasing their cash flow.
    Personally, I fail to understand why expensing isn't universal. 
There is no real revenue loss from expensing--any tax benefit I gain 
this year I will lose next year. Meanwhile, the money that I keep this 
year goes into the economy and may mean the difference between success 
and failure for my business. Long and complex depreciation schedules 
don't just add to tax complexity and cost; they are also a tax on 
investments.
    One way to make Section 179 more effective, aside from increasing 
its limits, might be to expand the types of purchases that can be 
expensed. Right now, only tangible property like business equipment, 
office furniture, and computer hardware can be expensed. Even auto 
purchases are subject to a limit. Expanding Section 179 to include 
purchases of computer software and other investments like leasehold 
improvements would make the section more effective. Once again, 
expanded Section 179 expensing is part of the Chairman's proposal, and 
it is certainly something NFIB would support.

            Clarify the Definition of Independent Contractor

    I understand the Chairman has joined others in introducing 
legislation to address the Independent Contractor issue. I also 
understand the Chairman is aware that NFIB has serious concerns about 
the direction of this legislation.
    That said, something needs to be done to create a bright line 
between an employee and an independent contractor. A recent NFIB 
Education Foundation Survey found that the issue of determining an 
independent contractor was one of the biggest problems facing small 
business today. The current 20 common law factor test has handcuffed 
small businesses for too long. We need an objective standard that is 
simple and easily understood.
    The 1995 White House Conference on Small Business's top 
recommendation was to establish a new test based on the following four 
criteria: (1) realization of a profit or loss; (2) separate principal 
place of business; (3) making services available to the general public; 
and (4) paid on a commission basis.
    These criteria formed the foundation of legislation introduced in 
both the House and the Senate--Senator Bond has a bill in the Senate--
and I encourage the Members of this Committee to use that legislation 
as a starting point for resolving this longstanding issue.

                      Cash vs. Accrual Accounting

    Another area related to accounting has to do with shoring up 
Section 448 of the IRS Code. Section 448 permits businesses with less 
than $5 million in annual revenues to use the cash method of 
accounting. While my business is too large to take advantage of this 
provision, many small shops in my industry do use it to their 
advantage. Cash accounting simply allows a business to only recognize 
those revenues it has actually received.
    There are two reforms that NFIB would like to see to this 
provision. First, the $5 million cap has been in place for some time. 
It would be helpful to increase this cap. I believe the Chairman has 
proposed to do just that.
    Second, the IRS has begun to use other portions of the IRS Code to 
undermine Section 448. In some cases, the IRS has disallowed the use of 
the cash accounting system for businesses with annual revenues below $5 
million because the IRS claims inventory is a material factor in their 
business. It is my understanding that the IRS's definition of 
``material'' can be extremely imaginative.
    Once again, a bright line is needed to ensure that businesses below 
the threshold and without extensive inventories can use cash accounting 
if they so choose.

          Abolish the Alternative Minimum Tax for Individuals

    Finally, let me mention the Alternative Minimum Tax. I believe the 
individual Alternative Minimum Tax is misnamed. It should be called, 
``The Alternative Small Business Tax.'' Take a look at the adjustments 
required under the individual AMT. Most of them are targeted at 
business-related deductions.
    And, like the death tax, the notion that the AMT is a rich 
taxpayer's problem is incorrect. According to the Joint Committee on 
Taxation, more taxpayers than ever will be subject to the AMT within a 
decade, with the largest increase coming from taxpayers earning between 
$50,000 and $100,000.
    Finally, the AMT has the side effect of hitting small businesses 
when they can least afford the bill. If I have a bad year, I'm more 
likely to trigger the AMT than when I do well. The AMT literally 
``kicks taxpayers when they are down.''
    In 1993 and 1997, Congress made numerous reforms to the corporate 
AMT to reduce its complexity and cost to certain industries. But many 
small businesses file as individuals, not corporations. The NFIB 
supports abolishing the individual Alternative Minimum Tax. At the very 
least, the existing AMT exemption should be increased and indexed to 
shield taxpayers from this onerous tax. Once again, I am pleased to see 
that the Chairman has proposed to do just that.

                               Conclusion

    I would like to thank the Chairman for the opportunity to testify 
before the Ways and Means Subcommittee on Oversight on the important 
issue of tax simplification. I would also like to thank him for taking 
on this issue with so much enthusiasm. Adoption of the reforms 
mentioned above would be a dramatic victory in the battle of tax 
simplification.

    Chairman Houghton. All right. Thank you very much. We will 
have them questions, Mr. Harkins.
    Mr. Steuerle.

     STATEMENT OF C. EUGENE STEUERLE, SENIOR FELLOW, URBAN 
        INSTITUTE, ON BEHALF OF NATIONAL TAX ASSOCIATION

    Mr. Steuerle. Mr. Chairman and Members of the Subcommittee, 
thank you for the opportunity to testify on tax simplification 
on behalf of the National Tax Association. Founded in 1907, NTA 
is the leading association of tax professionals dedicated to 
advancing the understanding and theory of public finance. The 
association will be pleased to assist the Subcommittee in any 
discussion of tax simplification.
    As has been expressed before, principles of tax law often 
conflict. In achieving a balance among principles, however, 
almost everyone would agree that simplicity has been given far 
too little weight in the legislative process. My 
congratulations go out to the Members of this Subcommittee for 
their willingness to tackle these problems and, in particular, 
to the three of you who have remained, Mr. Houghton, Mr. Coyne, 
Mr. Neal, for your special efforts. I realize that you will not 
be blinded by the TV lights for your giving attention to this 
issue, but I think, nonetheless, it is extremely important.
    Needless tax complexity, I believe, serves as one of the 
more important barriers to a healthy relationship between a 
citizenry and its government. In my testimony, I include 
several items of needless tax complexity which I will list very 
briefly and then get onto an issue that I think is also equally 
important but perhaps has not been given enough attention--and 
that is the question of a process that might give simplicity 
more attention.
    Among the items that I list are: an alternative minimum tax 
that treats items such as dependent exemptions as a tax 
shelter, thereby threatening to tax millions who were never 
meant to be affected; the phaseout after phaseout of such items 
as itemized deductions, personal exemptions, and educational 
tax breaks, each of which is like a little mini-tax unto 
itself; pension and savings incentives that add administrative 
costs and perhaps even reduce net saving because of their 
multiple rules on withdrawals, penalties, allowing amounts of 
exclusion and deduction and so on; a tax treatment of dependent 
children that needlessly causes millions of unnecessary tax 
returns to be filed; a capital gains tax law with seven 
different tax breaks; multiple educational tax breaks that are 
poorly coordinated with each other and with direct expenditures 
for education; complicated rules for charitable deductions and 
charities, including multiple limits on giving and an excise 
tax on foundations that actually discourages charitable giving; 
child credits and dependent exemptions that could easily be 
folded into one; and unnecessarily strict estimated tax rules 
that pick up very little revenue for all the complexity they 
introduce.
    I would like to concentrate, however, the remainder of my 
testimony not on particular proposals but on a broader issue. I 
believe that the complexity of the tax law is, at its heart, a 
failure of process. The process failure could be mitigated 
through the adoption of certain procedures that I have 
suggested for both the executive branch and Congress. The 
purpose of these procedures is simply to grant simplicity a 
higher priority in the overall process. I therefore suggest 
strong consideration be given to two types of process reforms: 
No. 1, those that require periodic reporting on existing law; 
and, No. 2, those that would apply to new legislation.
    Let me turn first to the possible periodic reports that I 
believe would help you in achieving your goal. My first 
suggestion is that the Treasury or the Joint Committee on 
Taxation should publish a formal study, year after year, 
listing tax simplification options. If you don't believe how 
important this could be, I invite you only to look at the list 
of revenue options and expenditure options put out annually by 
the Congressional Budget Office and the attention that those 
receive. Or to the tax expenditure list prepared by the 
Treasury and the Joint Committee on Taxation. This latter list, 
however, is not a list of items for simplification.
    Second, the Government Performance and Results Act of 1993 
requires a performance plan review that has been extended on a 
very embryonic basis to Treasury's tax expenditure budget. Now 
Treasury made some very tentative steps there. I believe that 
they could be expanded significantly and help you in your 
roles. At the same time, I believe there is a fundamental 
failure in the IRS administrative structure. Because it is 
organized around tax returns and not tax programs under its 
jurisdiction, IRS does not prepare analyses of programs and it 
takes no responsibility for their success or failure. It is not 
surprising, then, that IRS almost always ends up behind the 
eight-ball when Congress suddenly decides it wants to examine 
the effectiveness of, say, the earned income credit or the 
compliance costs imposed upon charities.
    I also suggest some procedures for giving simplicity 
greater weight in the legislative process. These include 
testimony on proposed bills that would always give at least 
some attention to witnesses who focus solely on simplification 
administrative issues. When the markup of a bill occurs and 
when you go to conference, I suggest that at least one person 
at the witness table should have the sole assignment of 
providing information on administrative aspects of the bill. 
Before going to conference, the IRS could also provide mock tax 
forms showing exactly what has been wrought from bills. I 
actually succeeded in having them do this with one piece of 
legislation in 1987 and it did significantly change what was in 
the bill, although the bill itself still had major problems.
    And, finally, the National Commission on Restructuring the 
IRS suggested the tax complexity assessment accompany future 
tax changes. Last year, the Joint Committee on Taxation did 
prepare a simplification analysis of the House bill at the 
request of Chairman Archer, even though it wasn't required that 
year. I am hopeful that this Subcommittee will devote some 
effort to making sure that these procedures continue to be set 
because precedents this year and next year are very important.
    Of course, none of these process reforms guarantee that 
simplification will occur. Nonetheless, a combination of some 
if not all of these procedures, I believe, could serve as a 
major deterrent to new sources of unnecessary complexity and as 
a spur to further efforts in achieving the types of 
simplifications of the Subcommittee that it has fostered today. 
Thank you.
    [The prepared statement follows:]

Statement of C. Eugene Steuerle, Senior Fellow, Urban Institute; on 
behalf of National Tax Association

    Mr. Chairman and Members of the Subcommittee: Thank you for the 
opportunity to testify on tax simplification on behalf of the National 
Tax Association (NTA). Founded in 1907, NTA is the leading association 
of tax professionals dedicated to advancing understanding of the theory 
and practice of public finance. The Association is the premier forum 
for debating complex and controversial public finance issues; testing 
new tax theories, practices, and policies; and disseminating impartial, 
nonpartisan research of the highest quality. NTA is a tax-exempt 
501(c)(3) organization and does not promote any particular tax program 
or policy. NTA's diverse membership brings together government, 
corporate, academic, and independent tax professionals: a rich mix of 
federal and state legislators and administrators; taxpayer 
representatives; tax lawyers and accountants; professors, librarians, 
and other scholars; and students and interested citizens.
    With its long history of exploring tax issues, and its broad 
membership, the Association will be pleased to assist the Subcommittee 
in its discussion of tax simplification. Most recently, NTA convened 
the major national project on taxation of communications and electronic 
commerce, which is sorting out issues facing governments, industry, and 
users of these services.
    Principles of tax law often conflict. For example, taxing all 
income on an equal basis is generally considered to promote both a more 
efficient and fair tax system, but carried to an extreme it can add to 
complexity. In achieving a balance among principles, however, almost 
everyone would agree that simplicity has been given far too little 
weight in the legislative process. There are many items in the tax law 
that add significant complexity with little gain in some other area 
like equity or efficiency. Almost no one would introduce many 
provisions now in current law, if designing a Code from scratch. Once 
there, however, these complexities are hard to remove. My 
congratulations go out to the members of this subcommittee who are 
willing to tackle these problems.
    Complexity creates waste, not merely cost. One must distinguish 
between costs that might provide benefits and those that do not. A 
transfer of $1 from me to you may cost me $1, but there is an offset in 
the $1 that you pick up. Economists often focus on the distortions that 
this transaction might bring about, such as changes in behavior. 
However, among the most important distortions are the extra time and 
effort involved. Joel Slemrod of the National Tax Association has made 
special efforts over time to study this issue and has concluded that 
administrative costs are significant. If it now costs me $1.10 to 
transfer $1 to you--$1 in cash and 10 cents in human resources--then 
that 10 cents is lost to society as a whole.
    Another cost, although more subtle, may be even more important. 
Many people do not mind paying their fair share of the cost of 
government, but they highly resent it when they see needless waste--
including waste of their time in filling out an unreasonable number of 
forms. They gradually lose respect for government and its functions. I 
do not mean to imply that tax complexity is the only, or even the 
primary, factor at play in the public's increasing cynicism toward 
government--a cynicism that goes well beyond the healthy skepticism 
that Americans have always had. But needless tax complexity does serve 
as one of the important barriers to a healthy relationship between a 
citizenry and its government.

                      A Few Candidates for Reform

    Included among the many items of needless complexity today are the 
following:
     An alternative minimum tax that treats items such as 
dependent exemptions as tax shelters, thereby threatening to tax 
millions who were never meant to be affected;
     Phase-out after phase-out of such allowances as itemized 
deductions, earned income tax credits, personal exemptions, eligibility 
for IRAs, eligibility for other saving incentives, eligibility for 
educational tax breaks--each of which is like an additional mini-tax 
system all to itself;
     Pension and saving incentives that add administrative 
costs and possibly even reduce net saving by providing different rules 
for withdrawals, penalties, Social Security tax treatment, allowable 
amounts of exclusion or deduction, and so on;
     A tax treatment of dependent children that needlessly 
causes millions of unnecessary tax returns to be filed;
     A capital gains tax law with at least seven different tax 
rates and that requires taxpayers to fill out pages of forms even when 
they have only a few dollars of gains;
     Multiple educational tax breaks that are poorly 
coordinated with each other and with direct educational expenditures, 
thus requiring duplicate administration and creating complexity for 
students, parents, educators, and the IRS;
     Complicated rules for charitable deductions and charities, 
including multiple limits on giving as a percent of income and a 
perverse excise tax on foundations that actually discourages charitable 
giving;
     Child credits and dependent exemptions that could easily 
be folded into one; and
     Unnecessarily strict estimated tax rules that pick up very 
little extra revenue for all the complexity they introduce.
    In the appendix to this testimony, I elaborate a bit on the first 
three of these items. My purpose here, however, is not to go through a 
laundry list of provisions in need of reform. Instead, I would like to 
concentrate the remainder of my testimony not on particular proposals 
but on a broader issue. I believe that the complexity of the tax law is 
at its heart a failure of process. This process failure could be 
mitigated through the adoption of certain procedures that I have 
suggested for both the Executive Branch and Congress. The purpose of 
these procedures is simply to grant simplicity a higher priority in the 
policy process.
    The issue, however, is not whether simplification should receive 
the top priority in every tax bill. It should not. There are often 
equally important, or more important, principles and issues at stake, 
such as financing government activity or providing equal justice to 
citizens in equal circumstances. After all, the government doesn't 
collect taxes merely to simplify its tax system. The issue, instead, is 
that simplification receives too little weight, especially given how 
complex the tax system has already become. Indeed, the good news in 
this bad news is that there are so many opportunities now for 
simplification that only a modest effort is required to ensure that 
most new tax enactments achieve net tax simplification.

                                Process

    When I speak of process reform, I refer partly to the fact that no 
one in the Executive Branch or in the Congress is responsible for 
reporting on the consequences of tax law. I believe the way to 
alleviate this situation would be to assign this fiduciary-like 
responsibility and to formalize it in some very specific procedures. 
Below I list two types of process reforms: (1) those that would involve 
periodic reporting on existing law; and (2) those that would apply to 
new legislation.

Periodic Reports

     My first suggestion is that Treasury or the Joint 
Committee on Taxation should publish a formal study year after year 
listing tax simplification options. This would be similar to the 
package of potential expenditure cuts and tax increases prepared by the 
Congressional Budget Office and the tax expenditure list prepared by 
Treasury and the Joint Committee on Taxation. I have become convinced 
that it is only through the publication of such a list that tax 
simplification is liable to get the greater attention it deserves, 
especially on an ongoing basis.
    Note, by the way, that the tax expenditure list is not sufficient 
for this purpose. Among the many reasons are that not all tax 
expenditures are complex, or more complex than direct expenditures. The 
purpose of the tax expenditure list is not to provide ideas for 
simplification, but to give tax programs a budgetary weight that is 
equivalent to the expenditure programs that they might replace.
    Some simplification options can be taken from Joint Committee on 
Taxation studies such as its recent overviews of individual income tax 
provisions on April 14, 1999 and of employer-sponsored retirement plans 
on March 22, 1999. The Treasury often makes some suggestions each year, 
especially at budget time. However, one should not discount the 
importance of assembling, packaging, and reissuing a much more 
comprehensive list on a regular basis.
     The Government Performance and Results Act of 1993 
requires a performance plan review that has been extended on an 
embryonic basis to Treasury's tax expenditure budget. Treasury has made 
some very tentative steps here, although it complains about the lack of 
data (see comment below on IRS structural defects). While it would be 
foolish to think that Treasury could study each of these programs 
adequately each year--Congress continually mandates studies without 
providing the resources to back up the mandate--a cycle could be 
established that would lead to periodic review of each of them.
     At the same time, I believe there is a fundamental failure 
in IRS administrative structure that leads to the Treasury complaints 
about inadequate information. Indirectly it also leads to some of IRS' 
internal problems in managing itself. That defect is the failure of the 
IRS to partially organize itself on a programmatic basis. IRS organizes 
itself by tax return category, not by the programs under its 
administration. Therefore, it prepares few analyses of these programs 
and takes no responsibility for their success or failure. Only 
indirectly do we find out about these programs, as when IRS measures 
error rates by line item on returns. It is not surprising, then, that 
IRS almost always ends up behind the 8-ball when Congress suddenly 
decides it wants to examine the effectiveness of, say, the Earned 
Income Tax Credit, the tax exclusion for employer-provided health 
insurance, or the compliance costs imposed upon charities.
    IRS sometimes excuses itself because it is in charge of 
administration, whereas Treasury and the White House are in charge of 
policy. While I am not unsympathetic with this argument, I still 
believe it is inadequate. No one can properly administer a program 
unless they understand how target-efficient it is and can analyze the 
costs of administration for both the government and their customer from 
a programmatic perspective. IRS does not have to make final judgment; 
it does have responsibility for better development and dissemination of 
the information it acquires in administering programs.
    IRS is also scared to put out reports on administrative 
effectiveness. In reporting on the EITC during the 1990s, for instance, 
it has faced the political constraint that both President Bush and 
President Clinton favored an increase in the grants made under this 
program. Unless a regular schedule of reporting is established, IRS 
will fear that the timing of release of any report will appear to be 
politically motivated by one side or the other.

Reporting on New Legislation

    Here are some methods for giving simplicity greater weight in the 
legislative process:
     Testimony on proposed bills should always include at least 
some witnesses who focus solely on the simplification and 
administration issues. Although affected persons should be invited, 
some of these witnesses should not represent anyone with a significant 
stake in the outcome.
     When the markup of a bill occurs, one individual at the 
witness table should have the sole assignment of providing information 
on the administrative aspects of the bill. This individual might be 
from the IRS, the Treasury's Office of Tax Policy, or the Joint 
Committee on Taxation, but the assignment must be separated from other 
issues so as to ensure that simplification concerns are not ignored.
     Before going to conference, the IRS should produce mock 
tax forms showing exactly what has been wrought from bills produced in 
both houses. Changes in number of users of forms and line items should 
also be provided, when possible.
     In conference committee, one person at the witness table 
should be held responsible for providing information only on the 
simplification aspects of the bills from both parts of Congress.
     The National Commission on Restructuring the IRS suggested 
that a tax complexity assessment accompany future tax changes. If 
interpreted in too legalistic a fashion, the requirement may be hard to 
implement, but the spirit of the suggestion could be met in a variety 
of ways. Last year the Joint Committee on Taxation prepared a 
simplification analysis of a House bill at the request of Chairman 
Archer, even though it was not required for that year. I am hopeful 
that this subcommittee will devote some effort to making sure the right 
precedents continue to be set and to guaranteeing that these analyses 
are given significant weight in future legislative efforts.
    Of course, none of these process reforms guarantee that 
simplification will occur. Nor, as I noted at the beginning of my 
testimony, should simplification be the only factor under 
consideration. Nonetheless, a combination of some, if not all, of these 
procedures could serve as a major deterrent to new sources of 
unnecessary complexity and as a spur toward achieving the types of 
simplifications sought by this subcommittee.

                                

APPENDIX

                    Three Major Areas of Complexity

Alternative Minimum Tax

    Many efforts at reforming the AMT deal with the failure to 
index the system over time, so that more and more taxpayers 
would not be forced to pay this tax. Under current law, for 
instance, many married couples with two children, average 
income, and no more deductions than their state and local taxes 
are scheduled to pay AMT in the future. As their income and 
state and local taxes--which are counted as preference items--
grow with normal inflation and economy-wide growth, these 
taxpayers are less likely to be excluded from the AMT. But 
while a reform that indexes the AMT is worthwhile, it still 
ignores whether or not the tax makes sense, whether its base 
includes items that should not be subject to taxation, and 
whether the administrative hassle and complexity are worth the 
trouble in the first place.
    A few of the preference items in the AMT have attributes 
associated with preferential treatment, such as generous 
depletion allowances or the tax exemption for interest received 
on private activity bonds. In those cases the taxpayer may be 
excluding from taxable income a significant portion of real 
income received. But most of these items are not large in terms 
of alternative minimum tax collections. Other items included at 
different times, such as an alternative depreciation schedule, 
are more debatable since they seem to deny to some taxpayers 
even those deductions that would be allowed if economic income 
were calculated accurately. Some of these provisions are 
enormously complex, as well, for they require the taxpayer to 
keep multiple records for years under alternative methods of 
calculation.
    There is little excuse for inclusion of items that are 
legitimate deductions reflecting a lower ability to pay tax. 
The standard deduction allowed to nonitemizers is treated as a 
preference item under the AMT. So also are extraordinary and 
legitimate work expenses when deducted as miscellaneous 
itemized deductions. The inclusion of personal exemptions as a 
preference item implies Congress believes that a dependency 
exemption is not an appropriate adjustment to ability to pay 
tax, but instead accords the taxpayer special treatment. In 
effect, for AMT purposes, the law implies that a family of four 
has the same ability to pay tax as a family of two with equal 
income.
    Finally, there are those items that under some theories 
might not be deductions under an income tax, but under other 
theories are quite reasonable. It is inconsistent and arbitrary 
to try to tax them through an AMT. These include state and 
local tax deductions and those few medical deductions allowed 
for regular tax, but not minimum tax, purposes. If there is a 
rationale for further limiting these deductions, it should be 
applied directly in the normal income tax, not through the more 
complex AMT.

Tax System after Tax System & the High Implicit Marginal Tax 
Rates

    In recent decades the tax and expenditure laws have 
witnessed the establishment of one new tax system after 
another. These tax systems derive from attempts to cut back or 
pare various ``benefits'' as income increases. As one 
consequence, they create a strange tax rate schedule with a 
number of side effects such as rising and increasing marriage 
penalties on individuals.
    The difficulty is that the tax systems are created in 
happenstance manner. They derive from nothing more than a 
glance at what might look politically salable when each part of 
a bill is up for adoption. For example, child credits are meant 
to apply to the middle class, so they will at least be limited 
for those with incomes of, say, $75,000 or $110,000 or more. 
Yet almost every one of these phase-outs has its own set of 
rates, base, and phase-out region. Should one of these income 
taxes apply at one level and the next at a very different 
level? Maybe, but no rationale is or has been provided. 
Moreover, granting some benefit at high income levels is not 
necessarily regressive if those individuals have more than paid 
for the benefit with their taxes.
    Meanwhile, there are now multiple tax systems implicit in 
expenditure programs as well. Consider all the possible 
interactions among the following: a federal income tax, a state 
income tax, the phaseout of an earned income tax credit, 
phaseouts of the benefits of nontaxation of social security 
income, phaseouts of personal exemptions, phase-ins of limits 
on itemized deductions, phase-ins of alternative minimum taxes, 
phaseouts of existing higher educational benefits like Pell 
grants, and phaseouts of various welfare benefits like 
Temporary Assistance to Needy Families, food stamps, 
Supplemental Security Income, and various forms of housing 
subsidies.
    For low and moderate income taxpayers--the primary group 
for which simplified filing at one time seemed possible--earned 
income tax credits, child credits, dependent care deductions, 
educational credits, and presidential campaign check-offs, 
among others, have been added to returns. Unlike the 
traditional personal exemption and standard deduction, these 
various provisions often require additional information by the 
taxpayer. Whatever their other merits, therefore, they have 
complicated filing significantly. To top matters off, the IRS 
has discovered that many of the errors in EITC filing and other 
allowances are related to claiming children incorrectly, 
especially when the parents of children are separated, 
divorced, or never married. To deal with this problem, the IRS 
has sought additional information from taxpayers to verify 
their eligibility for different allowances related to children.
    Most of the allowances for low and average income 
individuals, ranging from the EITC to child credits and 
dependent exemptions, could be combined or simplified 
significantly, even if some variations had to be eliminated. 
For example, there's little reason that the personal exemptions 
for dependents couldn't be folded into the child credit.

Pension and Saving Plan Simplification

    The number of rules and regulations applying to pension and 
saving plans is overwhelming (see attached table). This derives 
from an extraordinary number of so-called saving and retirement 
incentives in the tax code, each with its own separate limits, 
exceptions, and requirements on both individual taxpayers and 
employers. The consequent complexity reduces the net rate of 
return available to saving, in part because of the very large 
expenditure of time and paid labor that must be employed to 
interpret, administer, and seek to understand this universe.
    Thus, the issue is not whether there should be rules 
regarding eligible deposits, discrimination among employees, 
penalties for withdrawals, and so on, but whether there needs 
to be so many inconsistent rules and regulations across so many 
different plans.
    One type of reform does not address how many incentives 
might be offered, but, whatever their number, seeks to apply a 
more common set of rules on as many of them as possible. For 
example, there might be a single, common limit on deductible 
contributions for all types of employer-provided plans and a 
common income eligibility standard for individual plan options 
such as individual retirement accounts. The limit might be 
expressed simply as a dollar amount, rather than as percent of 
income. For withdrawals, a common but limited set of exceptions 
might be established, and a common penalty for early withdrawal 
might be applied. A simple standard could be adopted as to 
whether contributions are subject to social security tax or 
not.
    More complicated to design, but highly desirable, would be 
a simpler rule or set of rules regarding when plans 
``discriminate'' against lower-paid workers in a firm. A second 
approach to simplification would reduce the number of 
retirement and saving options. Do we need both traditional IRAs 
and Roth IRAs, both profit-sharing and employee stock option 
plans, both money purchase and profit-sharing plans, both 
401(k) and 403(b) plans? My feeling is that the gains from 
these differentiations are small, if any, and the costs of 
administration are almost inevitably higher than any gains.
[GRAPHIC] [TIFF OMITTED] T7314.003

[GRAPHIC] [TIFF OMITTED] T7314.004

 [GRAPHIC] [TIFF OMITTED] T7314.005

[GRAPHIC] [TIFF OMITTED] T7314.006

[GRAPHIC] [TIFF OMITTED] T7314.007

    Chairman Houghton. Thank you very much, Mr. Steuerle.
    Let me ask, is there anybody from the Internal Revenue 
Service in the audience? Interesting--with all this testimony. 
Well, I will be their advocate.
    It is very difficult to separate tax reduction from tax 
reform because you get all tangled up here. We are, however, 
really interested in the simplification issue. I mean, as we 
looked at the numbers, the No. 1 target for simplification was 
the AMT; it has just spread like an octopus far beyond the 
boundaries of what was intended.
    If you take a look at it--and I have just gotten the 
figures from Mac of our staff here--that over 10 years, this 
would cost $135 billion. It starts off at a $7 billion rate and 
ends up, in the 10th year, at a $27 billion rate. Now you can 
say, well, if those are the numbers, you better get at it 
pretty soon or it is going to strangle you. But are there any 
adjustments we can make? I am looking at it from the practical 
standpoint. We don't have a lot of money to play with, and 
there is the great concept of a 10-percent across-the-board tax 
cut out there. We are not going to do that.
    Yet, at the same time, there are so many things we can do. 
What--and several of you listed 10 issues--what are those 
things we can do? I don't mean to be cheap about this thing--
but what are the things we could do right now, and you could 
say to the leadership of the House, this thing is not going to 
cost us an arm and a leg. It will help the taxpayers 
tremendously. It will be a first cut in terms of overall 
simplification. What do you think are those things? Now, Hank, 
you mentioned compliance. What could we do in that area, 
without talking about billions and billions and billions of 
dollars?
    Mr. Gutman. Well, I think, Mr. Chairman, Mr. Neal said his 
bill was revenue-neutral. There is the start. If what we are 
worried about is cost, there is something on the table that has 
got revenue-neutrality and achieves enormous simplification. It 
has got elements that are in your bill as well. Capital gains 
is a mess. The AMT, as everyone has pointed out, is reaching 
into an area where it was never intended to be. And if the 
revenue raisers which Mr. Neal has proposed are acceptable, 
that ought to work.
    I have a little bit of doubt about increasing the floor 
under itemized deductions from 2 percent to 4 percent. I never 
understood, as a policy matter, why the floor was enacted in 
the first place. I do understand the pragmatics.
    You eliminate a huge amount of complexity with the 
elimination of Pease and PEP, the elimination of the 
alternative minimum tax and the rationalization of the capital 
gains structure.
    A second area, which may end up actually raising some 
money, depending upon how you do it, is rationalization of the 
education credits. The educational assistance programs that are 
in the code came in at different times with different 
objectives. They are impossible to figure out and you may be 
able to move them around, get some money and achieve 
significant simplification. So I think those are areas to focus 
on because people have already begun to focus on them.
    Chairman Houghton. Right now. Mr. Neal, have you got a 
comment? Because I would like to end it at any time, gentlemen. 
But why don't you go ahead, Rich.
    Mr. Neal. I would like to ask the other panelists about PEP 
and Pease since Mr. Gutman raised it and then I would like to 
come back to him with a specific question. The other----
    Mr. Steuerle. I was around then although I would like to 
claim that I am not fully responsible for the complications. I 
was coordinator of Treasury's study when we first put forward 
tax reform in 1984 to 1986 and PEPs and Pease ended up to be 
the result of a back-door attempt to basically hide tax rate 
increases by creating what then was called a bubble which----
    Mr. Neal. So you were part of it?
    Mr. Steuerle [continuing]. Meant your rate went up and then 
went down, but then leveled out. That bubble was not actually 
in the original Treasury proposal. It provided a way of saying 
``We cut rates,'' but then raise them on the side. As a 
professional in the tax field, I don't like hidden taxes and, 
therefore, I don't like PEPs and Pease. I would much prefer to 
put them in the rate schedule. I realize, however, that that 
causes considerable political consternation; that is, if hidden 
rates are all right, but direct rates aren't, then there is a 
real problem. But, for the most part, these phase-outs are 
nothing more than back-door rate increases. Outside of some 
slight differences across families, you could work them into a 
rate schedule, if you want to create a bubble in the rate 
schedule, but it would be explicit.
    Mr. Neal. The others? Would you like to comment on that?
    Mr. Tucker. The Tax Section has pointed out a number of 
times that we would far prefer to see rates raised than do it 
the indirect way through PEP and Pease and AMT and other 
phaseouts that come in and come out. We think that, No. 1, is 
really simplicity. No. 2, we understand it is politically 
difficult, but it is also very difficult to explain to our 
clients who are in the 39.6 bracket they think, when in 
actuality they are in the 42 percent bracket in most 
circumstances and we get a lot of anger. We get a lot of, you 
know, you are not helping me. You are telling me something I 
don't want to hear. And we think it ought to recognized. That 
that truly would be simplification.
    Mr. Neal. Mr. Gutman, yes, I know it is not a topic that we 
were to focus on today, but corporate tax shelters, the 
Treasury's approach. Do you have a comment?
    Mr. Gutman. Well, that is an interesting question, Mr. 
Neal. I guess from a congressional perspective, one of the 
things that I would have thought you and Chairman Houghton and 
others would want to focus on is the extent to which the 
Treasury proposals represent a shift of legislative authority 
from you to the Internal Revenue Service and the Treasury. That 
is something I would have thought would be of some concern to 
you, particularly given the IRS restructuring legislation which 
in large measure was directed to limiting the scope of 
authority that the Internal Revenue Service has to exercise 
power over taxpayers. From an institutional viewpoint, this is 
an issue that you ought at least to think about.
    From the point of view of practitioners, I think the 
Treasury proposals raise a number of issues. The first is 
simply the ambiguity of the proposals. That is a consequence, I 
think, of the attempt to create a one-size-fits-all rule. And, 
if nothing else has emerged from the debate so far, it ought to 
be clear that there is little consensus about the kinds of 
transactions that fall within the rule. And so, I think, one of 
the things that needs to be addressed is an attempt to make 
clear that we know what it is we are talking about.
    The second part of the Treasury proposals goes to what I 
call proportionality. Does the punishment fit the crime? The 
Treasury proposals impose strict liability penalty on taxpayers 
without regard to the nature of the advice they have received 
in connection with a transaction. And it is strict liability 
for transactions that are undefined. That is a big problem. If 
the motive for the imposition of strict liability is a 
perception that people aren't getting straight advice, then I 
think you should deal with the question of what kind of advice 
is required. But a no-fault penalty when it is not clear to 
what the penalty is going to apply, and when the Internal 
Revenue Service and the Treasury are the ones who define the 
scope of the penalty, seems to me to be problematic.
    And finally, there is, a very practical side to this. There 
will be an awful lot of power bestowed on the IRS in the audit 
process by these kinds of proposals and that is something, too, 
that you have evidenced concern about in the past. No matter 
how much people say that this won't happen, the fact of the 
matter is that agents who are armed with these kinds of weapons 
will use them to extract concessions from taxpayers. I think 
you ought to be concerned about that.
    Mr. Neal. Mr. Lifson. Mr. Lifson, you were nodding in the 
affirmative. Do you want to comment, too?
    Mr. Lifson. I would say that what petrifies the American 
Institute of CPAs is the effect of this legislation on a whole 
broad class of unintended participants, which are small 
business people and bestowing IRS agents with this extra level 
of authority absolutely petrifies us. On a second layer, the 
idea that it is a good idea to make a law that is fuzzy and 
nobody knows where they stand so they stand way back from the 
line, isn't consistent with our view of American justice.
    Mr. Neal. Thank you, Mr. Chairman.
    Chairman Houghton. Yes. Mr. Harkins. You run a business and 
you are concerned about a variety of things--the death tax and 
the independent contractor. Talk a little bit about those 
things.
    Mr. Harkins. Yes, Sir. The estate tax, death tax as we 
prefer to call it, is probably the most unfair tax there is. If 
a man works his whole life, pays his taxes, takes his after-tax 
income, hangs on to it, when he dies, the government, you know, 
sticks out their hand for another 37 to 55 percent of it. You 
know, the original intent of the law was to break up I guess 
large family monopolies. But I think it has been proven and the 
Joint Economic Committee study really made the point that the 
estate taxes cost almost $500 billion this century, or 3.2 
percent of the stock of capital, reduction in capital in the 
country. The cost of compliance is about $23 billion, which is 
almost the same amount as the tax takes in. It destroys 
families; it destroys farms; it destroys small businesses.
    Now that in my opinion is revenue-neutral. Now, I am not in 
favor of revenue-neutrality. I am in favor of less taxes being 
paid. You know, I think we have a projected surplus in this 
country and that surplus means that somebody has paid too much 
in taxes. And if somebody has paid too much in taxes, it would 
appear to me that the best thing to do would be to find a way 
to give some of it back. So I am totally not convinced by any 
revenue-neutrality logic.
    I would like to see the AMT eliminated because it punishes 
small businesses, especially. A lot more than it punishes 
anybody else. I just studied the IRS for a year and I worked 
with them for 9 years and I don't trust the IRS to make tax 
law. Congress needs to make tax law and they need to make it 
very specific so it is not subject to interpretation because it 
just costs the system a lot of money when you let a bureaucrat 
make the law and that is what happens.
    Chairman Houghton. What about the independent contractor 
issue?
    Mr. Harkins. Well, I am concerned about that. Your 
legislation, Chairman Houghton, is excellent. When I served as 
a delegate to the White House Conference on Small Business in 
1995, our No. 1 issue--and there were 2,000 small business 
owners from all over the country--and they all agreed that the 
No. 1 issue was the independent contractor issue. And what we 
said was we needed an objective standard. We were tired of the 
IRS interpreting the 20 common law factors. Because if you got, 
you know, 11 of them right or maybe you got 19 of them right 
and one of them wrong, then you were subject to 
reclassification. So there was a lot of uncertainty.
    What we said was you need to make it objective. But then 
what you need to do is you need to have safe harbors for 
industries who have been established and who have thrived on 
certain interpretations of that classification. You can't just 
throw them to the dogs by allowing the Internal Revenue Service 
to write regulations.
    And I assure you, if you let the Internal Revenue Service 
decide who is an employee and who is an independent contractor, 
there will be no independent contractors. They will all be 
employees because that is the line of least resistance with the 
Internal Revenue Service and it gives them the ability to 
collect more revenue which is what their job is. They are going 
to maximize revenue to the detriment of the taxpayer.
    Chairman Houghton. OK. What--I don't know how you feel 
about this, Mr. Neal, but I would like to end up with 4, or 5, 
or 10, specific things we can do to start this tax 
simplification process. As I mentioned earlier, we have got to 
be careful of the money, because we will just run up against a 
stone wall here. I have heard a lot of things; we have your 
testimony.
    I think it might be helpful--I hate to throw more work at 
you, but obviously you have invested enough as it is. However, 
I would appreciate your giving Mr. Neal and myself, a one-pager 
in terms of those specific things that you think are important, 
priority-wise, that will go with our report, and then we will 
take a look at our respective legislation and see what we can 
do together on this thing. I think if there ever was a time to 
do something, it is now, while the economy is going 
particularly well.
    [The information was not available at the time of 
printing.]
    Mr. Neal. Mr. Chairman, just a quick observation. To have a 
Democrat propose eliminating the AMT is a good starting point. 
It seems to me that--I have talked with Mr. Archer a couple of 
times about this. He is all excited about that aspect of it. I 
think our goal is to convince him that there are other aspects 
of this that are doable as well.
    Chairman Houghton. OK. That is your No. 1. I don't disagree 
with it either. Have you got any other comments to make.
    Mr. Harkins. Sure. Mr. Chairman, pardon me, but I do have 
one issue that I think could be revenue-neutral, as Mr. Neal 
would----
    Mr. Neal. You were against that a few minutes ago, Mr. 
Harkins.
    Mr. Harkins. No, but I am just--let me explain this, Sir. 
Is the capitalization, increase in capitalization for 
businesses? You know, if a business buys a piece of equipment 
for $10,000 and they have to depreciate it over 10 years, now 
they end up getting $1,000 a year in write-offs for that piece 
of equipment over the 10 years. If you let them expense that 
piece of equipment in year one, they would get to keep more of 
their money, but, in fact, they end up paying the same amount 
of tax.
    So it really--all it gives them is a break in the first 
year, which increases their working capital, which increases 
their ability to create jobs and to stimulate the economy, but 
yet it costs the Federal Government nothing except you might 
say, ``Well, what is the interest on the money that you would 
have gotten in the first year versus in the second or third or 
fourth?'' But, in my opinion, that is a very simple way of 
doing two good things without creating any problems for the 
budget process. But perhaps I am naive to think that.
    Chairman Houghton. I don't think you are naive, but I do 
think we have problems with that. I mean, the whole structure 
of the concept of long-term pay-out and short-term is at risk 
here. I wish, as a matter of fact, that we had the reverse in 
the Federal Government, because you have to expense everything. 
It is a cash system rather than an accrual system, and we get 
all tangled up in our scabbard on this thing. But let us take 
it into account, and if you feel strongly about this, maybe you 
can put that into your one-pager.
    Mr. Harkins. Yes, Sir. Thank you.
    Chairman Houghton. Anything else? Any other comments?
    Mr. Tucker. Just, I guess, there are two other items. No. 
1, we would ask at the Tax Section of the ABA that, as you 
think through these items, that you not add more exceptions and 
more complexities and more phaseouts, because we are concerned 
that what you may see on the one hand as burden reduction 
creates more complexity and not more simplification.
    Second, I think if we were to have our most-favored list, 
we would certainly focus on the alternative minimum tax and its 
elimination.
    Chairman Houghton. Right.
    Mr. Tucker. But if you can't eliminate it, there are some 
major concerns that every taxpayer has, including, 
particularly, the loss of itemized deductions and personal 
exemptions. Second, is the simplification of long-term capital 
gains and short-term capital gains and simplifying the rules. I 
mean, adding all the lines as a result of the 1997 Act had 
absolutely no benefit for anybody. And, third, we would look at 
the ability to eliminate the phaseouts. And I recognize that 
they are considered an offset to certain things, but I think 
really focusing on maybe rate brackets rather than phaseouts in 
a number areas and not just PEP and Pease would be very 
important.
    Mr. Steuerle. Mr. Chairman, can I also suggest that your 
efforts and yours, Mr. Neal, to make a bipartisan bill is 
extremely important. It is so much easier. Having served at 
Treasury, I can tell you, and perhaps Hank can tell you from 
the Joint Committee perspective that it is much more easy, in a 
bipartisan context, to pull together staff from different 
places to work together and really pull together. There are a 
lot of people at Treasury, the Joint Committee, ABA, the ICPA, 
National Tax Association, other places, who have no agenda at 
all.
    They can sit down and they can list items that are on these 
lists, on other lists. They can tell you the ones they agree 
with. They can say, ``Well, you know, this pushes a little bit 
toward simplifying, but we think you might have some equity 
concerns.'' With a deliberate bipartisan effort, you could come 
up with a longer list and build some momentum.
    Just as a trivial example, I have suggested a number of 
simplifications in the area of charitable deductions that I 
don't think cost revenue. You could add those to the bill. That 
might build you a little momentum in the charitable community. 
So there are a lot of areas where you could think about 
expanding what I think all of us at this table feel is a very, 
very commendable process.
    Mr. Lifson. You know, from the AICPA's perspective, we also 
have a list to further what you are saying, of simplification 
ideas that could lead to greater tax compliance. Now if you can 
combine simplification with improved tax compliance so that 
people pay their taxes more voluntarily than they do now and 
move your rate from 86 percent to 87 or 88 percent and attack 
people that are not paying the right amount of tax now, then 
sometimes your simplification vehicle can be a revenue-positive 
item without hurting anybody in the political structure.
    Chairman Houghton. Well, I think there are certain, 
fundamentals here. I think I can speak for you Rich; we are 
really serious about this. I mean, this isn't just a hearing to 
have a report and go on; we really are serious and, also, I 
think we are serious about doing something important. You know, 
time is the most precious thing we have and we ought to use it. 
If it is important, it must be bipartisan, because on any big 
issue, you know, one party can't do it.
    So, gentlemen, thank you very much for your time and your 
great thoughtfulness in these reports; I hope to hear from you. 
Thank you.
    [Whereupon, at 4:25 p.m., the hearing was adjourned.]
    [Submissions for the record follow:]

Statement of American Network of Community Options and Resources, 
Annandale, VA

                       Introduction and Overview

    This testimony outlines the comments and suggestions of the 
American Network of Community Options and Resources (``ANCOR'') 
relating to the current complexity of section 131 of the Code of 1986, 
as amended (the ``Code''), which provides rules on the tax treatment of 
foster care payments received by individual taxpayers.
    ANCOR was formed in 1970 to improve the quality of life of persons 
with disabilities and their families by coordinating the efforts of 
concerned providers of private support services. ANCOR is comprised of 
more than 650 organizations from across the United States together 
providing community support to more than 150,000 individuals with 
disabilities.
    ANCOR strongly recommends that section 131 of the Code be amended 
to eliminate current law's complexity by uniformly allowing individual 
taxpayers to exclude from income the foster care payments they receive 
from State and local governmental sources. ANCOR believes that amending 
section 131 in this manner would (i) simplify the tax treatment of 
foster care payments for individual taxpayers, (ii) eliminate an 
impediment to State and local governmental efforts to reduce 
bureaucracy and costs for their foster care programs, and (iii) support 
State and local governmental efforts to encourage much-needed 
individuals to participate in foster care programs.

                Description of Current Law and Proposal

Current Law

    Section 131 of the Code as it currently exists creates a complex 
dichotomy in the tax treatment of individuals who serve as foster care 
providers for individuals in foster care under 19 years of age and for 
those who provide treatment to individuals in foster care over 19 years 
of age. For children under 19 years old, section 131 of the Code 
permits individual taxpayers to exclude foster care payments from 
taxable income when a government entity or charitable tax-exempt 
organization directly places the child and makes the foster care 
payments to the provider. For individuals 19 years of age or older, 
section 131 allows an individual taxpayer to exclude foster care 
payments from taxable income only when a governmental entity makes the 
placement and the payment. Thus, an individual's ability to exclude 
foster care payments, even if all such payments are derived from 
government funds, is linked to the type of agency that places the 
individual with the provider.

Proposed Change

    Congress should amend section 131 to allow all individuals who 
serve as providers of foster care the ability to exclude from income 
those foster care payments that they receive from a governmental 
source, regardless of whether a governmental entity placed the 
individual, provided that a governmental entity has either certified or 
licensed the placement agency. Amending section 131 in such a way would 
not only simplify the tax treatment of foster care payments and reduce 
the administrative burden on the Internal Revenue Service (``IRS''), 
but the change would also support the efforts of State and local 
governments to address the needs of their communities more effectively.
    A. Current law is confusing to taxpayers and to the IRS. As 
illustrated by Table 1, incongruent treatment of individual taxpayers 
who are foster care providers has created a complex system for 
determining when such providers can exclude their foster care payments 
from income.

                  Table 1.--Excludability of Foster Care Payments from Income Under Section 131
----------------------------------------------------------------------------------------------------------------
                                                                  Age of  Foster Care
           Placement Agency                     Payor                  Individual          Payment  Excludable?
----------------------------------------------------------------------------------------------------------------
State or political subdivision.......  State or political       or an experienced tax advisor that their foster care payments were 
to be excluded from taxable income, when in fact those payments were 
not excludable. Amending section 131 would, therefore, prevent not only 
the confusion individuals and their tax advisors have over whether 
foster care payments are excludable, but also the confusion experienced 
by the IRS officials that are charged with administering the law.
    B. Current law fails to support the decisions of State and local 
governments. Governmental entities are becoming increasingly reliant on 
private agencies to place both children and adults with special needs 
in foster care. Governmental entities have found that foster care for 
adults with special needs reduces the expense that is usually incurred 
when maintaining group homes and institutional settings. In particular, 
the National Association of State Directors of Developmental 
Disabilities Services has found that over the past several years there 
has been a considerable increase in pressure on state agencies to 
reduce waiting lists. Additionally, State and local governments often 
use outside entities to make case-specific decisions (such as 
identification of those individuals who would benefit from foster care 
and those providers with whom such individuals should be placed) as a 
means of reducing bureaucracy in an already trying situation. Current 
law, however, fails to provide the same tax treatment to those 
individuals identified by private entities acting under a license or 
certification with States, counties and municipalities as is provided 
to individuals that are identified directly by the State. Disparate 
treatment exists despite the fact that from the governmental entities' 
perspectives, the activities are the same. As a result of the 
difference in treatment, State and local governments are discouraged 
from contracting with private agencies to make placement decisions. The 
tax code should support State and local governments that decide to cut 
costs, reduce bureaucracy and support individuals with special needs in 
their communities through expanding their foster care programs.
    C. Current treatment of foster care payments discourages much-
needed individuals from participating in foster care programs. The 
confusion created by section 131's complex rules discourages many 
potential foster care individuals from participating in these programs. 
Despite the fact that individual taxpayers could, under these rules, 
offset taxable foster care payments (paid by non-qualified agencies) by 
treating expenditures made on behalf of a foster individual as a 
business expense deductions, such deductions are permitted only if the 
families maintain detailed expense records. Accordingly, otherwise 
willing providers are discouraged from accepting foster individuals 
placed by non-qualified agencies, because such providers are forced to 
endure the time and inconvenience associated with keeping extensive 
records. The result is a smaller pool of available, qualified and 
willing providers and a growing pool of individuals with special needs 
for whom group housing or institutional living is inappropriate. 
Amending section 131 as suggested would help address the increasing 
demand for providers of foster care services.
    D. Legislation introduced this year would remedy these problems. 
Bills were introduced in the House (H.R. 1194) and in the Senate (S. 
670) that propose to simplify the current rules under section 131 for 
individuals receiving foster care payments. These bills would allow 
individual providers to exclude from income foster care payments 
received, regardless of the age of the individual in foster care and 
the type of entity that placed that individual. The exclusion would 
apply only if either (i) a state or local government or (ii) a 
``qualified foster care placement agency'' made the foster care 
payments. Such payments would have to be made pursuant to a foster care 
program of such governmental entity. Further, to be qualified, a foster 
care placement entity would have to be licensed or certified by a state 
or local government to make foster care payments to providers of foster 
care.

                               Conclusion

    ANCOR recommends amending section 131 of the Internal Revenue Code 
so that all governmental foster care payments received by individual 
taxpayer providers are treated the same. If enacted, current law's 
confusing and unfair tax rules would no longer discourage much-needed 
individual providers from participating in foster care programs. 
Amending section 131 in this fashion also will support State and local 
governments in their efforts to reduce bureaucracy and cut costs, 
provide more alternatives to institutionalization, while simplifying 
tax administrative burdens.

                                

Statement of Associated General Contractors of America (AGC)

    The Associated General Contractors of America (AGC) is pleased to 
provide the House Ways and Means Subcommittee on Oversight with this 
written statement on the ``Impact of Complexity in the Tax Code on 
Individual Taxpayers and Small Businesses.'' AGC is the nation's 
largest and oldest construction trade association, founded in 1918. AGC 
represents more than 33,000 firms, including 7,500 of America's leading 
general contracting firms. AGC's general contractor members have more 
than 25,000 industry firms associated with them through a network of 
101 AGC chapters. AGC member firms are engaged in the construction of 
the nation's commercial buildings, factories, warehouses, highways, 
bridges, airports, waterworks facilities, waste treatment facilities, 
dams, water conservation projects, defense facilities, multi-family 
housing projects, site preparation, and utilities installation for 
housing developments.
    While AGC's membership is diverse, the majority of AGC firms are 
closely-held businesses. AGC member firms are 94% closely-held, 81% are 
owned by fewer than four persons, and over 80% are small businesses 
with an average construction project size under $5 million.
    AGC supports tax simplification for general contractors in the 
following complex tax areas:

                     Lookback Method of Accounting

    AGC supports efforts in Congress to eliminate the burdensome 
lookback method of accounting for long-term construction contracts.
    The 1986 Tax Act extensively revised the methods of accounting 
available for long-term contracts, including enactment of a provision 
mandating the use of the lookback method for all long-term contracts 
accounted for on the percentage of completion method of accounting 
(PCM). The lookback method of accounting was adopted to address abuses 
in the application of the PCM in other industries that have long-term 
contracts spanning many years. The lookback method essentially requires 
a construction contractor to file amended tax returns each year for 
every prior year in which a currently completed contract was in 
progress. It also requires similar amendments for every year in which 
post completion changes occur. The difference between the theoretical 
taxes that would have been due if all facts were known in the year the 
contract was entered into, and the taxes actually paid in prior years, 
is calculated. Interest is then calculated on this change in prior-year 
tax liabilities. The lookback method does not result in any change in 
total tax liability. It does result in an interest adjustment based on 
this theoretical change in tax liabilities.
    The lookback method is exceedingly complex. It imposes tremendous 
compliance and administrative burdens on construction contractors. The 
lookback method diverts valuable time, labor, and resources of 
construction financial and accounting professionals from worthwhile 
functions. The lookback method is exceedingly burdensome for all 
construction contractors, but it poses special problems for smaller 
contractors that have to hire outside accounting experts in order to 
calculate lookback.
    The Taxpayer Relief Act of 1997 attempted to address this issue by 
providing an election to forego application of the lookback method if 
the estimated gross profit recognized in each contract falls within 10 
percent of the retroactively determined gross profit for each year the 
contract was in progress. However, this provision provides no relief 
from the paperwork burden. Election to apply this provision requires 
most of the above calculations as well as additional calculations in 
order to determine whether each contract falls within this 10 percent 
variance in each prior year.
    The lookback method is an overwhelming burden for both small and 
large contractors. Further, many contractors receive refunds of 
interest, which, in AGC's estimation, makes this a revenue loser for 
the Department of Treasury.

             Percentage of Completion Method of Accounting

    The Tax Reform Act of 1986 revised the long-term contract 
accounting rules for contractors. These rules--contained in Section 460 
of the Internal Revenue Code--place unfair burdens on smaller 
contractors and should be modified by Congress to account for inflation 
growth since 1986.
    In 1986, Congress enacted changes to the Internal Revenue Code 
(Section 460) requiring contractors to use the percentage of completion 
accounting method for reporting taxable income from long-term 
contracts. Long-term contracts are contracts for the manufacturing, 
building, installation, or construction of property that are not 
completed within the tax year in which they are entered into. The 
percentage of completion method requires contractors to calculate what 
percentage of the contract is complete in a tax year and then pay taxes 
on that percentage. Prior to the 1986 change, a contractor could pay 
taxes on their income from a long-term contract when the contract was 
completed.
    The 1986 tax law change was intended to prevent large contractors 
from deferring taxes for years on large contracts. Congress created an 
exception to Section 460 for smaller contractors. Those contractors 
whose contracts will be completed within two years of the contract 
commencement date, and whose average annual gross receipts for the 
three tax years preceding the tax year the contract is entered into do 
not exceed $10 million, are exempt from the percentage of completion 
requirements.
    Unfortunately, the $10 million threshold was not indexed for 
inflation. Today, more and more small contractors are crossing this 
threshold and are being forced into the burdensome and costly 
percentage of completion method. Congress clearly recognized the burden 
this change places on smaller contractors forced to switch to the 
percentage-of-completion method. AGC advocates that the $10 million 
exemption be updated to account for inflation since 1986.

                       Cash Method of Accounting

    AGC recognizes the cash method of accounting as a legitimate 
accounting method for small contractors that adhere closely to the 
Internal Revenue Code. AGC advocates clarifying that construction 
materials are not ``merchandise'' or ``an income producing factor,'' 
updating the small business exemption and mitigating unreasonable 
retroactive penalties. AGC strongly supports legislation by Chairman 
Houghton to update the threshold for cash accounting to $10 million. 
AGC also supports legislation by Chairman Jim Talent of the Small 
Business Committee to clarify that businesses under $5 million can use 
the cash method regardless of IRS inventory or merchandise tests.
    For small contractors, the cash method of accounting is the most 
practical method because it recognizes income and expenses when the 
cash is actually paid to the company or by the company. The accrual 
method requires recognition of income before the cash is received; that 
is, income is recognized when the right to the money arises even though 
it may never ultimately be received. Under the accrual method, the 
company is required, in effect, to pay taxes with money it doesn't 
have, which can be quite a burden for small contractors. The IRS has 
long favored the accrual method over the cash method, with little 
thought of small businesses that often find the accrual method a 
financial burden.
    Although I.R.C. Sec. 448 places limitations on the use of the cash 
method of accounting, a specific exception is provided for entities 
with average annual gross receipts of $5 million or less for three 
previous taxable years. Accordingly, small contractors should be able 
to use the cash method of accounting. The IRS has largely ignored the 
$5 million exception for small contractors and has aggressively sought 
to enforce the accrual method on small contractors. The IRS has done so 
by requiring contractors to inventory on-site supplies, because the IRS 
says that these supplies are an income-producing factor. Once the IRS 
requires an inventory to be kept, then a small contractor must switch 
to the accrual method and even pay substantial underpayment penalties.
    In a nutshell, the IRS is attempting to ignore certain sections of 
the Internal Revenue Code which allow the cash method, thus giving the 
IRS the luxury of using the method of accounting that most aggressively 
accelerates revenue recognition. The IRS position on the cash method 
ignores the sections of the Internal Revenue Code specifically allowing 
corporations with average annual gross revenues of less than $5 million 
to use the cash method of accounting. Regardless of what the Internal 
Revenue Code clearly states, the IRS has continued its assault on small 
contractors by administratively repealing the $5 million protective 
statute.

                     Alternative Minimum Tax Relief

    AGC supports total elimination of the alternative minimum tax. 
Short of total elimination, AGC supports legislative relief from the 
burdensome calculations required of smaller contractors under the 
alternative minimum tax. In this regard, AGC legislation by Chairman 
Houghton to increase the AMT gross receipts exemption for small 
businesses from $7.5 million to $10 million.
    The computation of AMT is administratively complex and inhibits the 
formation of capital, including complicating equipment and property 
acquisition decisions. The AMT long-term contract adjustment was 
enacted to require large contractors to report certain income from 
long-term contracts using the percentage-of-completion method (PCM). 
The AMT requires contractors with long-term contracts at their fiscal 
year end that are not subject to current regular taxation to add back 
to regular taxable income the unreported gross profit on the long-term 
contracts, and subject the long-term gross profit to an alternative 
minimum tax of 20% for corporate taxpayers or 28% for individual 
taxpayers. Therefore, a contractor is currently required to make the 
difficult and time-consuming cost-to-cost percentage-of-completion 
calculations for every long-term contract in progress at the fiscal 
end.
    The Taxpayer Relief Act of 1997 provided relief for a number of 
small contractors from the alternative minimum tax. The Act allowed C 
corporations with three-year average gross receipts of $5,000,000 or 
less with tax years beginning after December 31, 1996 to be exempt from 
the alternative minimum tax. This law allowed these corporate 
contractors to grow their business to a three-year average of 
$7,500,000 before they would once again become subject to the 
alternative minimum tax. However, S corporations and non-corporate 
contractors with the same three-year average of gross receipts continue 
to remain subject to the alternative minimum tax.
    Due to changes in the tax code following 1986, primarily small 
contractors are the only taxpayers subject to the AMT long-term 
contract adjustment. Small contractor's contracts typically are 
completed within one year, so any deferral is realized within the 
following year. The tax effect of any deferral cannot be abusive for 
small contractors.

    Thank you for this opportunity to submit this statement to the Ways 
and Means Subcommittee on Oversight.

                                

Statement of Hon. Christopher S. ``Kit'' Bond, a U.S. Senator from the 
State of Missouri

    Mr. Chairman and Members of the Subcommittee, I am pleased to 
submit this statement regarding the need for tax simplification. As the 
Chairman of the Senate Committee on Small Business, I am particularly 
concerned about the burden our overly complicated tax code places on 
small businesses and the self-employed. Over the past several years, my 
Committee has focused considerable attention to this issue, most 
recently with a hearing on April 12, 1999, to examine the tax filing 
and reporting burdens that small-business owners face nearly every day. 
What my Committee learned in that hearing was nothing short of 
startling. According to the General Accounting Office, a small-business 
owner faces more than 200 IRS forms and schedules that could apply in a 
given year. While no business will have to file them all, it is a 
daunting universe of forms, including more than 8,000 lines, boxes, and 
data requirements, which are accompanied by over 700 pages of 
instructions.
    Even more surprising was that 76% of small-business owners in 1995 
(the most recent data available) hired a tax professional to help them 
fulfill their tax obligations. When we consider the complexity of the 
forms, rules and regulations, no one should be surprised. And these tax 
professionals are far from inexpensive. By some estimates, small-
business owners pay more than 5% of their revenues just to comply with 
the tax law--five cents out of every dollar to make sure that all of 
the records are kept and the forms completed--all before the tax check 
is even written. In light of these burdens, I commend the Subcommittee 
for addressing this important issue.
    While the list of tax provisions crying out for simplification has 
grown considerably in recent years, I shall focus on a particularly 
troubling and long-standing area of complexity for America's businesses 
and entrepreneurs--the status of independent contractors.

                        A New Business Paradigm

    Throughout this decade, there has been an important shift in the 
American workplace, with an increasing emphasis on independent business 
relationships. The traditional single-employer career is rapidly being 
supplanted by independent entrepreneurs who provide specialized 
services on an ``as needed'' basis. They seek out individual contracts, 
apply their expertise, and move onto the next opportunity, bound only 
to their creativity and stamina. The members of this new workforce are 
often described as independent contractors, temps, freelancers, self-
employed, home-based businesses, and even free agents. Whatever their 
title, they are a rapidly growing segment of our economy and one that 
cannot be ignored.
    There are a number of reasons for this new business paradigm. 
Recent innovations in computer and communication technology have made 
the ``virtual'' office a reality and allow many Americans to compete in 
marketplaces that a few years ago required huge investments in 
equipment and personnel. In addition, many men and women in this 
country have turned to home-based business in an effort to spend more 
time with their children. By working at home, these families can 
benefit from two incomes, while avoiding the added time and expense of 
day-care and commuting. Corporate downsizing, glass ceilings, and 
company politics, too, contribute to the growth in this sector as many 
skilled individuals convert their knowledge and experience from 
corporate life into successful enterprises operated on their own.
    The rewards of being an independent entrepreneur are also numerous. 
The added flexibility and self-reliance of having your own business 
provide not only economic rewards but also personal satisfaction. You 
are the boss: you set their own hours, develop your own business plans, 
and choose your customers and clients. In many ways, this new paradigm 
provides the greatest avenue for the entrepreneurial spirit, which has 
long been the driving force behind the success of this country.
    With these rewards, however, come a number of obstacles, not the 
least of which are burdens imposed by the Federal Government. In fact, 
the tax laws, and in particular the Internal Revenue Service (IRS), are 
frequently cited as the most significant problems for independent 
entrepreneurs today. Changes in tax policy must be considered by this 
Congress to recognize this new paradigm and ensure that our laws do not 
stall the growth and development of this successful sector of our 
economy.

                          Legislative Advances

    In the last two Congresses, we have made substantial headway on a 
number of tax issues critical to these independent entrepreneurs. In 
the Taxpayer Relief Act of 1997, we restored the home-office deduction 
putting home-based entrepreneurs on a level-playing field with 
storefront businesses. The Small Business Job Protection Act of 1996 
and the Taxpayer Relief Act also made some important strides forward on 
the unbelievably complex pension rules so that the freelance writer, 
home-based webpage designer, and other small businesses have the 
opportunity to plan for their retirement as they see fit. Finally, and 
arguably most importantly, through several pieces of legislation in the 
last four years, we have finally made the self-employed health-
insurance deduction permanent and placed it on a path to full 
deductibility by 2003--still four years too long in my view. These 
examples are just a few of the tax law changes that are helping men and 
women who chose to work as independent entrepreneurs to enjoy a level-
playing field with their larger competitors and still maintain the 
flexibility of their independent business lives.

                         Classification Burdens

    Amid this progress, however, one glaring problem still remains 
unsolved for this growing segment of the workplace--there are no 
simple, clear and objective rules for determining who is an independent 
contractor and who is an employee. As the Chairman of the Senate 
Committee on Small Business, I have heard from countless small-business 
owners who are caught in the environment of fear and confusion that now 
surround the classification of workers. This situation is stifling the 
entrepreneurial spirit of many small-business owners who find that they 
do not have the flexibility to conduct their businesses in a manner 
that makes the best economic sense and that serves their personal and 
family goals.
    The root of this problem is found in the IRS' test for determining 
whether a worker is an independent contractor or an employee. Over the 
past three decades, the IRS has relied on a 20-factor test based on the 
common law to make this determination. On first blush, a 20-factor test 
sounds like a reasonable approach--if our home-based webpage designer 
demonstrates a majority of the factors, she is an independent 
contractor. Not surprisingly, the IRS' test is not that simple. It is a 
complex set of extremely subjective criteria with no clear weight 
assigned to any of the factors. As a result, small-business taxpayers 
are not able to predict which of the 20 factors will be most important 
to a particular IRS agent, and finding a certain number of these 
factors in any given case does not guarantee the outcome.
    To make matters worse, the IRS' determination inevitably occurs two 
or three years after the parties have determined in good faith that 
they have an independent-contractor relationship. And the consequences 
can be devastating. For example, the business that contracts with a 
freelance writer is forced to reclassify the writer from an independent 
contractor to an employee and must pay the payroll taxes the IRS says 
should have been collected in the prior years. Interest and penalties 
are also piled on. The result for many small businesses is a tax bill 
that bankrupts the company. But that is not the end of the story. The 
IRS then goes after the freelance writer, who is now classified as an 
employee, and disallows a portion of her business expenses--again 
resulting in additional taxes, interest and penalties.
    Mr. Chairman, all of us recognize that the IRS is charged with the 
duty of collecting federal revenues and enforcing the tax laws. The 
problem in this case is that the IRS is using a procedure that is 
patently unfair and subjective and one that forces today's independent 
entrepreneurs into the business model of the 1950s. The result is that 
businesses must spend thousands of dollars on lawyers and accountants 
to try to satisfy the IRS' procedures, but with no certainty that the 
conclusions will be respected. That is no way for businesses to operate 
in today's rapidly changing economy.
    For its part, the IRS has adopted a worker-classification training 
manual, which according to then-Commissioner Richardson is an ``attempt 
to identify, simplify, and clarify the relevant facts that should be 
evaluated in order to accurately determine worker classification. . . 
.'' While I applaud the agency's efforts to address this issue, the 
manual represents one of the most compelling reason for immediate 
action. The IRS' training manual is more than 150 pages in length, 
riddled with references to court cases and rulings. If it takes that 
many pages to teach revenue agents how to ``simplify and clarify'' this 
small-business tax issue, I think we can be sure how simple and clear 
it is going to seem to the independent day-care provider who is trying 
to figure it out on her own.

      Independent Contractor Simplification and Relief Act of 1999

    In recognition of the new paradigm and the IRS' archaic 20-factor 
test, I introduced in the Senate earlier this year S. 344, the 
``Independent Contractor Simplification and Relief Act of 1999.'' I 
understand that a companion bill will be introduced in this body 
shortly. My bill removes the need for so many pages of instruction on 
the IRS' 20-factor test by establishing clear rules for classifying 
workers based on objective criteria. Under these criteria, if there is 
a written agreement between the parties, and if our freelance writer 
demonstrates economic independence and independence with respect to the 
workplace, based on objective criteria set forth in the bill, she will 
be treated as an independent contractor rather than an employee. And 
the service recipient will not be treated as an employer. In addition, 
individuals who perform services through their own corporation or 
limited-liability company will also qualify as independent contractors 
as long as there is a written agreement and the individuals provide for 
their own benefits.
    The safe harbor is simple, straightforward, and final. To take 
advantage of it, payments above $600 per year to an individual service 
provider must be reported to the IRS, just as is required under current 
law. This will help ensure that taxes properly due to the Treasury will 
continue to be collected.
    The IRS contends that there are millions of independent contractors 
who should be classified as employees, which costs the Federal 
Government billions of dollars a year. This assertion is plainly 
incorrect. Classification of a worker has no cost to the Government. 
What costs the Government are taxpayers who do not pay their taxes. The 
Independent Contractor Simplification and Relief Act has three 
requirements that will improve compliance among independent contractors 
using the new rules we propose. First, there must be a written 
agreement between the parties--this will put the home-based webpage 
designer on notice at the beginning that she is responsible for her own 
tax payments. Second, the new rules will not apply if the service 
recipient does not comply with the reporting requirements and issue 
1099s to individuals who perform services. Third, an independent 
contractor operating through his own corporation or limited-liability 
company must file all required income and employment tax returns in 
order to be protected under the bill.
    In the last Congress, concerns were raised that permitting 
individuals who provide their services through their own corporation or 
limited-liability company to qualify as independent contractors would 
lead to abusive situations at the expense of workers who should be 
treated as employees. To prevent this option from being abused, I have 
added language that limits the number of former employees that a 
service recipient may engage as independent contractors under the 
incorporation option. This limit will protect against misuse of the 
incorporation option while still allowing individuals to start their 
own businesses and have a former employer as one of their initial 
clients.
    Much has also been made of the improperly classified employee who 
is denied benefits by the unscrupulous employer. This issue raises two 
important points. First, the legislation that I have introduced would 
not facilitate this troubling situation. Under the provisions of our 
bill, it is highly doubtful that a typical employee, like a janitor, 
would qualify as an independent contractor. In reality, this issue 
relates to enforcement, which our bill simply makes easier through 
clear and objective rules. Second, the issue of benefits, like health 
insurance and pension plans, is extremely important to independent 
entrepreneurs. But the answer is not to force them to all be employees. 
Rather, we should continue to enact legislation like the Small Business 
Job Protection Act, the Taxpayer Relief Act, and the tax provisions of 
last fall's omnibus appropriations bill, that permit full and immediate 
deductibility of health insurance for the self-employed and better 
access to retirement savings plans.

                         Repeal of Section 1706

    A special concern of technical-service providers, such as 
engineers, designers, drafters, computer programmers, and systems 
analysts is section 1706 of the 1986 Tax Reform Act. In certain cases, 
Section 1706 precludes businesses engaging individuals in these 
professions from applying the reclassification protections under 
section 530 of the Revenue Act of 1978. When section 1706 was enacted, 
its proponents argued that technical-service workers were less 
compliant in paying their taxes. Later examination of this issue by the 
Treasury Department found that technical-service workers are in fact 
more likely to pay their taxes than most other types of independent 
contractors. This revelation underscores the need to repeal section 
1706 and level the playing field for individuals in these professions.
    In the last two Congresses, proposals to repeal section 1706 
enjoyed wide bipartisan support. The Independent Contractor 
Simplification and Relief Act is designed to level the playing field 
for individuals in these professions by providing the businesses that 
engage them with the same protections that businesses using other types 
of independent contractors have enjoyed for more than 20 years.

                Relief from Retroactive Reclassification

    Another major concern of many businesses and independent 
entrepreneurs is the issue of reclassification. My bill provides relief 
to these taxpayers when the IRS determines that a worker was 
misclassified. Under S. 344, if the business and the independent 
contractor have a written agreement, if the applicable reporting 
requirements were met, and if there was a reasonable basis for the 
parties to believe that the worker is an independent contractor, then 
an IRS reclassification will only apply prospectively. This provision 
gives important peace of mind to small businesses that act in good 
faith by removing the unpredictable threat of retroactive 
reclassification and substantial interest and penalties.
    Mr. Chairman, the Independent Contractor Simplification and Relief 
Act is a common-sense measure that answers the urgent plea from 
independent entrepreneurs and the businesses that engage them for 
fairness and simplicity in the tax law. As we work toward the day when 
the entire tax law is based on these principles, we can make a positive 
difference today by enacting this legislation.

                         Troubling Alternatives

    Until recently, those that opposed positive improvements like the 
Independent Contractor Simplification and Relief Act have mainly 
expressed their objections and preferred to maintain the status quo--an 
alternative that few have been eager to embrace.
    With the introduction of H.R. 1525 by Congressman Kleczka and 
Chairman Houghton, a new alternative has been put on the table. While I 
am pleased that we now have broader recognition that worker 
classification is a problem in need of a solution, I am troubled by the 
regressive nature of this bill. From my reading, H.R. 1525 will 
rollback the progress we have made in the last 21 years in recognition 
of independent entrepreneurs and their contribution to the 
unprecedented growth of our economy. Instead, the Federal Government 
would dictate business relationships through the tax code--an 
alternative that we cannot afford to embrace.
    My concerns about this legislation are three-fold. First, as its 
title suggests, the bill is intended to ``clarify'' the independent 
contractor rules. Regrettably, it accomplishes that objective by 
establishing a presumption that everyone is an employee until proven 
otherwise. While seemingly simple, such a presumption would abandon all 
hope of neutral worker-classification rules and put independent 
entrepreneurs at an even greater disadvantage than they are today.
    Second, according to the bill's author, all one need do to rebut 
the presumption is satisfy ``a simple, easy to understand 3 point 
test.'' Upon taking a closer look, an independent entrepreneur like our 
home-based webpage designer is likely to be nonplused. One part of the 
test is indeed clear cut--she must make her services available to other 
customers. A second requirement is more complicated--she must 
demonstrate ``entrepreneurial risk.'' The final requirement is the 
antithesis of simplicity--she must demonstrate that her client has no 
``control'' over the webpage she designs.
    Unfortunately for the independent entrepreneur, the bill does not 
define what constitutes ``entrepreneurial risk'' or ``control.'' These 
two terms are exactly what the IRS' subjective 20-factor test was 
designed to determine. But under H.R. 1525, our webpage designer will 
no longer be able to rely on the common-law precedents underlying the 
20-factor test. Instead, the Treasury Department and the IRS will once 
again be permitted to write all the rules and regulations. With the 
events leading up to the Revenue Act of 1978, which established the ban 
on Treasury and IRS regulations concerning independent contractors, I 
have a good idea how fair and unbiased those rules will be for our 
independent entrepreneur.
    Third, H.R. 1525 repeals section 530 of the Revenue Act of 1978. 
For the last two decades this provision has been the only protection 
for businesses that utilize independent contractors. It is by no means 
a simple test to meet, but it permits small businesses and the 
independent contractors they utilize to rely on established industry 
practice as a roadmap for classifying their business relationships. By 
removing this protection, the value of which Congress reaffirmed with 
the 1996 legislative modifications, the bill will put countless 
businesses at the mercy of the IRS. With the extraordinary efforts over 
the last two years to improve taxpayer rights and IRS' customer 
service, do we really want to magnify the environment of fear 
surrounding worker classification, let alone expose even more 
businesses to huge tax bills at the whim of the IRS?
    One final point on H.R. 1525. Buried under the ostensible 
simplicity of the bill's requirements is an enormous hidden cost for 
small businesses and independent contractors. These individuals will 
have to spend more time and hire even more expensive lawyers and 
accountants just to sort out all of the undefined terms of the bill, 
not to mention the cost of proving that a particular business 
relationship meets the bill's strict requirements for recognition of an 
independent-contractor relationship. That time and money will not 
produce a single job and will contribute nothing to our economy or 
society. It is simply time taken away from the business and money 
thrown down the drain.

                               Conclusion

    For too long, independent entrepreneurs and the businesses with 
which they work have struggled for a neutral tax environment. For an 
equally long time, that tax environment has been unfairly and 
unnecessarily biased against them. It is well past time that the tax 
code embraces one of the fundamental tenets of our country--the free 
market. We must allow individuals the freedom to pursue new 
opportunities in the ever-changing marketplace through business 
relationships that make the best sense for them. Our tax code should 
facilitate those opportunities through fair and simple rules that 
permit the freelance writer, home-based webpage designer, and every 
other independent entrepreneur to pay their taxes without undue 
interference from the Government. Trying to force today's dynamic 
workforce into a 1950s model serves no one and only stands to stifle 
the entrepreneurial spirit in this country and dampen the continued 
success of our economy.
    Thank you for the opportunity to present my views on this critical 
issue for independent entrepreneurs in this country.

                                

Statement of Hon. Gerald D. Kleczka, a Representative in Congress from 
the State of Wisconsin

    Mr. Chairman, and members of the Subcommittee, I would like to take 
this opportunity to discuss H.R. 1525, the Independent Contractor 
Clarification Act of 1999. Working on a bipartisan basis, Chairman 
Houghton and I recently introduced H.R. 1525. Ten other members of the 
Ways and Means Committee joined us as original cosponsors of this 
legislation.
    The bipartisan spirit of this legislation cannot be underestimated. 
Congress has struggled with this issue since 1978. Unfortunately, 
legislation introduced in recent years has tended to favor employers 
and only served to polarize the debate on this issue. Congressman 
Houghton and I have worked with groups representing both employers and 
employees for most of the past year to develop H.R. 1525.
    The current 20 point test used to determine an individual's 
employment classification and the section 530 safe harbor are 
burdensome and unworkable. The 20 point test is a series of tests that 
provide employers with a general guideline as to how they are supposed 
to classify their workers. However, these tests do not provide 
employers with a clear definition of who is an independent contractor 
and who is an employee. This lack of clarity has led to countless 
workers being misclassified.
    For example, one of the criteria used in the 20 point test is the 
level of training of the worker. Some have interpreted a level of 
training to be a college degree while others would argue it is a 
person's general work experience. Another criteria is furnishing 
significant tools and assets. For a computer programmer, significant 
equipment and assets might be an expensive computer system whereas in 
the case of a laborer an employer might deem a significant investment 
to be some basic tools.
    The lack of clarity in the 20 point test has been compounded by the 
fact section 530 of the 1978 tax bill has prohibited the Department of 
Treasury from writing regulations to clarify the 20 test. Section 530 
was intended to be a temporary, one-year solution to a dispute over the 
Department of Treasury's efforts to bring about the proper 
classification of workers. A few years later, section 530 was made 
permanent.
    As a result of the lack of clear direction, many businesses have 
misclassified their workers as independent contractors. Such 
misclassifications have resulted in workers being denied essential 
benefits such as health coverage, a retirement plan, or the employer's 
share of FICA taxes. Workers who are actual employees and who work at 
the direction of and under the supervision of a superior are entitled 
to these benefits as part of their employment.
    The Independent Contractor Clarification Act would replace the 
current 20 point test with a three point test. An individual would be 
classified as an independent contractor if the employer does not 
control the manner in which the individual completes his or her 
assigned tasks; the individual is able to solicit and undertake other 
business opportunities; and the individual encounters entrepreneurial 
risk. The last point would include the ability of the independent 
contractor to generate a profit or bear the risk of financial loss.
    Detractors of the legislation have asserted that the three tests in 
H.R. 1525 is too vague and do nothing to clarify the employer-employee 
relationship. That is a red herring. In fact, other legislation that 
has been introduced on this issue would only add to the confusion by 
adding a layer of a new tests on top of the 20 point tests.
    For example, S. 344, the Independent Contractor Simplification and 
Relief Act of 1999 was recently introduced by Senator Bond. S. 344 
establishes a set of criteria to help businesses classify their workers 
as independent contractors. One of the criteria is whether a person 
``has a significant investment in assets.'' As I previously indicated, 
the concept of a significant investment in assets is already one of the 
most confusing aspects of the current 20 point test. Another criteria 
is whether a person ``operates primarily from equipment not supplied by 
the service recipient.'' That can hardly be considered a clear, concise 
standard. Finally, S. 344 would not allow the Department of Treasury to 
provide any clarification to those new tests.
    Instead of prolonging the confusion of current law, H.R. 1525 would 
move forward. By allowing the Department of Treasury to issue guidance, 
further clarification of the three criteria in H.R. 1525 will be 
developed. Congress, the Administration, and interested parties will 
have ample opportunity to express their views in this process. Congress 
will be able to write lengthy report language to specifically direct 
the Department of Treasury as to how the tests are to be interpreted. 
The issuance of regulations by the Department of Treasury will follow 
the established process of issuing proposed regulations, public 
hearings and comment on the proposed regulations, and final 
regulations.
    I would also like to point out that any person who has a statutory 
exemption would maintain that exemption under H.R. 1525. For example, 
current law says that real estate agents and direct sellers such as 
newspaper delivery persons are independent contractors, and they would 
maintain that status under the Independent Contractor Clarification 
Act.
    Finally, H.R. 1525 would give many businesses something they do not 
have under current law--protection from retroactive taxes. The single 
largest hurdle to employers reclassifying their workers as employees is 
the fear the IRS is going to take the reclassification as an admission 
of wrongdoing and, as a result, assess retroactive employment taxes. 
Under this legislation, the IRS would be prohibited from collecting 
back taxes if an employer meets certain criteria.
    The effective date of this legislation is January 1, 2001. This is 
designed to give businesses a reasonable amount of time to implement 
the changes in the independent contractor statutes. Furthermore, any 
business that is told to reclassify its workers would have 60 days 
after final notification from the IRS to implement the change.
    H.R. 1525 is a bipartisan solution to a difficult and longstanding 
problem. The Independent Contractor Clarification Act attempts to 
balance the interests of employers and their workers. If enacted, this 
legislation will provide employers the guidance they need to properly 
classify their workers. It will also serve the interests of hard-
working Americans and their families.

                                

Statement of National Association of Home Builders

    On behalf of the 197,000 member firms of the National Association 
of Home Builders (NAHB), we would like to express our support for 
Congressman Amo Houghton convening a hearing on the impact of 
complexity in the tax code on individuals and small businesses. This 
issue is important to all taxpaying Americans who desire to comply with 
the tax code's thousands of confusing rules and regulations while at 
the same time operating a business or running a household. This hearing 
is both very timely and necessary and NAHB applauds the Chairman on his 
efforts.

                       Cash Method of Accounting

    NAHB would like to also support a key provision in the ``Tax 
Simplification and Burden Reduction Act'' that is sponsored by 
Subcommittee Chairman Amo Houghton. This provision would increase the 
gross receipt threshold for the cash method of accounting from $5 
million to $10 million. Not only does Representative Houghton believe 
that the tax code is forcing far too many small businesses to use the 
accrual method instead of the cash method but builders and small 
contractors experience this costly and burdensome change annually.
    Home builder subcontractors who supply both service and materials 
have traditionally used a cash method for tax accounting. The Internal 
Revenue Service (IRS) has a long history of enabling small contractors 
to use the cash method of computing taxes; however, the IRS has now 
begun to enforce a tax court ruling that requires these firms to use an 
accrual method of tax accounting. The result has been that some small 
firms must pay taxes on income not yet realized or are not allowed to 
deduct expenses actually paid. Some of the builders and small 
contractors do not have the cash available to pay taxes on funds that 
have not been received and these small firms are sometimes forced to 
close because of the tax change. The IRS code does allow service 
businesses with gross receipts of under $5 million per year to use the 
cash method of tax accounting and NAHB would like to extend this 
exception to builders and small contractors.
    Although NAHB supports the efforts of Congressman Houghton, we 
believe it does not go far enough to allow builders and small 
contractors as defined by IRS code section 460 to be included within 
the scope of service businesses as defined by IRS code section 448 and 
we would recommend that the legislation be modified to include this 
equitable and necessary change.

     Protect and Preserve the Low Income Housing Tax Credit Program

    Another issue that has recently become a major problem for NAHB is 
the unnecessary and harmful recapture of low income housing tax credits 
by the IRS. As many of you know, the low income housing tax credit 
program in Internal Revenue Code Section 42 provides a limited amount 
of tax credits to each state which in turn is sold to investors in the 
open market and the proceeds of which is used to finance the building 
and maintenance of low income affordable housing. In order to be 
awarded the tax credits, developers of affordable housing must endure a 
very costly underwriting process at three different times. Once the 
state issues the final amount of tax credits (in the form of an 8609 
determination), the developer then sells those credits to investors at 
a discount to raise the equity necessary to build the project. 
Unfortunately, the IRS in the last couple of years has begun auditing 
these affordable housing projects and recalculating the amount of 
credit and in some cases recapturing a significant amount of those tax 
credits. This is causing the financing arrangements for some existing 
low income housing projects to unravel and raising concern in the 
industry about the financial security of all projects that have been 
built in the last 10 to 12 years. This approach by the IRS is somewhat 
akin to a bank recalculating a mortgage to determine whether you meet 
the right ratios to qualify for a loan after you have bought the house, 
have moved in and are paying monthly on the debt. This violates notions 
of fundamental fairness.
    The recapture risk by the industry to date has been perceived to be 
a risk of non-compliance with the Section 42 rules on occupancy 
eligibility for the most part. Many investors have a staff of 
compliance monitors as well as contractual reporting requirements for 
their LIHTC investments in order to compensate for and reduce this type 
of recapture risk. Many developer/builders, whether for-profit or non-
profit, also have increased their on-site and off-site staff that 
monitor leasing procedures to assure compliance with the complex rules. 
Syndicators and investors have led the way, in cooperation with state 
agencies, in promoting additional training and credentialed standards 
of competency for LIHTC professionals and also in efforts to reduce the 
risk of recapture from program non-compliance, this we applaud and 
support.
    Developers, syndicators, bond counsel, underwriters' counsel, and 
investors implicitly have relied on the state agency determination and 
allocation of the credit amount (the 8609). The industry from lenders 
to investors, and agencies to developers, has operated on the basis 
that they could rely on the amount of the credit on the 8609, unless 
there was non-compliance with program requirements. This new risk from 
recalculation of a projects eligibility for credits and that the amount 
of the eligible basis could be reduced and tax credits recaptured was 
not anticipated. This risk for an existing project can apply back three 
years from the date of the audit and forward to the end of the 10 year 
credit period. The states' final determination (the 8609) has been the 
definitive statement of allocated amount for buyers and sellers of 
credits. When the IRS is now coming in to redetermine the amount, it 
undermines the state agency's obligations imposed by Congress.
    In its 1989 amendments to the housing credit program, Congress 
imposed on State agencies the burden of determining the appropriate 
amount of credit. Congress did not choose the federal pre-approval 
method (e.g. HUD administration), nor did they rely on the market alone 
and professional opinions (e.g. tax-exempt bonds) to assure that the 
developer and investors take the appropriate amount of credit. In our 
view, for this housing program there should not be, nor previously was 
there perceived to be, an obligation or ``threat'' of recalculation of 
the agency's credit allocation. Part of the ``magic'' of the LIHTC 
program is that each State determines what kind of projects and how 
much federal investment to make in that project. When the IRS 
recalculates basis and recaptures tax credits it is second-guessing the 
state agency. This over regulation is burdensome and will have a severe 
negative impact on the program.
    As with so many tax law issues, the IRS could probably recalculate 
eligible basis for every project and come up with a different amount 
than the state agency. This should not be surprising given the 
complexities of tax law and, the plethora of potentially applicable tax 
cases, combined with the enormous amount of detail and number of 
documents that are amassed for any development project. In this 
program, Congress put the calculation burden on the state agency and 
the developers of the projects are already incurring the cost of that 
obligation in the form of fees to the states. This does not need to be 
duplicated.
    After the burdensome audit process is concluded, it does not result 
in any increased benefit for the LIHTC program. Recaptured credits do 
not increase funds for affordable LIHTC housing. A recapture by the IRS 
does not return the funds to the states for reallocation and no 
increased affordable housing results from a recapture. Audits and 
threats of audits and recaptures will reduce the amount of housing 
benefit from the already very limited amount of credit available to the 
states each year.
    Most states do not have enough funds to satisfy the outstanding 
need for affordable housing in their area and the method the IRS is 
taking regarding the audit process will further impede the flow of 
capital to this program. The magic of the LIHTC program is that it 
leverages private money to produce affordable housing that reaches a 
policy goal set by Congress. Private capital and capital markets, 
however, are very sensitive to risks and potential risks. Thus, whether 
IRS audits of credit projects are done frequently or infrequently is 
irrelevant. When the possible result is the recapture of credits, the 
capital markets and potential investors may flee the market based on 
the perception of the extent of the risk.
    In addition to a slow down or break in capital flows to LIHTC 
projects, the prices paid for credits may decline to compensate for the 
increased risk of recapture and loss of credit to the investor. When 
the discount paid by investors increases and the price for credits 
declines, there will be fewer housing units or lesser quality units 
built for the same revenue offset to the Treasury.
    The affordable housing industry would like to continue to make the 
LIHTC program the best and longest lasting affordable housing program 
in existence but we need certainty and finality for housing credit 
allocations. The objective is to protect and preserve the public-
private partnership that produces section 42 affordable housing for our 
communities. The congressional objective is also being achieved which 
is to provide low income individuals with an affordable place to live 
and ultimately the public benefits through better neighborhoods and 
communities.
    After discussing this issue with the IRS, it is clear that the only 
method to provide certainty regarding the allocations provided by the 
states is to address the problem legislatively. As a result, NAHB would 
like to work with Congress to develop a legislative proposal that would 
protect and preserve the public-private partnership that produces 
section 42 affordable housing.
    NAHB has developed a legislative proposal that is intended to 
eliminate disputes over what is in, or out, of eligible basis for 
purposes of calculating the credit allocation for an 8609. The 
objectives of the proposals are to: (1) assure certainty for 
determining eligible basis and hence credit allocations, (2) protect 
existing credit allocations and (3) provide finality in credit 
allocations. The concept behind the legislative language is that a 
credit allocation is really an equity gap calculation to determine how 
many credits are necessary for the financial viability of the project. 
The gap calculation needs to be as formulaic as possible, in order to 
assure the certainty of the allocation. Allocations should not be at 
risk of recapture and lost to the affordable housing stock due to 
disputes over what is or is not in eligible basis.
    The legislative language will also preserve the existing credit 
allocations by preventing the retroactive recalculation of eligible 
basis on outstanding allocations. Additionally, the legislation will 
help provide finality for future tax credit allocations because 
predictability, finality and certainty is what the low income housing 
development and investment community needs to continue the effective 
public-private partnerships that has built so many affordable housing 
projects under Section 42.
    NAHB would like Congress to prevent these retroactive recaptures 
and allow for certainty and finality in credit allocations by the 
states. Credit allocations need to have finality in order to assure a 
vibrant, competitive market where investors and developers can rely on 
an allocation once it is received. Legislative reform in this area is 
necessary to preserve the LIHTC program and continue to ensure that 
this program will supply America's affordable housing needs.

                      Independent Contractor Issue

    An additional issue that must be addressed is our opposition to 
Congressman Kleczka and Houghton's bill, H.R. 1525, the ``Independent 
Contractor Clarification Act.'' NAHB is opposed to this bill for 
various reasons. First, this bill will turn back the clock 20 years and 
undermine the current law regarding whether an individual is an 
independent contractor or an employee. This bill begins with the 
statutory presumption that an individual is an employee unless the 
parties can prove otherwise. Current law is neutral and does not, in 
theory, present a preference either way although, in practice, there is 
a bias against independent contractors. By creating a statutory 
preference towards employees, Congress would ignore a national policy 
that placed the utmost importance and value on independent contractors 
and the small businesses that utilize their services.
    Secondly, the bill provides a three-prong test to determine 
employment status that does not simplify the test but only complicates 
it further. The test consists of three elements: the service recipient 
must lack control, make their services available to others and have 
entrepreneurial risk. Neither ``control'' nor ``entrepreneurial risk'' 
is defined in the bill. Although the bill repeals the common law test, 
the new test would be even more subjective than current law, and would 
create even greater uncertainty and confusion because the new test 
lacks clear definition and guidance.
    Thirdly, the bill repeals Section 530, a safe harbor provision that 
allows small businesses and the independent contractors they may engage 
to rely on ``long standing industry practice'' as a guide to the 
appropriate classification of individuals. H.R. 1525 repeals Section 
530 and replaces it with a narrower safe harbor, reliance on 
substantial authority. There have been few favorable IRS rulings over 
the years that might constitute substantial authority. What makes this 
repeal so damaging is that it will return us to an era when the IRS had 
the tools, the authority and power to stifle the entrepreneurial spirit 
or independent contractors and small businesses and was subject to the 
mercy of the enforcers.
    What NAHB and other small businesses are looking for is clarity and 
surety regarding the classification of the service provider and 
protection against retroactive reclassification. A bill S. 344, the 
``Independent Contractor Simplification and Relief Act of 1999'' 
sponsored by Senator Kit Bond does achieve that goal. Please consider 
other avenues to address worker classification because H.R. 1525 is not 
the answer.
    NAHB appreciates your attention to issues of concern to our members 
and look forward to changes in the tax code that include some of the 
priorities mentioned in this testimony.

                                

                   National Conference of CPA Practitioners
                                          Lake Success, NY,
                                                       June 7, 1999
A.L. Singleton, Chief of Staff
House Ways and Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, D.C. 20515

    Dear Mr. Singleton:

    I am writing in response to your advisory concerning the hearing on 
the impact of complexity in the tax code.
    The National Conference of CPA Practitioners has been in existence 
since 1979. The organization is comprised solely of CPA firms in public 
practice. The majority of our members represent small to mid-sized 
businesses and individual taxpayers. As such, we are in a position to 
understand the problems that taxpayers have with the complexities of 
the tax code.

Alternative Minimum Tax

    The AMT is perhaps the most difficult item for taxpayers to 
understand. The perception is that AMT was instituted to thwart the 
efforts of rich taxpayers to pay little or no tax. Even tax 
professionals have trouble planning for this onerous tax. It is nearly 
impossible to prepare a tax projection for a client with a reasonable 
degree of accuracy.
    Many AMT items are passed through on K-1 Forms from partnerships 
and S corporations. In most cases it is not possible to know what the 
effect will be until the K-1 is received. Taxpayers can not react on a 
timely basis.
    Code Section 469 was enacted in 1986 to limit the ability of 
taxpayers to use passive losses to offset other income. There are many 
other areas of the code that place limitations on deductions. Some 
examples are medical expense, investment interest expense, gambling 
losses, the 2% floor for miscellaneous deductions and the 3% overall 
limit on itemized deductions. It seems that these limitations are 
already complex and onerous. The AMT further complicates the ability of 
taxpayers to understand what their actual effective deductions will be.
    The rules for employee business expenses, coupled with the AMT, 
create complexity and discriminatory treatment of some taxpayers. The 
employee business expenses are reported on Form 2106 and passed through 
to Schedule A. They are not deductible for AMT purposes, even though 
there is a valid business purpose for the deduction. Taxpayers that 
qualify as statutory employees can deduct their expenses on Schedule C 
without any effect for AMT purposes. Most individuals and many 
businesses don't understand the statutory employee criteria. Our 
committee is aware of cases in which the employee qualified as a 
statutory employee and the employer refused to check the proper box on 
the W-2 Form. One case involved a large employer. We contacted the home 
office in Chicago and were informed that the legal department mandates 
a position whereby nobody is a statutory employee. During a mail in 
audit, IRS determined that the facts and circumstances indicate that 
the taxpayer does qualify. If a large employer can't deal with these 
rules, there is no hope of smaller entities reporting properly. As 
well, the employee is placed at a tax disadvantage merely because of 
his status as an employee. This is an unfair tax policy and should be 
rectified.
    I recently had to prepare a projection for a client who had 
eligible Section 1202 transactions. This provision was enacted to 
encourage investment in small businesses. The effective tax rate on 
Section 1202 transactions is nominally 14% (50% of the gain taxed at 
28%). Because 21% of the gain is added back for AMT, most taxpayers 
will not pay the 14% rate. The effective rate including the AMT is 
19.88%, which was enacted to keep the rate no more than the ordinary 
20% capital gain rate. My projection software does not handle the AMT 
on Section 1202 transactions automatically and the analysis required to 
make the proper adjustments is onerous. Accordingly, my initial 
estimate of how much money to set aside for the income tax on his sale 
was understated. In fact, the AMT for this taxpayer was approximately 
$130,000. For practical purposes, the people who make these investments 
would need to sell their holdings over many years if they wish to avoid 
the AMT. As well, the 21% AMT adjustment will expose other income to 
AMT that ordinarily would not be. This make the effective rate on the 
Section 1202 transaction 28%, which is not consistent with the 
intentions of the statute.
    I presented the Section 1202 topic as part of a tax update seminar. 
Over 500 of our members attended the seminar and most of them did not 
understand the nuances of the AMT on Section 1202 transactions. If one 
presumes that the CPAs attending seminars are well versed in taxation, 
there is little hope of unlicensed tax practitioners being able to work 
with these rules. One would doubt that any lay person could understand 
them.

Independent Contractor Rules

    This issue has been on our legislative agenda for years. The 
difficulty of working with the 20 common law tests is well documented. 
The Microsoft case should be a clear indication that ordinary taxpayers 
can not work with the existing rules. The potential ramifications of a 
worker classification error are Draconian. If Congress is unable to 
devise a logical approach, taxpayers should be given liberal relief in 
correcting errors. We understand the need for IRS to capture the taxes 
that many independent contractors do not report. In our experience, the 
honest taxpayer that made a good faith attempt to comply is most likely 
to be hurt. The true non-compliant taxpayer is likely to be out of the 
tax system completely.
    We have reviewed several previous bills that were intended to 
modify the independent contractor rules. Every bill attempts to place 
statutory definitions on the concepts of (a) control, (b) profit 
motive, and (c) availability to other entities. While these concepts 
may be easier to comply with than the common law tests, they still 
leave significant room for interpretation. Taxpayers need clear and 
concise criteria that can be assessed without the assistance of a tax 
lawyer. It is likely that, as taxpayers find ways to bend new rules, 
additional legislation will be required to close the loopholes. Before 
long, the new rules will be as complex and burdensome as the old ones.
    Congress has always been concerned that employers will coerce 
employees to elect independent contractor status. This is a concern has 
merit, but the tax code can not solve every social problem. At this 
time an employer may pass IRS scrutiny and lose an audit with the 
Federal or State Department of Labor. We believe that independent 
contractor status should require a written agreement between the 
service provider and the service recipient. Perhaps a model agreement 
could be developed by statute. If the statutory language were adopted, 
there would be a presumption that the arrangement is valid. The IRS 
should only have the ability to interfere if undue influence can be 
proven.
    We are concerned about conflicts between Federal and State laws. We 
believe that most states mandate workers compensation coverage for sub-
contractors that don't have their own coverage. Any new Federal 
legislation should address this area. It should be mandated that the 
service recipient is not required to cover the service provider for 
workers compensation if the provider is an independent contractor for 
Federal purposes.

Phase Out Tables

    Since 1986 Congress has become enamored with phase out tables. An 
example of this concept is the phase out of passive losses for rental 
real estate losses for income ranges from $100,000 to $150,000. We now 
have phase out tables for IRA contributions, Roth IRAs, education 
savings bonds, education IRAs, education credits, itemized deductions, 
personal deductions, student loan interest, etc., etc. At our seminars 
the standing joke is that you need a table to keep track of the tables. 
Practitioners who work with the tax code continuously can't remember 
all of these tables. When a practitioner attempts to explain these to a 
client they usually just give up. The fact is taxpayers just can't deal 
with it. Clients may call with a simple question, such as ``should I 
fund my IRS as early as possible?'' The practitioner now responds that 
it depends on the gross income because of the phase out ranges. 
Taxpayers can't plan under this scenario. Some of the decisions must be 
made prior to December 31, however they can't determine whether they 
qualify until the year is over. Taxpayers that receive K-1 Forms might 
not know their AGI until October 15 of the following year because of 
extensions. This is unfair and unmanageable.
    The reason for phase out ranges in the law is understandable, but 
the rules need to be codified. We believe that Congress should develop 
a set of phase out ranges that will apply to each filing status 
(single, married joint, etc.). These tables should be used for every 
area of the code that requires a phase out. In many cases it would make 
sense to use the prior year adjusted gross income to make the 
calculation. An example is the conversion of an IRA to a Roth IRA. 
Conversions are only allowed if AGI is less than $100,000, but the 
conversion must be made by December 31. While the law does provide a 
remedy to correct invalid conversions, the complexity involved to 
correct the conversion creates an additional burden on taxpayers. 
Taxpayers are losing confidence in our tax system because they can't 
understand the rules.
    I wish to thank you for the opportunity to submit our comments. Our 
committee welcomes any future opportunity to be involved in the process 
of seeking a more fair and equitable tax code. We applaud your efforts.
            Respectfully submitted,
                                      Steven Greenberg, CPA
                                        Chair, Tax Policy Committee

                                

Statement of LaBrenda Garrett-Nelson and Robert J. Leonard; on behalf 
of Washington Counsel, P.C., Attorneys-at-Law

    Washington Counsel, P.C. is a law firm based in the District of 
Columbia that represents a variety of clients on tax legislative and 
policy issues.

                              Introduction

    As Chairman Houghton stated in his announcement of today's hearing, 
``simplification of the most complex provisions of the code may help to 
reduce significantly the burden on individual taxpayers and small 
businesses.'' In this regard, the provisions that make up the U.S. 
international tax regime certainly rank among the most complex 
provisions in the Code. This statement sets forth a proposal to reduce 
complexity in this area by repealing the little used regime for export 
trade corporations (``ETCs''), enacted in 1962 to provide a special 
export incentive in the form of deferral of U.S. tax on export trade 
income. The rationale for the proposed repeal is that the special 
regime for ETCs was, effectively, repealed by the 1986 enactment of the 
passive foreign investment company (``PFIC'') rules. At the same time, 
the proposal would provide appropriate (and prospective) transition 
relief for ETCs that were caught in a bind created by enactment of the 
PFIC regime.

I. The Overlap Between the ETC Regime and the PFIC Rules Effectively 
Nullified the ETC Rules For Many Corporations

    Although the PFIC rules were originally targeted at foreign mutual 
funds, the Congress has recognized that the scope of the PFIC statute 
was too broad. Thus, for example, the Taxpayer Relief Act of 1997 
eliminated the overlap between the PFIC rules and the subpart F regime 
for controlled foreign corporations. Similarly, in the 1996 Small 
Business Jobs Protection Act, the Congress enacted a technical 
correction to clarify that an ETC is excluded from the definition of a 
PFIC.
    The 1996 technical correction came too late, however, for ETCs that 
took the reasonable step of making ``protective'' distributions during 
the ten-year period between the creation of the uncertainty caused by 
enactment of the PFIC regime and the passage of the 1996 technical 
correction. Although U.S. tax on distributed earnings would have been 
deferred but for the ETC/PFIC overlap, these ETCs were, effectively, 
required to make distributions to protect against the accumulation of 
large potential tax liabilities under the PFIC rules. Thus, the PFIC 
rules, in effect, repealed the ETC regime.

II. Congressional Precedents for Providing Transition Relief for ETCs

    The proposal would simplify the foreign provisions of the tax code 
by repealing the ETC regime. When the Congress enacted the Domestic 
International Sales Company (``DISC'') rules in 1971, and again when 
those rules were replaced with the Foreign Sales Corporation (``FSC'') 
rules in 1984, existing ETCs were authorized to remain in operation. 
Moreover, ETCs that chose to terminate pursuant to the 1984 enactment 
of the FSC regime were permitted to repatriate their undistributed 
export trade income as nontaxable PTI.
    The Proposal also provides a mechanism for providing prospective 
relief to ETCs that were caught in the bind created by the PFIC rules. 
Consistent with the transition rule made available in the 1984 FSC 
legislation, the proposal would grant prospective relief to ETCs that 
made protective distributions after the 1986 enactment of the PFIC 
rules. Essentially, future (actual or deemed) distributions would be 
treated as derived from PTI, to the extent that pre-enactment 
distributions of export trade income were included in a U.S. 
shareholder's gross income as a dividend. Note that the proposed 
transition relief would provide only ``rough justice,'' because taxes 
have already been paid but the proposed relief will occur over time.

                               Conclusion

    Repeal of the ETC provisions would greatly simplify the 
international tax provisions of the Code, but such a repeal should be 
accompanied by relief for ETCs that were caught in the bind created by 
the PFIC rules.
```