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HEARING ON IRS LATEST ENFORCEMENT: IS THE

BULLS-EYE ON SMALL BUSINESS?

HEARING

BEFORE THE

COMMITTEE ON SMALL BUSINESS 

HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

WASHINGTON, DC, APRIL 5, 2006

Serial No. 109–46

Printed for the use of the Committee on Small Business

(

Available via the World Wide Web: http://www.access.gpo.gov/congress/house

COMMITTEE ON SMALL BUSINESS 

DONALD A. MANZULLO, Illinois, Chairman 

ROSCOE BARTLETT, Maryland, Vice 

Chairman 

SUE KELLY, New York 

STEVE CHABOT, Ohio 

SAM GRAVES, Missouri 

TODD AKIN, Missouri 

BILL SHUSTER, Pennsylvania 

MARILYN MUSGRAVE, Colorado 

JEB BRADLEY, New Hampshire 

STEVE KING, Iowa 

THADDEUS MCCOTTER, Michigan 

RIC KELLER, Florida 

TED POE, Texas 

MICHAEL SODREL, Indiana 

JEFF FORTENBERRY, Nebraska 

MICHAEL FITZPATRICK, Pennsylvania 

LYNN WESTMORELAND, Georgia 

LOUIE GOHMERT, Texas 

NYDIA VELA ́ ZQUEZ, New York 

JUANITA MILLENDER-MCDONALD, 

California 

TOM UDALL, New Mexico 

DANIEL LIPINSKI, Illinois 

ENI FALEOMAVAEGA, American Samoa 

DONNA CHRISTENSEN, Virgin Islands 

DANNY DAVIS, Illinois 

ED CASE, Hawaii 

MADELEINE BORDALLO, Guam 

RAU ́ L GRIJALVA, Arizona 

MICHAEL MICHAUD, Maine 

LINDA SA ́ NCHEZ, California 

JOHN BARROW, Georgia 

MELISSA BEAN, Illinois 

GWEN MOORE, Wisconsin 

J. MATTHEW SZYMANSKI, Chief of Staff 

PHIL ESKELAND, Deputy Chief of Staff/Policy Director 

MICHAEL DAY, Minority Staff Director

(II) 

C O N T E N T S 

WITNESSES

Page 

Everson, The Honorable Mark W., Commissioner, Internal Revenue Service ... 4

Sullivan, The Honorable Thomas M., Chief Counsel for Advocacy, U.S. Small 

Business Administration ..................................................................................... 6

Brown, Mr. Kevin, Commissioner, Small Business/Self-Employed Division, 

Internal Revenue Service .................................................................................... 26

Olson, Ms. Nina, National Taxpayer Advocate, Internal Revenue Service ........ 28

Satagaj, Mr. John, President and General Counsel, Small Business Legislative Council ........................................................................................................... 31

Hall, Mr. Keith, CPA, Partner, Hall and Hughes, PLLC ..................................... 32

Fredrich, Mr. Michael, President, Manitowoc Custom Molding, LLC ................. 35

Sawicky, Dr. Matt, Economic Policy Institute ....................................................... 37

APPENDIX

Opening statements: 

Manzullo, Hon. Donald A. ................................................................................ 57

Velazquez, Hon. Nydia ..................................................................................... 60

Prepared statements: 

Everson, The Honorable Mark W., Commissioner, Internal Revenue Service ................................................................................................................... 62

Sullivan, The Honorable Thomas M., Chief Counsel for Advocacy, U.S. 

Small Business Administration ................................................................... 72

Brown, Mr. Kevin, Commissioner, Small Business/Self-Employed Division, Internal Revenue Service .................................................................... 78

Olson, Ms. Nina, National Taxpayer Advocate, Internal Revenue Service . 84

Satagaj, Mr. John, President and General Counsel, Small Business Legislative Council ................................................................................................ 99

Hall, Mr. Keith, CPA, Partner, Hall and Hughes, PLLC .............................. 104

Fredrich, Mr. Michael, President, Manitowoc Custom Molding, LLC ......... 113

Sawicky, Dr. Matt, Economic Policy Institute ............................................... 118

Additional material: 

Brown, Alvin S., Alvin Brown and Associates, LLC ...................................... 124

Stoner, Floyd E., American Bankers Association .......................................... 146

(III) 

(1)

HEARING ON IRS LATEST ENFORCEMENT: IS 

THE BULLS-EYE ON SMALL BUSINESS? 

WEDNESDAY, APRIL 5, 2006

HOUSE OF REPRESENTATIVES

COMMITTEE ON SMALL BUSINESS

Washington, DC 

The Committee met, pursuant to call, at 10:00 a.m., in Room 

2360 House Office Building, Hon. Donald Manzullo [Chairman of 

the Committee] presiding. 

Present: Representatives Manzullo, Kelly, Akin, Sodrel, Velazquez, Bordallo, Barrow. 

Chairman MANZULLO. Good morning. 

Before receiving testimony from the panel, I want to remind everybody that we would like to keep the second panel witnesses to 

their oral testimony to five minutes. In front of you on the table, 

you will see a box that will let you know when your time is up. 

When the light is yellow, you have one minute remaining. When 

five minutes have expired, a red light will appear. Once the red 

light goes on please wrap up your testimony as soon as you are 

comfortable. 

This is the second hearing we have been having on the so called 

tax gap, which the IRS defines as the difference between what is 

paid and what should be paid. And everybody agrees that people 

should be paying taxes legally owed. 

The purpose of this hearing really is twofold. The first part is 

whether or not small businesses have been unfairly targeted by the 

IRS to the exclusion of others that may not be paying their taxes 

correctly. The second part has to do with what types of remedies 

are available to the IRS. But I want you to notice that the IRS’ efforts are targeted at mom and pop small businesses. 

I read over the GAO’s report on the IRS last night while watching the tremendous game with the University of Maryland. I do not 

know if I was more excited over that basketball game or over 

GAO’s report on the IRS. This is a report you have to read yourself. 

It is dated July 2005. Page 11 makes it explicitly clear because the 

IRS has no way of knowing whether or not corporations pay their 

taxes correctly, they do not even discuss going after corporations, 

instead the IRS goes after the little guys, the most vulnerable, the 

ones without the big lobbying firms in Washington, the ones represented by trade associations and the little guys who always get 

the crap kicked out of them on Capitol Hill. This GAO report is 

nothing less than condemning over what the IRS is doing. It should 

make the IRS hang its head in shame. 

2

I want to read from it on page 11. Estimates for some components of the tax gap are based on old data. The data is used by 

the IRS to determine which persons to pursue to reduce the tax 

gap. The report explains that ‘‘The IRS has difficulty estimating 

the tax gap because of different interpretations that complicate determination as to whether or not taxes are paid fairly by corporations. Further the report states that the IRS also ‘‘explained that 

due to these complexities and the costs and burdens of collecting 

complete and accurate data for corporation, IRS has not systematically measured large corporate tax compliance through statistically 

valid studies, even though the officials acknowledged that such 

studies would be useful in estimating the related tax gap.’’ 

If I were a professor and you turned in the report the IRS is 

using to go after the small people, you would get nothing less than 

a F or an F minus. 

I find it incomprehensible that the IRS is coming out with these 

new and fiscal schemes going after small businessmen when the 

data they rely upon is not worthy of a first grader. It’s a disgrace 

that the IRS should rely upon virtually no information. But the 

word is out. Last year, audits were up 100 percent. If you’re a 

small businessman, they were up 140 percent. 

The remedies that the IRS is proposing only attach to the little 

guys, the moms and pops and not to the C corporations. And the 

incredibility of these proposals means that if a small businessman 

is the sole shareholder in a C corporation, he’s exempt. But, if he 

can’t afford the attorney to go into a C corporation he’s not exempt 

from the wrath of the IRS. I’m really upset about this. And I’m 

upset about it because of the poor scholarship that’s gone into the 

study, as much respect as I have for Mark Everson and I know 

that he inherited this. This study was in place even before he came 

into office. Mark is still using this information for the purpose of 

going after the most vulnerable. 

Our job here in the Small Business Committee is to look after 

people that no one else cares about in this place, the forgotten 

ones, the 7 billion small business people that always get shuffled, 

the ones that pay health and accident insurance premiums after 15 

percent FICA and FUTA taxes. They’re the only business people 

that have to pay for their insurance with after tax money. 

And the frustration level of this Chairman is running extremely 

high at this point because of the number of small business people 

that are being hit. But in spite of that, we look forward to the testimony of Mark Everson, who I think has done an exemplary job at 

the IRS. He’s got a job that Congress has mandated to go after 

these people, and he’s going after them on the best information 

that he has and the only methods that he knows. We disagree with 

the quality of his information and disagree with the remedies he’s 

proposed but agree with the fact that you cannot have a nicer person than somebody like him. 

And I yield to the minority, Ms. Velazquez. 

[Chairman Manzullo opening statement may be found in the appendix.] 

Ms. VELAZQUEZ. Thank you, Mr. Chairman. 

With April 15 right around the corner, taxes are undoubtedly on 

everyone’s mind. Today’s hearing will focus on the tax gap; the difVerDate 0ct 09 2002 13:54 Oct 31, 2006 Jkt 000000 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 G:\HEARINGS\28570.TXT MIKE
3

ference between what the IRS is supposed to collect and what is 

actually collected. According to the IRS, the tax gap is estimated 

to be $345 billion per year and growing. As the budget deficit mounts, around $400 billion, the administration is looking for ways to recover lost revenue that was supposed to come flowing in as a result of their fiscal policy. But it has 

not. Unfortunately, it appears the administration is trying to make 

up for these shortfalls and balance the budget by unfairly targeting 

small businesses. Today, we will hear from the IRS about a plan 

in the President’s FY 2007 budget to crack down on small firms by 

granting the IRS even greater authority for enforcement. 

This proposal, while having a significant impact on entrepreneurs will only reduce the tax gap by one tenth of 1 percent. 

This is a large price to pay for a solution that will not even fix the 

problem. However, any attempt to solely blame the IRS is wrong. 

What seems to be lost in this discussion is the impact wrong policy 

choices, specifically tax policy made by congressional Republicans 

and the administration, have had on this nation’s small businesses. 

While providing minimal relief for entrepreneurs, the bulk of the 

reform passed has only further complicated the process. It has 

added thousands of pages to the tax code, which will only exasperate the growing tax gap problem. 

For proof, one only has to look at the 2004 tax bill. Even the 

Chairman of the Ways and Means Committee testified that this 

legislation set back efforts to simplify the tax code. Small businesses are being hit twice; once with the ever-increasing complexities of the tax code and again with the rising possibility of an 

audit. 

Given the growing complexity, tax assistance is needed now more 

than ever for small businesses. Unfortunately, rather than providing assistance, the Administration is closing taxpayer assistance 

centers. It simply does not make sense for the IRS to shift these 

resources when the complexity of the tax code is increasing. 

Congress will be voting on the budget this week and we will see 

just how much commitment there is to fairness for small businesses. The question at hand is: Will Members support the Administration’s budget proposal to further reduce tax compliance assistance efforts and impose strict enforcement efforts? Or will they reject these proposals? 

While many in the President’s party are more than happy to vote 

for his tax cuts and trump all the supposed good they are doing, 

when it comes to the consequences, increased compliance costs and 

a growing tax gap, they are vehemently opposed. Unfortunately, 

you simply can’t have it both ways. 

As has been the case with tax, energy and health care policy, the 

Administration continually favors large corporations. It is no surprise that while the tax gap is not only made up of small business 

taxpayers, this Administration lets the big corporations off the 

hook and instead focuses on entrepreneurs. At the same time, 

many small firms have little or no resources to defend themselves. 

Small businesses are the drivers of this nation’s economy, and 

they deserve every effort possible to decrease the burdens they 

face. If the goal today is to reduce the costs to small business, Congress should first look to reduce the complexity of the tax code. 

4

Most entrepreneurs are doing everything they can to pay the 

taxes they owe. They should not be blamed for the tax gap. This 

Administration needs to come to terms with the role their policies 

have had in furthering the tax gap. They need to admit the problem, then work to reduce the effects rather than point the finger, 

which is exactly what is happening with this current debate. 

Thank you, Mr. Chairman. 

Chairman MANZULLO. Thank you. 

The first panel we here from, Mark Everson, who has served as 

Commissioner of the IRS since 2003. 

Next, the Committee will hear from Tom Sullivan who is Chief 

Counsel of the U.S. Small Business Administration Office of Advocacy. 

Both have been before this Committee on several occasions. We 

look forward their testimony. 

I am going to set this clock at about ten minutes for the first 

panel. And if you do not use it up, that is fine. But because your 

testimonies are so complex, I want to give you plenty of time to do 

that. 

And Commissioner Everson, thank you for coming and we look 

forward to your testimony. 

And I also want to state to the folks here that you will be leaving 

after your testimony, but the taxpayer advocate plus somebody else 

from the IRS will be sitting on the second panel. Kevin Brown will 

be on the second panel, plus I understand you are going to have 

people from the agency in the audience that will be monitoring all 

the testimony. We appreciate that. 

STATEMENT OF MARK W. EVERSON, INTERNAL REVENUE 

SERVICE 

Mr. EVERSON. Thank you. I do not think I will use the whole ten 

minutes. But we already covered a lot in the opening statements, 

so I think we will get to plenty in the questions. 

Good morning Mr. Chairman, Ranking Member Velazquez and 

the members of the Committee on Small Business. 

I am pleased to be here again to update you on our efforts to reduce the tax gap. As you know, the tax gap is the difference between the amount of tax taxpayers should pay for a given year and 

the amount that is actually paid on a timely basis. The tax gap 

represents in dollar terms the annual amount of noncompliance 

with our tax laws. 

We now estimate that for the year 2001, the overall gross tax 

gap for all types of tax was approximately $345 billion, or a noncompliance rate of 16.3 percent. Our estimate of the net tax gap 

or what remains after enforcement and other late payments is $290 

billion. 

To reduce the tax gap we seek to improve service to taxpayers, 

we also enforce the law against those who do not comply. Our 

working equation at the IRS is service plus enforcement equals 

compliance. We strive to pursue to a balanced approach for all taxpayers, not just small businesses. 

For service, our outreach and education programs help small 

businesses deal with the complexities of the tax code. And we are 

reducing wherever possible the paperwork and reporting burden 

5

small businesses face. Electronic filing, which is growing rapidly 

across the nation, sharply reduces taxpayer errors on their returns. 

Our award winning website, IRS.gov, is one of the most widely 

used websites in the world during tax seasons. 

On the next panel, you will hear from Kevin Brown, the head of 

our Small Business/Self Employed Division. Kevin will talk more 

about our efforts to decrease the amount of time and money taxpayers must spend to meet IRS requirements. 

We will continue to work to improve services. But as you know, 

we are also boosting enforcement. The typical small business already has enough challenges without having to deal with a competitor who does not pay his or her fair share in taxes. We need to 

make sure that all are playing by the same rules. We want a level 

playing field. 

No businessman or businesswoman should gain an unfair competitive advantage because he or she decides to underreport income, overstate deductions or fail to properly remit payroll taxes. 

In recent years we have restored the credibility of our overall enforcement programs. In fiscal year 2005 individual audits were up 

20 percent from 2004 to 1.2 million. They’re up 97 percent since 

2000. 

High income audits were also up and have increased a 120 percent since 2000. 

Corporate audits bottomed out in 2003, but by 2005 had recovered by over 50 percent. 

Collections are more robust. Last year we had 2.7 million levies 

versus 200,000 in the year 2000. All told, enforcement revenues have increased from $43.1 billion 

in 2004 to $47.3 billion last year. 

In the President’s fiscal year 2007 request we seek to build on this progress. We are asking for an additional $137 million in enforcement. This increase will allow us to maximize the return on 

the investment made in enforcement last year when Congress provided $42 million in additional enforcement funding. 

Our research on the tax gap clearly indicates that where there 

is third party reporting, there is better compliance. In this regard 

I would draw to your attention a number of proposals in the President’s 2007 budget aimed to address administrative and reporting 

issues. The most important of these is the proposal to mandate reporting to the IRS of gross receipts by credit card issuers for their 

business customers. 

I believe the five legislative proposals that accompanied the Administration’s funding request can make a significant contribution 

to reducing the tax gap. I hope they will enjoy your support. 

In addition to these specific legislative proposals, I would also 

note that we plan to study the distinction between independent 

contractors and employees under current law. 

Let me make one final point. The extraordinary complexity of our 

tax system contributes to the tax gap. I continue to be a strong advocate of tax reform and simplification. 

Thank you. 

[The Honorable Mark Everson’s testimony may be found in the 

appendix.] 

Chairman MANZULLO. Thank you. 

6

Mr. Sullivan? 

STATEMENT OF THOMAS M. SULLIVAN, U.S. SMALL BUSINESS 

ADMINISTRATION 

Mr. SULLIVAN. Good morning Chairman Manzullo, Congresswoman Velazquez, Congressman Kelly. I am Tom Sullivan, the 

Chief Counsel for Advocacy at SBA. Congress established my office 

to independently represent the views of small business before Congress and federal agencies. So the comments expressed here don’t 

necessarily reflect the Administration or the SBA. 

My written statement was not circulated to OMB for comment. 

I’d like to submit my written statement for the record and briefly 

summarize. 

Chairman MANZULLO. All the written statements of the witnesses will be inserted into the record without objection. 

Mr. SULLIVAN. Thank you, Mr. Chair. 

The small business industry groups who come to my office to try 

to appeal to us to bring their views into other government agencies 

have expressed concern that IRS is focused on small entities as a 

primary means of improving tax compliance. News articles illustrate the reasons why these trade groups view IRS’ focus to be 

trained on their members. A March 20th ‘‘Tax Notes Today’’ article 

reported that IRS increased its number of audits primarily through 

a spike in small business audits. 

In recent testimony the Commissioner highlighted the return on 

investment for resources spent on enforcement each dollar, the 

Commissioner said, spent generated $4 in additional taxes collected. 

Small business groups who have appealed to my office are insistent that a similar analysis of how the service function of IRS realizes a return on investment would go far to demonstrate the balance of service plus enforcement. 

Nina Olson, the National Taxpayer Advocate who is on the second panel this morning, has on numerous occasions and recently at 

a hearing over in the Senate encouraged the IRS to ‘‘recognize the 

central role taxpayer service plays in achieving compliance and do 

more to study the optimal ways to deliver taxpayer service and the 

magnitude of the impact.’’ 

Also you mentioned, Mr. Chairman, in your opening statement 

the GAO. GAO has encouraged the IRS to conduct research on the 

reasons for taxpayer noncompliance. And in 1996 GAO made similar recommendations. 

Small business groups feel that this type of research on the service components of IRS can guide the IRS’ education in taxpayer 

compliance programs. 

Now let me turn my attention to some of the specific proposals 

that were mentioned by the Commissioners and will be mentioned 

in the second panel by the National Taxpayer Advocate. 

The Treasury proposals and the Taxpayer Advocate’s proposals 

that I will address require third party reporting and withholding. 

The Administration has proposed information reporting and backup 

withholding on credit card payments, payment card issuers, which 

are credit and debit cards. They would report reimbursements 

made to merchants and withhold taxes in certain circumstances. 

7

Second, the Administration has proposed to require information 

reporting and backup withholding on all non-wage payments made 

to government contracts. 

Small business groups who have come to my office have expressed that an unintended consequence of the increased withholding will be its harm to the cash flow of small businesses. In 

general, cash flow or liquidity is one of the most significant constraints small entities face in managing their business. According 

to a recent NFIB survey cash flow issues ranked in the top ten of 

important problems faced by small businesses. Small entities have 

a more difficult time paying their bills when their cash flow is interrupted. And small businesses must either borrow additional capital or forego early payment discounts to manage cash flow shortfalls. 

Another unintended consequence of increased withholding is that 

tax deductible expenses of small entities may unnecessarily be 

taxed. Payments received by small entities for the services and 

products they provide include both their expenses and profits. 

Small business groups are concerned that another unintended consequence does not enter into the equations of withholding because 

expenses are generally tax deductible while profits are subject to 

tax. 

Before Treasury and IRS impose new reporting and withholding 

requirements, small business believe it is important to determine 

the impact that small card issuers and small local governments 

will need to absorb as a consequence of these reporting and withholding strategies. 

The National Taxpayer Advocate has proposed other reporting 

and withholding regimes. The third party proposals detailed in my 

written statement, while presented as voluntary really impose additional administrative burdens on small businesses that contract 

with self-employed taxpayers. Small businesses currently shoulder 

exceedingly high tax compliance costs. A study that was recently 

updated by my office shows that the cost of compliance costs employers with less than 20 employees a total of $1304 per employee. 

Additionally, requiring the payors of self-employed taxpayers to 

withhold may distort the line between being an employee and being 

an independent contractor. 

Payors of self-employed taxpayers may become vulnerable to employer liability issues in that blurry line of independent contractor 

versus employee. Those issues include workman’s compensation 

and unemployment tax issues. 

Research sponsored by my office continues to show that the cost 

of tax compliance is 67 percent higher in small firms than in large 

firms. What can the IRS do to limit this disproportionate burden 

or unlevel playing field? Small businesses believe that IRS can 

evaluate the service they provide taxpayers so the importance of 

taxpayer service is not lost as they attempt to improve tax compliance. 

And certainly this hearing is an opportunity for IRS to consider 

some alternatives that may minimize the unintended impact of 

some proposals on small business. 

Thank you for allowing me to appear this morning. 

8

[The Honorable Thomas Sullivan’s testimony may be found in 

the appendix.] 

Chairman MANZULLO. Thank you. 

Ms. Kelly, why don’t you go first? 

Ms. KELLY. Thank you. I appreciate it. I have a markup in another Committee I have to get to. 

I am very pleased to have the two of you here. There is no one 

that knows who really likes to dip in their pocket on April 15th and 

pay taxes. They would rather keep the money. Quite frankly, as a 

Republican in this Congress, I would like to have them keep the 

money. But that being said, when you talk about small business as 

a small business owner, former small business owner I know that 

the tax system is very complicated, but I also know that there is 

an attitudinal problem. Many times when someone comes into your 

office and says ‘‘I am here from the IRS for an audit,’’ the attitude 

is ah-ha got you. 

At point in the past in my husband’s office there was an auditor 

who came and said ‘‘I have not found anything, but I have to find 

something because I have to cover the cost of my salary for being 

here.’’ I know that that is not the first time that I have heard that. 

I have heard that in testimony in this Committee from other people, other small business owners. 

Our problem as small business owners is several. The basic problem is clarity. We do not get enough education at the small business level to truly understand the tax codes. So you wind up holding on to every tiny little slip of paper because you do not know 

what the tax man is going to want when he comes in. It is everything from whether or not your business has donated to charity, 

paid for an ad in a high school book, all kinds of things that effect 

us as small business owners. 

And I would encourage you, Mr. Everson and your group, your 

staff; Mr. Sullivan, I know you are out trying to help with clarity, 

but I know that both of you know that we have got to work through 

chambers of commerce, the NFIB, the groups that are out there to 

get more education on this tax code to the small business owners. 

It makes it easier for them. And without their full knowledge of all 

the little tiny tangential laws that may effect their particular business, then they do not save or have necessarily what is there. 

Because my husband and I own several different small business 

we at one point in our lives for a period of about 15 years were audited on every single year by the IRS because the IRS did not know 

enough about the businesses that we were running to understand 

what we were filing as our tax code. And I see heads in the audience shaking. Sure, other people have been through that. I am not 

the only person. 

Well, what concerns me is that we have some evidence here in 

this study that Chairman Manzullo was talking about that nothing 

really has changed over the course of the last ten years. We need 

to have a change. 

So I would like an open commitment from you to try to help us 

teach small businesses better than you have been to approach a 

clarity with the type of business that people are in. Someone who 

shoes horses for a living has a totally different business than someone who is making small pieces of equipment for the Intel industry. 

9

All these different businesses have different approaches to their 

business. 

You have got a one size fits all approach to the filing of things, 

and that is very difficult and it makes it very complicated. I would 

like to see you work toward clarity. Can you give me some assurance that you are going to do that? 

Mr. EVERSON. Well, you have covered a lot of ground there, and 

I agree with a great deal of it. We are committed to outreach and 

education and I think Kevin will get into some more of the details 

on that. But we have active programs working with the NFIB, 

which you mentioned, and all the different groups and get involved 

in their newspapers. And I think that is an area where I would 

suggest to you that that has been a success story of recent years. 

Can we do more? Absolutely, we need to do more. 

Two other points on this. Again, simplification of the Code. As 

you keep handing us the Jobs Act. The Jobs Act was this thick. 

We’ve talked about the proposals. The Chairman and I talked 

yesterday about one of the things we want to look at is the definition of employee versus independent contractor. This is our training manual to apply the 20 part test on whether somebody is an 

employee or an independent contractor. We can only educate our 

people so well with the law that you have given us, if you will. So 

this is a joint discussion. 

But, yes, we will continue to focus on the education and the outreach. 

The last point I would say is I do not agree with the idea that 

somebody has to find something. Our no change rate on audits that 

you are talking about runs something like 16 or 17 percent. This 

research that we have undertaken the Chairman does not have 

much faith in it but we think it is pretty good, we believe will help 

us better figure out where we want to look so that we are not in 

that situation that you are discussing; that somebody is in there 

saying ‘‘gee, there is nothing here.’’ This is something where we believe if we use the research properly, we will be able to risk adjust 

where we look. 

Ms. KELLY. Well, just a follow-up on that, Mr. Everson. Are you 

in fact investigating more small businesses in this nation, is that 

a fact? 

Mr. EVERSON. Yes, that is fact. If the Chair will indulge me for 

just a minute I would like to show several charts that will sort of 

frame this issue. 

Selected coverage rates 2005. Companies with assets of $250 million, 44 percent. That is why we did not bother to do the research. 

We did the 46,000 audits on individuals, the coverage is so much 

lower. I would not use any more money on the corporations based 

on even if I knew that the tax gap was understated by half, because it is a relatively small piece. We are in there all the time auditing the biggest companies. 

Estate tax, gross estates with over $5 million, 28 percent audit 

rate. 

Corporations $10 to $50 million assets, 14 percent audit rate. 

Individuals with income over a million dollars, that’s 5 percent. 

This is still too low. We are bring this up. 

10

What we are talking about here is individual businesses, individuals with the Schedule C, that is at 3 percent audit rate. That is 

in contrast to the fact that if we go to the tax gap map you will 

see that the problem. 

Time filing that’s most the individuals, that’s about 8 or 9 percent, underpayment. You say you what you owe us but then you 

just do not pay us, that is another 8 or 9 percent. Eighty percent 

of it is under reporting. Most of that is in the individual income 

tax. 

The biggest piece is in the under reported business income and 

that has an effect on the self-employment taxes. So it is really a 

bigger number than the $109 billion that effects the $39 billion? 

The areas where we don’t get much reporting, third party report- ing come up to $110 billion of the tax gap. The biggest piece there 

is Schedule C income, that is $68 billion. That $68 billion has different components. The biggest single piece of that is gross income, 

that is $39 billion. There are other pieces in here. 

And I agree. Look, education of what depreciation could be or car 

and truck expenses, we can do better there. But I don’t think that 

gross income is—that most of this education will do it on this $39 

billion. The question here is whether the income is being reported. 

Why is this important? Because if you look at individual returns, 

this shows the change in individual returns since 1978. It has gone 

up 50 percent for all individual returns. We are up at over 135 million now. But Schedule C filers have gone up by 175 percent. This 

is no surprise to you. You know what has happened; there is a 

small growth in small businesses. But that issue that I just showed 

there, that is going to get bigger as time goes on. 

So the basic rule here, we want to increase the audits, and we 

are increasing them everywhere, it is not just small businesses. 

But when we get the legislative proposals this is what you—this 

breaks out the compliance relatively speaking. 

Wages, we have 150 million Americans, we are not talking about 

them here, but there are 150 million American employees. They are 

used to reporting and withholding, by the way. We are not proposing withholding. We are proposing backup withholding. But the 

average America, 150 million of us including everybody on this 

panel, is used to reporting on your wages. There is no cheating on 

wages, a one percent noncompliance rate. Where you have no reporting. no reporting like the income for the Schedule C filer, the 

noncompliance rate is over 50 percent. That is the problem. That 

is the problem. 

Ms. KELLY. That is possibly, sir, because of confusion. 

Mr. EVERSON. I would agree on things like depreciation of car expenses, but not on gross receipts. Not that complicated when somebody pays you, when somebody pays you in cash or with a credit 

card, it is not that complicated. 

Ms. KELLY. Mr. Everson, what is your basis for all of this? Have 

you hypothesized a number? 

Mr. EVERSON. No. Forty-six thousand audits were done as a part 

of the national research program that has been reviewed by GAO 

and others. What the Chairman was talking about earlier was, 

with which I agree, he stated accurately what happened. We did 

not do the research on the C-Corps and the reason we didn’t do the 

11

research on the C-Corps was because, as I said, we are already auditing those big firms by over 40 percent a year. So that this was 

a very intensive effort, cost of tens of millions of dollars to do this 

research. Looked at by GAO and others, a lot of academics participated in it. 

Ms. KELLY. Let me just say that I notice here the reason I am 

saying, all these yellow boxes have a little code down here saying 

‘‘dependent on older estimates.’’ 

Mr. EVERSON. Yes. Yes. 

Ms. KELLY. So I wonder about the metrics you are using on these 

charts. 

Mr. EVERSON. What I would say to you is all of what we have 

been talking about is over here. I concede freely to you that these 

are the big corporations right here. Even if this number is doubled 

because it is off by a factor of 100, what I am suggesting to you 

is we already have plans in place to attack that. So that where we 

spend our research effort, our initial— 

Chairman MANZULLO. With withholding plans in place, your 

remedies are aimed solely at small businesses. You want to have 

backup withholding on credit card companies and on independent 

contractors solely as small businessman, completely excluding the 

C corporations. 

I am sorry. Ms. Velazquez? 

Mr. EVERSON. I’m sorry, Congresswoman. I am happy to come 

see you and continue to talk about this. 

Ms. VELAZQUEZ. Mr. Emerson, thank you for your testimony. 

Everson, I am sorry. 

Mr. EVERSON. Actually, I hate to correct the Chairman, but it is 

Everson. So if you will give me that opportunity. 

Ms. VELAZQUEZ. Everson. Okay. 

How much did you say that you spent on this study? 

Commissioner EVERSON. I think that study cost us something 

like $100 million. I could be wrong. Is that? This is the head of our 

research program, Mark Mazur. He says that is about right. 

Ms. VELAZQUEZ. Okay. So you spent all that money to figure out 

the tax gap? 

Mr. EVERSON. Yes. 

Ms. VELAZQUEZ. And did you figure out why people were under 

reporting? Do you have that data, complete data? 

Mr. EVERSON. We do not have that. The problem— 

Ms. VELAZQUEZ. So is it because they are cheaters or the tax code 

complexity? What is it? Because let me tell you, if you go to any 

university and you are going to do a research on a problem and 

then you make a conclusion without really trying to figure out why 

these people are not paying or are under reporting so that you can 

then develop a public policy to tackle the real issue, so why do you 

think that enforcement is the answer? 

Mr. EVERSON. Well, I think that there are a number of studies 

that have certainly substantiated the impact of the enforcement in 

terms of both the direct impact if you look at what we have 

brought in, we have increased the direct monies that have come 

back to us in the last three or four years, plus the indirect impact 

that if I am audited and I mention it to my neighbor, they will perhaps file differently. So that is clearly there. 

12

The debate that you are talking about is, which I agree, is on trying to quantify the service impact which we have been looking at. 

It is very difficult to do that. The statisticians who have looked at 

that have had a great deal of difficulty trying to find that. 

Now when we did the research, to answer your question, our people tried to determine but were not successful because if we go to 

you, if we find a problem in your return, if we ask you did you intentionally cheat, what are you going to say? You are going to say 

no. I mean, that is the normal response. Nobody is going to admit, 

or very few anyway, that they were intentionally violating the law. 

So it is very hard to determine with the precision that you or I 

might want when you do the audit the exact reason. 

Ms. VELAZQUEZ. But your response and your answer is based on 

a prejudged finding that they are under reporting because they do 

not want to pay. In no way you are doing any effort to find out 

whether or not the tax code complexity is the one preventing these 

people from paying? 

Mr. EVERSON. No. I would not agree entirely with that. I have 

stated— 

Ms. VELAZQUEZ. But let me ask you so enforcement is the sole 

answer? 

Mr. EVERSON. No, not at all. I think— 

Ms. VELAZQUEZ. So let me ask you another question. 

Mr. EVERSON. Yes. 

Ms. VELAZQUEZ. I just want to hear yes or no. 

Mr. EVERSON. Yes. 

Ms. VELAZQUEZ. So enforcement coupled with what? 

Mr. EVERSON. With service. As I said at the beginning, we believe in service and enforcement. 

Ms. VELAZQUEZ. Okay. 

Mr. EVERSON. You need to do both. And if I can say again what 

I said in the oral statement, I believe simplification is essential to 

get after this, particularly for small businesses and people— 

Ms. VELAZQUEZ. In terms of reducing the taxpayer assistance 

programs and the reduce of staffing at your office that have been 

the trend in the last three to five years? 

Mr. EVERSON. You made reference to this in your opening statement. Last year the Administration had a proposal to shutter 68 

walk-in centers. We have not done that. The ’07 request that is 

pending before the Congress right now maintains services at a 

steady state. We are not contemplating any reductions in the services in the request, ma’am, that is before the Congress right now. 

So I think we got the lesson from last year’s difficult discussions. 

Ms. VELAZQUEZ. Okay. 

Mr. EVERSON. So we are not proposing that again. 

Ms. VELAZQUEZ. Okay. So we will hear a lot about what the IRS 

is doing towards enforcement. But I want to look at Congress’ 

record on the issue. According to a report published by the Democratic staff of the House Ways and Means Committee there were 

900 changes to the tax code in the 108th Congress. The FSC/ETI 

legislation passed— 

Mr. EVERSON. Yes. 

Ms. VELAZQUEZ. —in 2004 provided for 561 changes and added 

250 pages of tax law changes. This does not even include the 2001 

13

and 2002 tax cut that added complexity and thousands of burden 

of hours on small businesses. How would you assess Congress’ 

record on helping reduce the tax guide? 

Mr. EVERSON. Well I take my own self interest seriously and I 

am not going to take a particular shot at Congress, other than to 

say that that record that you are talking about adding complexity, 

it gets us nowhere. What I have said repeatedly is— 

Ms. VELAZQUEZ. Give me a grade, A, B, C? 

Mr. EVERSON. I’ve got to say that over time Congress fails in the 

effort to get a simple understandable tax code. 

Ms. VELAZQUEZ. So that is an F? You know, I used to be a college 

professor and I love— 

Mr. EVERSON. I think we can agree on that. 

Ms. VELAZQUEZ. Mr. Sullivan and then Mr. Everson— 

Mr. EVERSON. Thank you. 

Ms. VELAZQUEZ. —would you agree that the tax codes has in 

2001 have increased complexity? 

Mr. EVERSON. I would agree that the tax code since 1986 over 

a period of years of control of Congress by both parties has grown 

in complexity. This is an inevitable process. And what happens is 

you have got these cycles where people eventually get feed up with 

all the complexity and there is a real call for reform. I am an advocate of that reform. 

Ms. VELAZQUEZ. But five years ago we heard a lot about, you 

know, this is going to be the Congress and this is going to be the 

Administration’s— 

Mr. EVERSON. I am not wading into— 

Ms. VELAZQUEZ. Of course. 

Mr. EVERSON. Let me make one thing clear. I am not wading into 

a partisan debate on this. I am giving you the simple fact that over 

decades this code has continued to grow; that’s all. 

Ms. VELAZQUEZ. Mr. Sullivan, Advocacy has done numerous reports on the issue of taxes and small businesses. For example, I 

know that the Office of Advocacy studied the impact of marginal 

rates on small businesses. That was quite a timely report considering Congress was voting on marginal rates in 2003. 

Given the huge impact of this $2 trillion in tax cuts, why have 

you not done any work to study whether these changes have increased complexity for small businesses. 

Mr. SULLIVAN. Congresswoman, actually we have done some 

studies on the overall complexity. We have not narrowed in on 

whether specific year tax cuts contribute. 

Ms. VELAZQUEZ. Okay. 

Mr. SULLIVAN. But I would point the Congresswoman and this 

Committee to a working paper by an economist in my office, Dr. 

Saade Radwan that documents what Commissioner Everson was 

saying, that however well intentioned each different change may 

be, and this echoes your concerns, Congresswoman Velazquez, the 

overall complexity actually is harmful to small business. 

Ms. VELAZQUEZ. So are you telling me that are you going to commission a study on this? This is huge for small business. 

Mr. SULLIVAN. Well as the Congresswoman pointed out, sometimes our timing of studies does not exactly comport with congresVerDate 0ct 09 2002 13:54 Oct 31, 2006 Jkt 000000 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 G:\HEARINGS\28570.TXT MIKE
14

sional action. Actually, this is not on purpose, but our studies take 

anywhere from one year to two years. 

Ms. VELAZQUEZ. I know. It was coincidental 2003. But can I get 

a— 

Mr. SULLIVAN. But we tried to get that study done as quickly as 

we could, and we hope that it benefits the debate. 

What we will try to do is continue to focus in on what parts of 

the tax code or the over all complexity of the tax code benefit small 

business. And as far as focusing in on specific year tax changes, I 

would direct the Committee’s attention to a March report by the 

Department of Treasury that is peer reviewed that documents a 

number of different pros and cons of recent tax changes. 

Ms. VELAZQUEZ. Thank you, Mr. Sullivan. 

Mr. Everson, does Small Business Self-Employment Division of 

the IRS has served a critical role by meeting with members of the 

small business community to identify concerns. It has also been 

helpful to small business and tax practitioners who need a system 

making determinations about tax code questions. 

I am concerned that there have been efforts by the IRS to shift 

resources in this division from compliance towards more enforcement. Can you talk about the staffing level at your department? 

Mr. EVERSON. Sure. And I’ll let Kevin talk about it afterwards 

in more detail. But what we did in the last year was we had people 

who were on the enforcement side within this division, SB/SE, and 

we were doing part time work on outreach. And what we did was 

we consolidated this to make this a year around full time responsibility. Because what was happening was when you get into this 

busy season that we are in now, they were being taken off of that 

outreach. We did not think that was particularly effective. So we 

have made some changes in the last year or two to try and have 

a more dedicated full time work force on this. 

Ms. VELAZQUEZ. So, Mr. Everson, we constantly hear how small 

businesses are paying less taxes under this Administration and 

they saw enormous benefit from the tax cuts. If that is the case 

and rates are lower, it seems there will be less incentive to intentionally taxes by under reporting income. However, the IRS is 

cracking down on small businesses. Do this not seem kind of backward? Do you disagree with the theory that lower tax rates should 

lower tax avoidance? 

Mr. EVERSON. I think that the debate, I do not want to wade into 

the policy debate because my job is to administer the code, good or 

bad, as written. Obviously policy decision are taken to provide incentives for economic activity. There are compliance issues, though. 

Complexity is one, also stability is another. We have not talked 

about stability. 

The constant changing of the rules is an issue on top of just how 

complex they are. 

If you look at our research, which is for 2001, you are right that 

each year the revenue stream of the government changes. It 

changes for rates, it changes for increases in corporate receipts 

versus individual receipts. So there is a mix effect that takes place 

over time. But what we would suggest is we’re concerned about 

going after the gap in all the areas, but we do prioritize. 

15

If we go back to the bar chart, one of the things that’s very clear 

from the research is is that, again, where there’s no reporting like 

there is for employees, that the gap is largest. So we want to get 

after that through not just some more audits, but also through 

some additional reporting. 

Ms. VELAZQUEZ. I would have more questions later, Mr. Chairman. 

Chairman MANZULLO. Thank you. 

Could you put up that chart, selected IRS coverage rates FY 

2005? Sometimes these charts remind me of that guy on Johnny 

Carson giving the directions to the used car lot. Do you remember 

that with the freeways, wore the big hat and everything? 

Mr. EVERSON. This? 

Chairman MANZULLO. How many corporations are there with assets above 250 million? Do you know the figure for that? 

Mr. EVERSON. I don’t have the figure. I can certainly get it for 

you. But the number of the largest corporate audits that we did 

last year were—I guess this would be all of our companies over 10 

million in assets. See, Kevin’s group has companies with assets up 

to 10 million; it has got the C-Corps and the individuals filing the 

Schedule C. Our large and mid-sized business unit is anything over 

10 million assets. We did about 13,000 audits last year. 

Chairman MANZULLO. Well, how many companies are there? 

Does anybody know? The gentleman just handed you a— 

Mr. EVERSON. Yes. This is the number of audits. It doesn’t say 

with—the number of returns. Okay. I am told it is about 11,000. 

Chairman MANZULLO. For corporations with assets over 250 million? 

Mr. EVERSON. Yes. Yes. That is correct. I guess we got 11,000 returns filed in calendar 2004, 11,000 had assets over 250 million. 

Chairman MANZULLO. Not the estate, but the next one, corporations between 10 and 250 million? 

Mr. EVERSON. That would be— 

Chairman MANZULLO. You guys can help your boss out. Don’t let 

him guess here. 

Mr. EVERSON. Oh, he’s got it right here. 

Chairman MANZULLO. Okay. 

Mr. EVERSON. It’s all right here. He is just making me add up 

the numbers. 

Chairman MANZULLO. All right. 

Mr. EVERSON. It is about 43,000. 

Chairman MANZULLO. But where are the number of corporations 

that are under 10 million? 

Mr. EVERSON. That is a different category. I think that that 

audit rate is less than 1 percent. For C-Corps assets of 10 million, 

it is about seven-tenths of one percent, Mr. Chairman, that audit 

rate. 

Chairman MANZULLO. Do you know how many there are? 

Mr. EVERSON. Oh, a couple million, I guess. 

Chairman MANZULLO. Well— 

Mr. EVERSON. Let’s see. Yes. Now let me show you one additional— 

Chairman MANZULLO. Let me back up. There are 2 million firms 

that have 10 million— 

16

Mr. EVERSON. Two million C-Corps. 

Chairman MANZULLO. Two million C-Corps that have under 10 

million in assets? 

Mr. EVERSON. C-Corps. Let me show you what is happening with 

the C-Corps, Mr. Chairman, and why this is not as big an area of 

emphasis. 

Chairman MANZULLO. And the audit rate on that group is about 

.3 percent. 

Mr. EVERSON. Point seven. 

Chairman MANZULLO. Point seven. All right. Go ahead. 

Mr. EVERSON. Mr. Chairman, this lays this out. Because you 

have talked to me before about S-Corps what has happened over 

the years, again, starting at the same point. 

1978 we had about 2 million C-Corps and a half a million of the 

S-Corps. Look at what has happened here, and this line is crossed 

now. Far more businesses are operating as S-Corps. The C-Corp 

number— 

Chairman MANZULLO. Now let me stop you. What is the audit 

rate for S-Corps? 

Mr. EVERSON. The audit rate for S-Corps, go back to that chart, 

.3 percent; it is next to nothing. 

Chairman MANZULLO. All right. 

Mr. EVERSON. That is why— 

Chairman MANZULLO. Then how many S-Corps are there? 

Mr. EVERSON. Well, it is right here. 

Chairman MANZULLO. Okay. Wait a minute. So it is about three 

and a half million? Okay. All right. 

Mr. EVERSON. So what we are doing, this is an area where we 

were doing nothing. Nothing at all. I am not saying we missed this, 

but take a look at this. S-Corps, .3 percent. So one of these we have 

corresponded is about is your concern that the next stage of the research we are putting here. Now we may conclude that there are 

not problems with the S-Corps, but with an audit rate like that we 

just do not know. 

Chairman MANZULLO. Well, that is the whole point. 

Mr. EVERSON. That is why we are doing the research. 

Chairman MANZULLO. No. You see, you just do not know and yet 

you go full ahead pell-mell after the mom and pops? 

Mr. EVERSON. Well the S-Corps we’re doing the research program 

with 5,000 returns— 

Chairman MANZULLO. I mean you spent $100 million. How much 

more money and more time do you need to do this? And why do 

you advocate such draconian withholding measures when your research is not done? 

Mr. EVERSON. Let me make sure that I clarify the—I would not 

agree with the characterization of draconian. We are proposing— 

Chairman MANZULLO. Well, how about plutonian then? 

Mr. EVERSON. We are proposing reporting and backup of withholding. If you look at backup withholding which is in place for all 

Americans now for let’s say dividends and interest. Let year we got 

something like 330 million reports on dividends and interest. Only 

a little over one in a thousand didn’t come in with the proper taxpayer identification number. That is what would trigger potentially 

17

the backup withholding. So it is a very de minimis number of people. 

Chairman MANZULLO. Let me finish with this before we get into 

that, because I want you to explain the withholding on it. Well, 

how many individual businesses are there that fild Schedule C? 

Mr. EVERSON. It is now up to about 16 percent of all the returns. 

So what would that be? About 18, 20 million? Twenty million let 

us say. 

Chairman MANZULLO. So you got 20 million people. So there 

would be substantially a lot more people would be audited— 

Mr. EVERSON. Well, as I indicated, our priority has been to— 

Chairman MANZULLO. No. Let me finish. Let me finish. A lot 

more people would be audited. You have a better chance of being 

audited if you are a small business person in terms of the personnel that the IRS is dispatching for that? 

Mr. EVERSON. Well, those are the rates right there. And we have 

a high rate. A lot of controversy. I get a lot of comments from 

Madam Velazquez side of the aisle on EITC audit rates, because 

look at that. That is 2.4 percent and some people think that is too 

high. That program has a lot of concern because of the high error 

rate stemming sometimes from fraud, but largely from the complexity of all the definitions. There are a lot of issues in there. 

We try to run a balanced program, but what we have worked on 

in the last several years has been particularly in the high income 

area, take a look at that five percent audit rate and also on the 

corporate areas where we brought that back up and progressively 

worked on the shelters. 

So I would not agree with the characterization that we have focused particularly on small business. I would not agree with that 

at all. 

Chairman MANZULLO. Well, you said that yourself. 

Mr. EVERSON. No. I said we are, we need to do more and we need 

keep forward. 

Chairman MANZULLO. You are focusing on small business. What 

you do not understand here, do you know who comprise a lot of C 

corporations that have under 10 million in assets? These are lawyers, accountants; these are all service organizations. 

Mr. EVERSON. Yes. 

Chairman MANZULLO. Service companies. Manufacturing companies and other retailers would have more than 10 million. And 

there is a whole group of people in there that are under 10 million 

that you are not even touching as long as they are a C Corporation. 

Mr. EVERSON. Well, the thing is, Mr. Chairman, again we measure our effectiveness in part by what I mentioned before, this no 

change rate. For the small C-Corps the no change rate, that is 

where we go in and it is Congresswoman’s Kelly’s issue of we do 

not find anything. When we have done the C audits on the smallest 

businesses, that no change rate is something around 40 percent in 

contrast for individuals that rate is 15 or 16 percent. So— 

Chairman MANZULLO. Well wait a second. Your audit rate on two 

million companies with under 10 million in assets is .7 percent? 

Mr. EVERSON. Yes. 

Chairman MANZULLO. That is a pretty small number? 

Mr. EVERSON. Yes. 

18

Chairman MANZULLO. But you have already made the assumption based on your study that GAO does not like that you are not 

going to go after these people. 

Mr. EVERSON. I did not say we are not going to go after these 

people. But what we do is we use the studies to risk adjust and 

also we use our own results. And as I just indicated, when we look 

at the C-Corps, the very smallest of them, a no change rate means 

we do not find anything 40 percent of time. There is in our field 

experience, if you will, we see relatively more compliance in that 

entity. 

Chairman MANZULLO. But the only remedies you are proposing 

are against non-C entities, mom and pops, withholding, is that correct? 

Mr. EVERSON. I think that we are working across three fronts, 

if you will, to do more across the board. And what we are doing 

first is we are increasing our enforcement activities. We are improving our procedures, which includes a whole series of productivity and other improvements and using research where we have 

it. And then we are making, as you suggested, some legislative proposals. 

Chairman MANZULLO. Right. Now the legislative proposals, and 

by the way I found it very interesting that you want to level the 

playing field. I have never known the IRS that wants to level the 

playing field between two businesses. I am sure that businesses 

would rather have less regulations and the IRS trying to make 

things easier for one and not for the other. I just find that astonishing. 

But in terms of the withholding, let me walk you through a scenario. 

Mr. EVERSON. Yes. 

Chairman MANZULLO. Let us say that I am a restaurant owners, 

a non-C-Corporation, mom and pop, the way my brother was. And 

I report a million dollars in gross receipts for tax year 2006. And, 

hypothetically, through your research IRS estimates that restaurants receive 50 percent of their payments from customers 

using credit cards and 50 percent in cash. 

Then the credit card companies send the IRS information which 

you want from every credit card company for every business except 

C corporations. They send you information that my restaurant reports $400,000 in credit card charges. No. I’m sorry. Reports 

$800,000 in credit card charges. The return shows a million dollars 

gross, you have $800,000 in credit card charges. What would the 

IRS do? 

Mr. EVERSON. Well, I will not give you a specific answer because 

I am not an expert in that area. But what we do is we have formulas where we work based on history and research and we select 

our audits based on those formulas. 

Chairman MANZULLO. No, I— 

Mr. EVERSON. No, please, let me finish. 

Chairman MANZULLO. No, just a second. 

Mr. EVERSON. I’m trying to say— 

Chairman MANZULLO. I made it easy for you. 

Mr. EVERSON. I can’t tell you what we would do. It depends on 

resources we have. 

19

Chairman MANZULLO. Well, let us say you decide to audit. So you 

decide to audit. 

Mr. EVERSON. Right. It comes down to what Congresswoman 

Kelly was asking about before, having a knowledge of the business. 

The pattern of credit versus cash receipts might be different in a 

restaurant than it is in a dry cleaner or a small gardening services. 

Chairman MANZULLO. Let me go through it one more. 

Mr. EVERSON. Yes. 

Chairman MANZULLO. The return shows a million dollars gross 

receipt. 

Mr. EVERSON. Yes. 

Chairman MANZULLO. This is a restaurant. 

Mr. EVERSON. Yes. 

Chairman MANZULLO. Hypothetically, all right, the IRS says 50 

percent comes from credit cards and 50 percent comes from cash. 

And then the credit card companies send you notice that there was 

$800,000 charged in credit cards which should trigger in somebody’s mind that it should be 1.6 million reported as opposed 1 million reported. My question is if the IRS has that information, which 

is what you want, is that not correct? 

Mr. EVERSON. Yes, that is correct. That is what we want. 

Chairman MANZULLO. What would you do with it? 

Mr. EVERSON. If someone sticks out, if a business sticks and is 

different from others— 

Chairman MANZULLO. And this one would. 

Mr. EVERSON. Yes. If it would, it might trigger an audit. 

Chairman MANZULLO. All right. And then what would you do? I 

mean not talking about the audit. Would you ask the credit card 

company to withhold? 

Mr. EVERSON. No. 

Chairman MANZULLO. You would not? 

Mr. EVERSON. No. Because the backup withholding attaches if 

you as—let us say you are the credit card issuer. 

Chairman MANZULLO. Okay. 

Mr. EVERSON. If you forward it to us the wrong number, a number that matched up Everson and you reported that I had a taxpayer identification number, but when we went to match up it 

didn’t match up to what we showed for Everson, that is what would 

trigger backup withholding. 

Chairman MANZULLO. So in the hypothetical that I gave you that 

would not trigger any backup withholding? 

Mr. EVERSON. No, sir. Not at all. 

Chairman MANZULLO. Okay. So that is why the documents that 

you put out are— 

Mr. EVERSON. They are unclear. 

Chairman MANZULLO. They are unclear. 

Mr. EVERSON. Okay. 

Chairman MANZULLO. So it is only if there is something wrong 

with the taxpayer identification number? 

Mr. EVERSON. That is it. And that is the same way it works on 

dividends and interest right now, which people are used to doing. 

Chairman MANZULLO. Okay. Let me take you to another scenario. The restaurant owner, not everybody who has a credit card 

has a TIN number, is that correct? We used to call it an SS-4 when 

20

I practiced law. Has a taxpayer identification number or Social Security number? 

Mr. EVERSON. Well if you don’t have a Social Security number, 

you have got a bigger problem than that, because you got to file 

a tax return with us, you got to have a number that identifies you. 

So you got to have a number. 

Chairman MANZULLO. Okay. Do you need a Social Security number to get a Visa or MasterCard, anybody? Is it normally required? 

I think it is, would that be correct? 

Mr. EVERSON. I think it’s a pretty standard piece of information. 

Chairman MANZULLO. Am I correct in assuming that? 

Mr. EVERSON. Yes. 

Chairman MANZULLO. Now there are a lot of small businesses 

that do not get a taxpayer identification number but report their 

income on a Schedule C through their own Social Security numbers? 

Mr. EVERSON. Absolutely. That is correct. 

Chairman MANZULLO. You don’t have a problem with that?? 

Mr. EVERSON. No. No. We are not suggesting we change that. 

Chairman MANZULLO. Okay. Well then explain to me, Commissioner Everson, where there’s a faulty taxpayer identification number, give me the scenario in that restaurant thing if you could? 

Mr. EVERSON. Yes. They haven’t been square with you as the 

credit card issuer. They put down my Social Security number because they don’t want the IRS to get the right number. And this 

is no different than, again, dividends and interest. 

Chairman MANZULLO. So this is really actual fraud? 

Mr. EVERSON. Yes, or—well, look, what we do is we send out notices. We do not impose backup withholding. Let me be clear here. 

There can be confusion. A credit card issuer, somebody could have 

made a mistake just like Merrill Lynch might. We send out notices. 

Again, let me give you the numbers for last year total returns filed 

in 2003 for dividends and interest. We got almost 320 million reports. The number where the TINs did not mention up was 

334,000. That is a little over one in a thousand. That is what triggers notices and ultimately backup withholding. 

Chairman MANZULLO. But notwithstanding, you still would require every credit card issuer or clearinghouse give the IRS information on how much every single small business in the nation was 

generating in credit card receipts? 

Mr. EVERSON. That is the gist of the proposal, that is it, sir. 

And— 

Chairman MANZULLO. No, let me stop you right there. 

Mr. EVERSON. Yes. 

Chairman MANZULLO. Do you have any idea what that would 

cost in terms of regulation? 

Mr. EVERSON. We are working with the industry. We have the 

banking— 

Chairman MANZULLO. The answer is you do not know? 

Mr. EVERSON. We do not know a precise number at this stage. 

Chairman MANZULLO. But notwithstanding the fact that you do 

not know, you are still asking Congress this year for those legislative proposals? 

21

Mr. EVERSON. We have made a broad proposal. We are going to 

work with the Congress and we will try to minimize the burden, 

but you are correct? 

Chairman MANZULLO. All right. Now let me give you a scenario 

where I got involved and Ms. Velazquez also got involved. When 

the HOPE Scholarship for the $1500 tax credit for middle and 

lower income taxpayers was instituted, Secretary Rubin testified 

before the Senate and he was asked a question: How much would 

it cost the 7,000 universities, colleges and community colleges and 

trade schools across the nation to send out a form showing the 

source of the payment for the tuition? He said the cost would be 

the cost of the stamp. 

I got involved as Chairman of the Small Business Committee because actually, believe it or not, we have jurisdiction over colleges 

that have less than 500 employees. The annual cost was $100 million. And I worked with Chairman Rossotti for five years, changed 

the law and changed the regulations. And, of course the IRS, because the IRS considers itself exempt from the Regulatory Flexibility Act and continually refuses to do any research or reporting 

or compliance with that Act as to what it would cost the small 

business people, IRS was off by $100 million. Now I would say with 

these fine research fellows that you hire for $100 million a year, 

before the IRS even comes out with any notion of any change in 

reporting, I would suggest that you figure out exactly how much it 

is going to cost and you do that before you even come up with a 

proposal. And that is where this is deficient because Secretary 

Rubin was so wrong. In fact, I was fighting the software manufacturers and you were in the middle of that also. Remember that? 

And it is a good thing that Commissioner Rossotti was a systems 

person. I mean his background was in computers and analysis. And 

he recognized the problem right away. And we worked with 7,000 

schools across the nation. They could not believe that this burden 

had been imposed. 

Now Congress had imposed that burden. And that is what can 

happen when legislation is proposed and there is no research done 

on it. 

Ms. Velazquez? Okay. Well then I have just got one other question to conclude. 

And that would be I understand fully now the withholding on 

credit cards would only be triggered in the event that there is some 

fraud going on. 

Mr. EVERSON. Well there could be confusion, sir, and we send notices out. 

Chairman MANZULLO. But there’s confusion and it is corrected 

right away and there’s no withholding? 

Mr. EVERSON. That would be right. We send out notices. 

Chairman MANZULLO. Let us say that I have got the restaurant 

and Mr. Sullivan is a plumber. I do not like to use the words 

plumber around Congress. But let us say he is a plumber and he 

does work in my restaurant from time-to-time. And then you notice 

that Mr. Sullivan is not, maybe he has been late in filing the quarterly estimate from time-to-time and you think that perhaps he is 

not reporting all the income that comes in. Are you proposing any 

22

remedy that would have me as the payor withhold or report to you 

on the money that I owe him as the plumber? 

Mr. EVERSON. No, sir. We are not changing those. Our proposals 

do not run to increased reporting from business. I know you do not 

believe this, Mr. Chairman, but I tried to be sensitive to your concerns. And what we proposed is the more reporting by the credit 

card issuers, and here ten of those businesses do 84 percent of the 

$2.2 trillion in credit card issuances around the country or dollars 

that come in through credit cards, and also governmental entities 

do some more reporting, not a business doing it; what you are talking about. That is— 

Chairman MANZULLO. So under your proposals I, as the restaurant owner would not have to do anything more? 

Mr. EVERSON. No, sir. 

Chairman MANZULLO. Is that correct? And you would never ask 

me to withhold on any payments that I would owe to him? 

Mr. EVERSON. No, sir. 

Chairman MANZULLO. And I understand that there is a present 

law passed by Congress and for which you are not responsible, that 

says even in that scenario I am supposed to report any independent contractor payments in excess of $600 a year? 

Mr. EVERSON. That is correct. 

Chairman MANZULLO. That is the existing law? 

Mr. EVERSON. The existing law, I think you are correct in stating— 

Chairman MANZULLO. And that is not followed. That is not followed? 

Mr. EVERSON. I would not say that it is not followed. I think we 

could do better on that. 

Chairman MANZULLO. The more sophisticated the business, the 

more that is done? 

Mr. EVERSON. Well, yes, that would probably be right. I mean, 

it gets to some of the issues we were talking about before as to 

what gets reported. People may if they get the 1099s, they may be 

reporting the 1099s they get as income, but not the ones they do 

not get. 

Chairman MANZULLO. So let me make sure this is very clear. 

Mr. EVERSON. Yes. 

Chairman MANZULLO. This helps both you and me. The only additional reporting that, yes I guess I will use the word ‘‘only’’, that 

you are requesting would be to have the credit card companies 

issue to the IRS at the end of the year all the transactions— 

Mr. EVERSON. No, gross receipts. Just one number. 

Chairman MANZULLO. I’m sorry. Gross receipts for unincorporated businesses. 

Mr. EVERSON. For all the businesses, yes. That is right. 

Chairman MANZULLO. For incorporated businesses also or just 

unincorporated businesses? It’s just unincorporated. 

Mr. EVERSON. I think it’s just unincorporated. Yes. 

Chairman MANZULLO. It is just the little guys? 

Mr. EVERSON. Well— 

Chairman MANZULLO. Yes. 

Mr. EVERSON. —we have not been that specific, sir. 

Chairman MANZULLO. Well— 

23

Mr. EVERSON. We said it by general language so you have got an 

opportunity to weigh in. Do you want to put the companies in 

there, too. 

Chairman MANZULLO. No, I understand. But it is targeted at 

small businesses? That is your target— 

Mr. EVERSON. It is targeted where I showed. 

Chairman MANZULLO. I have got your paper here. 

Mr. EVERSON. Yes. It showed—I think we have been pretty clear 

as to where we think we can get the money. 

Chairman MANZULLO. No, I want to clear this up before I let you 

go here. 

Mr. EVERSON. Okay. All right. 

Chairman MANZULLO. It is targeted at sole proprietorships, the 

25 million people out there and the partnerships that are not corporations. 

Mr. EVERSON. I think that is fair enough. Fair enough. That is 

where the biggest under reporting is. 

Chairman MANZULLO. Do you think that corporations under report? 

Mr. EVERSON. It goes back down that other road. 

Chairman MANZULLO. No, I mean— 

Mr. EVERSON. Yes. 

Chairman MANZULLO. Because if you are doing that much auditing— 

Mr. EVERSON. We are doing the auditing, yes. We set up— 

Chairman MANZULLO. And you find out that they do not pay 

the— 

Mr. EVERSON. We set up billions of dollars in additional assets 

from them. 

Chairman MANZULLO. But you only want to impose the additional reporting on small unincorporated businesses and not on the 

incorporated business, is that correct? 

Mr. EVERSON. Well, we have not been that specific. If you want 

to add the big C-Corps, you know, Blockbuster Video to it, I do not 

know. 

Chairman MANZULLO. No, it is here. 

Mr. EVERSON. We can certainly put that in there. It is a general 

proposal. We did not submit language. We have said we want to 

work with the Congress on the contours of the proposal. 

Chairman MANZULLO. Well— 

Mr. EVERSON. We have got the American Bankers Association 

coming in this week to talk to people about this. So we clearly want 

to talk about this. 

Chairman MANZULLO. It says payment cards are a growing form 

of payment for retail business transactions. And it goes on here. I 

mean, it is obvious that the additional reporting that you want to 

have the credit card companies do is only for the little guys because 

you consider them to be the biggest cheaters. 

Mr. EVERSON. ‘‘Biggest cheaters,’’ I have not use that word. 

Chairman MANZULLO. But it is true. It is true. 

Mr. EVERSON. I have showed you where the biggest piece of the 

tax gap is. 

Chairman MANZULLO. No, I understand. People cheat, people 

cheat. 

24

Mr. EVERSON. What we are trying to do here again is level the 

playing field so that: (1) The Government gets what it is due. And 

also so that the small businesses playing by the rules does not get 

disadvantaged. 

Chairman MANZULLO. Let me read your writing here, your proposal. ‘‘It is expected that as under current information reporting 

regulations certain categories of merchant payees such as corporations will be excluded from the reporting and backup withholding 

requirements.’’ These are your own words. 

Mr. EVERSON. If you have a problem with that, we will work with 

you on that. 

Chairman MANZULLO. You think I am sitting here because I 

enjoy reading this? 

Mr. EVERSON. Okay. 

Chairman MANZULLO. I mean the reason for this hearing is the 

fact that in your own words the only people that you think of significance who are not paying their income taxes are these little 

guys. 

Mr. EVERSON. I do not think that. I am not suggesting that, sir. 

But we do not see—I do not think the revenue line is where we see 

problems with C-Corps. 

Chairman MANZULLO. Well, you know, I think— 

Mr. EVERSON. That is what we are talking about here, is the revenue line. 

Chairman MANZULLO. What is the revenue line? 

Mr. EVERSON. Gross receipts. They have more sophisticated accounting systems and I believe you would find that— 

Chairman MANZULLO. You mean like Enron and those clowns? 

Mr. EVERSON. I do not think that— 

Chairman MANZULLO. How much did those clowns take from the 

American people? How many corporations out there are the 

Enrons, the small Enrons? 

Mr. EVERSON. Look— 

Chairman MANZULLO. Ms. Velazquez, do you have any idea? 

Would you not like to know? 

Ms. VELAZQUEZ. But let me just say that you sound like a Democrat today. 

Chairman MANZULLO. Oh, no, no. We are in there with the little 

people. 

Mr. EVERSON. Mr. Chairman, if you talk to your colleagues at 

Ways and Means and, Ms. Velazquez, nobody would tell you that 

we have done anything except work on high income and corporate 

people. You can look at the KPMG matters, the aggressive shelter 

work we have done with Son of Boss increasing all this. 

Chairman MANZULLO. Well, no, I— 

Mr. EVERSON. We are not going after just the little guy. 

Chairman MANZULLO. No. I am just saying that in your own 

words you have already said you are going after the little guys. 

Mr. EVERSON. No. On revenues the bigger problem is clearly 

where we have indicated. 

Chairman MANZULLO. All right. You know this page 117, this is 

your document. 

Mr. EVERSON. Okay. 

Chairman MANZULLO. And I just read from your document. 

25

Mr. EVERSON. Fair enough. 

Chairman MANZULLO. Mr. Sullivan, am I correct that this is targeted at little people? 

Mr. SULLIVAN. I think the Chairman and Commissioner Everson 

are actually expressing the same concern, although a little bit differently. The small businesses that come to my office have said 

that there is reporting in the proposal and they are terrified that 

the next step after reporting is withholding. That is what they are 

terrified about. And I think you will hear more about that from the 

next panel. 

Chairman MANZULLO. Okay. 

Mr. SULLIVAN. Because that is certainly something that the Taxpayer Advocate has talked about. And I think Commissioner 

Everson has said he is sensitive to those concerns, which I think— 

Chairman MANZULLO. Okay. 

Mr. SULLIVAN. But they are fearful of what comes after reporting. 

Mr. EVERSON. I understand that concern and I am making no 

proposal and do not support the withholding. As you know, I have 

said to you privately to you in the past. 

Chairman MANZULLO. Yes. Because my question is, and I will let 

you go on this finally— 

Mr. EVERSON. Okay. 

Chairman MANZULLO. Treasury has different compliance suggestions than the Taxpayer Advocate, is that correct? 

Mr. EVERSON. Yes. The Taxpayer Advocate is set up to look at 

issues of problems of dealing with the service and gives us internally as a part of the IRS to try and help us improve our administrative procedures. 

Chairman MANZULLO. Right. 

Mr. EVERSON. But she also makes an annual report to Congress 

highlighting 20 areas where her office has concluded that there are 

particular problems navigating the code or enforcement procedures. 

Chairman MANZULLO. But her suggestions for enforcement compliance are separate from yours? 

Mr. EVERSON. Absolutely. They are not Administration proposals. 

Chairman MANZULLO. All right. And hers are even more pervasive, and we will have fun with her shortly. 

Mr. EVERSON. Let her characterize her own thoughts. 

Chairman MANZULLO. All right. 

Mr. EVERSON. I never try to speak for Nina. I have learned that 

in my three years on the job. 

Chairman MANZULLO. I want to thank both of you for coming. I 

know we have taken a lot of time, but I wanted to get explicitly 

clear what the Treasury has proposed in terms of withholding. And 

I know we have taken a lot of time to do that, but it has been 

worthwhile to do that. 

Again, Commissioner Everson, every time we have called you 

have come to the office, you have been available. You have been 

very transparent with us. And I really appreciate the efforts that 

you are doing at the IRS. 

And, Mr. Sullivan also, we did not ask you a lot of questions but 

we did not have to. I appreciate the work that you do on behalf of 

the small businesses. 

26

And the first panel is excused. 

Mr. EVERSON. If I can say one last thing, Mr. Chairman. 

Chairman MANZULLO. Yes. 

Mr. EVERSON. I am happy to be here. I appreciate the vigor with 

which you and your Committee members represent your interest. 

And I think this is the way that tax policy ought to be reached. Because it should not be done in the dark of night in some appropriations rider where people are doing things that have impact. This 

is a full debate. We want to work with the Congress on these 

issues. 

Chairman MANZULLO. Thank you, Commissioner. I appreciate it 

very much. 

Let us get the second panel ready. 

[Recess.] 

Chairman MANZULLO. I’m surprised you guys stuck around after 

the first panel. We are going to go from left to right. If you could 

keep it to five minutes, I would appreciate it. Obviously your full 

statements will be a part of the record. 

Our first witness on the second panel is Kevin Brown, who also 

has been a frequent visitor to the office. And he is the Commissioner of the Small Business/Self-Employed Division at the IRS. We 

look forward to your testimony. Thank you very much. 

STATEMENT OF KEVIN BROWN, SMALL BUSINESS/SELFEMPLOYED DIVISION, INTERNAL REVENUE SERVICE 

Mr. BROWN. Good morning, Chairman Manzullo, and Ranking 

Member Velazquez, and distinguished members of the Committee. 

I appreciate the opportunity to talk with you today about the work 

of the Small Business/Self-Employed Division of the Internal Revenue Service. 

The SB/SE organization is made up of 28,000 employees who 

serve about 45 million taxpayers, roughly one-third of the taxpaying population. Our taxpayer base consists of seven million 

small businesses, including corporations and partnerships with assets of $10 million or less; 33 million self-employed and supplemental income earners; and five million other taxpayers who file 

employment, excise, estate, gift, fiduciary and international tax returns. 

As I begin, I want to echo a couple of the themes you have just 

heard from Commissioner Everson. First, whether we are providing 

service through education, outreach or burden reduction, or we are 

seeking out noncompliance through our enforcement efforts, our intent is to help all taxpayers, including small businesses, comply 

with the tax laws and to ensure that these laws are applied fairly 

to all. Secondly, it takes a balance between service and enforcement to achieve compliance, and SB/SE strives daily to maintain 

this balance for its taxpayer community. 

Today I am going to focus primarily on the service side of the 

equation by highlighting some of our recent efforts. 

We know that the vast majority of small business taxpayers rely 

on their practitioners to handle their tax returns. Given this situation, it is vitally important that we reach out to the practitioner 

community so that they can, in turn, support their small business 

clients. We have built a robust outreach and education program to 

27

do just that, to touch thousands of stakeholders and through them 

reach millions of small business taxpayers. The result is more than 

15,000 relationships with national and local partners including 

practitioner organizations, small business and industry associations 

and federal and state agencies and governments. One of the more 

well-known services we provide is the Small Business Forums 

which we co-host with the United States Chamber of Commerce, 

the National Federation of Independent Business and the Small 

Business Legislative Council. Through these forums small business 

organizations receive the latest small business information from 

the IRS and in turn are able to share their members’ concerns and 

issues with us. 

Due to the success of the national forums, we are launching local 

small business forums at the state level this spring. 

SB/SE also devotes resources to identifying major sources of taxpayer burden and to developing and implementing ways to reduce 

this burden. Since 2002 our Office of Taxpayer Burden Reduction 

has been instrumental in reducing taxpayer burden by over 200 

million hours. Here are some highlights. 

In January 2006, we implemented the Annual Forum 944 for em- ployers who have a total annual employment tax liability of $1000 

or less. Most of the estimated 950,000 eligible Form 944 filers also 

will be able to pay annually with their form 944. 

This year we implemented a new automatic six-month extension 

period reducing burden by 11 million hours. 

Simplification of the office in the home deduction for the small 

business taxpayer is high in our priority list for tax year 2006. We 

are looking into several ways to address the burden caused by 

Form 8829, which is completed annually by about 2.4 million 

Schedule C filers as well as Schedule A filers. 

I also want to mention our SB/SE Disaster Coordination Office. 

In the aftermath of the recent hurricanes this office played a key 

role in the IRS’ success in providing on the ground assistance to 

individuals and businesses in dealing with the myriad of related 

tax issues. 

Most recently the IRS has been partnering with the Department 

of Housing and Urban Development and Mayor Ray Nagin of New 

Orleans to help make businesses in the hardest hit areas of New 

Orleans and Louisiana aware of Federal incentive relief that is 

available to them. 

In summary, Mr. Chairman, I believe that the SB/SE Division of 

the IRS is providing much-needed support to the small businesses 

of America. We have demonstrated our commitment to service 

through the outreach and education we are providing, the partnerships we have developed and our numerous efforts to reduce taxpayer burden. At the same time, by using our enforcement resources to detect noncompliance, we are helping compliant businesses by eliminating the unfair advantage created when their 

competitors fail to comply with the tax laws. 

Thank you, Mr. Chairman. I will be happy to answer any questions you and the other Members of the Committee may have. 

[Commissioner Brown’s testimony may be found in the appendix.] 

Chairman MANZULLO. Thank you. 

28

Our next witness is Nina Olson. She is the National Taxpayer 

Advocate serving as advocate for taxpayers to the IRS and the Congress. We look forward to your testimony. 

STATEMENT OF NINA OLSON, TAXPAYER ADVOCATE SERVICE 

Ms. OLSON. Thank you. I believe you. 

Mr. Chairman, Congresswoman Velazquez and Members of the 

Committee, as you know, my organization, the Taxpayer Advocate 

Service devotes a substantial portion of its efforts to assisting small 

businesses and self-employed individuals who experience problems 

with the IRS. Through February of this fiscal year, small business 

cases accounted for about 44 percent of Taxpayer Advocate Service 

case closures, around 90,000 cases a year. And we have been able 

to provide relief to small business taxpayers in nearly 75 percent 

of those cases. 

In addition to our case work, the Taxpayer Advocate Service is 

actively involved in identifying areas of the tax system that impose 

burdens on small business taxpayers. When we identify systemic 

problems we make administrative and legislative recommendations 

to help mitigate these burdens. I discussed several of the recommendations I have made in my written testimony, including recommendations from my 2004 annual report to reduce burdens on 

small businesses. I am please that Chairman Manzullo included 

many of these proposals in the Small Employer Tax Relief Act of 

2005 that he introduced last fall. 

In my annual reports to Congress I have also made administrative and legislative recommendations to reduce the tax gap. The 

IRS estimates that the net tax gap runs at about 290 billion a year. 

The IRS expects to receive about 135 million individual income tax 

returns this year. Therefore, the average individual tax filer is effectively paying a surtax of more than $2100 a year to subsidize 

noncompliance. As the statutory voice for all taxpayers, I find that 

to be an unacceptable state of affairs. It is unfair to the millions 

of taxpayers who pay their taxes in full and it erodes public tax 

confidence in our tax system. After all, if my neighbor is not paying 

his taxes, why should I. 

When you drill down a level the IRS data show that the cash 

economy is the largest single contributor to the tax gap. And while 

99 percent of wage income earned by employees shows up on tax 

returns, the IRS estimates that only about 43 percent of self-employment income reportable on a Schedule C shows up. 

The low rate at which taxpayers report cash economy income creates two sets of problems. First, it places honest businesses at a 

competitive disadvantage. If one taxpayer is paying his taxes but 

a competitor is not, the honest business person will lose out on 

sales because the noncompliant competitor can use its tax savings 

to undercut the price of goods and services. Second, taxpayers operating in the cash economy have greater opportunities to be noncompliant because they know the payments they receive are not 

being reported to the IRS and therefore will be difficult for the IRS 

to detect. 

And as I know from 27 years I spent working with small business taxpayers professionally and as a self-employed person myself 

for those years, many small businesses operate on tight margins 

29

and plow every cent they can save back into their business. They 

have enormous difficulty saving money and since there is no mechanism to withhold taxes from their income, they often find they 

have spent their funds by the time tax payments are due. Then the 

IRS may come calling and these people would often come to me for 

help. Unfortunately, the most I could do in some of these cases was 

to help them request collection alternatives and in other cases it 

was simply too late. The sheer weight of the tax debt caused the 

business to go under. 

In light of the concerns I’ve expressed about the high rate of noncompliance in the cash economy and the extreme pressures small 

businesses face if they are audited, I have tried to offer proposals 

that strike a reasonable balance between reducing the high rate of 

noncompliance in the cash economy and avoiding excessive burdens 

on small businesses. There is no one size fits all solution and my 

proposals are just that; proposals that I and others may be able to 

improve on. But I think they represent a useful starting point. 

My written statement discusses some of my proposals in greater 

detail, but I would like to briefly highlight our proposal to amend 

the Internal Revenue Code to require the IRS to promote making 

estimated tax payments through its electronic funds transfer payment system and to establish a goal of collecting at least 75 percent 

of all estimated tax payment dollars through EFTPS by fiscal year 

2012. 

One key feature of EFTPS that many taxpayers may find attractive is the ability to voluntarily schedule more frequent automatic 

estimated tax payments up to— 

Chairman MANZULLO. Ms. Olson, could you talk about the most 

controversial, the backup withholding? 

Ms. OLSON. Certainly. 

Chairman MANZULLO. I think it starts on about page 11, 11 and 

12. You can tell that’s where our concern is. 

Ms. OLSON. All right. 

Chairman MANZULLO. We appreciate the other information and 

agree with it, but we want you to address the proposal we disagree 

with. 

Ms. OLSON. Okay. But I would like to say about that proposal— 

Chairman MANZULLO. Go ahead. 

Ms. OLSON. That it is the third in a tiered approach. That my 

goal is to get people to be able to stay out of trouble by being able 

to make estimated tax payments as easily as they would make 

automatic debits from their accounts for a car or a mortgage payment. 

And then I also have a proposal about companies that want to 

do withholding for their independent contractors, that they could 

come into the IRS, and this would not be the IRS contacting them, 

but that they would come into the IRS and say we want to treat 

our people as independent contractors but they are having a hard 

time saving and we want to do this voluntary withholding. And 

they would be considered independent contractors for all purposes 

such as deducting expenses and everything like that, except for the 

fact that the payor would be withholding. 

30

And I believe that those two proposals will eliminate a large 

amount of noncompliance and help companies, small businesses 

stay out of trouble in the first place. 

But for those individuals, those persons, those entities that are 

substantially noncompliant and repetitively noncompliant, and I 

believe that that is something Congress could determine or you 

could allow the Secretary to determine, but where there is a repetition of nonpayment of taxes year after year, then I propose that the 

IRS be able to use backup withholding in order to get the attention 

of those taxpayers and get them to call us. And once they call us, 

then we can channel them and say, folks, we will release backup 

withholding if you will schedule a year’s worth of estimated taxes 

a year in advance so we know that you are not getting into trouble 

again. We will help you resolve your arrears, but we want to put 

you in a going forward basis with your estimated taxes. 

And so that is the withholding proposal. I am saying that you 

have to have a demonstrated history of noncompliance, in your 

words these might be the cheaters, they are cheating other taxpayers. 

Chairman MANZULLO. And that would—I have got to get this out 

in your testimony in chief here. And that backup withholding 

would be on money coming from? 

Ms. OLSON. Payors. 

Chairman MANZULLO. Such as a credit card company? 

Ms. OLSON. Well, I did not propose the credit card company. 

Chairman MANZULLO. Or? 

Ms. OLSON. It would be from, for example, if you were in construction and you were working for a large contractor and you were 

on the framing crew, then you would have the contractor do the 

backup withholding. 

Chairman MANZULLO. But that is done now because of withholding for? 

Ms. OLSON. For interest and dividends, that is right. 

Chairman MANZULLO. No, no, no. For worker’s compensation insurance to make sure it is— 

Ms. OLSON. That is correct. 

Chairman MANZULLO. But your proposal would also apply in the 

hypothetical that I gave the Commissioner about the restaurant 

owner that would owe money to the plumber if you found that the 

plumber was substantially noncompliant, is that not correct? 

Ms. OLSON. That might happen in that instance. Now, I would 

imagine that the IRS would not be taking it down to that level. 

That they are going to be looking at persons who are repeatedly 

noncompliant and that it is worth them implementing— 

Chairman MANZULLO. We always look at the worse possible scenario. 

Ms. OLSON. I agree. I think that that is a legitimate concern. 

Chairman MANZULLO. I interrupted your testimony. Did you get 

out everything that you had wanted to? 

Ms. OLSON. I think so. 

Chairman MANZULLO. Okay. Thank you. 

Ms. OLSON. Yes. Thank you, sir. 

[Ms. Olson’s testimony may be found in the appendix.] 

31

Chairman MANZULLO. Our next witness is John Satagaj. And, 

John, we look forward to your testimony. 

STATEMENT OF JOHN SATAGAJ, SMALL BUSINESS 

LEGISLATIVE COUNCIL 

Mr. SATAGAJ. Thank you, Mr. Chairman, Ms, Velazquez, Members of the Committee. It is always a pleasure to be here. 

I think I noted last time I was here it was just a year ago for 

the same subject, it was a historic moment because I completed 

Commissioner Brown for the great work he is doing. So I am going 

to double it up. He is two-for-two, he continues to do a marvelous 

job. If we clone Commissioner Brown, we would have a much better 

situation and maybe not as combative and we have to be with the 

IRS sometimes. So I compliment— 

Chairman MANZULLO. That was combative. The Commissioner is 

very smart because there’s a Proverb that says that a soft answer 

turns away wrath. And he succeeded in doing that with his great 

smile and his personality, and also his candor. 

Go ahead. 

Mr. SATAGAJ. There is always going to be a tax gap; we all know 

that. And you alluded to the GAO study earlier in your testimony 

and opening statement. I believe the IRS has been doing tax gap 

studies since the studies. I think the first one was 1977. The first 

GAO report was in 1988. It looked at the ’77, ’82 and ’87 tax gap 

ones And I guarantee if you take that ’88 study and put it up 

against the one you referenced, it would say all of the same things. 

You know the data is old, we do not know what it is, we are not 

asking. We have been talking about the same issues about how you 

analyze the tax gap and how you find it. Nothing has changed between the 1977 tax gap estimate and the one today in terms of understanding what it is really about. And I think you illustrated 

that very well in your opening statement. 

The next point I want to make is about the blue book that you 

referenced, the five proposals and the one I call it the phantom six, 

the one on the independent contractors. And with all due respect, 

I think whoever wrote that did a disservice to the President of 

United States. Because the words are there and I’ve heard for the 

two or three weeks or four weeks since that has been out is ‘‘Well, 

it is a general proposal and we need to figure out what it really 

means.’’ And your conversation with the Commissioner about the 

corporations and the credit cards illustrates perfectly how little we 

know about those proposals and the potential impact. Does it cover 

C corporations? Is it excluding C corporations and S-Corporations? 

If it is, and I think for a while there I heard the Commissioner say 

that, then we are looking at all sole proprietors. How many sole 

proprietors take credit cards? 

And when you exclude all the brick and mortar that our S-Corporations and C corporations, who are you going after? You have 

got 25 million of them maybe, but how many of them take the credit cards? And if it was not meant for that universe, why did we propose it? But it illustrates that that proposal, those words means 

things to us in the small business community and we get upset 

about them. 

32

I was talking to Advocate Olson, Nina, about that sentence, the 

phantom six. Well, I guarantee every one of us, and I told her this, 

it was a disservice to her. Because all of us who worked that independent contractor issue read that sentence, the first reaction is, 

ah ha, the Advocate is getting her proposal through in a different 

way through that proposal. And you have heard what she has 

talked about, and it is not that. And so we have a disservice to the 

President and to all of us if we are not careful how we choose our 

words. Because it means something to those of us in the small 

business community, and we did not see that there. 

So with those points, one last point. The IRS every year puts out 

a—they give bunk frivolous myths about filing your return. You 

know, things that you should not do that people claim, like the 

16th Amendment is invalid so I do not have to file my return or 

if I put all zeros, I do not have to pay a tax. 

There was one that was interesting in there, and I pulled it out 

because I think it’s really relevant to today. Filing a tax return is 

voluntary. A lot of people say I do not have to do it. And this is 

the IRS’ words. Some people mistake the word voluntary for optional. But filing a tax return is not optional for those who meet 

the law’s minimum gross income requirement. The word ‘‘voluntary’’ as used in the IRS publications, court decisions and elsewhere refers to the fact that the U.S. tax system is a voluntary 

compliance system. Now here is the important sentence in my 

mind and everything we are talking about here today about whether it is information report, it is backup withholding or it is anything. This is the sentence that we talk about our system. ‘‘This 

means only that taxpayers themselves determine the correct 

amount of tax pursuant to law and complete the appropriate returns rather than have the government do this for them as done 

in other countries.’’ 

This is what America is about. This is what about being a small 

business is American is about. And we had better be darn careful 

if we are taking away any one element of that voluntary system. 

Thank you, Mr. Chairman. 

[Mr. Satagaj’s testimony may be found in the appendix.] 

Chairman MANZULLO. Thank you. 

I forgot to state that you are testifying on behalf of the Small 

Business Legislative Counsel. 

Thank you for your testimony. 

Next witness is Keith Hall, CPA speaking on behalf of the National Association for the Self-Employed. We look forward to your 

testimony. 

STATEMENT OF KEITH HALL, HALL AND HUGHES, PLLC 

Mr. HALL. Thank you. 

Chairman Manzullo, Ranking Member Velazquez, I thank you so 

much for the opportunity to be here today as a small business 

owner. 

To a small business guy like me any number that ends in billions 

is a touch concept to grasp. The tax gap that we are talking about 

today is one of those touch concepts. 

Through the National Association for the Self-Employed I visit 

with thousands of small business people each year. Based on that 

33

experience, I hope to shed a little light on some of the proposals 

and how they effect people like me. I specifically would like to talk 

about three things. 

First, and perhaps the most concern for me, is a proposal to initiate required withholding on non-employee payments. The withholding proposals would be based on gross payments as opposed to 

taxable income. This would require the same amount of cash withholding from all independent contractors regardless of the nature 

of their business. The business owner with the lowest profit margin 

would be hurt the worst, since they would be hit with the same 

amount of cash withholding even though they have less money to 

work with. 

Tracy Boulware, who is an NASE member from Houston, told us 

and I quote, ‘‘I own a small company. I pay my taxes. Sometimes 

my profit margin is only 3.5 to 5 percent. This type of legislation 

could put me out of business. It is that simple.’’ 

The small business that has only a 3 to 5 percent profit margin 

would be devastated and probably could not continue to operate. 

But that is not the only bad stories that would be out there. 

I personally have a client in Garland, Texas that has a business 

cutting grass at retail strip centers. His total gross income for last 

year was about $240,000, which seems like a lot of money. But he 

has two full time crew chiefs and employees a number of college 

students during the summer. So at the end of the day he has about 

$40,000 of net income and pays about six grand in taxes. But under 

a withholding rule he would have $12,000 of his money withheld. 

That translates into about $500 per month less to manage his family and manage his business. When I asked him if he could manage on $500 less a month, he 

also gave me a quote, but I thought I probably should leave it out 

here. 

We talk a lot about creating jobs and we talk about a stronger 

America, but this guy is actually out there doing it. And because 

he chooses to put a lot of his money back into the community he 

is going to be hurt the worst. The key point is that withholding 

based solely on gross payments would be greatly unfair to many 

taxpayers and for some it would mean the difference between surviving and not surviving. 

A second is the credit card reporting. Almost everyone has some 

type of information that is reported to the IRS either by their employer, by their bank or by their clients. This proposal would expand that type of reporting to credit and debit card transactions. 

Now capturing information can only have a positive impact, in my 

opinion, particularly in light of those taxpayers who consciously 

choose to avoid reporting income. If requiring the credit card companies to report these payments will help identify those that abuse 

the system, I am all for it. If reporting is used to match credit card 

receipts to the tax returns similar to the way 1099s are done today, 

I think it is a great idea. If, on the other hand, the reporting is 

used to make judgments regarding other items on the item, I think 

problems could arise. 

Discussions have included taking the total credit card receipts reported for a particular business and then extrapolating that total 

to total income, thereby making assumptions on amounts that are 

34

not reported. Making assumptions on information that is not reported will, again, paint all small businesses with the same paint 

brush which can only end up causing more problems then it solves. 

Perhaps the most critical problem with this proposal is an estimated return on investment. The Treasury estimated that it would 

save $225 million compared to 335 billion, which is nominal, especially compared to the burden it is going to place on both the IRS 

and on business taxpayers. 

The bottom line here is I am in favor of increased reporting, I 

am just afraid that this proposal will provide a lot more numbers 

but won’t really have a big impact on fixing the tax gap. 

Lastly is education versus enforcement. Most issues faced by 

small businesses deal directly with the complexities of the tax code. 

The IRS’ commitment to education over the last five years has 

made a tremendous difference. Anyone who thinks that the IRS 

has not been a friendly and more helpful entity has not had a 

chance to review their website. The commitment to that website 

changes in the Form 941, 940, the new Form 944; all prove that 

they have been listening and that they want to help. I am afraid, 

however, that the commitment to education might be fading. It 

seems clear that the proposed budget is moving away from education and toward enforcement. Point blank, more education means 

more compliance. My belief is that $1 in education is worth much 

more than $1 in enforcement. 

When I graduated from college, and I will not say how long that 

was, my goal was to make a lot of money, to conquer the business 

world and to be the man. But as I have gotten older I recognize 

that all we really have a chance to do is make a difference. Today 

you guys are called on to make a difference, not only for me, but 

for millions of small business owners just like me in evaluating 

each one of these proposals. It is my wish that the difference you 

strive to make is based on reducing overall tax code complexity and 

maintaining a commitment to education. 

Thanks again for the opportunity to be here, and thanks for 

making a difference. 

[Mr. Hall’s testimony may be found in the appendix.] 

Chairman MANZULLO. I appreciate that. 

Our next witness is Michael J. Fredrich. And I am going to touch 

upon his biography because first of all, I forgive you for graduating 

from the University of Wisconsin because I went to Marquette. 

Mr. FREDRICH. It was a rough time and I forgive you, too. 

Chairman MANZULLO. That is all right. It says personal, married 

31 years to the same woman, no children, 13 dogs, 10 cats, six 

horses and no mice. And with that introduction— 

Mr. FREDRICH. That is right. 

Chairman MANZULLO. But BS degree in nuclear engineering, 

MBA in finance, corporate turnaround specialist. Industries include 

manufacturing. You know the time I spend in manufacturing. I 

really do look forward to your testimony. 

STATEMENT OF MICHAEL FREDRICH, MANITOWOC CUSTOM 

MOLDING, LLC 

Mr. FREDRICH. Well, thank you, Mr. Chairman. And thank you 

Ms. Velazquez. 

35

Chairman MANZULLO. I’m sorry. On behalf of the Small Business 

and Entrepreneurial Council. 

Go ahead. 

Mr. FREDRICH. Yes. Thank you. 

Well, I am happy to be here today. 

And I read the testimony of Mr. Brown and I would have to say, 

I would not want your job. I think you are trying to do the right 

thing and you are dealing with really an impossible situation. I 

mean our tax code is so complex it crosses people’s eyes. I mean, 

I do not know how many people in here actually do their own 

taxes, but I mean it is just impossible to do. 

And I know this is not a debate, but Ms. Olson, I read yours, too. 

And if you are helping the small business, do not help so much. We 

do not need that kind of help. 

I view this proposal as one more straw on our back of small business. We are, you know, a professional tax collector. We collect federal tax, state tax, Social Security tax, Medicare, unemployment 

tax, state and federal. We file W2s. We do 1099s. And we do not 

get paid for any of this service. And on top of this now we are going 

to become immigration police, which is not the topic of this. 

There was competition mentioned that we want to make everybody pay their taxes so we have a level playing field. I would offer 

this to anybody that thinks adding more burden on small business 

creates a level playing field and improves competition. I would say 

this: You are looking at the wrong competitors. Our competitors are 

not other small businesses in this country. Our competitors are 

small businesses and companies around the world. And I offer this 

as an example. 

One of our customers, Kohler Engine—we make parts that’s 

Kohler Plumbing, but they also make engines. Most people probably do not know that. 

They have a group of people that go around and assess your cost 

structure and they compare you not just to other people in this 

country, they compare you to other of your competitors in the 

world. So we have competitors in China and we have competitors 

in India. And they look at our cost structure and they say well your 

costs are too high. So here is your choice. You can lower your price 

or you can lose the business. And that is fact. And they are not the 

only company that has it, lots of companies have that. So that is 

the cost reality that we are dealing with. 

In my testimony I have a thing here called the Anthony factor. 

Small businesses do not and cannot have a high overhead. We cannot employ more people than we absolutely need to. So in situations like our computer system, we cannot have an IT person on 

staff so we use Anthony. We pay Anthony the way we pay everybody else. We pay him by check an we issue him a 1099. And the 

thought of having to start now messing around withholding on Anthony is just silly. I mean, it is just one more straw. And at the 

increment it does not seam like it is a lot, but it is. I mean, you 

have to look at the whole thing in its total. 

Another example. We do not have a direct salesman, we have a 

guy that we have been trying to leave his current employment 

where he makes $120,000. He has a salary of $120,000. And we 

said to him, look it, why do you not start your own company. Be 

36

your own boss. We think you would flourish and you could represent our company in selling our products and we would benefit 

and you would benefit and it would be good for us. 

So now here is a guy, he is going to leave, walk away from 

$120,000 salary into a situation here he makes zero on day one. 

Absolute zero. So now you are going to enact some legislation that 

is going to require us to withhold 28 percent of what we are going 

to pay him. Well, he cannot afford that. I mean, he is already walking away from $120,000. So, you know, that is how this kind of 

thinking, I mean you would think you would want to encourage 

people to start their own business, and that is how businesses 

start. I mean, they start with people going out on their own and 

saying, hey, you know, I can do this for myself. And this legislation 

or this proposal it really dampens that. 

One other thing I would like to say. I heard this with regard to 

audit activity $1 yields $4. That is just bunk. 

When you make a calculation like that in a free market transaction where you have a willing buyer and a willing seller and the 

IRS does not come to you and say hey, we would like to do an 

audit, what do you think. No. They say we are going to do an audit. 

Okay. So then you have to go and hire your support, your tax accountant, you have to go hire Kevin here and say hey I need representation that pulls you away. And they do not factor those costs 

in there. They do not factor the focus that is taken away from the 

business. 

Can you imagine? We do not run on a big staff. I mean, I am 

not there today. My partner is there today. But we are there everyday that we can be. And to take our focus away to have an audit 

where somebody thinks they make $4 for every dollar of audit cost 

ignores the other half of the equation. What is our cost? I mean, 

that has to be your true yield on what an audit costs. 

So I mean they go through this plan of we are going to expand—

my time is up. I am sorry. I will summarize quickly. 

I think you need to be simpler. You need Hagelian logic; less is 

more. Our tax structure is too, too complicated. 

That is my testimony. 

[Mr. Fredrich’s testimony may be found in the appendix.] 

Chairman MANZULLO. Now I am convinced that you were at the 

University of Wisconsin. Hagel is the author of Communism. 

Mr. FREDRICH. The solution. In business if you want to make 

something better— 

Chairman MANZULLO. You do not get it. Everybody accuses the 

University of Washington of being very liberal and said— 

Mr. FREDRICH. I was in engineering school there. 

Chairman MANZULLO. All right. Sorry about that. 

Appreciate your testimony. 

Mr. FREDRICH. Thank you. 

Chairman MANZULLO. The next witness is Dr. Max Sawicky, an 

economist with the Economic Policy Institute, who has worked at 

the State and U.S. Treasury Department. 

We look forward to your testimony, Dr. Sawicky. 

37

STATEMENT OF MATT SAWICKY, ECONOMIC POLICY 

INSTITUTE 

Mr. SAWICKY. Thank you. 

I would like to thank you, Mr. Chairman and Ranking Member 

for inviting me. 

If Ms. Olson does not supply enough disagreement, maybe I can 

fill in the gap. 

The United States has enjoyed a tax holiday for years now. We 

are, as you know, spending much more than we are taking in, both 

in terms of the Federal Government in the U.S. relative to the rest 

of the world. Very few economists think these imbalances can be 

sustained indefinitely. And because of that the need for revenue, I 

think, is going to become inescapable. Tax increases are not fun 

and I think that fact is going to compel renewed and expanded interest in the tax gap, which is another source of solution. 

Now, I would take exception to some of my friends. Tax increases, in and of themselves, do not fix this because in the long 

run we have health care spending increases in both the public and 

private sector which will need to be paid for one way or another. 

If they are not paid for by the government, they are paid for by 

someone else. If they are not paid for, then somebody loses health 

care. So the problem is much bigger then revenues, but revenues 

I think are going to be impossible to avoid. And that means the tax 

gap, among the other things. 

Now the elephant in the room here which nobody has really 

touched upon which pertains to a number of the issues that have 

come up is resources for the IRS. If there is a lack of service and 

education of taxpayers, that is amenable to remedy with more resources. If there is a lack of research or an unevenness in the focus 

of research, that is amenable to more resources. If there is a shortfall in technology, which I think is a particular problem with the 

IRS, that is a crying need. 

Proposals to flat fund the agency or even reduce funding in real 

terms after adjusting inflation mean that when we talk about more 

service, it is going to come from somewhere else. The agency absolutely has to process returns; that is an unavoidable expense. If we 

do more education, it is going to mean less enforcement with all 

the problems that have come up. 

And unlike other issues in the budget, this is not a trade off 

issue. The research, contrary to my college here, I think is pretty 

decisive and emphatic that more spending on a variety of measures, not only the ones that have been mentioned here, bring in 

much more money than they cost. There is very high payoff ratios 

that have resulted from very elaborate and sophisticated research 

on this question. 

So then of course the question remains what is the right focus. 

And people are concerned here that small business is being singled 

out. As the Commissioner said, the IRS uses formulas to determine 

audit. These are confidential; they have to be. I think nobody from 

the outside is supposed to know what those are. I think the confidence in terms of what the agency is likely to do with better financing, although it cannot be simply given away without any 

oversight, is that they are going to go where the money is. And 

that is not particularly to small business, it is to businesses with 

38

lot of employees and/or high net income. It is not to very short with 

very high income. 

So in terms of small business within that dreaded blue box in the 

tax gap map there is a lot of differentiation between really small 

and small compared to Chrysler but not small compared to most 

Americans. And I think the agency can be relied upon if their mandate is to get the best bang for the buck in terms of revenue to go 

to where the money is and not to the really small people. 

In that final vein, one small business category that has not been 

mentioned here is, let us say a woman taking in sewing making 

$13,000 a year, somebody mowing lawns. People receiving the 

earned income tax credit have been the target, the real target of 

inordinate attention by the IRS I think at the behest of the Congress in a gross misfocus of priorities from the standpoint of revenues as well as justice. And if there is unfairness there, we cannot 

be surprised if it bleeds over into other places. 

Two more thoughts. One, I think the advance in the computer 

technology and the economy, the reduction of the cost of transactions which we already see burgeoning ahead is going to make 

a lot of these discussions obsolete. It is going to be easier and easier to collect and report information, the process, and without necessarily the need for draconian withholding rules, which I am impressed by some of the testimony in terms of the problems in that 

vein. But reporting, I think, is much less of an issue, will become 

decreasingly so in the future. 

And finally, I cannot disagree with all the commentary about the 

importance of the simplicity of the tax code and the fact that it has 

gone radically in the wrong direction really since 1997, I would say. 

And this complexity for good, bad and different reasons has increased costs all the way around. And everybody in Congress is 

concerned about this but nobody has roused themselves to really 

deal with it seriously. And again I come back to the fundamental 

imbalances in our economy and in the budget which get much 

worse in the long run, which I believe will compel the political system, Congress and the President, to approach the revenue including the tax gap with high seriousness. And part of that solution 

will be, I think, significant simplification of the tax code. 

Thank you very much. 

[Dr. Sawicky’s testimony may be found in the appendix.] 

Chairman MANZULLO. Thank you. You must have been rejoicing 

last night with that marvelous basketball game. Was that not 

something? 

Mr. SAWICKY. I have a 6:30 school bus to catch in the morning, 

so I miss a lot of that late night stuff on TV. 

Chairman MANZULLO. You’re alma mater. 

Mr. SAWICKY. My alma mater is—oh, yes. Yes. Right. 

Chairman MANZULLO. Okay. 

Mr. SAWICKY. I read about it in the paper. I missed it. 

Chairman MANZULLO. It’s obvious you do not like basketball, so 

I will go on to something else here. 

Ms. Olson, on withholding, your proposals do not even touch 

credit card withholding, is that correct? 

Ms. OLSON. Well, I did not propose the credit card withholding, 

the Administration— 

39

Chairman MANZULLO. That comes from Treasury. 

Ms. OLSON. The Administration proposed it. 

Chairman MANZULLO. So I guess unless you want to talk about, 

let us go on to— 

Ms. OLSON. Right. 

Chairman MANZULLO. —what your proposal for withholding is. 

Could you walk us through a scenario? 

Ms. OLSON. Yes. First, when you and I had talked earlier you 

asked me to get numbers, so now I have numbers. 

Chairman MANZULLO. Is it not great to come into the office first? 

Ms. OLSON. Yes, it was very helpful. 

Chairman MANZULLO. Good. 

Ms. OLSON. And it crystallized the mind. 

There are for tax year 2004, which would be last year’s filing season and are the most recent data that we have since this year’s filing season is not finished, there were balance due returns overall, 

there were approximately 4 million balance due returns. Individual 

returns they reported tax dollars, they made some payment and 

here is the dollars that are owed. 

Chairman MANZULLO. These are individual returns? 

Ms. OLSON. These are individual returns. 

Chairman MANZULLO. Okay. Go ahead. 

Ms. OLSON. So that will include Schedule C. 

Chairman MANZULLO. Okay. Go ahead. 

Ms. OLSON. Of those returns 1.45 million were Schedule C returns. So that is first the universe that we are talking about. Out 

of the 128, 133 million returns that we get every year, to even 

begin to look at my withholding proposal, we are talking about 1.45 

million returns. That is just the starting point. 

Now of the dollars that are balance due for 2004. Okay. Let me 

just say one thing. That Schedule C balance due returns then constituted 35 percent of all balance due returns we got in tax year 

2004. 

Chairman MANZULLO. Can I stop you right there? What percentage of the total returns do the Schedule C returns comprise, do you 

know that? 

Ms. OLSON. Maybe 18 percent my research guy says. 

Chairman MANZULLO. About 18 percent. Go ahead. 

Ms. OLSON. Okay. 

Chairman MANZULLO. Thank you. 

Ms. OLSON. And then when you look at the dollars that are due 

on these balance due returns, we had about $12 billion on all individual income tax returns due. Okay. A balance due. And I am not 

talking here about under reported income. I am saying people said 

this is how much we owed, we were not able to pay. 

Chairman MANZULLO. Right. Okay. 

Ms. OLSON. So on those 4 million returns for all individual taxpayers, it was about $12 billion due. 

And for Schedule C returns what we had was about $6 billion 

due. 

So the Schedule C balance dues were about 50 percent of the dollars, although they were 35 percent of the balance due returns and 

18 percent of the overall taxpaying population. 

40

So that is not the end of the equation, though, before you get to 

backup withholding. I mean, some of those people may be one time 

people, of those 1.4 million taxpayers that were Schedule C that 

filed a balance due return. They may just have had a bad year, you 

know, and they are going to contact us and get into an installment 

agreement. They may never repeat that problem again. 

So what my universe is to even begin to look at backup withholding are people who have had recurring balance due returns 

where they are getting so far behind, where they are showing a 

balance due of $5,000 a year and you have three years in a row 

and you are getting to $15,000 with penalty and interest accruing 

and you are never going to dig yourself out of that debt. And that 

goes back to what I was trying to say in my oral testimony. You 

never dig yourself out of that debt. 

And so what we were trying to say there is we have got a repeater, we have got a problem, we have got a trend starting with 

this taxpayer. And the next thing that is going to happen is that 

taxpayer is going to go out of business. 

So what I want to do because all of our notices that have been 

sent out to that taxpayers are not bringing him in and we are not 

getting an arrangement. He is not coming in and he is not scheduling his self-employment, his estimated tax payments on a monthly basis is to institute backup withholding, just like we do with the 

individual with the interest and the divide where people are not responding. 

Chairman MANZULLO. On whom? 

Ms. OLSON. On repeaters who are showing a trend on Schedule 

C. 

Chairman MANZULLO. No, I am sorry. The people that would 

have to withhold? 

Ms. OLSON. Okay. If they have 1099s, we would go out to their payors. And I would imagine if you just got a 1099 for $600 or $650 

the IRS would not be contacting that person. But if you had someone that it looked like there was one payor, you know you were 

really working for one person, we would go out to that person and 

say we want you to withhold. 

Chairman MANZULLO. So that could be a corporation? 

Ms. OLSON. It could be a corporation. 

Chairman MANZULLO. It could be a sole proprietor? 

Ms. OLSON. It could be another sole proprietor, that is right. 

Chairman MANZULLO. So you would be asking a sole proprietor, 

a small business person, to withhold? 

Ms. OLSON. Yes. 

Chairman MANZULLO. And then to send that money to the IRS? 

Ms. OLSON. Yes. 

Chairman MANZULLO. John Satagaj has something to say about 

that, is that the segue? 

Mr. SATAGAJ. It is hard to believe, I guess is the only words I 

can use. 

Chairman MANZULLO. I am astonished. I am astonished. This is 

the Taxpayer Advocate. 

Mr. SATAGAJ. Yes. I mean, actually, I do not want to get into 

too— 

Chairman MANZULLO. Go ahead. You can argue with her. 

41

Mr. SATAGAJ. I am struggling with the repeat, how many of them 

are repeaters even. 

Ms. OLSON. Actually, we were supposed to have that number this 

morning and we did not receive that number. But it would obviously be less than 1.45 million because that is the total balance due 

that we have. 

Chairman MANZULLO. So then you would be asking businesses 

that hire this repeater who is an independent contractor to withhold because this independent contractor is not paying his tax, is 

that correct? 

Ms. OLSON. On a repeated basis, yes. 

Chairman MANZULLO. Okay. So then unless that independent 

contractor comes in with this magic certificate of compliance— 

Ms. OLSON. No, we have not gotten to that yet. No. 

Chairman MANZULLO. But in any case, but it is correct— 

Ms. OLSON. Well, what I would like is that what you would have 

is that essentially one backup withholding payment would make 

that taxpayer call the IRS and then part of my proposal is that 

when the taxpayer calls the IRS, we will release withholding, 

backup withholding if they will get into this monthly payment 

plan— 

Chairman MANZULLO. That is correct. But now what you are saying now is that the creditors of the guy who— 

Ms. OLSON. Right. I am asking this small business employer, 

right. 

Chairman MANZULLO. —is continuously—not the employer. It is 

not employer. It is the payor. 

Ms. OLSON. Right. Okay. The payor. You are right. 

Chairman MANZULLO. The payor, that is correct. 

Ms. OLSON. The payor. That is correct. 

Chairman MANZULLO. You would be asking that person— 

Ms. OLSON. Yes. 

Chairman MANZULLO. —let us say it is the plumber. Let us say 

the plumber does, I do not know, 300 jobs a year, whatever it is. 

So you would be going after all those people— 

Ms. OLSON. Well, not necessarily. I mean, those are the questions 

that the IRS has to decide whether you were going to get money 

from them or not. 

Chairman MANZULLO. The problem is this— 

Ms. OLSON. Yes. 

Chairman MANZULLO. — is you make a general recommendation. 

You are smart enough to say general recommendation, a little bit 

smarter than Treasury that comes right out and says let us do this. 

You make this general recommendation, but you have done nothing 

to show the cost of implementing it in terms of the burden that is 

on the innocent business, like my brother with the restaurant. I 

mean, he is supposed to be placed in a position to determine 

whether or not his plumber is paying his taxes? 

Ms. OLSON. Well, see that is a valid point. But with all of my 

recommendations, they are recommendations. The IRS now has a 

small business burden reduction model. And we will feed this proposal in and look at what it should be. 

Chairman MANZULLO. Well, can I help you feed it right now? I 

think— 

42

Ms. OLSON. So I mean I have been listening to the panel. 

Chairman MANZULLO. —it is stupid and it stinks. And may we 

go on to something else on behalf of all the Frank Manzullo Juniors 

who went out of business after 41 years. I am sorry. There is no 

way Frankie ever would have known about a certificate of compliance if you asked him to withhold. He would look at that thing and 

say well what does this mean? I mean, he has a high school education, actually a business school education, and he is a veteran. 

And he is a very smart guy. 

Ms. OLSON. Well, many of these— 

Chairman MANZULLO. But he would have no idea what that 

means. 

Chairman MANZULLO. He already— 

Ms. OLSON. Well, many of these small business people have employees in additional to independent contractors. 

Chairman MANZULLO. Of course. I understand that. 

Ms. OLSON. And they are handling withholding in the context, 

too. 

Chairman MANZULLO. Right. But I mean— 

Ms. OLSON. So it is the same mechanism. 

Chairman MANZULLO. But look at the different small business 

groups out there, NFIB members went from the average of three 

employees to I think it is now about five, and the other groups are 

somewhere in that particular area. I mean what happens if not 

only it is his plumber but also the electrician? You know, these 

small business people hire small business people because it is good 

for business. That is the culture; it is just the way it is. I mean, 

there could be a half of dozen people that you would send a notice 

to, especially if it is an area like Rockford, Illinois that led the nation in unemployment at 25 percent. And now it is still at seven 

percent where people are struggling to make their payments, taxes 

are going up and the average wage for the people in the biggest 

county in my District has gone down because of the loss of manufacturing jobs. And they are struggling. They are hurting. 

Ms. OLSON. I understand this. 

Chairman MANZULLO. So you would be asking the small businesses that are left to do backup withholding— 

Ms. OLSON. No, I would not, sir. 

Chairman MANZULLO. —in the event that you find these characters that are not fully compliant with the IRS? 

Ms. OLSON. Right. Now so the other point that I want to make 

is that the IRS in its current levy program, for example, what it 

has the authority to do under law right— 

Chairman MANZULLO. Right. 

Ms. OLSON. —now if someone is behind in their taxes and we can 

tell that someone is working for one individual person or we can 

see from the 1099s or that they are working for 25 individual people, we can go out to those payors and levy on the payments that 

they are making on that person right now. 

Chairman MANZULLO. Only if they owe money. 

Ms. OLSON. Well, that is what I am talking about here. 

Chairman MANZULLO. That is correct. 

Ms. OLSON. The IRS has tolerances. We do not go out if there 

are 25 people and they are paying X amount of dollars and it is 

43

below our tolerances, we do not go out to absolutely everybody who 

shows up on a 1099 when we go out and do our levies. 

You know, and the same procedures would occur here. We would 

be making those tolerance decisions. 

Chairman MANZULLO. I mean whenever you have decisions, you 

are talking about bureaucrats. You talk about bureaucrats, you are 

talking about forms, you are talking about the forms—you know 

what my brother would do if you said any future work this plumber 

does you have to withhold? Do you know what he would do? 

Mr. SATAGAJ. New plumber. 

Chairman MANZULLO. New plumber. 

Ms. OLSON. Well, what is he doing in the current situation when 

we go out and say to him we’re going to levy on— 

Chairman MANZULLO. Well, no, that is the whole point. Then you 

end up putting this guy out of business. 

Ms. OLSON. That is happening today in the levy context. 

Chairman MANZULLO. Well, no, but it is different in the levy. The 

levy is where the creditor is actually holding money that is owed. 

You can’t levy on zero. 

Ms. OLSON. You can put it on accounts receivables. And if the 

plumber is working and there is a payment that is due to him, 

then we can levy on that. And that is— 

Chairman MANZULLO. Well you know what he would do as a 

small businessman? 

Ms. OLSON. —precisely what we are doing now. 

Chairman MANZULLO. He would just go on to get somebody else. 

Why should the small— 

Ms. OLSON. But I am saying that that is what is happening here 

and it is happening today. 

Chairman MANZULLO. No, I understand it. But I mean you have 

got so much research you have to do and of course the IRS considers itself exempt from the Regulatory Flexibility Act on any regulation. So you come out with these regulations and you have absolutely no way of knowing what the cost will be. 

Ms. OLSON. Well, actually, to that point part of the reason why 

we have said that these were proposals is because I am making 

them publicly and I am sitting here willing to discuss them with 

you. 

Chairman MANZULLO. But that’s— 

Ms. OLSON. And I have stood before 22 small business groups 

and listened to their concerns, and I have incorporated many of 

their concerns. 

Chairman MANZULLO. John? 

Mr. SATAGAJ. I mean to there is the issue of, you have raised the 

issue. You are going to get rid of that plumber and go to another 

one. You have got the fact that you are going to have a lag time 

here between the years involved and when you are getting out the 

notices. It presumes they keep going back to the same people all 

the time for the same business. I mean, there are a lot of presumptions in this to get to the point where you’re actually going to be 

able to match up the person that you want to withhold from the 

person. 

Ms. OLSON. Yes. 

Mr. SATAGAJ. I mean, you got too many— 

44

Chairman MANZULLO. All right. Michael, how many subs do you 

have in any given year in your business, in your plastics industry, 

subcontractors? 

Mr. FREDRICH. Oh, I would say five to ten. 

Chairman MANZULLO. Okay. What about sub-subs? Of course, 

you would not be dealing directly with them, would you? 

Mr. FREDRICH. We would not. But— 

Chairman MANZULLO. How many people do you buy materials 

from? 

Mr. FREDRICH. The materials are all larger customers, people 

that we use as subcontractors. For example, we have a guy that 

comes in and runs a machine that measures the tolerance on parts. 

And we do not have to do that that often because it is just for new 

parts that are getting approved by the customer. So, you know, he 

would come in maybe seven/eight times a year and we pay him as 

an independent contractor. 

But I would say this: You know, they are talking about withholding. If you withhold 28 percent of somebody’s gross revenue, 

nobody has a 28 percent profit margin. It is just not there. I mean 

if you are talking about withholding, maybe you would have to figure out what their profit margin is. 

Ms. OLSON. We did do that. 

Mr. FREDRICH. And then the percentage of tax. But 28 percent 

is— 

Chairman MANZULLO. It is a lot of money. 

Mr. FREDRICH. It is off the wall. I mean you put— 

Chairman MANZULLO. Congresswoman Velazquez?

Ms. VELAZQUEZ. Thank you. 

Ms. Olson, what will be a liability issue for the payor 

Ms. OLSON. It would be the same rules under backup withholding today, which is that if you have the obligation to do backup 

withholding, then you would be liable just like a bank would today. 

If I could make two points. One is my proposal is not to go to 

anything but payments that are currently subject to 1099 reporting. 

Ms. VELAZQUEZ. Okay. In your recommendations would you ask 

the IRS to put more resources into education? 

Ms. OLSON. I have made— 

Ms. VELAZQUEZ. Personnel? 

Ms. OLSON. —at my number one most serious problem for taxpayers in this past year’s annual report the trend in taxpayer service, which includes the outreach and education to taxpayers. And 

I have criticized some of the changes that have been made in the 

Small Business Self-Employed Operating Division— 

Ms. VELAZQUEZ. And do you hear that more staff people have 

been shifted around— 

Ms. OLSON. I state that in my testimony. 

Ms. VELAZQUEZ. —and that the resources will be put into outreach and education? 

Ms. OLSON. I am very concerned about that. 

Ms. VELAZQUEZ. So how do you expect then for business to understand when they will be in violation or noncompliance? 

45

Ms. OLSON. If I am not satisfied that the IRS is adequately staffing this, then I would not be supporting this. I would not be putting forward this proposal. 

Ms. VELAZQUEZ. Right. 

Ms. OLSON. This cannot be separated out from just compliance. 

I mean enforcement. 

Mr. BROWN. Excuse me. We do take the service component of our 

mission very seriously. And there has not been a reduction in the 

number of resources devoted to it. I mean, there has been a recasting of who performs some of those services. And some have migrated to other divisions. But in terms of sheer number of people 

and sheer number of hours devoted to the service side of the equation, that has been constant. And we take that very seriously. We 

have tax forums around the country and they are very important 

in terms of educating taxpayers. 

Ms. VELAZQUEZ. Let me ask: Have you shifted resources from assistance to enforcement? 

Mr. BROWN. We are devoting the same amount of resources to 

service as we did before. We had an organization called Taxpayer 

Education and Communication and there was an error— 

Ms. VELAZQUEZ. But then you are defeating the purpose because 

if you are going to implement this new proposal and go after all 

these people now, if you are going to have and devote the same 

type of resources, that means— 

Mr. BROWN. You are suggesting we would devote more resources 

to it? 

Ms. VELAZQUEZ. Correct. 

Mr. BROWN. I agree with you that we need to do more in this 

department. That we need to devote both more research and become— 

Ms. VELAZQUEZ. But I understand your funding, your budget will 

be flat funded. 

Mr. BROWN. Our budget will be adequate for what we need to do 

here. Obviously— 

Ms. VELAZQUEZ. That is what I hear from the Administrator of 

SBA when he comes here and you see the mess that as a nation 

we have been witness in regarding the victims of Katrina. Why? 

Because the budget of SBA has been cut by 50 percent in the last 

years. 

Mr. BROWN. We believe we have the resources necessary to do 

the work here. 

Ms. VELAZQUEZ. Okay. Thank you. 

Mr. Satagaj, in your testimony you seem to focus on the problem 

of complexity as a driver of noncompliance. Unfortunately, the 

President’s Commission Tax Reform Panel that put together a report on simplifying the tax code and nearly all of their recommendations have simply been put aside. Why do you believe 

that efforts to simplify the tax code have failed and this problem 

only continues to get worse? 

Mr. SATAGAJ. A real question. I do not know that I know the answer to that one, and I am honest to say that. It is frustrating that 

we have not done it. You allude to that report. Former Commissioner Rossotti sat on that panel and I would say that he has been 

one of the very effective spokesman for small business and he had 

46

some very intriguing proposals in there, and some of them lead to 

actually the very systems we are talking about here ironically 

about reporting. Because he talked about checkbooks and he talked 

about credit card. But the payback to get that was you would have 

a simpler system. 

Ms. VELAZQUEZ. Sure. 

Mr. SATAGAJ. And there is something there to make an incentive 

for the businesses to be part of that system, whereas these proposals there is no incentive to it. 

I do not have an answer to why, to be honest with you. 

Ms. VELAZQUEZ. Okay. Well would you agree that if our tax bills 

focus on simplifying the tax code, that concerns about the tax gap 

will be reduced? 

Mr. SATAGAJ. I think so. I think that certainly is a part of it. 

There are several things that fall in there, but that is one part. 

Ms. VELAZQUEZ. Mr. Sawicky, would you like to comment. 

Mr. SAWICKY. Sawicky. 

Ms. VELAZQUEZ. Yes. Would you like to comment on my questions to Mr. Satagaj? 

Mr. SAWICKY. Well, a broader simplification if it broadens the tax 

base makes lower rates possible. And I think the research and common sense is universal that lower rates reduces the incentives to 

evade taxes and also reduces the incentives to look for legal ways 

to reduce one’s tax payments. So you cannot have too much base 

broadening from my standpoint. Why do we not get more? Well, I 

think it is because half the people in this room are involved in activities to get concessions in the tax code for one or another interest. And as the Commissioner I think said, as these things pile up 

to the breaking point, at some point I think probably with a financial crises resulting from our trade and budget deficits, they will 

be compelled to do something serious about simplification for the 

purpose of gaining revenue. The alternative would be problems in 

financial markets that cause serious damage to the economy. 

Ms. VELAZQUEZ. But in your view both Congress and the Administration bear some responsibility for increasing complexity of the 

code? 

Mr. SAWICKY. Well, the people that write the code are responsible for the complexity of it. And from my standpoint and including the legislation in ’97 as well as what came after, we have had 

increasing complexity in the tax code. And also that entails all 

kinds of swiss cheese holes that take parts of the base away from 

taxes. 

Ms. VELAZQUEZ. Mr. Brown, in terms of the area of enforcement 

do you believe that by focusing on corporate tax shelters will be a 

more efficient use of the IRS resources as opposed to the current 

efforts to go after small businesses? 

Mr. BROWN. I think both are necessary, as the KPMG situation 

the Commissioner alluded to earlier, many of those taxpayers are 

involved in a deal called Son of Boss that involved about 1300 individual taxpayers who ended up paying us more than $3.7 billion. 

And this is not money we hope to collect. This is money that we 

have received. 

Ms. VELAZQUEZ. So would you say that these larger businesses 

over $250 million or more are better equipped to deal with an audit 

47

in terms of manpower and costs? Would you agree that the relatives costs are much higher for these Schedule C filers? 

Mr. BROWN. Yes. 

Ms. VELAZQUEZ. And with this measure let us talk about the cost 

to the honest taxpayer who is subject to an audit? 

Mr. BROWN. Well, the credit— 

Ms. VELAZQUEZ. Does that represent a win/win for our economy? 

Mr. BROWN. Well, I think that is why we really wanted third 

party reporting. The intent here was to not place the burden directly on the small business. And I realize, of course, that there are 

some pass-through costs when you are talking about credit card 

companies having to report this type of information. But that was 

the genesis of the idea for increased third party reporting as opposed to withholding or going some other way which would put the 

cost directly on the small business. 

Ms. VELAZQUEZ. But you do not think that that will represent a 

financial burden on small businesses? 

Mr. BROWN. I do think it will represent somewhat of a financial 

burden on small businesses, yes I do. 

Ms. VELAZQUEZ. Do you really think so, because you have not 

done any impact analysis? 

Mr. BROWN. Well, we obviously have to meet with the industry. 

When you are talking about third party reporting, there are always 

going to be costs that we might not be able to know, but that is 

exactly why we are meeting with the industry. 

Ms. VELAZQUEZ. Mr. Brown, the IRS suggests five initiatives to 

close the tax gap. And according to your figures the cumulative impact of these changes will reduce the tax gap by one-tenth of one 

percent. Even that, would not the time of the Administration, the 

IRS, the Treasury and Congress be better spent on taxing simplification rather than trying to go after such a small amount given 

the huge administrative burdens that they seem to create? 

Mr. BROWN. The proposals we believe do not create huge administrative burdens. I guess I would take issue with that word. 

Ms. VELAZQUEZ. Well, we would start $100 million that you pay 

for a study. 

Mr. BROWN. I think Senator Baucus asked the Commissioner at 

a hearing recently the same question and he said is this enough? 

This does not represent enough in terms of efforts. So I think the 

point is valid that this is a minor piece. 

As to tax simplification, I applaud any efforts to simplify the 

code. It is very difficult for our revenue agents to enforce the laws 

when even they sometimes are not certain about the laws, let alone 

the small business they’re intending to audit. 

Ms. VELAZQUEZ. So you agree with me that since 1997 the tax 

code are more complex? 

Mr. BROWN. I have been in this business since 1987 and every 

year it has gotten more complex. 

Ms. VELAZQUEZ. More so after 1997. 

Mr. BROWN. 1987 is when I got into this business, and it is been 

much more complex every year. 

Ms. VELAZQUEZ. Thank you, Mr. Chairman. 

Chairman MANZULLO. Thank you. 

48

Now, what side of these proposals do you come down on, with 

Ms. Olson or with the Commissioner? 

Mr. BROWN. Oh, with the Commissioner, obviously. 

Ms. OLSON. The Advocate speaks for herself. 

Chairman MANZULLO. Are you not glad that the Commissioner 

went first? 

Mr. BROWN. Yes. 

Chairman MANZULLO. Right. 

Mr. Brown, I guess this was the so called ‘‘blue book’’? 

Mr. BROWN. Yes. 

Chairman MANZULLO. On page 117. Do you have it there? 

Mr. BROWN. I do somewhere in this rule book, yes. 

Chairman MANZULLO. Could you flip to it? This is when it talks 

about increased information reporting on payment card transactions. Do you see that? 

Mr. BROWN. If you will give me a second, I will find that for you. 

Thank you. 

Chairman MANZULLO. Does that say on top increased information at page 117? 

Mr. BROWN. It sure does. 

Chairman MANZULLO. Okay. Would you go down to where it says 

‘‘reasons for change’’ And read the last sentence in there where it 

says ‘‘in addition.’’ 

Now this is only, as the Commissioner said, with regard to people that give somebody else’s wrong tax number. 

Mr. BROWN. That is correct. 

Chairman MANZULLO. You want to read it out loud for us? 

Mr. BROWN. Sure. ‘‘In addition, implementing a backup withholding system for payment card reimbursements to businesses 

would lead to material improvements in the compliance rates of 

these taxpayers without imposing a significant burden on card 

issuers.’’ 

Chairman MANZULLO. Who came up with the last portion of that 

sentence? 

Mr. BROWN. This was a combined effort between the Treasury 

Department, the IRS and other parts of the Administration. 

Chairman MANZULLO. And I would note that, first, this is put out 

and then come the meetings with the industry. Is that order correct? 

Mr. BROWN. There were some preliminary discussions with people who are familiar with the industry and who worked in the industry before we did this. And there are ongoing discussions as we 

speak with members of the Credit Card Association, the American 

Bankers Association. 

Chairman MANZULLO. But why would you put this out? I mean, 

this is a statement of fact. This is a sales piece that you give to 

Congress. I mean you have made a factual determination that 

there would be no significant burden on card issuers. I mean, this 

is not— 

Mr. BROWN. Well, this refers to just the backup withholding, this 

particular sentence. 

Chairman MANZULLO. Well, you have to start with that. 

Mr. BROWN. But this is— 

49

Chairman MANZULLO. I mean how could you come to that conclusion? 

Mr. BROWN. By talking to people who are familiar with the industry. I have worked in the industry. And this is the way the 

budget process works. We obviously want to work with the Congress to make sure and to work with the industries to make sure 

that we do this— 

Chairman MANZULLO. First of all, I do not believe this. I mean 

this is factually incorrect because every time you do something else 

to withhold, it is going to be new software. I mean, the software 

people must love you. You would have to change programs here. 

Mr. BROWN. No. We have backup withholding regimes in place 

now. This really is designed to mirror the current backup— 

Chairman MANZULLO. No, no, no. This is something new. This is 

credit cards. And what I don’t understand is if somebody gives you 

a bad TIN number, what kind of people are these? Are these 

crooks? What are they? Who is doing that and why do you not put 

them in jail or charge them with a crime if they are using somebody else’s instead of going after the credit card issuer and saying 

this guy who was using a bogus TIN number, we want you to withhold on the money you give him? Why do you not just put him out 

of business or arrest him or something? That sounds like credit 

card fraud to me. 

Mr. BROWN. Well, some of these are just made in error. People 

transpose number. So we do not jump right to back— 

Chairman MANZULLO. Well, I realize that goes on all the time. 

Mr. BROWN. That is correct. 

Chairman MANZULLO. That proposal does not even address that. 

Because once the error is brought to their attention, you know 

somebody could have interposed a number or transposed a number. 

Mr. BROWN. The vast majority of them, correct once we notify. 

Chairman MANZULLO. Right. But I do not understand this. I 

mean, if somebody gives a wrong TIN number and it is not an 

error, what kind of a person is that? Is that a thief? 

Mr. BROWN. Well, it can be. 

Chairman MANZULLO. Or what? 

Mr. BROWN. It can be someone who is generally trying to avoid 

the information going to the Internal Revenue Service. And there 

are other reasons that you would— 

Chairman MANZULLO. Well, that is pretty serious, is it not? 

Mr. BROWN. It can be. And there are also all sorts of Bank Secrecy Act provisions that would be run afoul of here, too, as well. 

I mean often times you are dealing with banks with taxpayer identification numbers and they want to launder money. There are a 

lot of reasons why people want to avoid that kind of scrutiny. 

Chairman MANZULLO. But I mean you are really not in the business here of going after the money launders. 

Mr. BROWN. Unfortunately I am. 

Chairman MANZULLO. Well, not with this proposal? 

Mr. BROWN. Not with this proposal. But I unfortunately own the 

Bank Secrecy Act program for the Internal Revenue Service, it is 

in my division. 

Chairman MANZULLO. Okay. Well, that is another part of your 

portfolio. 

50

And again, this is aimed at the small business people, as finally 

we got the Commissioner to agree that this particular provision 

was. I still do not understand how you can make this statement. 

Because what you are talking about is that for every small business person you are going to make, and I think you said 25 million 

people, the credit card companies give all that information to the 

IRS so they can filter through all of that to see who is giving a 

wrong number, is that not correct? 

Mr. BROWN. What we are looking for is an aggregate number on 

gross receipts, payments made to if you are a restaurant. That is 

the number we are looking for. And also we are looking to make 

sure that when the information comes in that there is a proper taxpayer identification number. 

Chairman MANZULLO. Well, that it is interesting because now 

you are talking about withholding on credit cards on an aggregate 

number and your boss just testified to the fact that the only time 

that credit cards would be involved is because of a false TIN number. 

Mr. BROWN. That is correct. No— 

Chairman MANZULLO. Well, why did you mention aggregate 

number? Because that could be something that you might be looking for, is it not? It could give reason for an audit, could it not? 

Mr. BROWN. The third party reporting is specifically designed to 

give us an aggregate number for credit card receipts— 

Chairman MANZULLO. You have it back there? Yes. This stinks 

because now I know what you are doing. You want to have all the 

credit card companies report to you so then you can take that information and then compare it against their income tax return. So 

this is more than the people with the false TIN numbers, is that 

not correct, on credit cards? 

Mr. BROWN. The false TIN numbers only applies to the backup 

withholding. The TIN numbers do not come into play other than 

for the backup withholding. 

Chairman MANZULLO. Well, yes, but then what would you do? 

This is just a big net. Just a fishing net out here so you can get 

more information. Because you know what? Let me share what occurs on page 41 of this report that you guys just love. Page 34. This 

says, but unfortunately these are not your own words so I can’t 

cross examine you like I did your boss, ‘‘Appendix 3 IRS key efforts 

to reduce the tax gap. The IRS strategic plan outlines, it does not 

prioritize service and enforcments to improve compliance.’’ That is 

not good. ‘‘Therefore, we asked IRS officials to identify IRS’ key efforts to reduce the tax gap. IRS divisions provided lists that totaled 

47 efforts which are described in the following examples. The Small 

Business/Self-Employed Division,’’ that is you? 

Mr. BROWN. Yes. 

Chairman MANZULLO. Okay. ‘‘Identified 15 efforts such as models 

to identify higher priority collection cases to pursue.’’ Another word 

for modeling is profiling, is that not correct? 

Mr. BROWN. I will agree with that. 

Chairman MANZULLO. Good. And another one is a computer 

matching program to identify under reported income. That is what 

you want? 

51

Mr. BROWN. Well, what that is referring to is, I mean, it is somewhat like Max explained before. We have a formula we use to assess returns. We do not just audit randomly. We view random audits as a waste of time. I do not want to hassle taxpayer where 

there is not a high probability of there being something wrong. You 

know, we do not have the resources to do that and, frankly, neither 

do the taxpayers. So the idea of the National Research Project was 

to get us better formulas that would allow us— 

Chairman MANZULLO. No. But you want that information from 

the credit card companies because then you could match that information with what appears on income tax returns. See, that is what 

you want. 

Ms. OLSON. But that is what we do today with the 1099 information. 

Chairman MANZULLO. Oh, I understand that. But this would be 

a 25 million small businesses, we are not talking about corporations. This is just little guys, small businesses. All that information 

would be going from their credit card company to you so you could 

take that information and you could measure it against what they 

are reporting? 

Mr. BROWN. Yes. 

Chairman MANZULLO. What is that going to cost the IRS to manage all that information? 

Mr. BROWN. We do not know right now. 

Chairman MANZULLO. You do not know? Do you not think it is 

important? 

Yes, we talked to the credit card people. We did that. We have 

in our office. Do you want to know the figure? Eight million transactions per second; that is the entire credit card industry. 

Ms. OLSON. But I do not think that—I mean, this is not my proposal, but the proposal is a total for the year on a calendar year. 

Mr. BROWN. That is right. 

Chairman MANZULLO. Wow, goodness gracious. Eight million per 

second. I cannot even figure that out as a Congressman times 60 

what that is. I mean, can you not see why we are excited here? Can 

you not see why we want to know what is this thing going to cost 

the taxpayers? 

I mean, the first thing that I would do is the guy behind with the $100 million study, all right, and you are with the IRS, right? 

Okay. Mark. Okay. 

The first thing I would do is say before I get Congressman Manzullo all excited, I am going to sit down with Mark and say ‘‘Mark, 

what is this going to cost? Give me a guesstimate. Give me a ballpark figure so that when I come up with efforts to do things, I do 

not come up with a statement that says without imposing significant burden on cad issuers.’’ 

You have no idea what this is going to cost, do you, That 8 million transactions per second? 

Mr. BROWN. We do not precise numbers. That is why we are 

working with the industry right now. 

Chairman MANZULLO. Well, you do not have anything. You have 

got nothing. 

Mr. BROWN. That is not true. We did have meetings with people 

who are familiar with the— 

52

Chairman MANZULLO. No. You can have all the meetings you 

want. They do not know. They are in the business of issuing credit 

to consumers, not giving background information to the IRS. That 

is not their mission. 

Mr. BROWN. But we have ready reference point with banks which 

do report the information to us now. 

Chairman MANZULLO. Oh. I mean, sure you got your 1099s. I can 

understand. But can you not see as the Chairman of the Small 

Business Committee why we see this as angst? Because one thing 

that you could never realize is you come up with formulas and you 

will say well if it is a restaurant, it has got to have this amount 

and that it has got to be 42 percent has to be credit cards and we 

are going to set up our computers so that at 42 percent, whatever 

it is, it is not on credit cards that is going to trigger an audit. 

Somebody has to come up with all those figures and that is another 

study and you already have those secret formula that you cannot 

show the public. Maybe if we shared the formula with the public, 

then the public would know better than to cheat if they know what 

you are looking for. 

Ms. OLSON. Sir, would you rather us not do those studies and go 

out and randomly audit taxpayers? Because the point of the studies 

is that if we do do an audit—I mean, I am supporter of the studies 

because I do not want us going out and just randomly auditing people. I want the IRS to focus its audit resources on the people who 

have the highest amount of noncompliance. 

Chairman MANZULLO. No, I understand. But the problem is this: 

You have already spent $100 million of the taxpayer’s money on a 

study that is lousy. If I may, if I may and I went through this last 

night as I was watching the basketball game. And every time I saw 

something, I would underline it. Every time I saw a basket made 

for your old alma mater, which you do not watch, I saw— 

Mr. SAWICKY. I was working on my testimony then. 

Chairman MANZULLO. That probably put you to sleep. 

But I mean where you do not even have provisions to track your 

data. In other words, you do not even know what you are capturing 

before you are making conclusions. Let me read this to you. 

‘‘Several factors concern IRS about its data on the reasons for 

noncompliance which could be unintentional or intentional, though 

IRS is developing the system to capture better examination data.’’ 

Yes, right. ‘‘IRS does not have firm or specific plans to develop better data on the reasons for noncompliance even though lack of such 

data makes it harder to decide whether it should address specific 

areas of noncompliance through nonenforcement efforts such as designing clear forms of publications on enforcement efforts.’’ 

You do not have the data for that and yet in your testimony you 

went after your boss where you said I am concerned because when 

the IRS Small Business/Self-Employed Division, that is you, Kevin, 

Taxpayer Education and Communication Division was merged with 

its Communication Liaison or Disclosure Division, education staffing was reduced from 699 in fiscal year 2003 to I believe there is 

a typo error in the testimony, is that correct? 

Mr. BROWN. We might want to confirm that. 

53

Chairman MANZULLO. But this says ‘‘Is reduced from 699 to 

184.’’ And I think someone from the IRS contacted us and said the 

real number is 480. 

Ms. OLSON. They disagree with us, but we got this off of the time 

keeping records. So I do not know what to tell you about that. 

Chairman MANZULLO. Okay. Is she right? 

Ms. OLSON. But I mean I have no numbers. 

Mr. BROWN. No. 

Chairman MANZULLO. She is wrong? 

Ms. OLSON. It is all numbers from the IRS. 

Mr. BROWN. I think the number is incorrect. 

Chairman MANZULLO. What is the number? 

Mr. BROWN. The number is approximately 500. But it is not accurate— 

Chairman MANZULLO. You went from 699 to 500? 

Mr. BROWN. No, it is not apples-to-apples. That is what annoys 

me about this. The 699— 

Chairman MANZULLO. This is your fruit you are looking at. 

Mr. BROWN. Yes. The 699 were people who did not work full time 

on education and outreach. They went off for half the year to do 

other duties. Now we have 500 people working full time on this. 

So— 

Chairman MANZULLO. But you are going to have to hire another 

5,000 if you are going to have somebody 8 million transactions per 

second. 

Ms. OLSON. If I might, sir, I think that your point about needing 

to know the reasons for noncompliance is very important. And I 

have written a lot about that in my annual reports. And I think 

that that actually was what was motivating to make the proposals 

about the voluntary estimated tax payments. Because you do not 

want to use an audit— 

Chairman MANZULLO. You mean such as salons? 

Ms. OLSON. Well, the salons, exactly, but also to scheduling a 

year in advance, that you do not— 

Chairman MANZULLO. Yes. I do not think that there is much 

angst in the small business community— 

Ms. OLSON. About that? 

Chairman MANZULLO. —over a system set up like that to make 

it easier for people to be in compliance like that, and if it is truly 

voluntary— 

Ms. OLSON. Well, the way that I looked at this was, and this 

really was me on relying on my own personal experience because 

I have prepared returns for 27 years for these folks and saw these 

things happening, that I believe that the vast majority of people 

who are behind on their payments are self-employed, it really is 

just a matter that they just cannot save. And I do not think that 

we should be using all the clubs and all the enforcements actions 

that the IRS has for those kinds of people. You need to think 

about— 

Chairman MANZULLO. Put them on a budget? 

Ms. OLSON. Exactly. 

Chairman MANZULLO. Good. Good for you. 

Ms. OLSON. And so then what you need to reserve your enforcement resources for are those people who are the most recalcitrant, 

54

who are tending in a direction where they will never get themselves out. 

Chairman MANZULLO. True offenders. 

Ms. OLSON. Yes. 

Chairman MANZULLO. Let me read something else here. This 

says, this is on page 4, I mean this is some pretty interesting reading. ‘‘IRS approach for reducing the tax gap includes improving taxpayer service to increase voluntary compliance and enhance an enforcement of tax laws by detecting and addressing noncompliance, 

but does not incorporate some steps consistent with results oriented management. To support this approach IRS has established 

two broad strategic goals and identified over 40 related key efforts 

which includes using direct enforcement actions to address high income non-filers and using analytical models to pursue higher priority collection cases. However, IRS has not established long term 

quantitative compliance goals and regularly collected data to track 

progress is reducing the tax gap which would compliment its current important compliance efforts.’’ 

I mean, so you have no way to determine if what you are doing 

is the right way to go, but you are on your way. And now you are 

off into a whole area, you with your own proposal, to have individuals withhold and the credit card companies to have them withhold 

on people that are not paying their taxes. More government, more 

rules, more regulations, more compliance. 

Ms. OLSON. Well, I can only tell you that in my proposal I would 

insist on those controls. And I think that— 

Chairman MANZULLO. Yes, but you will not be there forever. 

Ms. OLSON. Well, that is true. But one would hope that you all, 

someone will be in your chair and we will hope is honest. 

Chairman MANZULLO. And it does not work that way. Because 

unless you have been raised in small business, you have no idea. 

No idea what is going on. 

What this is saying here is that the IRS goes off in new directions in enforcement but does not look where you have been. It 

does not seem to care because you have no way of measuring it. 

I mean you were there so long you dropped off your sleeping bag 

in the office last night, you stop by and see us so frequently. 

Ms. Everson said that the tax gap was reduced from 43.1 to 47.3 

billion. Evidently, an extra 6 billion came in approximately, or 4 

billion came in. 

Mr. BROWN. That is referring to enforcement revenues. 

Chairman MANZULLO. Enforcement revenues from one year to 

the next? 

Mr. BROWN. Yes. 

Chairman MANZULLO. How much of that came from the small 

businesses that we’re talking about? Do you have any idea? 

Mr. BROWN. The increase? 

Chairman MANZULLO. Yes. 

Mr. BROWN. I do not know. 

Chairman MANZULLO. I will bet you do not. That is what they 

are talking about. 

Mr. BROWN. No, I can get—no, I can get— 

Chairman MANZULLO. See, you have no way to determine it because you do not have the procedures set up for that. 

55

Mr. BROWN. Oh, I can get you the number. We can get you that 

number. 

Chairman MANZULLO. You have got it there? 

Mr. BROWN. I just do not have it now. 

Chairman MANZULLO. It is not there? Obviously, you cannot 

bring everything with you. The point is is that that is important 

to determine whether or not you are spending your resources in the 

same area. Do you not agree? 

Mr. BROWN. Yes, but— 

Chairman MANZULLO. I mean you have to know if you are successful. 

Mr. BROWN. Yes, but we have a number of measures that do tell 

us whether or not we are successful. We look at no change rates; 

when you have a high no change rate as the Commissioner described in the C-Corporation, area— 

Chairman MANZULLO. Right. 

Mr. BROWN. — you realize that those are not a fruitful way to 

spend your audit time. 

Chairman MANZULLO. Right. So you go after the little guys? 

Mr. BROWN. You have other measures about average adjustment, 

things like that. I mean, there are a number of measures there 

that tell you are you auditing in the right areas and are you getting anything out of the audits. 

Chairman MANZULLO. Well then if that is the case, then why is 

this report so damning? 

Mr. BROWN. Because they are talking about closing the overall 

tax gap, which at the time they wrote the report we did not even 

have a precise estimate for. 

Chairman MANZULLO. I mean they said, GAO actually complimented IRS on having the right figure on what the tax gap was, 

which I thought was quite interesting. 

Mr. BROWN. And we are also now in the process of developing. 

We have gotten a number of the same sorts of questions from the 

Senate Finance Committee. 

Chairman MANZULLO. Why do you not develop all this stuff? Why 

do you not get all your facts before you come out with these proposals? I mean you know how this Congress is. I mean this could 

be slipped in. I think Commissioner Everson said himself that he 

appreciates a hearing like this because he’s afraid stuff like this 

would get slipped in in the middle of the night into something and 

then everybody’s scared. 

I know I have prolonged this beyond it. But what happened with the HOPE Scholarship thing, I mean that was $100 million a year 

that was imposed on higher education that would have been passed 

on to the students. And that got put into law. President Clinton insisted that the colleges report that. That was his language that was 

added to it before he signed the bill. And no one had ever done that 

estimate on the compliance of it. 

I mean you guys have got to find out what this stuff is going to 

cost— 

Mr. BROWN. We agree. 

Chairman MANZULLO. —before you do it. And then look at the 

second thing is how much more of the underground economy are 

you going to create? Word gets out on the streets, IRS is going after 

56

credit card transactions, if you pay me in cash, I will give you 20 

percent discount. Do not take any credit cards. How much are you 

going to push underground with this? 

Mr. BROWN. Well, I can tell you unfortunately that is already 

going on. 

Chairman MANZULLO. Well, of course. It is going to go on even 

more. 

Now do you really think that the sophisticated cheater who gets 

his money from Visa is going to encourage his consumers to say 

this transaction is priceless. He is going to say pay me in cash. And 

what you are proposing is going to have even more of an underground economy. It will be counter productive and then we lose on 

both ends. 

Mr. BROWN. Ultimately I think time is on our side. When I can 

go to the Wendy’s drive-through window now and use a credit card, 

I mean we are moving into— 

Chairman MANZULLO. That’s Wendy’s. They’re big. 

Mr. BROWN. Yes, but I can— 

Chairman MANZULLO. I mean, you know, what about the Shady 

Grove Drive-In that my dad ran from 1954. No, that was the name 

of it. 1954 to 1970? 

Mr. BROWN. Even taxicab drivers are now frequently taking credit cards. 

Chairman MANZULLO. Well, you know what? My brother never 

took credit cards in his restaurant. You know why? 

Mr. BROWN. Probably the fee. 

Chairman MANZULLO. No. That is right. His margin was so small 

that he was not about to pay 3 percent. And he told his customers 

if they came there, they wanted to give him a Visa, he said give 

me a personal check. The guy said I left my checkbook at home. 

And my brother would give him a 3 by 5 card with his name, address and the amount of the bill and the guy would send him a 

check in the mail. 

You know, our goal is to keep things simple. But you are off on 

a terrible road there. And as long as I sit in this chair, and unfortunately that is only until the end of this year, this will get slipped 

in in the middle of the night. I understand the guys over in the 

Senate, the millionaires over there, most of them are millionaires 

that do not know what it is like to meet a payroll to be raised in 

small business, are trying to come up with a proposal to slip this 

in somewhere. Okay. Well thank you guys for coming. I appreciate 

what a diverse background we have. 

Did you have fun, Michael? 

Mr. FREDRICH. I had a thrilling time today. 

Chairman MANZULLO. Have you ever testified before Congress 

before? 

Mr. FREDRICH. I did one time on minimum wage. 

Chairman MANZULLO. Well, to each of you thank you so much for 

coming, especially those that traveled a long distance. 

And this hearing is adjourned. 

[Whereupon, at 12:59 p.m., the Committee was adjourned.]

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