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




                               before the

                       SUBCOMMITTEE ON OVERSIGHT

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             SECOND SESSION


                             JUNE 29, 2000


                             Serial 106-95


         Printed for the use of the Committee on Ways and Means

69-865 DTP                  WASHINGTON : 2001
            For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 

                      COMMITTEE ON WAYS AND MEANS

                      BILL ARCHER, Texas, Chairman

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

                     A.L. Singleton, Chief of Staff

                  Janice Mays, Minority Chief Counsel


                       Subcommittee on Oversight

                    AMO HOUGHTON, New York, Chairman

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

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public 
hearing records of the Committee on Ways and Means are also published 
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                            C O N T E N T S



Advisory of June 22, 2000, announcing the hearing................     2


Internal Revenue Serivce, Hon. Charles O. Rossotti, Commissioner.     5



                        THURSDAY, JUNE 29, 2000

                  House of Representatives,
                       Committee on Ways and Means,
                                 Subcommittee on Oversight,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 10:07 a.m., in 
room 2167, Rayburn House Office Building, Hon. Amo Houghton 
(Chairman of the Subcommittee) presiding.
    [The advisory announcing the hearing follows:]



                       Subcommittee on Oversight

                                                Contact: (202) 225-7601

June 22, 2000

No. OV-21

 Houghton Announces Hearing on Complexity in Administration of Federal 
                                Tax Laws

    Congressman Amo Houghton (R-NY), Chairman, Subcommittee on 
Oversight of the Committee on Ways and Means, today announced that the 
Subcommittee will hold a hearing on the Internal Revenue Service (IRS) 
report to Congress regarding complexity in the administration of the 
Federal tax laws. The hearing will take place on Thursday, June 29 , 
2000, in the main Committee hearing room, 1100 Longworth House Office 
Building, beginning at 10:00 a.m.
    The sole witness will be Charles O. Rossotti, Commissioner of the 
Internal Revenue Service . However, any individual or organization may 
submit a written statement for consideration by the Committee and for 
inclusion in the printed record of the hearing.


    In section 4022 of the Internal Revenue Service Restructuring and 
Reform Act of 1998 (RRA) (P.L. 105-206), Congress required the IRS to 
report annually regarding sources of complexity in the administration 
of the Federal tax laws.
    Congress instructed the IRS to take into account the following 
factors in making its report: (1) frequently asked questions by 
taxpayers, (2) common errors made by taxpayers in filling out their tax 
forms, (3) areas of law that frequently result in disagreements between 
taxpayers and the IRS, (4) major areas in which there is no, or 
incomplete, published guidance, or in which the law is uncertain, (5) 
areas in which revenue agents make frequent errors in interpreting or 
applying the law, (6) the impact of recent legislation on complexity, 
(7) information regarding forms, including a listing of IRS forms, the 
time it takes taxpayers to complete and review forms, the number of 
taxpayers who use each form, and how the time required changed as a 
result of recent legislation, and (8) recommendations for reducing 
complexity. The report to be presented by the Commissioner is the first 
annual complexity report to Congress since the enactment of the RRA.
    In announcing the hearing, Chairman Houghton stated: ``I have long 
sought simplification of the Federal tax laws. I am hopeful that the 
Service's first complexity report will highlight the most problematic 
provisions and lead to possible legislation to reduce unnecessary 
complexity for taxpayers.''


    The focus of the hearing will be to discuss the most complex 
provisions in the Internal Revenue Code as identified by the IRS and 
possible remedies.


    Any person or organization wishing to submit a written statement 
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch 
diskette in WordPerfect or MS Word format, with their name, address, 
and hearing date noted on a label, by the close of business, Thursday, 
July 13, 2000 , to A.L. Singleton, Chief of Staff, Committee on Ways 
and Means, U.S. House of Representatives, 1102 Longworth House Office 
Building, Washington, D.C. 20515. If those filing written statements 
wish to have their statements distributed to the press and interested 
public at the hearing, they may deliver 200 additional copies for this 
purpose to the Subcommittee on Oversight office, room 1136 Longworth 
House Office Building, by close of business the day before the hearing.


    Each statement presented for printing to the Committee by a 
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exhibit not in compliance with these guidelines will not be printed, 
but will be maintained in the Committee files for review and use by the 
    1. All statements and any accompanying exhibits for printing must 
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect or 
MS Word format, typed in single space and may not exceed a total of 10 
pages including attachments. Witnesses are advised that the Committee 
will rely on electronic submissions for printing the official hearing 
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
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these specifications will be maintained in the Committee files for 
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    3. A witness appearing at a public hearing, or submitting a 
statement for the record of a public hearing, or submitting written 
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    4. A supplemental sheet must accompany each statement listing the 
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    The above restrictions and limitations apply only to material being 
submitted for printing. Statements and exhibits or supplementary 
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and the public during the course of a public hearing may be submitted 
in other forms.

    Note: All Committee advisories and news releases are available on 
the World Wide Web at `http://www.waysandmeans.house.gov'.

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


    Chairman Houghton. The hearing will come to order.
    Commissioner, we are delighted to have you here.
    Before I begin, I want to tell you a story. George Lyman 
Kittridge was a great Shakespearean scholar at Harvard and he 
used to stride up and down the platform. One day he fell off 
the platform and nobody could see him. He brushed himself off 
and said, ``This is the first time I have ever been on the 
level of my audience.''
    Chairman Houghton. We are trying to have a little more 
informal attitude here and I hope it will be all right with 
you, sir.
    We are here to discuss, as most of you know, an issue that 
is near and dear to all our hearts, which is simplifying the 
Tax Code. One of the most important provisions in the IRS 
Restructuring and Reform Act that we passed nearly 2 years ago 
directed the IRS to study and report back to us on the sources 
of major complexity in the Code.
    We get plenty of input from the Treasury and from the Joint 
Committee on Taxation, but who better to study this issue than 
you, Commissioner, and the employees at the Service who answer 
taxpayer questions through TeleTax, customer service call 
centers, the Internet, and a variety of areas? Who better than 
the agents who review the millions of errors in tax returns 
each year?
    A provision we pass may make good sense in terms of 
fairness and equity but may be absolutely unworkable in the 
real world. We need your help in making the law more easy to 
    Your first report to Congress focuses on provisions that 
affect individual taxpayers and small businesses. These are the 
taxpayers least able to fend for themselves in terms of time 
and resources. I hope that future reports expand beyond the 
specific provisions you will discuss today, and I hope that 
future reports will be expanded to cover other taxpayer groups 
as well.
    You have stated in the report that reducing complexity will 
reduce taxpayer burden, both in time and money spent, and 
increase taxpayer compliance. I agree, but I would add that 
reducing complexity will also restore faith in the tax system. 
I hope that we in Congress heed the call to keep simplification 
in mind as we pass tax bills in the future.
    I would like to yield to our ranking Democrat, my friend, 
Mr. Coyne.
    Mr. Coyne. Thank you, Mr. Chairman.
    I want to thank you for holding this hearing here today--a 
very important hearing--and also to welcome Commissioner 
Rossotti to the hearing as a witness today.
    Today's hearing will address the recommendations of the 
Commissioner's first annual report on tax law complexity. This 
report was mandated by the IRS Reform and Restructuring Act of 
1998. It s completion marks an important milestone in our 
efforts to implement the law and offers suggestions for making 
the tax law simpler and more equitable for all taxpayers.
    Aside from this report, there are many other proposals 
before this Committee to reduce complexity in the tax law. Mr. 
Neal, from Massachusetts and a member of our Committee, has 
proposed legislation to substitute a simpler method for the 
alternative minimum tax. With several of my colleagues on this 
Committee, I have introduced a bill to simplify the capital 
gains tax.
    I am certain that this Committee can work together to 
consider these various proposals. I hope we can work in a 
bipartisan manner, which has been the tradition of this 
Committee, to pass legislation this year that will further the 
goal of reducing complexity in the Tax Code.
    Thank you, Mr. Chairman.
    Chairman Houghton. Thank you, Mr. Coyne.
    Mr. Commissioner?

                        REVENUE SERVICE

    Commissioner Rossotti. Thank you very much, Mr. Chairman.
    It is great to be able to see straight across like this. I 
appreciate that very much.
    Commissioner Rossotti. I appreciate the opportunity to 
testify before the Committee on this first annual report on tax 
law complexity.
    I think you have pointed out many times, Mr. Chairman, that 
the Tax Code has continued to grow in complexity. In fact, over 
the last 14 years since the 1986 legislation, there have been 
about 9,500 changes to the Tax Code. Of course, we know there 
are number of factors that contribute to the complexity. These 
include a desire to provide tax cuts while limiting revenue 
losses, a desire to achieve fairness in the tax system, and 
finally a general growth of complexity in the global economy.
    Many of the taxpayers, tax practitioners, and other people 
that we spoke to when writing and compiling this report have 
emphasized that sometimes even seemingly small changes to the 
Code can have serious consequences for taxpayers and the IRS, 
especially if there are frequent changes and if there is short 
lead time to implement these changes due to the effective dates 
of the provision.
    Whenever a tax law changes, the IRS must ensure that our 
systems, training, and employee tools are current and reflect 
the most current legislation. We must also issue guidance and 
tax forms covering the changes in time for the taxpayers to 
file in the next filing season. It is especially problematic 
when these changes come late in the calendar year when forms 
and publications for the next filing season may have already 
been designed.
    So I think, Mr. Chairman, before we get to specific 
provisions, it is worth noting that one of the most helpful 
things the Congress can do is to provide the IRS with adequate 
time prior to the statutory effective dates when changes go 
into effect. I do want to say that the taxwriting Committees 
over the last year have been really receptive to many of our 
recommendations in this regard. This was particularly true when 
we were going through the Y2K Program. In fact, I doubt that we 
would have been successful with the Y2K Program had we not had 
a good relationship in working out these effective dates.
    I just want to put that on the agenda as a general problem 
and a general issue that we need to work with the taxwriting 
Committees on in the future.
    With respect our report, which you have seen, it really had 
three objectives, one replying specifically to the request in 
RRA 98. We have tried to provide information on such things 
such as frequently asked taxpayer questions, areas where 
taxpayers have difficulty in complying with the Tax Code, and 
missing or incomplete guidance.
    Second, the report does describe how we selected and 
analyzed certain specific areas of the Code for further 
scrutiny in this particular report. With no pun intended, Mr. 
Chairman, analyzing the entire Code would have been too complex 
to do the first time. So instead, we tried to look at the 
complexity from a taxpayer's point of view. After consulting 
with numerous experts and others who have looked at this and 
analyzing our own data, we chose to focus on three particular 
areas of the Code that in particular affect a large number of 
    For each of the three areas we selected--filing and 
dependent definitions, alternative minimum tax for individuals, 
and estimated taxes--we tried to analyze why those provisions 
are considered very complex. And then we provided a number of 
options the Congress might want to consider that would reduce 
    I do need to stress, Mr. Chairman, that the options in our 
report are not recommendations in the full sense as they do not 
take into account revenue impact or the distribution of 
revenue, which would have to be considered in any legislation.
    But just to note the first one of these--and the one that 
really affects the most taxpayers--can be seen on this chart 
over here on the left. This one deals with the first set of 
provisions of the Code that have to do with definitions of 
filing status, dependent exemptions, and various tax credits. 
These tend to go together.
    As you can see, there are six different kinds of elections 
or credits the taxpayers have the option to elect, such as head 
of household, or filing status, dependent exemptions, and 
various credits, including the earned income credit and the 
child credit. These are six different areas. And then across 
the top there are five different kinds of tests that are 
applied in the Tax Code to determine eligibility or the status 
of these elections.
    As you can see, some apply in some cases and some apply in 
other cases. But in addition to that, of course, there are 
different definitions under these tests. Even where it appears 
to be the same, such as the age limit, there are different 
definitions. For example, there is no general age test for 
dependents or for the education credit. However, for the 
dependent child care credit, it is limited to qualifying 
individuals under the age of 13. The child tax credit is 
limited to those under 17. The EITC applies to qualifying 
children under 19. And the kiddie tax is under 14. And 
actually, there are more complications than that.
    This illustrates some of the confusing aspects of the 
varying definitions.
    Based on our analysis, we developed a number of options to 
be considered that would reduce the complexity associated with 
these inconsistent definitions, such as adopting one definition 
of the relationship test for dependents and qualifying 
individuals for tax credits, including the EIC.
    The second area that we covered was the alternative minimum 
tax. This, of course, was created to see that no taxpayer who 
had substantial economic income avoids a tax liability through 
the use of exclusions, deductions, and credits. This is a 
complex provision that has not been indexed for inflation. We 
estimate that about 27 percent of the taxpayers who now pay the 
AMT have less than $100,000 in adjusted gross income. If it is 
not changed by 2005, we would have about 6.3 million AMT payers 
compared to a little over 1 million today.
    Based on our analysis, we developed a number of options 
that could alleviate AMT complexity. These include calculating 
the AMT using information that is already on the tax return and 
possibly repealing the provisions related to married filing 
separate taxpayers.
    The third area, briefly, is the complexity of the taxpayer 
encountering meeting their estimated tax obligations. Mr. 
Chairman, as you know, this provision particularly affects 
self-employed and small business taxpayers, a rapidly growing 
segment. Some of the options that could be considered here for 
simplifying would be to make the estimated tax periods 
standardized and would in each case equal to one-quarter, and 
perhaps make the filing data 15 days after the end of each 
calendar quarter. Another possibility would be to keep the safe 
harbor provisions constant. They have been changing quite 
    I know that is a very brief summary, but I just wanted to 
mention the three areas that we have covered. We recognize that 
this does not cover all the areas of complexity by any means, 
but we hope it is a start in covering some of the more 
troublesome areas related to Tax Code complexity and providing 
some options that could be used to reduce undue and unnecessary 
    Thank you very much, Mr. Chairman. I would be glad to 
answer questions.
    [The prepared statement follows:]

Statement of Hon. Charles O. Rossotti, Commissioner, Internal Revenue 


    Mr. Chairman, I welcome this opportunity to testify before 
the Subcommittee on Oversight on the Internal Revenue Service's 
first annual report to Congress on tax law complexity. The IRS 
Restructuring and Reform Act of 1998 (RRA 98) requires the 
Commissioner of Internal Revenue to report annually to the 
House Ways and Means Committee and Senate Finance Committee on 
areas of complexity in the Internal Revenue Code (Code). My 
testimony will summarize the report's major findings.


    Few issues have generated as much discussion in recent 
years as Tax Code complexity. Executive and legislative branch 
policymakers, as well as taxpayers, have been vocal about the 
burden that complexity places on taxpayers as they seek to meet 
their tax obligations, and on the Internal Revenue Service as 
it works to administer the Code.
    Mr. Chairman, many circumstances contribute to the Code's 
complexity. Complexity is added both knowingly and 
inadvertently as (1) tax laws are changed, (2) legislative 
tradeoffs among different policy objectives are made, and (3) 
the economy and society as a whole become more complex.
    The Code's complexity becomes even more burdensome to 
taxpayers and the IRS when the Code changes frequently or when 
changes are made effective shortly in the future or 
retroactively. One of the largest problems that the IRS 
encounters is short or retroactive effective dates for changes 
in the tax law. Mr. Chairman, the single most helpful thing 
Congress can do in this regard is to provide the IRS with 
adequate time prior to the date statutory changes go into 
effect. I am pleased to say that the tax writing committees 
have been receptive to our recommendation in this regard, 
particularly with respect to provisions that might have 
jeopardized our Y2K program.
    Reducing complexity can alleviate taxpayer burden by 
cutting the time and costs taxpayers face in meeting their tax 
obligations, and increase compliance by making those same 
obligations easier to understand and meet. Reducing complexity 
will also make it easier for IRS' employees to do their jobs of 
providing services to taxpayers and enforcing the law.
    The IRS tax law complexity report has three objectives. 
First, to the extent available, the report provides the 
specific information requested in RRA 98, including frequently-
asked taxpayer questions, areas where taxpayers have difficulty 
in complying with the Code, and missing or incomplete guidance.
    Second, it describes how these specific areas of the Code 
that were analyzed for inclusion in this report were selected. 
Third, the report analyzes where complexity occurs, and 
possible options for reducing complexity in filing definitions, 
the non-corporate or individual Alternative Minimum Tax (AMT), 
and estimated taxes.
    The short-term goal is to respond to the immediate issues 
suggested in the legislation; the long-term goal is to provide 
a systematic examination of complexity in tax administration 
that correlates with both taxpayer burden and taxpayer 
compliance issues.

Tax Law Complexity: Best Seen Through Both Burden and 

    While complexity, burden and compliance are key integrated 
concepts in tax administration, each is also a stand-alone 
issue. Burden results from taxpayers spending time and money 
trying to understand and meet their filing, reporting and 
payment responsibilities. Complexity adds to that burden when 
these taxpayers must also determine if and how specific Code 
provisions apply to them. On the other end of the spectrum, 
significant reductions in burden, as well as increases in 
compliance may be driven by a simplification change that 
affects many taxpayers.
    By the same token, noncompliance can result from taxpayers' 
frustrations with the complexity encountered when trying to 
obey the law. Individual taxpayers cope with complexity as best 
they can. Some struggle with it by themselves, while others 
rely on tax preparation software or paid preparers. 
Approximately 50 percent of all individual taxpayers use paid 
preparers to complete their tax returns. At least 33 percent 
use software.
    Complexity also creates opportunities for ``gray areas'' 
where taxpayers can take aggressive positions that may or may 
not be legitimate. For example, this could include the use of 
conflicting definitions for the same terms or concepts, such as 
the definition of a child. Taxpayers with children may be 
eligible for a number of different tax benefits. However the 
definition of a child may vary among these provisions, and as a 
result, taxpayers may find that they are not able to claim the 
same child for dependent exemptions, head-of-household, filing 
status, child tax credits, the Earned Income Tax Credit (EITC), 
and other child-related benefits. These same considerations 
make it all the more difficult for the IRS to enforce the Code 
consistently and fairly.
    This complexity also requires providing additional 
government resources to carry out all of the IRS' programs, 
from providing taxpayers telephone and walk-in assistance, as 
well as easy-to-understand forms and publications, to auditing 
potentially non-compliant returns. For example, for calendar 
year 1999, the IRS responded to almost two million taxpayer 
inquiries related to filing season definitions, yet over three 
million returns were filed with errors involving filing 
    Complexity is also introduced through a variety of sources, 
including the Code, other federal statutes, regulations, forms, 
publications, and procedures. In addition, changes in 
individuals' circumstances can introduce complexity. For 
example, when two people marry, they must decide which filing 
status to use to minimize their taxes. They are now dealing 
with tax system complexity. Divorce creates its own set of 
complexity considerations.
    Complexity is rooted even deeper in the national landscape. 
In a complex economy and social structure, such as those in the 
United States, many tax goals can be achieved only through tax 
provisions that reflect the underlying complexity of the 
financial transaction or goal. Complexity is frequently 
introduced as policymakers make trade-offs between simple tax 
designs and the desire to make the tax system fair and 
equitable in a fashion that supports social and economic as 
well as tax policy goals.

The Impact of Statutory Change

    At one time or another, legislative changes to the Code 
have had an impact on all taxpayer segments. When tax laws 
change, individuals often face uncertainty as to how to comply 
with the changes. In addition, the inability to stay current 
with tax law changes has been cited by small business owners 
and individuals as a primary reason for their use of paid 
    Many of the taxpayers, tax practitioners, scholars, and 
other stakeholders with whom the IRS spoke when researching and 
writing the tax complexity report, emphasized that even the 
simplest changes to the Code can have complex and serious 
consequences for taxpayers and the IRS if the change is 
frequent and/or has a retroactive or short lead time for the 
effective date.
    Mr. Chairman, let me provide some historical context for 
this discussion. Since 1986, seventy-eight tax laws have been 
enacted. The EITC has been changed almost yearly for the past 
decade. One of the 78 new laws, the Tax and Trade Relief 
Extension Act of 1998, contained 25 sections of tax changes. Of 
these changes, 11 were effective retroactively and four were 
effective within 90 days of the end of the calendar year.
    The enactment of provisions with retroactive or short 
effective lead times also increases complexity. Both the IRS 
and taxpayers are challenged and frustrated by this situation 
and both must act quickly to accommodate these changes.
    The IRS must ensure that its systems, training, and other 
employee tools are current and reflect the most recent 
legislation. The IRS must also issue clear guidance and tax 
forms covering the changes in time for the next filing season. 
Especially problematic are changes that come late in the 
calendar year when the forms and publications for the next 
filing season are ready to go, or have already been sent to the 
    Beyond the logistical challenges and the additional costs 
the IRS may incur, short time frames frequently do not allow 
the IRS to consult with taxpayers and other stakeholders when 
developing new forms. This can result in the forms being more 
difficult for taxpayers to understand or complete than they 
would be under normal circumstances.
    Taxpayers also face the uncertainty that late changes 
introduce around their current and future tax obligations. With 
short lead times, both the IRS and taxpayers have little time 
or opportunity to become knowledgeable about the changes to the 
Code. This creates additional opportunities for error as well 
as heightened frustration and conflict.
    In addition, because the time between when a tax return is 
filed and when it could be audited could be from one to two 
years, taxpayers and IRS employees must also accommodate 
circumstances where the Tax Code has changed in the intervening 
time period.
    Obviously, time limitations affect our ability to make the 
systems changes necessary to support the statutory changes I 
have described. The Taxpayer Relief Act of 1997 and RRA 98 are 
good examples of statutes with many challenging tax-related 
changes and short effective date lead times. The following 
table provides in greater details the extensive changes and 
effective dates set by recent statutes.

                                                                                   Total  Number     Effective
                                                      Number of        Retro-       of  Sections   Date  Between
 Bill Title and Public Law Number     Date Passed      Sections     active Over       that are       Oct. 1 and
                                                                       1 Year       Retroactive       Dec. 31
Small Business Job Protection Act       8/20/96            111             12              28              44
                     of 1996 P. L. 104-188
  Taxpayer Bill of Rights 2 P. L.       7/30/96             47              0               3               2
Balanced Budget Act of 1997 P. L.        8/5/97            218             10              24              77
Taxpayer Relief Act of 1997 P. L.
          Tax Provisions of the          6/9/98             13              1               2               0
 Transportation Equity Act for the
                21st Century P. L. 105-178
IRS Reform and Restructuring Act        7/22/98            113              2              12               2
                     of 1998 P. L. 105-206
Tax and Trade Relief Extension Act     10/21/98             25              2              11               4
                     of 1998 P. L. 105-277
Source: IRS Legislative Affairs

    Mr. Chairman, as I mentioned at the beginning of my 
testimony, I also want to commend the House Ways and Means and 
Senate Finance Committees for their enormous help, 
understanding and cooperation on effective dates related to the 
IRS' Century Date Change project. I seriously doubt that we 
would have had such a successful Y2K conversion without this 
excellent working relationship.

Report's Objectives and Scope

    For this report, the IRS limited its analysis to provisions 
of the Code that impact individual taxpayers--both Wage and 
Investment, and Small Business/Self-Employed taxpayers. The 
three specific provisions in the Code that we selected for our 
in-depth review were filing definitions, individual Alternative 
Minimum Tax (AMT), and estimated taxes.

Filing Definitions

    The IRS focused its analysis on inconsistencies in filing 
definitions because they clearly illustrate how complexity is 
introduced into the Federal tax return preparation and filing 
    Numerous definitions are used to determine a taxpayer's 
filing status and eligibility to claim the dependency 
exemptions and credits for qualifying individuals. The 
complexity associated with filing status definitions is 
reflected in the high volume of contacts IRS receives from 
taxpayers through customer service calls, TeleTax, and the 
Internet. Frontline IRS employees also identified definitions 
for eligibility of credits as a major contributor to taxpayer 
complexity. Of special interest to the IRS was how relationship 
tests and income tests, which are used to determine eligibility 
for credits, can have an impact on complexity.
    Based on our analysis, we developed the following options 
for Congress to consider that would reduce complexity 
associated with inconsistent filing definitions:
     Adopt one definition of relationship for 
dependents and qualifying individuals for tax credits including 
the EITC;
     Use Adjusted Gross Income rather than the modified 
Adjusted Gross Income for determining eligibility under the 
Child Tax Credit and Education credits;
     Use one set of income thresholds for the Child Tax 
Credit and Education credits; and
     Adopt one age criterion for defining a qualifying 
    It is important to note that we have not analyzed the 
budgetary effects of these options or the others presented in 
the complexity report or their effects on other policy goals, 
such as fairness and promoting economic growth. Accordingly, 
the options should not be considered as policy recommendations. 
However, we hope that they will at least other ways to simplify 
the tax system.

Individual Alternative Minimum Tax

    The AMT was created by the Revenue Act of 1978 and was 
intended to ensure that no taxpayer with substantial economic 
income avoids a tax liability through the use of exclusions, 
deductions, and credits. The AMT is a complex provision that is 
not indexed for inflation. As such, the number of taxpayers 
experiencing the complexity of computing Alternative Minimum 
Tax Income (AMTI) and paying AMT is projected to increase 
substantially in the years to come.
    Our analysis of AMT included a review of many elements that 
contribute to the provision's complexity, including the various 
thresholds and phase-outs that must be considered, the complex 
mathematical calculations that must be performed, and the 
linkages that must be made between forms and schedules.
    Based on our analysis of the complexity within AMT and a 
review of proposals made by stakeholders, both inside and 
outside of government, the IRS developed the following options 
for enacting or amending legislation that would alleviate AMT 
complexity. Once again, these options should not be considered 
as policy recommendations:
     Calculate AMTI using information already on the 
tax return;
     Repeal the excess AMTI provisions for married 
filing separately taxpayers;
     Repeal the requirement for recalculation of 
depreciation; and
     Index exemption amounts and phase-out thresholds 
for inflation.

Estimated Taxes

    Taxpayers face several areas of complexity in meeting their 
estimated tax obligations. These include complexity in the Code 
and regulations regarding inconsistent time periods for 
calculating and remitting the tax and the safe-harbor 
provisions for high-income taxpayers. These are the areas we 
focused on in our analysis for this report.
    Some of the options that Congress may wish to consider for 
alleviating the complexity associated with preparing and filing 
estimated tax returns are:
     Standardize the installment payment schedule with 
payments due 15 days after the end of the quarter;
     Standardize the payment periods under the 
annualized method; and
     Keep the high-income safe harbor percentage 


    Mr. Chairman, in conclusion, I believe that this first 
report represents an important initial step in identifying, 
analyzing and explaining some of the most fundamental problems 
related to tax law complexity and providing options for 
reducing undue and unnecessary complexity. Although these 
options should not be considered policy recommendations, we 
look forward to working with the Administration and Congress to 
help reduce taxpayer burden related to tax law complexity.


    Chairman Houghton. Thank you very much, Mr. Commissioner.
    Mr. Coyne?
    Mr. Coyne. Thank you, Mr. Chairman.
    Commissioner Rossotti, in your testimony--as you alluded 
to--the chart that shows that since 1995 there have been 527 
tax law changes and you are required to implement those changes 
as quickly and as fairly as possible.
    What are the most complex of those 527 changes, from your 
    Commissioner Rossotti. I don't know that I could answer 
that off the top of my head, Mr. Coyne. I would have to go back 
and analyze those changes and get back to you on that.
    I think one point to be made is the sheer numbers. It is 
not just one change, but the sheer combination of them that 
really causes probably the most difficulty. But if you would 
like, I can get back to you with an answer.
    Mr. Coyne. Just maybe the top three or four most complex.
    Commissioner Rossotti. Sure.
    [The information follows:]

    Because the tax code does not affect all taxpayers in the 
same way, it is difficult to quantity exactly which of the 527 
tax law changes since 1995 qualifies as the ``most complex.'' 
Generally speaking, for individuals the most complex tax 
provision is the 1997 capital gains tax reduction which 
requires taxpayers to apply up to four separate rates to the 
different components of the taxpayer's net long-term capital 
gain to calculate their capital gain tax. Part IV of the 1999 
Schedule D, which is used for this computation, contains 35 
lines entries. Compare this to the pre-1987 capital gains tax 
which simply excluded a percentage of the taxpayer's long-term 
capital gain (60% in 1986) and applied the regular tax rates 
tot he remainder. (Between 1987 and 1996, the tax on long-term 
capital gains was limited to 28%.)
    Another notable area of complexity is the multiple benefits 
provided for education. These benefits include education IRAs, 
two different credits for college expenses, exemption from tax 
for qualified stat tuition programs, and the deduction for 
interest on education loans. While none of these provisions in 
and of itself is that complicated, the total of these benefits 
and the rules for coordination between benefits can be 
overwhelming. Pub. 970, Tax Benefits for Higher Education, 
which attempts to provide an oversimplified explanation of 
these benefits, contains more than 15 pages of text.


    Mr. Coyne. How does your report recommend, for instance, 
that the capital gains be simplified? Do you have any 
    Commissioner Rossotti. In this particular report, we did 
not address the capital gains provisions--not that that isn't 
one that could be subject to analysis--and I would hope that in 
future years we could perhaps include capital gains as one of 
the provisions. Because of the limitations of time and the 
enormity of the tax code, we thought it would be more effective 
to pick certain areas this year and try to provide some 
analysis for those. We are not claiming those are the only 
complex areas.
    We did not analyze capital gains, although certainly that 
is a complex area.
    Mr. Coyne. Do you hold out hope that there might be some 
salvation for being able to simplify capital gains filing?
    Commissioner Rossotti. I really don't know, Mr. Coyne. I 
think what we can do, as we go on each year, is add additional 
analyses for different provisions. I certainly have heard from 
many people that capital gains is one that we ought to analyze. 
So we can certainly put that high on our priority list for next 
    Mr. Coyne. Has the statutory requirement for tax complexity 
analysis, as required by the Reform Act of 2 years ago--has 
that been effective?
    Commissioner Rossotti. Of course, there haven't been too 
many major tax changes since that was put in, so I think we 
will have to wait and see. I know we have worked with the Joint 
Committee on every significant tax provision and have provided 
information through the Joint Committee to the taxwriting 
Committees on the impact of proposed changes. I hope that those 
have been helpful to the members as they have considered these 
    We have conformed to the requirements of the law and have 
provided that analysis in working closely with the Joint 
Committee. But of course, there hasn't been too much in the way 
of tax legislation yet, so we will have to wait and see how 
effective that is.
    Mr. Coyne. Thank you.
    Chairman Houghton. Ms. Dunn?
    Ms. Dunn. Good morning, Mr. Rossotti. It is nice to see you 
    I have been trying to simplify the Tax Code for you by 
eliminating a whole class of taxes, the estate tax. We 
succeeded in passing that in the House of Representatives, 
which is now before the Senate.
    Some of the alternatives are based on an effort to increase 
the exemption for family held businesses and farms and estates. 
I don't mean to shanghai you on this--and maybe it is something 
you would like to answer in writing--but I have great concerns 
about that way to approach the relief of the death tax because 
it seems to me that the work that we did in 1997 to define a 
family held estate created such a narrow spectrum of 
possibilities that only between about 3 and 5 percent of family 
held businesses were even able to take advantage of it.
    So I believe it is deceptive for some to say now we are 
going to increase the exemption based on that same description.
    I was wondering if you had any thoughts on this, if you 
know about that.
    Commissioner Rossotti. I would have to say I would have to 
get back to you. Not because it isn't complex, but only because 
we had limited resources, we did not cover any estate tax 
provisions in this report. So I don't have any data right now 
to really answer your question. But I would be happy to get 
back and try to get with your staff.
    Ms. Dunn. Perhaps I can put it in writing.
    Commissioner Rossotti. Sure. We will attempt to do that.
    Chairman Houghton. I have a couple of questions here. The 
first is pretty broad, and that is really the working 
relationship between the IRS and Congress. Where do you see 
Congress really helping--within the next year--us make a dent 
in this complexity issue? Where do you see us working with you 
on this?
    Commissioner Rossotti. In my statement, I made a couple of 
points. On any provisions that the Congress chooses to change--
hopefully in the direction of simplification, but for perhaps 
other reasons as well--I think the kind of relationship we had 
as we were going through the Y2K change, where we really had 
good conversation as these provisions were being considered is 
    There are two points, really. One is as required by the 
law, and through the Joint Committee we do provide an analysis 
of the complexity and the impact on tax forms and things like 
that. That would be our opportunity to provide that input to 
the Congress. Then the other extremely important one is just 
the timing of these things, which I mentioned in my statement.
    Those are two very practical things. I think we have a 
channel to work with and if we can maintain that and improve 
it, I think it would be extremely good for everyone.
    Of course, the other one is that we do have this report and 
we have laid out some possibilities there. We will again have a 
report next year in the early part of the year that will build 
on this. Based on the comments we get in this hearing and from 
other stakeholders, we will expand into other areas of the 
Code--as you suggest in your opening statement--to analyze 
additional areas of complexity. We hope that those would be 
helpful to the taxwriting Committees in considering ways that 
the Committee could reduce complexity in the Code.
    Those would be my two major suggestions.
    Chairman Houghton. Moving more toward the administrative 
rather than the legislative route, and picking up on something 
Mrs. Dunn was talking about, small businesses.
    I understand that there are upward of 200 requirements, 
forms, and reports for small businesses. It seems like an awful 
lot. I can't put a figure on it, but it is just sort of a gut 
feeling that it is wrong. I wonder whether there are things you 
can do administratively, rather than having to go through the 
legislative process, to help with that.
    Commissioner Rossotti. I think there is. This is one of our 
real priorities. As you know, part of our whole modernization 
plan is to set up a whole division that will be dedicated to 
small businesses and self-employed individuals. A major part of 
their mission is just going to be focusing on working with 
small business taxpayers, identify what we need to do to make 
life simpler for them, and to also educate them because there 
is a minimum that has to be done to comply with the Code.
    Some of the things we have done already--and there is more 
we can do--we took about 2 million taxpayers out of the need to 
provide what are called tax deposits. These are usually monthly 
forms that you fill out with employment taxes. It used to be 
that if you had more than $500 per quarter--which is a very 
small number in today's economy--you had to file these. We were 
able to administratively, with the help of Treasury, to 
increase that to $1,000 a quarter. That doesn't sound like 
much, but it took 2 million businesses out of that whole thing 
    So we are looking at those kinds of options. That is 
already done and there are other possibilities like that.
    Another approach that we are trying to take is to package 
things. As you mentioned, the 200 plus--and if you take a big 
book like this and hand it to somebody it is hard to figure out 
what applies to you and what doesn't. A lot of things don't 
really apply, but you don't know which ones apply. So we are 
trying to package them to make them easier.
    One of the things we have done, working with the Small 
Business Administration, is to come up with a CD-Rom that has 
been quite positively received. It has all the information on 
it looked at from a small business point of view. First of all, 
it is all there in one place and you can search it and it 
points you down to what is really applicable to you.
    Your question is very, very much on target and is really a 
whole strategy that we have. There is no one solution that I am 
aware of that magically solves it. But I believe if we keep 
working on it and working with the small business community and 
the self-employed individuals we can definitely reduce that 
    One of the areas that we covered in our report has to do 
with estimated taxes. One of the reasons we picked that one out 
is because that one does affect self-employed individuals and 
small business owners in particular. It is important for people 
to pay taxes as you go, but we think that is an area that 
potentially could be simplified in terms of how it is 
implemented to make it easier for people. That is one of the 
most common places that self-employed individuals go wrong and 
get into penalty situations.
    I am just summarizing some of the areas, but I certainly 
agree with your point and I think it is something, if we keep 
working on it, we can over time make a dramatic difference in 
the ease with which small businesses and self-employed people 
can comply with the Code.
    Chairman Houghton. Thank you very much.
    Mr. Coyne?
    Mr. Coyne. Thank you, Mr. Chairman.
    Commissioner, I commend you in taking on the problem of the 
complexity of the earned income tax credit through 
standardizing criteria for a qualifying child and adopting one 
definition of relationship for dependents and qualifying 
    Can you tell us to what extent this could serve to reduce 
errors in the EITC Program?
    Commissioner Rossotti. I don't have any way to quantify it 
precisely, but I can tell you that the whole area of people 
putting down an individual as a qualifying child and having it 
be incorrect is the most common error that occurs. As you can 
tell from the complexity of the definitions and the fact that 
those definitions are different from what you need to qualify 
for an exemption, there is certainly an understandable reason 
why there would be errors in that.
    And by the way, people also make errors without the EIC in 
terms of their dependents. It seems to the average person that 
these are all the same thing. But according to the Tax Code, 
they are not the same thing.
    It is a complex area to figure out how to solve, but I 
would certainly say if you had to pick out one area that 
affects the largest number of taxpayers, these things that are 
on this chart--to the extent they could be simplified, it would 
make a big difference.
    To give you an example, here is a booklet that we put out 
that is pretty popular, a common thing that people use, similar 
to what is in their tax forms. The first part explains how to 
fill out your 1040 return. If you look at this, there are about 
13 pages here just in the beginning that cover just the first 
two rows on there, which is the filing status and the dependent 
    There is a flow chart. This is to determine if you can take 
someone who lives in your house--your son or your daughter or 
anyone who lives in your house--as a dependent. This is pretty 
complicated for the average person to do, and it is the average 
person that is doing this.
    This is why we highlight this area in our analysis. 
Certainly from the point of view of our employees, from the 
point of view of our hot line, and from the point of view of 
the phone service, this is the area we get the most questions 
on, and that we get the most errors on. It is perfectly 
understandable if you just leaf through the first 13 pages here 
to tell someone what seems like a simple question.
    Can I take my niece that lives with me as a dependent? That 
sounds like a simple question, but you have to wade through 
quite a bit of information to try to find the answer to that 
    I think that if we could find a way over time to combine 
these things and simplify them to make a standard definition, 
it would without question reduce the burden on individual 
taxpayers and reduce the number of errors that we have to work 
with taxpayers on.
    Mr. Coyne. You have a report that is due relative to the 
earned income tax credit. I think you told us at one time that 
it might be due out by the end of the year.
    Commissioner Rossotti. Yes. I hope that will be the case. 
We are working on that now.
    Mr. Coyne. You are still hoping that it could come out 
before the end of this year?
    Commissioner Rossotti. Yes.
    Chairman Houghton. Ms. Dunn?
    Ms. Dunn. No questions, Mr. Chairman.
    Chairman Houghton. Mr. McDermott?
    Mr. McDermott. I have no questions, Mr. Chairman.
    Chairman Houghton. Commissioner, you may or may not know 
this, but I introduced a bill in Congress that seeks to reduce 
the burden on taxpayers, the same recurring theme. As your 
report did, my bill focused on tax provisions affecting 
individuals and small businesses. The bill addresses ways to 
simplify AMT, estimated taxes, and things like that. It also 
proposed replacing the current capital gains tax regime of the 
50 percent, exclusion from income, raising the gross receipts 
exemption, broaden the exemption so that more small businesses 
could avoid the burdensome uniform capitalization, and reducing 
recordkeeping requirements.
    I wonder if your agency had any response to that. Did they 
develop any other options?
    Commissioner Rossotti. We have not specifically analyzed 
both provisions, Mr. Chairman. I think that certainly we could 
look at them, as with the legislation we are required to do, 
and provide tax estimates of what it would do to reduce 
    As I mentioned in answer to Mr. Coyne's question, capital 
gains, in particular, is one area that we know has complexity. 
I think it would be high on our agenda for next year to 
analyze. We just didn't get to it for this particular year.
    Some of the things, such as reducing recordkeeping 
requirements and getting rid of records--those kinds of things 
are practical issues that would probably be very helpful.
    I will mention one thing. On July 17th, next month, as a 
follow-up to this and in preparation for next year, we are 
actually sponsoring with OMB a Tax Complexity Forum in 
Washington. We have asked a lot of stakeholders who represent 
small businesses and practitioners to come in and, having 
looked at our reports the first time, give us additional input 
as to what we could do next year.
    At that meeting on the 17th--and we would be glad to 
provide you more information about it--it would be an 
opportunity to get some input on a variety of additional 
proposals and ideas that haven't yet been considered in our 
    Chairman Houghton. I have another question for you. We have 
talked about this before, but I am still fascinated with the 
whole concept of training.
    There are so many changes in the tax laws and regulations. 
How do you keep abreast of this in training your people?
    Commissioner Rossotti. As I mentioned in my statement, this 
is probably our number one issue. It is interesting. It isn't 
even the complexity of the Code that is the hardest problem, it 
is the change in the Code. Many of our practitioner friends and 
colleagues tell us this over and over again, that even when 
there are simple changes--people do adjust to the Tax Code over 
time because they take last year's return. I figured it out 
last year and my situation doesn't change that much from year 
to year. They kind of get used to it.
    When you interject significant changes--or sometimes even 
insignificant changes--the education process, both for our own 
employees and for taxpayers, is a major challenge. Then, of 
course, you have all the computer software and computer things 
like that that have to be done.
    So the rate of change is without a doubt one of the 
greatest challenges in tax administration. We have a whole 
process in our organization, because we know that there will be 
changes. But the faster they come and the shorter the lead 
time, the more difficult it is.
    Chairman Houghton. Well, that's not a bad record for a 
hearing, is it?
    Commissioner, just one final point. You obviously have 
nothing to do with the writing of the Tax Code, but obviously 
the IRS can play a very important role in alleviating some of 
the Tax Code complexities. We look forward to working with you.
    Commissioner Rossotti. Thank you.
    Chairman Houghton. We thank you very much for being with us 
    [Whereupon, at 10:37 a.m., the hearing was adjourned.]