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21–288 PDF 2005

CLOSING THE TAX GAP AND THE IMPACT ON

SMALL BUSINESS

HEARING

BEFORE THE

COMMITTEE ON SMALL BUSINESS 

HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

WASHINGTON, DC, APRIL 27, 2005

Serial No. 109–13

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 ... 2

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

Business Administration ..................................................................................... 5

Satagaj, Mr. John, President and General Counsel, Small Business Legislative Council ........................................................................................................... 18

Hall, Mr. Keith, CPA, Partner, Hall and Hughes ................................................. 20

Schneier, Mr. Abraham, Abraham Schneier & Associates ................................... 22

Steinberg, Mr. Leonard, EA, CMC, The Steinberg Group ................................... 23

Hegt, Mr. Ronald, Member, American Institute of Certified Public Accountants ........................................................................................................................ 25

APPENDIX

Opening statements: 

Manzullo, Hon. Donald A. ................................................................................ 28

Velazquez, Hon. Nydia ..................................................................................... 30

Prepared statements: 

Everson, The Honorable Mark W., Commissioner, Internal Revenue Service ................................................................................................................... 34

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

Small Business Administration ................................................................... 46

Satagaj, Mr. John, President and General Counsel, Small Business Legislative Council ................................................................................................ 54

Hall, Mr. Keith, CPA, Partner, Hall and Hughes .......................................... 58

Schneier, Mr. Abraham, Abraham Schneier & Associates ............................ 65

Steinberg, Mr. Leonard, EA, CMC, The Steinberg Group ............................ 72

Hegt, Mr. Ronald, Member, American Institute of Certified Public Accountants ....................................................................................................... 80

(III) 

(1)

CLOSING THE TAX GAP AND THE IMPACT ON 

SMALL BUSINESS 

WEDNESDAY, APRIL 27, 2005

HOUSE OF REPRESENTATIVES

COMMITTEE ON SMALL BUSINESS

Washington, DC 

The Committee met, pursuant to call, at 2:15 p.m. in Room 311, 

Cannon House Office Building, Hon. Donald Manzullo [Chairman 

of the Committee] presiding. 

Present: Representatives Manzullo, Kelly, Sodrel, Fitzpatrick.

Chairman MANZULLO. Good afternoon and welcome to this hearing on a very important topic for small businesses around the country, closing the tax gap. 

There would be no tax gap without the Income Tax Code. Interestingly, almost 92 years ago to the day and in this very hearing 

room, then Ways and Means Chairman Oscar Underwood, with the 

assistance of Representative Cordell Hull, reported the first income 

tax out of Committee shortly after the ratification of the 16th 

Amendment. 

This income tax consisted of only eight pages in an 814-page tariff bill. Today the Internal Revenue Code spans more than 60,000 

pages. 

I guess maybe we can go back 92 years and back to eight pages 

again. That might work. 

As we sit here today, President Bush is delivering a speech during the Small Business Administration 2005 Small Business Expo. 

His speech will likely not include anything about the topic of the 

hearing today. 

The tax gap is something not many want to talk about, but is 

nonetheless real. There is a difference between what is owed by 

many taxpayers and what is actually paid to the Treasury. 

The National Research Project was an effort to study the tax gap. 

Using data from 2001, the study validated that there was a big tax 

gap in the magnitude of $300 billion. A large portion of this gap 

has been attributed to small businesses and the self-employed. 

The purpose of the hearing is to review with the Commissioner 

and other witnesses where to go with this data. Before we begin 

that process, it is important to point out that the preliminary data 

is woefully incomplete, because it provides no estimate of the tax 

gap for C corporations or flow-through entities, such as partnerships. 

2

The data for these entities is still from the 1980’s, a time that 

is far removed from the aggressive tax strategies that many blue 

chip accounting and law firms developed during the late 1990’s. 

While the data has some deficiencies, no one can argue that 

there is not a big problem. The question becomes, ‘‘What is the appropriate response?’’ 

How do we make small business taxpayers more compliant, while 

at the same time minimizing the burden? Increasing enforcement 

means nothing if those being policed don’t understand the laws or 

the nature of the violation. 

While I understand the push to lower the budget deficit and the 

readily available statistics that support increased enforcement, imposing increased burdens on small businesses through more audits 

cannot be the only answer. 

Many times small business owners are attempting, to the best of 

their ability, to comply with the complex Tax Code. It is not that 

they don’t want to comply. Rather, the system and paperwork are 

so complex that it is difficult to comply. 

No matter how many additional auditors and collection agencies 

are added to the IRS, there will still be a more pressing need to 

educate taxpayers about their obligations. 

The IRS will never have enough resources to police everyone and 

thereby enforce compliance. Small business people are not tax experts and they face real difficulties with complying with the tax 

system. 

The method used by the IRS to interact with these individuals 

can be the difference between success and failure. It is much easier 

for a small business owner to learn how to comply with the tax 

laws through taxpayer education and outreach than the adversarial 

audit and collection processes. 

Congress certainly needs to simplify the Code and strongly support the President’s effort to analyze and reform the current system. 

While the IRS Commissioner will not be able to stay for the entire hearing, Kevin Brown, the Commissioner of the Small Business Self-Employed Division and other staff will stay for the entire 

hearing so that they can listen to the testimony of the other witnesses. We appreciate that very much. 

Commissioner Everson, it is a pleasure to have you here today 

as well as Mr. Sullivan. Mr. Everson, you are up first. Go ahead. 

I am not going to set the clock here. 

[Chairman Manzullo’s opening statement may be found in the 

appendix.] 

STATEMENT OF THE HONORABLE MARK W. EVERSON, 

INTERNAL REVENUE SERVICE

Mr. EVERSON. I don’t think I will use too much time, sir. Mr. 

Chairman, thank you for the opportunity to discuss the important 

subject of the tax gap and in particular, the portion of the gap relating to small businesses and self-employed individuals. 

I very much appreciate your interest in and efforts to increase 

compliance with the tax laws. 

3

Simply put, the tax gap is the difference between the tax that 

taxpayers should pay according to law and what they actually pay 

on a timely basis. 

Our research confirms that the vast majority of Americans pay 

their taxes honestly and accurately, but the findings also show that 

even after IRS enforcement efforts and late payments, the government is being shortchanged by over a quarter trillion dollars each 

year, because some pay less than their fair share. 

People who aren’t paying their taxes shift their burden to the 

rest of us. In this time of budget deficits, a dollar not received by 

the government becomes debt, the burden of which will be felt by 

future generations. Our research shows the gross tax gap to be between $312 billion and $353 billion. The old tax gap estimate for 2001 was $311 billion, a figure based on studies conducted in 1988 and earlier. 

So there has been what I would term a modest deterioration in 

tax compliance among individual taxpayers since the last study 

was conducted in 1988. 

IRS enforcement efforts, coupled with late payments, recover 

about 55 billion of the total gross tax gap, leaving a net annual tax 

gap of between $257 billion and $298 billion. Current data are preliminary, so our tax gap estimates are shown as ranges. 

As refinements are made to the analyses, some estimates may 

change. It is unlikely, but possible, that the final estimates of the 

total tax gap will fall outside the established range. 

There are two views of the tax gap: By type of noncompliance, 

that is non-filing, underreporting and underpayment and by type 

of tax. The new research for 2001 addresses the underreporting of 

income and self-employment taxes by individual taxpayers. It is 

based on audits of 46,000 individual returns. 

As you indicated, Mr. Chairman, the study did not address compliance for either small or large businesses organized as corporations. 

Preliminary findings include: Underreporting noncompliance is 

the largest component of the tax gap. Preliminary estimates show 

underreporting accounts for more than 80 percent of the total tax 

gap, with non-filing and underpayment at about ten percent each. 

Individual income tax is the single largest source of the annual 

tax gap, accounting for about two-thirds of the total. 

For individual underreporting, more than 80 percent comes from 

understated income, not overstated deductions. Most of the understated income comes from business activities, not wages or investment income. 

Compliance rates are highest where there is third party reporting or withholding. For example, preliminary findings show less 

than 1.5 percent of wages and salaries are misreported. 

The next stage of our research will be to finish the data analysis 

and refine the tax gap data by late 2005. The IRS will use the data 

to update its statistical tools for selecting individual returns for 

audit. 

Our tax gap research confirms two key points involving tax enforcement and simplification. The IRS needs to enforce the law so 

that, when Americans pay their taxes, they are confident that their 

neighbors and business competitors are doing the same. 

4

At the same time, this research underscores the President’s call 

for tax reform. Complexity obscures understanding. Complexity in 

the Tax Code compromises both the Service and enforcement missions of the IRS. 

Those who try to follow the law, but cannot understand their tax 

obligations, may make inadvertent errors or ultimately throw up 

their hands and say, why bother? 

Meanwhile, individuals who seek to pay less than what they owe 

often hide behind the Code’s complexity in order to escape detection 

by the IRS and pay less. 

Mr. Chairman, as I have said before, enforcement activity to 

close the tax gap is only part of the equation. We must also provide 

good service to taxpayers to help them understand their tax obligations. 

Small businesses in particular struggle to deal with an increasingly more complex Tax Code. We view our goals of reducing taxpayer burden and helping small businesses understand our very 

complicated and I would note ever changing Tax Code as a cornerstone of the services we provide. 

We are very cognizant of the fact that small business owners 

have unique needs. In recognition of the fact that different groups 

of taxpayers have different characteristics, the IRS is currently organized around four taxpayer segments. 

Our small business and self-employed operating division’s mission is to address the tax compliance needs of small businesses and 

self-employed individuals through education, outreach, assistance 

and where necessary, enforcement. 

I was pleased to note that the NFIB, in its written statement, 

observed that ‘‘One of the lesser known successes over the past five 

years has been that with the assistance of the staff of the small 

business, self-employed division at IRS, the concept of common 

sense rules for smaller business owners has taken root.’’ 

Through the small business, self-employed division, we are able 

to focus on initiatives to reduce the burden of tax compliance on 

small business. 

For example, we recently increased the Federal Unemployment 

Tax deposit threshold from $100 to $500, reducing burden for over 

2.6 million employers. 

We also simplified the Schedules K-1 for partnerships and S corporations, reducing burden by an estimated 95 million hours for 

the 20 million taxpayers who file these forms. 

In addition, we are actively considering allowing very small employers to file their employment tax returns annually instead of 

quarterly. 

We estimate this action alone could reduce burden on approximately one million businesses by some 50 million hours. 

Finally, I would like to point out that our system of tax administration is fundamentally one of self-assessment and enjoys a high 

compliance rate. 

The IRS is moving aggressively to reduce the tax gap. With proper funding over a number of years, we will be able to close a significant portion of the gap, but no one should think we can totally 

eliminate the gap. That would take Draconian measures and make 

the government too intrusive. 

5

We have to strike the right balance. Thank you. 

[The Honorable Everson’s statement may be found in the appendix.]

Chairman MANZULLO. Thank you, Commissioner. 

Our next witness is Tom Sullivan, Chief Counsel for Advocacy at 

the U.S. Small Business Administration. 

Mr. Sullivan, we look forward to your testimony. 

STATEMENT OF THE HONORABLE THOMAS M. SULLIVAN, US 

SMALL BUSINESS ADMINISTRATION

Mr. SULLIVAN. Thank you, Mr. Chairman. Thank you for giving 

me the opportunity to appear before the Committee this afternoon. 

My name is Tom Sullivan, the Chief Counsel for Advocacy at the 

Small Business Administration. 

My office is an independent office within the SBA and therefore, 

the comments expressed in this statement do not necessarily reflect 

the position of the Administration or the SBA. 

With the Chair’s permission, I would like to submit my written 

statement for the record.

Chairman MANZULLO. The entire written statements of all the 

witnesses will be made part of the record without objection.

Mr. SULLIVAN. Thank you, Mr. Chairman. 

The Office of Advocacy shares with the Commissioner the view 

that the tax gap is a serious problem. The funding shortfall is not 

the only problem created by the tax gap. 

As National Taxpayer Advocate Nina Olson stated in her 2004 

testimony before the Senate Committee on Finance, ‘‘It comes down 

to a simple issue of fairness.’’ 

The fact that 85 percent of taxes are paid in full reinforces the 

view that the remaining 15 percent needs to be paid by those who 

owe it. 

The Office of Advocacy, however, does not agree with the view 

that prioritizing enforcement will necessarily close the tax gap. We 

believe, like the Commissioner stated in his oral statement, that a 

balanced approach, relying on a combination of compliance, assistance, taxpayer education and enforcement, is likely to close the gap 

in an efficient manner. 

Most small businesses pay their taxes in full and on time. However, doing so is never easy for them, as the cost of complying and 

the difficulty in following the Tax Code can be overwhelming. 

In 2001, my office released a report on the regulatory costs faced 

by small firms. That study contained an estimate of tax paperwork 

compliance costs and in 2000, the typical small business, with 

fewer than 20 employees, spent over $1,200 per employee to comply 

with tax paperwork, recordkeeping and reporting requirements. 

This is over two times the compliance costs faced by larger firms, 

but the estimated burden hours for filling out forms do not tell the 

whole story of how difficult compliance can be for small business. 

Most small firms do not have full-time personnel to handle tax 

compliance issues. Many hire outside assistance and many more 

6

small business owners devote valuable time to taxes that is not 

then available for them to run their business. 

This Committee certainly knows the contribution of small business to the United States’ economy. Small businesses make up over 

99 percent of all businesses in the United States and employ just 

over half of the American workforce. 

Perhaps even more importantly, small firms create over twothirds of the net new jobs annually and recently led the American 

economy out of a recession. 

Yet, small business accomplishes this even while facing a regulatory compliance burden that is roughly 60 percent greater per 

employee overall than that faced by larger firms and a tax compliance burden more than twice as large. 

At issue then is how compliance can be improved and the tax gap 

narrowed without adding to the burden of small business? 

My office favors a balanced approach, one that includes commensurate doses of education, compliance assistance and enforcement. 

In order to focus its efforts, the IRS did develop the National Research Program to measure reporting, filing and payment compliance for different types of taxes and different groups of taxpayers. 

The final report isn’t available, but IRS has published 17 pages 

of preliminary results. The release generated a flurry of comments 

coinciding with the weeks preceding April 15, when Federal tax filings were due. 

I think that this Committee and really all the folks and policy 

leaders in Washington, D.C. should be clear that these results are 

preliminary. 

Let me also caution that the connection between enforcement 

and compliance is not necessarily clear either. Research by economist Bruno Frey and Lars Feld suggests that excessive enforcement can lead to less compliance. 

Compliance cannot be increased only through enforcement, but 

rather the more balanced approach that was mentioned by the 

Commissioner and myself. 

Although tax rates have declined over recent years, the costs of 

complying with taxes has increased. Noncompliance is a more subtle, hidden cost of tax complexity, but the direct costs in time and 

effort to maintain the necessary records and complete the proper 

forms is the more obvious direct cost. 

According to OMB paperwork burden estimates, the number of 

hours Americans spend on taxes has grown by 24 percent over the 

last ten years. 

I believe in the honesty of the majority of small businesses and 

their willingness to comply with the Tax Code and contribute their 

fair share. 

Additional taxpayer education, compliance assistance and a more 

simple Tax Code are key ingredients to increased compliance. If 

small businesses are able to understand and easily follow the rules, 

they probably will. 

Thank you for allowing me to present these views and I am looking forward to questions. 

[The Honorable Sullivan’s statement may be found in the appendix.]

7

Chairman MANZULLO. Thank you. I guess what concerns me is 

that the last IRS report done addressing the tax gap was done in 

1988. The latest update by the National Research Program excludes C corporations and the extent to which they may be underreporting or cheating. 

Our concern here at the Small Business Committee is that if you 

are talking about more enforcement and the only study that has 

been done as to noncompliance or updated study as to noncompliance are small businesses and individuals, then why are we having 

enforced compliance if we don’t know the extent to which the C corporations may be ripping off the taxpayer? That is sort of a loaded 

question.

Mr. EVERSON. No. But I am happy to explain why I think the sequencing is what it was. This program was all laid out about three 

or more years ago and the decisions taken at the time was that this 

was the place to start. It wasn’t a view that you would never get 

to C corporations. 

For the last several years, Mr. Chairman, we have articulated 

four enforcement priorities that have been in the heart of the President’s budget request for more enforcement monies. The very first 

element of that is to detect and deter abusive activities by corporations, high income individuals and other contributors to the tax 

gap. 

The more monies that have been requested for the IRS, up to 

this point for enforcement, have been largely targeted towards abusive tax shelters, towards corporations and high income individuals. 

We can show you the rate of increase in the high income audits 

that have taken place over the last several years. It has been doubled basically in terms of the total number of returns. 

You can see what happened here was a very precipitous decline 

that was coincident with the Roth hearings, the bashing that the 

Service took in the 1990’s. Real efforts were made to increase services and those efforts were successful by any measure. 

But what happened was we backed away from enforcement generally. What is happening now is a recovery of enforcement. This 

is the high income piece.

Chairman MANZULLO. If I could interrupt you.

Mr. EVERSON. Yes.

Chairman MANZULLO. I accept that, but my question deals with 

new energy at the IRS for increased audit, et cetera. But the study 

excludes C Corporations. These could be small businesses.

Mr. EVERSON. You are exactly right. Let us go to the tax gap 

map if we could, Bill. The map will show you that of that estimated 

gross gap of $312 to $353 billion, the corporations, using that old 

methodology from the 1988 study that you talked about and updating it for changes in economics and demographics, the corporate 

piece would be about 30 billion. 

Now, you are right. If you—

8

Chairman MANZULLO. I have to interrupt you on it, because I am 

concerned that there is not a new study updating the 1988 study 

for C corporations.

Mr. EVERSON. Yes.

Chairman MANZULLO. As to everybody, except the C corporations, but you are making conclusions here and you are also going 

to step up your enforcement, as to those people to whom you find 

are involved in the tax gap.

Mr. EVERSON. We knew there were problems with corporations 

and we have been devoting the additional resources to that. That 

has been the very top line item of the President’s budget request 

to get more auditors for corporations. 

We have been working aggressively on that. Congress has not 

provided all the money. You may know that we asked for an additional 500 million last year. We got 50 million. 

But we have been devoting more to corporations. The rough point 

I would say is even if you believe that there is more noncompliance 

there and I do, I am on the record repeatedly, as you may know, 

to go after these areas. We are devoting more resources to that. 

Even if you look at 2001 as you indicate, there is a change in receipts mix, by the way, too. Since 2001, receipts have recovered for 

corporations. The individual rates have resulted in income taxes 

going down for individuals as a portion of the two trillion we get. 

Even if you double this though, sir, in terms of the corporate 

number, you get 60 or 70 billion. You are still left, even if the total 

gross gap approaches 400 billion, with over half of it coming from 

small business and by small businesses. That would be the combination of the individuals with the Schedule C, it would be the 

Subchapter S corps, those C corps and as you know the C corps for 

small businesses and by small businesses for C corps we say those 

are less than $10 million in assets. 

Those numbers have been coming down over the years. They 

have been replaced by more partnerships and more S corps. 

If you take all that, you are right. That number is understated. 

It is no doubt understated. But still half that gap, even if you inflated these numbers, would still be in the small business area. So 

it needs to be addressed.

Chairman MANZULLO. It needs to be studied before we can enforce it. 

Mr. Fitzpatrick?

Mr. FITZPATRICK. Mr. Everson, thanks for your testimony today.

Mr. EVERSON. Thank you, sir.

Mr. FITZPATRICK. My district is in Pennsylvania. I don’t have a 

lot of big businesses. We have a ton of small businesses. We like 

to say in Bucks County, Pennsylvania, small business is big business. So a lot of people are watching this.

9

Mr. EVERSON. Yes.

Mr. FITZPATRICK. I would be happy to report back to them. I 

have a question on the tax gap. I think it was reported that back 

in the 1970’s the tax gap was about ten percent, but by 1984 it had 

risen 40 percent to about 14 percent, but by the time President 

Reagan’s tax cuts and his Tax Reform Acts were fully implemented 

and realized, the tax gap had come back down to below ten percent. 

That it was easier I guess for small business, you could conclude, 

to comply—

Mr. EVERSON. Yes.

Mr. FITZPATRICK. —with the simpler Tax Code. 

Is it your belief that there is a relationship between the tax gap 

and the simplification of the Tax Code and lower taxes specifically?

Mr. EVERSON. Yes, absolutely, sir. I think you may have come in 

after I started to give my oral statement. 

I believe that what has happened here is the enforcement has 

fallen off. You have to recover there and have a balanced approach, 

but that the second piece of this and the President has got it right, 

is a call for tax reform. 

I have testified before the Tax Panel and made this very clear. 

Complexity obscures understanding. There is a real element of this 

where if people don’t understand the law, they make inadvertent 

errors. Some throw up their hands and say, why bother? 

At the same time, those who seek to avoid detection or not comply and here you get to the Chairman’s point, largely the more sophisticated corporations who have been led into these structures by 

attorneys and accountants, they profit from the complexity. 

At the IRS, we are absolute advocates of simplification of the 

Code. Yes, sir.

Mr. FITZPATRICK. How much time and effort is spent on advocacy 

and education I guess is the better word? An awful lot of small 

businesses get to the end of the quarter and they are struggling. 

They have got to make their quarterly payment. The resources 

aren’t there and so some just sort of drop out of compliance. 

This is Small Business Week. I think this is financial literacy 

month. What does the IRS and perhaps Mr. Sullivan, from the 

SBA, can comment as well, what is the plan for a greater education 

of small business on the importance of and obvious benefits of compliance?

Mr. EVERSON. At this stage, what happened was, as I indicated, 

the IRS, it was reorganized after these hearings in the mid 1990’s 

to have four business units, as well as our criminal investigation 

unit. That is the bulk of the employees. 

One of the units that was established was the small business, 

self-employed unit, to focus on this basket of taxpayers, if you will. 

I think that that has been a successful reorganization, because 

it has allowed a targeting, if you will, just along these lines. 

10

We have got about 400 people who work full-time. They do do the 

work of education, working with practitioner groups, working with 

the various organizations, if you will. 

I meet from time-to-time with some of these groups as well and 

we try to get the word out through publications, a whole series of 

things. 

I think that has been successful, frankly and made a difference, 

in terms of the relationship. I quoted the NFIB’s statement in my 

oral remarks and I think that there is a rather positive story here. 

Now I will be clear. At this stage, because of the absolute problem on the enforcement side, the incremental resources we are putting into this are on the enforcement side. 

The President has asked for a bump up of eight percent in the 

budget. I would like to say that is supported by GAO. If the Chairman will indulge me for just a minute, I will tell you what GAO 

has said on this subject. 

It says on service that the IRS has made significant progress in 

improving the quality of its taxpayer services. For example, IRS 

now provides many Internet services that did not exist a few years 

ago and has noticeably improved the quality of telephone services. 

This opens up the possibility of maintaining the overall level of 

taxpayer service but with a different menu of service choices. 

Cuts in selective services could be offset by the new and improved services. On the other hand, they have listed enforcement 

of the tax laws as one of their high risk areas. 

I don’t know if you are familiar with this, but every two years 

they issue a list of about two dozen high risk areas for government 

and what they have said on enforcement is, this is a quote from 

the GAO’s report, ‘‘Given the broad declines in IRS’ enforcement 

workforce, IRS’ decreased ability to follow up on suspected noncompliance, the emergency of sophisticated evasion concerns and 

the unknown affect of these trends on voluntary compliance, IRS 

is challenged on virtually all fronts in attempting to ensure that 

taxpayers fulfill their obligations.’’ 

‘‘IRS’’ success in overcoming these challenges becomes ever more 

important, in light of the nation’s large and growing fiscal pressures. Accordingly, we believe the focus of concern on the enforcement of tax laws is not confined to any one segment of the taxpaying population or any single tax provision. 

Our designation of the enforcement of tax laws as a high risk 

area embodies this broad concern. 

So we are not suggesting we wouldn’t want to do more in services, but this is a tight fiscal situation for the country, but the 

greater need frankly is in enforcement.

Chairman MANZULLO. Mrs. Kelly.

Ms. KELLY. Thank you, Mr. Chairman. 

Thank you both for speaking today. Mr. Everson, you are talking 

about going out and essentially the way it is going to read to the 

public, lowering the boom on small businesses. 

I want you to tell me some things now that you are going to do 

to make sure that if an IRS agent walks into a small business, it 

11

isn’t going to be a ‘‘gotcha’’ attitude, but it is going to be a helpful 

attitude. 

Our tax laws are so complex. Our small businesses are taxed. 

Some people who own small businesses are taxed twice. This is 

hardly fair to small businesses carrying a huge tax load of huge tax 

burden in this nation. We need our small businesses. We are creating the new jobs.

Mr. EVERSON. Yes.

Ms. KELLY. Tell me, sir, what you are doing to bring across an 

attitude and ensure that the people who enter a small business will 

be there saying, ‘‘I am from the IRS and I am going to help you 

figure out how you can do this right.’’ 

Most people want to live by the law. Most people don’t want to 

evade, but they eventually throw up their hands, because it costs 

small businesses much more to file than it does large businesses. 

You know that, sir. 

What can you tell me? How can you help me go back and tell my 

small businesses that you aren’t going to come in and really just 

wrap the rules around their neck?

Mr. EVERSON. I think those are all valid points and the first 

thing I would say is obviously the experience of the 1990’s where 

there were the difficult hearings and the great focus on the service 

issues. They have had a very clear effect. 

First of all, the Congress wrote in a whole series of new procedures that protect taxpayer rights. If our people get out of line, rest 

assured they get into pretty significant trouble quite quickly. So 

that is very important. The procedures are different. 

The second thing I would say, and this is where the research will 

be very helpful, right now the audit rate is around one percent. 

This is not a very high rate and when an audit takes place, the 

no change rate within the audits, that is to say what happens you 

go in and then do you assess tax or not, the no change rate, where 

we are not assessing more tax, it is about 12 percent. 

As we update this research, it better helps us to find out, based 

on what is on the return or third party information we have received, where we should go so that we are not going into a business 

that is or looking at a Schedule C return where it doesn’t look pretty likely, frankly, that there is a problem. So that is a very important part of this as well.

Ms. KELLY. Excuse me, sir, but you really didn’t answer my question. I want to know what you in particular are doing to tell the 

people when they arrive, because you have suspicion that there 

may be a problem there. I was here. I voted on that law.

Mr. EVERSON. Yes.

Ms. KELLY. Mr. Manzullo was here. He voted on that law.

Mr. EVERSON. Yes.

12

Ms. KELLY. What I want to know is what you are doing right 

now? If you are going to push this enforcement, to make sure that 

when people come in, the person from the IRS doesn’t walk in and 

say, ‘‘Look I am sorry, but I have got to find something, because 

they think you have hidden something?’’

Mr. EVERSON. Sure. All I can tell you, ma’am, is that we constantly emphasize this in our meetings with executives and other 

employees that, as we rebuild enforcement, we have to pay absolute attention to taxpayer rights and to not letting anybody go 

overboard thinking that this is a license to act inappropriately. We 

talk about—

Ms. KELLY. Have you ever—

Mr. EVERSON. I am sorry?

Ms. KELLY. Have you ever fired anybody for abusing taxpayer 

rights?

Mr. EVERSON. We fire people all the time. I can get you data on 

what happens, and I don’t want to give you a precise answer on 

what the history is on this. Since RRA98, what has happened is 

there is a series of ten deadly sins that you wrote into the law and 

there is a Committee that is below me that looks at this. 

There are things where they are automatic firings and they bring 

up to me cases where they are asking for some mitigation and typically they are not in this area. That is not an area where we would 

count as a problem. 

You wrote in standards where somebody might presumably be 

fired for late filing their own tax return, even if it was a refund 

to a return. Those are the kinds of things that are brought to my 

attention, to mitigate the automatic presumption of firing.

Ms. KELLY. Thank you.

Mr. EVERSON. Certainly.

Chairman MANZULLO. I am still intrigued by the study that is incomplete and yet the results of this incomplete study are being 

used to increase enforcement upon what is apparent to be small 

business people. 

Let me tell you how bad this study is and why there may be a 

limitations amendment to the appropriations bill to not give you 

any more money for enforcement until this is taken care of. 

This was a study of 45,000 taxpayers. In the general population, 

six percent of the returns have a Schedule C, but in the sample 

through this study, 46 percent of the returns had Schedule C. 

I can only come to the conclusion that this thing was targeted 

right at the small business people. Can you or perhaps your aide 

with you who did the study, explain to us why this sampling is so 

grossly out of proportion to the normal people that have, normal 

number of taxpayers that file a Schedule C?

13

Mr. EVERSON. Certainly, sir. If my answer is too general, my director for research will answer that. This was intentional and it 

was intentional both for high income individuals and Schedule C 

filers, because of the more complexity. 

Just because you over sample, it helps you make sure you have 

the right results. This was looked at by GAO. GAO has reviewed 

the National Research Program three times as to how it was set 

up and their initial review of this in 2002, they concluded, ‘‘NRP’s 

design is likely to yield the sort of detailed information that IRS 

needs to measure overall compliance, develop formulas to select 

likely noncompliant returns for audit and identify compliance problems for the agency to address. The sample is adequately sized for 

these tasks’’ and they go on from there. 

Just because you take a larger sample doesn’t mean you don’t adjust that for when you extrapolate or do the research. That is what 

they are doing.

Chairman MANZULLO. It still doesn’t make sense. Six percent of 

the general population files a Schedule C, but 46 percent of the returns in your sample has Schedule C’s. Therefore, the IRS purposely aimed its guns at small businesses.

Mr. EVERSON. I don’t share that assessment of that.

Chairman MANZULLO. Let me ask you a question. If 46 percent 

of the returns had Schedule C’s attached to them, what does that 

indicate to you? I mean who files Schedule C’s?

Mr. EVERSON. I am sure you are aware there about 18 or 19 million Schedule C filers at present. So it is a big number. It has increased to almost 15 percent of the 1040 returns.

Chairman MANZULLO. Wouldn’t you agree that small business 

people are more likely to file a Schedule C?

Mr. EVERSON. Absolutely. Yes, sir. Yes, sir, but—

Chairman MANZULLO. That is the whole point.

Mr. EVERSON. But it is not blown out of proportion. The statistics 

they are using this to get a better handle. I would have thought 

you would be happy about it, because statistically, as I understand 

it, you are going to get a more reliable projection from this.

Chairman MANZULLO. I can’t accept that. The sample has seven 

times more people with Schedule C than the general population. 

If you are going to do a sample, you go all the way across the 

breadth on it. This survey was intended and aimed at small business people.

Mr. EVERSON. It was aimed at the more complex. The overstatement was in the more—

Chairman MANZULLO. Those are small business people.

14

Mr. EVERSON. Not only small business people. Not only small 

business people.

Chairman MANZULLO. One thing that the work has not been 

done is on the C corporations. I would suggest before the IRS lowers the hammer on going after small business people, who have 

enough problems in this world, that you do your research on C corporations so instead of extrapolated and whatever the words that 

were used on there, we know exactly what is going on with the 

gross tax gap. Because the resources that you are going to take, the 

additional resources are going to be aimed at those small business 

people and not at the C corporations.

Mr. EVERSON. That is not true, sir.

Chairman MANZULLO. That is—

Mr. EVERSON. That is not what the budget request has provided. 

We asked for—

Chairman MANZULLO. That may be the budget request, but I can 

assure you that this is the gravamen of your whole study. It is the 

small business people.

Mr. EVERSON. We are seeking to do more in this area, but as I 

say, the allocation of resources has been—

Chairman MANZULLO. You know, Commissioner, allocation of resources—I mean this is not a class in English. If you don’t have 

enough money, you don’t have enough money. But you know what? 

There isn’t one agency in this city, there isn’t one Committee, there 

isn’t one member of Congress that says I have more than sufficient 

money to run my operation. 

To say we don’t have enough money for audits, I mean there are 

what, 97,000 IRS employees?

Mr. EVERSON. That is about right.

Chairman MANZULLO. And it is down. It is down.

Mr. EVERSON. It has come down because of the electronic filing, 

you don’t need as many—

Chairman MANZULLO. Right.

Mr. EVERSON. —people to process returns.

Chairman MANZULLO. Of that, 400 are involved in education, is 

that correct?

Mr. EVERSON. No, sir. That is a number that is within this business unit for the small business, self-employed piece. That unit is 

maybe something like 28,000 people.

15

Chairman MANZULLO. Okay. Mr. Fitzpatrick, do you have some 

more questions?

Mr. FITZPATRICK. Yes. I just want to get back to the issue of how 

to get small businesses into compliance, those who have fallen out 

of compliance and I heard the Commissioner talk about some of the 

programs. 

I thought maybe, Mr. Sullivan, from the Administration, you 

may have—

Mr. SULLIVAN. I would love to respond and give the Commissioner just a little breathing room, if I may. I think what you have 

heard, Congressman, not only from me and the Commissioner, but 

also GAO, the Taxpayer Advocate and the Inspector General on 

April 14 on the Senate side, talked about balance. 

I think the balance has got to be based on data. That is what 

the Chairman was just referring to making sure that that data is 

as best possible, before directing the IRS where to direct its resources, whether it be education or enforcement. 

A problem, Congressman Fitzpatrick, is there does not seem to 

be that type of data on whether or not the education, the taxpayer 

education is producing compliance benefit. 

Now there is positive news on this side. The Treasury IG in his 

statement on April 14 does say that taxpayer education has led to 

many improvements and I quote, ‘‘Individual taxpayer satisfaction 

rates with IRS have increased since the law’s passage, rising from 

51 to 64 percent, between 1999 and 2004.’’ 

If you put that type of statistical analysis on top of economic 

work, like those that are contained in my written statement by Dr. 

Bruno Frey, it shows that that type of satisfaction has a direct correlation into greater compliance. 

So what I think is missing in part of this balance is more data 

that shows that taxpayer education is in fact working and if better 

prioritized will also help fill the gap, commensurate with increased 

or greater attention to enforcement. 

Now that is lacking and so I am hopeful that now that Congress 

has their attention on the President’s budget, the Commissioner, 

my office and others have already done our work in presenting the 

President’s budget to Congress. Now it is your chance to look at 

that and how you prioritize. 

I am hoping that the IRS will focus on creating data that documents whether or not taxpayer education will fill in that tax gap. 

Because as of now, aside from the IG, there really isn’t information 

that documents all the hard work from the taxpayer education, 

whether or not it is making a positive or negative difference.

Mr. FITZPATRICK. Do you, Mr. Sullivan, have any recommendations as to how we could get non-filers back into the system?

Mr. SULLIVAN. I believe that again—

Mr. FITZPATRICK. Through education.

16

Mr. SULLIVAN. Congressman, I believe that the way to approach 

the tax gap is through the balance. It is the balanced approach. It 

is one, reducing the complexity and the President has absolutely 

made that a priority and many of us are looking forward to the bipartisan Tax Panel’s recommendations to reduce complexity. 

I should also point out that behind the scenes there is a division 

at IRS. Mr. Chessman, who heads the Office of Burden Reduction, 

is behind me. They actually look at administrative ways to reduce 

complexity. The Commissioner mentioned some great success stories there. 

So one is reduce complexity. Two is obviously prioritize enforcement as an important ingredient. Three is to bring in an equal and 

balanced way of taxpayer education and I think through a balanced 

approach, through all of those three, you will see the tax gap reduced.

Mr. FITZPATRICK. Is there the possibility though over reliance on 

the enforcement piece of the three-pronged approached you just 

talked about, could have the maybe unintended consequence of 

driving more small businesses underground?

Mr. SULLIVAN. Yes, Congressman. Not only does this seem to be 

the case, you know where is that fine balance between just enough 

enforcement and too much? 

That was detailed out by Dr. Bruno Frey in a paper that I cite 

in my written statement. It does show that too much enforcement 

actually does drive more folks underground. 

So you would have, despite good intentions, you would have the 

exact opposite consequence. So again, I will just restate that the 

real key to reducing the tax gap is a balanced approach.

Mr. FITZPATRICK. Thank you. I yield back.

Chairman MANZULLO. For every one dollar in revenues that is 

collected by the IRS, how much of that is represented by employees? How much by small businesses? Then how much by large businesses? Do you have—

Mr. EVERSON. Yes. The small—

Chairman MANZULLO. I guess on that pie—

Mr. EVERSON. The IRS collects about two trillion dollars a year. 

Probably, Mr. Chairman, about a quarter of that comes from small 

businesses. By small businesses, I am taking that whole family of 

the Schedule C filers, the 1120 filers, the S filers, the partnership 

filers, that whole group. 

Now what is different about this population, sir, is that it is the 

mix of taxes within that total. The preponderance of those monies 

that I am talking about are employment taxes. They are not the 

income taxes. 

If you look at the whole two trillion, employment taxes are a little less than 40 percent or so of what is the budgeted receipts this 

year, but if you look at this population that you are concerned 

17

about, the small business population, the biggest driver in there is 

in the employment tax area, where I think that is about two-thirds 

of the total, sir.

Chairman MANZULLO. The National Taxpayer Advocate, Nina 

Olson, suggested in her 2003 annual report to Congress that implementing non-wage withholdings, in particular, withholding for income reported on Form 1099, by the small business people, would 

greatly enhance compliance among independent contractors and 

help to close the tax gap. 

Same question to both of you. Do you agree this reform would 

help close the gap?

Mr. EVERSON. I have stated, Mr. Chairman, I am not an advocate 

of going down the withholding path. I just think that it would be 

very burdensome and I stick by the perhaps unpopular desire to do 

more in the enforcement area with those who are noncompliant, 

rather than have that withholding regime, which I think would be 

quite burdensome.

Chairman MANZULLO. Mr. Sullivan?

Mr. SULLIVAN. I think the idea first stated by Nina Olson in her 

annual report, then picked up by GAO and then the IG, is absolutely the wrong way to go. 

It would be a disaster for small business and coincidentally a disaster for the economy primarily for two reasons. First of all, the 

recommendation of proprietors withholding for folks who use their 

premises as independent contractors punishes the very population 

of small businesses that recovered America from a recession. 

So here we are after pulling ourselves out of recession, where 

small businesses are literally the only entities hiring new employees and their reward is, according to this recommendation, you will 

now be responsible for withholding from another set of taxpayers. 

I think that would be a disaster and you would unbelievably stifle the economic engine that is created by small business. 

The second reason why it is a terrible idea is that it further 

blends, it further blurs the distinction between employer and independent contractor. 

Now this could be a whole other Congressional hearing, and in 

fact, there have been plenty of Congressional hearings on this 

issue. In the construction field in particular, there still are, in the 

small business community, the folks who talk with me every day. 

They still are very, very troubled by the confusion that exists over 

whether you are an employer or an independent contractor and if 

something bad happens, who is responsible? 

The idea that withholding then become the responsibility of the 

proprietor further blurs and confuses the distinction between employer and independent contractor. It would be a terrible way to go, 

Mr. Chairman.

Chairman MANZULLO. The Commissioner agrees with you. It 

took him 20 seconds to say so. It took you three minutes, but that 

is okay. 

18

The Office of Burden Reduction, how many employees are in 

that?

Mr. EVERSON. It is not a large office. It is a highly skilled office. 

I am not sure. Half a dozen, dozen people. Ten people.

Chairman MANZULLO. Ask him if he needs more people to help 

reduce the burden of reduction.

Mr. EVERSON. I think you have done fine in asking the question, 

sir. Let me tell you something though, Mr. Chairman. What we did 

do here was in order to increase the prominence of this effort. 

When Kevin took over from this business division, we asked Mike 

to report directly to him so that it gets enough prominence within 

that business unit. Those issues are addressed on an ongoing basis. 

I think that has helped this area.

Chairman MANZULLO. Thank you very much for coming this 

afternoon. Sorry we were running late. I appreciate the testimony. 

I appreciate your candor. If we could get the second panel ready. 

Mr. Sullivan, is there somebody from your office that might be 

able to stick around?

Mr. SULLIVAN. Yes, I will.

Chairman MANZULLO. Thank you. We will recess for about five 

minutes until we can set up the table. 

[Whereupon, a short recess was taken.]

Chairman MANZULLO. We are starting our second panel. First 

witness is John Satagaj, testifying on behalf of the Small Business 

Legislative Council. We look forward to your testimony. 

The complete written statements will be made part of the record, 

without objection and I will set the five-minute clock here. 

You need to push the button and then pull the—

Mr. SATAGAJ. I am used to talking without the microphone. I 

don’t need it normally. 

STATEMENT OF JOHN SATAGAJ, SMALL BUSINESS 

LEGISLATIVE COUNCIL

Mr. SATAGAJ. Mr. Chairman, it is great to be here. I am John 

Satagaj. I am the President and General Counsel for the Small 

Business Legislative Council, which is a coalition of about 60 trade 

associations, all of which have common interests that they represent the interest of small business. 

For us, this comes down to a pretty simple equation in regards 

to what needs to be done and what we can accomplish to help small 

businesses. 

Number one, we have got to simplify. We heard it here in the 

first panel of testimony today about the need for simplification. We 

think a lot of the problems that small business has with Tax Codes 

19

and with complying has to do with the complexity of the Code. So 

if we can simplify, we can solve a lot of these problems. 

Secondly, we need to educate. We are particularly concerned 

about where things are going at the IRS in general and in the 

small business sector in particular, as it relates to education. 

There is taxpayer education and communication. They call it 

TEC, which has done a marvelous job. You talked today about it—

I think you used the hammer. 

Representative Kelly used the boom. For me the metaphor is the 

pendulum and the pendulum is coming right at small business 

again. What is remarkable for me is how quickly the pendulum has 

swung back. 

In Washington terms, it has been like a nanosecond since we recognized that there was a lot of burdens being imposed on small 

business. That we were really aggravating the small business taxpayer with the audits. That it was unfair and in that nanosecond 

it switched back already to where we are coming back to that. 

We had eased off on it and now we are right back to the point 

where we are very aggressively going to pursue small businesses. 

We needed to give taxpayer education more time. We haven’t 

given it enough time. We hear some rumors that over at the IRS 

they are even cutting back further on taxpayer education. 

Mr. Chairman, if you could see one of the cool sessions that we 

are all involved in, in the small business community, once every 

two months we get together in a session hosted on a rotating basis 

by NFIB, the Chamber and SBLC. 

Our partner is TEC at the IRS. We have a meeting every two 

months. They bring in different folks. We talk about problems. 

You should see all the material we are getting from them that 

we then use for our members, but you can’t change that overnight. 

It takes time. 

We are working hard. We are making a lot of progress. If they 

are, in fact, diverting resources elsewhere instead of that education, I fear we are going to lose everything we built up when the 

pendulum was going our way. We are going to lose it in a nanosecond and that is where we are right now. 

For us, simplification is number one. Number two, taxpayer education. We do those two things, we are going to do great. 

The last thing I want to mention—I don’t know if he has come 

back in the room or not, you noted at the beginning that Kevin 

Brown was going to stay for the entire—

Chairman MANZULLO. Kevin’s here.

Mr. SATAGAJ. Kevin’s here. He has come back in the room. He 

is behind me. I want to mention, because you know you don’t get 

too many chances to say, you got a friend at the IRS. I can tell you 

I have had my share of non-friends at the IRS. This is a good person for small business running that section.

Chairman MANZULLO. The record will note your friendship.

Mr. SATAGAJ. Good friendship. Maybe I won’t get audited next 

year if I am lucky. But it is important to have somebody there who 

20

understands small business and Kevin does do that. I think he is 

a great asset for us to have over there. 

With that, Mr. Chairman, that concludes my testimony. Thank 

you. 

[Mr. Satagaj’s statement may be found in the appendix.]

Chairman MANZULLO. Thank you. 

Our next witness is Keith Hall. He runs the Tax Talk service for 

the National Association of Self-Employed. He is a resident of 

Texas, where he is also partner in Hall and Hughes, a local accounting firm. 

We look forward to your testimony, Mr. Hall. 

STATEMENT OF KEITH HALL, HALL AND HUGHES

Mr. HALL. Mr. Chairman, members of the Committee, I appreciate the opportunity to be here today, both as a small business 

owner and as a member of the National Association for the SelfEmployed. 

I hope to provide a small business owner’s perspective on the existing tax gap and various proposals for reducing that tax gap. 

Through the NASE Tax Talk service, I help answer over 8,000 

questions every year from small business owners across the country. I think that gives me a unique opportunity to share the small 

business perspective. 

A vast majority of the questions that we answer are based on 

some specific complexity in the Tax Code. For example, many small 

business owners operate out of their home, but they are intimidated by a very complicated home office deduction form. 

Most use their personal vehicle in operating their business, but 

are confused regarding that deduction as well. 

Some hear that they can fully deduct the cost of their vehicle, 

but only if it weighs over a certain number of pounds. Then they 

find out that there is a different set of rules for SUVs and then still 

a different set if it is purchased before October 22 or after October 

22. 

Now these issues directly contribute to the tax gap, since the 

small business owner doesn’t know what they owe. That leads to 

incorrect estimated tax payments, late filing of returns and late 

payment of tax that is due. 

It is my opinion that the number one reason for noncompliance 

among small business owners is the complexity of the Tax Code. 

Further, I believe that reducing that complexity will lead directly 

to increased compliance and therefore a reduced tax gap. 

There are a number of other proposals, besides reducing complexity, that have been proposed. As mentioned earlier, the National Taxpayer Advocate has proposed withholding requirements 

on payments made to independent contractors. 

This is the most troubling of any proposals so far for the small 

business owner. First, by adding another level of reporting and 

complexity, another level of potential noncompliance is also added. 

But more importantly, withholding based solely on gross payments disregards the expenses that are incurred to generate those 

gross payments. 

21

Consider an independent painter of office space who has a $5,000 

contract. They have no employees but do all the work themselves. After the cost of paint and supplies, they may have about $4,000 

in gross profit. Withholding five percent right off the top, about 

$250, may make some sense, but what about a second painter who 

uses other contractors or employees to do the work? They may have only a ten percent gross profit or about $500 in taxable income. Withholding the same $250 straight off the top 

represents a 50 percent withholding on their taxable income. Treating those two small business owners the same just doesn’t make 

sense. 

Further, the current proposal would only apply to sole proprietors. A painter who happens to operate as a corporation would not 

be subject to the requirement. The same painter, the same issues, 

the same headaches would have a different set of rules solely based 

on business structure. 

Another proposal is based on increased IRS enforcement. This 

proposal does have merit. Those taxpayers who willfully disregard 

their tax liability should be held accountable. 

I certainly support efforts to make sure they are held accountable. My concern is at what cost? The Commissioner mentioned, 

and has mentioned before, that he believes that service plus enforcement equals compliance. My concern is that budget dollars 

added to enforcement might be taken away from service. 

The complexity of the Tax Code clearly contributes heavily to 

noncompliance, especially for the small business owner. Over the 

last several years, the IRS has done a tremendous job in providing 

service to the small business taxpayer. 

Their website is unparalleled in depth of information and ease of 

navigation. Their commitment to developing comprehensive publications to address complex tax issues has been unbelievable and I 

truly believe that their commitment has made a real difference. 

Diverting the attention of the IRS to enforcement, at the cost of 

service, would be devastating. 

Another option is to increase the level of compliance data and the 

efforts to review that data. As a professional accountant, I always 

think it is a good idea to look at the numbers. 

Knowing which taxpayers are noncompliant, whether intentional 

or unintentional, can only improve efforts to increase compliance, 

therefore reducing the tax gap. 

However, the data can only be effectively analyzed in connection 

with the why related to that noncompliance. It is my concerted 

opinion that the why is in fact the complexity of the Tax Code 

itself. 

Tax compliance and its effect on the tax gap is clearly a significant issue. However, efforts to close that gap and reclaim missing 

revenue must be based on balanced and equitable measures. 

I believe that these efforts should avoid adding new levels of 

complexity, but instead focus on overall simplification of the Tax 

Code. 

Most taxpayers want to comply with tax laws and pay their fair 

share. Simplifying the Code will give them the ability to do that. 

Thanks again for the opportunity to be here. 

[Mr. Hall’s statement may be found in the appendix.]

22

Chairman MANZULLO. Thank you. 

Our next witness is Abraham Schneier. Mr. Schneier is a tax 

consultant for the National Federation of Independent Businesses 

and a certified financial planner. 

I look forward to your testimony. 

STATEMENT OF ABRAHAM SCHNEIER, ABRAHAM SCHNEIER & 

ASSOCIATES

Mr. SCHNEIER. Thank you, Mr. Chairman, members of the Committee. My name is Abraham Schneier and I am a tax consultant 

to the National Federation of Independent Business and a self-employed business owner. 

On behalf of the 600,000 members of NFIB, I appreciate the opportunity to offer views on the tax gap and to express the concerns 

of small business owners over IRS attempts to address this gap. 

Let me first state that NFIB does not defend or attempt to rationalize that portion of the tax gap that is created by willful violation of our tax laws. 

Clearly, the tax gap is caused by different factors and NFIB 

agrees with others that tax complexity continues to be responsible 

for a significant portion of the tax gap. 

As Nina Olson, Taxpayer Advocate for the IRS, stated in her testimony before the Senate Finance Committee on April 14, ‘‘Tax law 

complexity provides gray areas and loopholes for taxpayers who are 

not trying to comply. Complexity also trips up taxpayers who are 

trying to comply. It is just too hard to figure out what the law requires and honest efforts to comply can result in a gotcha situation.’’ 

Since the Commissioner was kind enough to mention some of my 

testimony, I figure it is only right that I mention some of his previous testimony. 

At the same hearing, the Commissioner said, ‘‘The tax gap does 

not arise solely from tax evasion or cheating. It includes a significant amount of noncompliance, due to complexity of the tax laws 

that results in ignorance, confusion and carelessness. We do not 

have sufficient good data to help us know how much of the tax gap 

arises from willfulness, as opposed to innocent mistakes.’’ 

We have heard both Commissioner Everson and Tom Sullivan 

from SBA’s Office of Advocacy talk about the cost of compliance to 

the government. But there is also a heavy cost to the small business owner, in terms of the cost of advice that he is required to obtain on a regular basis, in terms of the cost of not knowing whether 

he or she is doing the right thing. 

Too often they get tripped up on footfalls and too often they get 

tripped on just not knowing that there is a certain requirement 

coming. 

Granted some of them do get into difficulties because of financial 

issues and at that time, you certainly don’t want to be in debt to 

the IRS, which unfortunately too often can happen. 

But we seriously believe that the tax gap is being driven in a 

major portion by the complexity. In that regard, I would like to 

echo some of John Satagaj’s thoughts about the efforts of the small 

business, self-employed and the TEC division, in terms of the outVerDate 0ct 09 2002 09:49 Nov 04, 2005 Jkt 000000 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 G:\HEARINGS\21288.TXT MIKE
23

reach and the communications that has been going on with the 

small business community over the last several years. 

It has been a long time since small business has had the opportunity to have input on the front end of items that were going to 

come out before the small business community. That has been a 

major benefit of having this regular communications. 

Too often we hear this is what you have to do and maybe we 

can’t change that, but on a more regular basis we were having an 

opportunity to have input on the front end on new forms that were 

going to be put forward and on new rules. 

I guess probably the best example is maybe the cash method of 

accounting changes that we all worked on so hard several years 

ago. 

There is an increased reliance as well on technology, which I 

think we have to be a little concerned about. NFIB does regular 

surveys of its members on a variety of issues and despite everything we read in the news, not all taxpayers, which includes small 

business owners, use or are comfortable with computer technology. 

17 percent of small employers are not even on the Internet. The 

issue is not just relevant to those who are not on the Internet. 

Many questions simply require talking to a real person who can 

sometimes ask the appropriate follow up question that will lead to 

a correct answer. 

Sometimes the taxpayer will call up Taxpayer Service and ask a 

particular question or look up something on the Internet. Unless he 

has a live person on the other end who can maybe ask a follow up 

question to really help him get to the kernel of the issue, he is 

going to come up with the wrong answer more often than not or 

come up with no answer, which can also lead to unfortunate 

events. 

Recently NFIB asked a sample of small employers if they had 

contacted government to learn about or clarify an existing rule or 

obligation, such as a tax rule. 

60 percent indicated that they had. Of that number, only five 

percent said that their primary means of contact was the Internet. 

The most frequent was by telephone. 

It is highly likely that the proportion using the Internet and 

using it effectively will increase, but to the extent that reliable, 

readily accessible and easily understandable information reduces 

the tax gap, mismatches between the way IRS—

Chairman MANZULLO. Mr. Schneier, I am going to cut you off 

here. I want to get this testimony and we have got a bunch of votes 

and a big fight going on, on the floor. I am going to cut you off 

right there and go to our next witness, Mr. Steinberg.

Mr. SCHNEIER. Thank you, Mr. Chairman. 

[Mr. Schneier’s statement may be found in the appendix.]

Chairman MANZULLO. I look forward to your testimony. 

STATEMENT OF LEONARD STEINBERG, THE STEINBERG 

GROUP

24

Mr. STEINBERG. Thank you, Mr. Chairman.

Chairman MANZULLO. I am going to reduce your time to four 

minutes. I just want to get everybody in and get this completed, 

because we may be gone for an hour, an hour and a half on a floor 

fight.

Mr. STEINBERG. All right. Thank you, Mr. Chairman. I appreciate 

it very much and I will be as brief as possible.

Chairman MANZULLO. If you could move the mike closer to you, 

Mr. Steinberg. Thank you.

Mr. STEINBERG. Thank you, sir. I am here to talk about the how 

and why of the tax gap and although everyone has talked about the 

complexity of the tax gap, I will give you a classic example. 

There are some people that will form a business as a limited liability corporation. According to the IRS rules, if you are a single 

person limited liability corporation, you are considered a sole proprietor. 

If you are a two-person limited liability corporation, you are considered a partnership. These kinds of complexity drives small business people nuts, because they really don’t understand the difference in the type of organizations that they are really forming. 

Another reason for the tax gap is the effect of the alternative 

minimum tax. Although this is not a hearing on the alternative 

minimum tax, many small business owners and self-employed individuals will intentionally underreport their income in order to specifically avoid the AMT. This is accomplished by not reporting all 

cash transactions and by not reporting all income derived from 

other sources. 

The AMT is specifically devastating to those small business owners and taxpayers who live in high tax states, such as New York, 

my home state of New Jersey, California and Massachusetts. 

Another reason for the tax gap is operating a cash business. As 

an example, a small business owner may operate a pizzeria. The 

store is open six days per week from Tuesday through Sunday. 

The business has been in the same location for many years and 

though the ownership has changed twice, the business has a wonderful reputation. 

On very busy days, the owner and helpers prepare pizzas and 

other foods as quickly as they can. Orders are phoned in. Customers come to pick up their orders. 

The people behind the counter do not have either the time or the 

proximity to get to the cash register in order to record the sale. The 

cash is held and then placed in the register at the end of the busy 

period and each cash sale is not accurately reported. 

So the mathematics of this non-reported cash will work as follows: If there are five unreported transactions with a value of $10 

each day, the total amount of unreported sales transactions will 

equal $15,600 for a year, based on a six-day week for 52 weeks. 

If the money goes into the owner’s pockets, that is $15,600 of unreported income and there is also an effect on state and local sales 

tax. 

25

Another reason for the tax gap is that many people do not understand the tax laws. As an example, I had a case of a client who 

did not understand why he could not expense his entire franchise 

fee. 

His franchise fee was $40,000. Why can’t I expense it? I had to 

explain to him that it has to be amortized over 15 years, over the 

life of the business. 

Here again, the franchisor received the $40,000, which is claimed 

as income, but the franchisee can only take a portion of it. 

Lastly, I would like to talk about unenrolled preparers. I know 

Nina Olson has talked about this. This is a pernicious affect on unreported income. There are unscrupulous, unenrolled preparers 

who will prepare tax returns and take undue deductions and not 

claim all the income for the people. I know my time is almost up. 

So I would like to thank the Committee for the opportunity. 

[Mr. Steinberg’s statement may be found in the appendix.]

Chairman MANZULLO. Thank you very much. 

Mr. Hegt, we look forward to your testimony. I am sorry about 

the rushed up time. Please. 

STATEMENT OF RONALD HEGT, AMERICAN INSTITUTE OF 

CERTIFIED PUBLIC ACCOUNTANTS

Mr. HEGT. Thank you, Mr. Chairman. The AICPA thanks you for 

the opportunity to appear before you today. I am Ron Hegt, a member of the AICPA Tax Executive Committee. 

The AICPA is the national professional organization of CPA’s 

comprised of more than 350,000 members, many of whom provide 

services to America’s small businesses. 

It is from this broad base of experience that we offer our comments today. The AICPA has long been an advocate for tax simplification. Small business in particular needs advocates to collect 

and voice their concerns about the burdens imposed on them. 

We are committed to helping make our tax system as simple and 

as fair as possible. Unfortunately, we believe that the law’s complexity in certain key areas may be strangling voluntary compliance. 

The lack of deliberation in the legislative process, the frequent 

law changes in recent years and the increasing magnitude and 

complexity of the Internal Revenue Code creates serious compliance issues for small businesses. 

The end result is the erosion of voluntary compliance. By and 

large, small businesses obey the law, but it is only human to inadvertently disobey a law if you do not or cannot understand the 

rules. 

The dynamic American economy is changing and moving rapidly 

against an unnecessarily cumbersome income tax system. The 

AICPA has long understood the consequences of tax law complexity 

and has supported efforts to move toward a simple system. 

More recently, the AICPA has developed three tax policy concept 

statements guiding principles for good tax policy, guiding principles 

for tax simplification and guiding principles for tax law transVerDate 0ct 09 2002 09:49 Nov 04, 2005 Jkt 000000 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 G:\HEARINGS\21288.TXT MIKE
26

parency, which are intended to aid in the development of tax legislation in a direction that we believe is in the public interest. 

Simplification must be given a prominent position in the tax 

process on an ongoing basis. Although it should not take precedence over revenue and tax policy objectives, simplification must be 

an integral part of the tax legislative regulatory and administrative 

process. 

We recognize that a tax system that is simple for all taxpayers 

may never be designed, but we do believe a simpler system is attainable. 

For a number of years we have joined our professional colleagues 

from the ABA tax section and the Tax Executive Institute in this 

simplification effort. 

We have, on many of occasions, submitted simplification recommendations to Congress, which specifically address a number of 

issues that add to the difficulties small businesses have in complying with the tax laws. 

Some of these suggestions have particular interest to small businesses include eliminating the alternative minimum tax, clarification in worker classification area, developing objective, administrable tests relating to capitalization, expensing and recovery of 

capitalized costs, simplifying capital gains provisions and 

rationalizing estimated tax safe harbors. 

In addition, we suggest allowing small business start ups an additional tool to successfully navigate their start up life cycle by providing the flexibility to adopt any fiscal year from April through 

November. 

The AICPA supported the Small Business Tax Flexibility Act of 

2003, HR 3225, which would have increased small business prospects for survival. 

Moving to another area, I would like to address two critical topics. One, how the IRS can help taxpayers in its own enforcement 

efforts through administrative simplification and two, how the IRS 

can leverage its external stakeholders to achieve a more highly 

compliant tax population. 

We are well aware of the substantial decline in the number of 

income tax return examinations conducted by the Service in recent 

years. 

We support the Service’s efforts to reverse this trend by hiring 

new revenue agents and implementing a number of administrative 

simplification measures within its four operating divisions. 

Over the years, the AICPA has urged full funding of the IRS 

budget and continues such support. Commissioner Everson recognized that any increase in enforcement funding must be balanced 

with positive responses to the taxpaying public, his customers. We 

encourage—

Chairman MANZULLO. I have to enforce the clock, which I can’t 

stop. 

[Mr. Hegt’s statement may be found in the appendix.]

Chairman MANZULLO. What I would ask is this: I am going to 

formally end the hearing. I will come back personally and we will 

have about a 20-minute or so town meeting so the people here can 

27

ask questions and we can get more input from you, especially those 

of you that have traveled far distances. 

The stenographer would be excused, because at this point the 

hearing is formally adjourned. 

[Whereupon, at 3:30 p.m., the Committee meeting was adjourned.]

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