[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]



                     2001 TAX RETURN FILING SEASON

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

                                HEARING

                               before the

                       SUBCOMMITTEE ON OVERSIGHT

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                               __________

                             APRIL 3, 2001

                               __________

                           Serial No. 107-13

                               __________

         Printed for the use of the Committee on Ways and Means



                      COMMITTEE ON WAYS AND MEANS

                   BILL THOMAS, California, Chairman

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

                     Allison Giles, Chief of Staff

                  Janice Mays, Minority Chief Counsel

                                 ______

                       Subcommittee on Oversight

                    AMO HOUGHTON, New York, Chairman

ROB PORTMAN, Ohio                    WILLIAM J. COYNE, Pennsylvania
JERRY WELLER, Illinois               MICHAEL R. McNULTY, New York
KENNY C. HULSHOF, Missouri           JOHN LEWIS, Georgia
SCOTT McINNIS, Colorado              KAREN L. THURMAN, Florida
MARK FOLEY, Florida                  EARL POMEROY, North Dakota
SAM JOHNSON, Texas
JENNIFER DUNN, Washington

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


                            C O N T E N T S

                               __________
                                                                   Page
Advisory of March 27, 2001, announcing the hearing...............     2

                               WITNESSES

Internal Revenue Service:
    Hon. Charles O. Rossotti, Commissioner.......................     5
    Nina E. Olson, National Taxpayer Advocate....................    42
U.S. Department of the Treasury, Hon. David C. Williams, 
  Inspector General for Tax Administration.......................    52
U.S. General Accounting Office, James R. White, Director, Tax 
  Issues, accompanied by Randolph C. Hite, Director, Information 
  Technology Systems Issues, and Robert F. Dacey, Director, 
  Information Security Issues....................................    55
H&R Block, Mark A. Ernst.........................................    77
National Association of Enrolled Agents, Claudia Hill............    82

                       SUBMISSION FOR THE RECORD

American Institute of Certified Public Accountants...............    92

 
                     2001 TAX RETURN FILING SEASON

                              ----------                              


                         TUESDAY, APRIL 3, 2001

                  House of Representatives,
                       Committee on Ways and Means,
                                 Subcommittee on Oversight,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 2:08 p.m., in 
room 1100 Longworth House Office Building, Hon. Amo Houghton 
(Chairman of the Subcommittee) presiding.
    [The advisory announcing the hearing follows:]

ADVISORY

FROM THE 
COMMITTEE
 ON WAYS 
AND 
MEANS

                       SUBCOMMITTEE ON OVERSIGHT

                                                CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE

March 27, 2001

No. OV-3

      Houghton Announces Hearing on 2001 Tax Return Filing Season

    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 2001 tax return filing season. 
The hearing will take place on Tuesday, April 3, 2001, in the main 
Committee hearing room, 1100 Longworth House Office Building, beginning 
at 2:00 p.m.
    Oral testimony at this hearing will be from invited witnesses only. 
Witnesses will include Internal Revenue Service (IRS) Commissioner 
Charles Rossotti, the National Taxpayer Advocate Nina Olson, and 
representatives from the U.S. General Accounting Office, the U.S. 
Department of the Treasury Inspector General for Tax Administration, 
and tax practitioner groups. However, any individual or organization 
not scheduled for an oral appearance may submit a written statement for 
consideration by the Committee and for inclusion in the printed record 
of the hearing.
      

BACKGROUND:

      
    The 2001 tax return filing season refers to the period from January 
1st to April 15th (April 16th this year in most of the 
United States) when U.S. taxpayers will file over 130 million tax 
returns, including 42.3 million e-filed returns (a projected 9.6 
percent increase over the 2000 filing season). During this period the 
IRS is expected to issue over 96.8 million tax refunds, answer 62 
million telephone calls from taxpayers asking for assistance, and its 
homepage will receive 2 billion hits.
    In announcing the hearing, Chairman Houghton stated: ``Customer 
Service. This was the promise of the new IRS after the Restructuring 
and Reform Act of 1998. This hearing gives us the opportunity to ensure 
that the IRS is living up to its promise by processing taxpayer 
questions, returns, and refunds as efficiently as possible. I am 
looking forward to the Commissioner's testimony.''
      

FOCUS OF THE HEARING:

      
    The Subcommittee will review the progress in customer service 
offered by the IRS in the 2001 tax filing season, including progress in 
the customer communications system, electronic filing, and systems 
modernization.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Any person or organization wishing to submit a written statement 
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch 
diskette in WordPerfect or MS Word format, with their name, address, 
and hearing date noted on a label, by the close of business, Tuesday, 
April 17, 2001, to Allison Giles, Chief of Staff, Committee on Ways and 
Means, U.S. House of Representatives, 1102 Longworth House Office 
Building, Washington, D.C. 20515. If those filing written statements 
wish to have their statements distributed to the press and interested 
public at the hearing, they may deliver 200 additional copies for this 
purpose to the Subcommittee on Oversight office, room 1136 Longworth 
House Office Building, by close of business the day before the hearing.
      

FORMATTING REQUIREMENTS:

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

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

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

                                


    Chairman Houghton. Ladies and gentlemen, thank you very 
much for being here. The hearing will now come to order. It is 
good to see you, Commissioner. Thanks very much for your 
presence here. You may have one of the most difficult jobs in 
the city. I believe, though, that you have run the agency 
admirably, and I know the service is not where you want it to 
be yet, but you have made great strides and I am sure you have 
high hopes.
    Let me say just a few words about customer service. 
Customer service means many things, among them are courtesy, 
efficiency, and, most importantly, fairness. The relationship 
between the IRS and the ordinary citizen, because of the nature 
of the function, sometimes can be potentially difficult, but if 
each time the taxpayers reach out to the IRS or the IRS reaches 
out to them and they are treated with these three objectives in 
mind, the IRS will be able to increase its trust in the eyes of 
the American public. So we will discuss many topics today and 
ask many questions, but the underlying theme will remain the 
same: courtesy, efficiency and fairness.
    One more thought. No one can understate the importance of 
security. Taxpayers must feel that the information on their tax 
returns is safe. This information must be secure from both 
internal browsing and external break-ins. And I know, 
Commissioner, that you have made security a focal point. So I 
thank you for coming today. And the rest of the witnesses, I 
thank you also and I look forward to your ideas. I am pleased 
to yield to our ranking democrat, my friend, Mr. Coyne.
    [The opening statement of Chairman Houghton follows:]
    Opening Statement of the Hon. Amo Houghton, M.C., New York, and 
                  Chairman, Subcommittee on Oversight
    Good afternoon. It is good to see you Commissioner. You may have 
one of the most difficult jobs in this city. Because nobody 
particularly likes to interact with the IRS, it is all that more 
important that when they must, the service they receive be the best 
possible. I believe that you have run this agency admirably. I know 
service is not where you want it to be yet, but you have made great 
strides.
    I want to say a few words about customer service. Customer service 
means three things to me: (1) courtesy, (2) efficiency, and most 
importantly (3) fairness. If each time a taxpayer reaches out to the 
IRS, or the IRS reaches out to him, heaven forbid, he is treated with 
these three objectives in mind, the IRS will improve its image and 
increase its trust in the eyes of the American public. We will discuss 
many topics today and ask many questions. The underlying theme will 
remain the same: courtesy, efficiency, and fairness.
    Thank you Commissioner for coming today and to the rest of the 
witnesses. I look forward to hearing your ideas.
    I want to add one more thought. I cannot understate the importance 
of security. Taxpayers must feel that the information on their tax 
returns is safe. This information must be secure from both internal 
browsing and external break-ins. I know, Commissioner, that you have 
made security a focal point, but do not let your guard down. If you do, 
you risk the trust of the taxpayers.
    I am pleased to yield to our ranking Democrat, Mr. Coyne.

                                


    Mr. Coyne. Thank you, Mr. Chairman. I, too, would like to 
welcome Commissioner Rossotti. With less than 2 weeks before 
Monday, April 16th, it is timely that this Oversight Committee 
of Ways and Means review how the 2001 tax return filing season 
is progressing. Reports are that all systems are up and running 
and that this filing season may be one of the best ever. The 
commissioner is doing an excellent job in reorganizing and 
modernizing the IRS and should be commended for the work that 
he has completed already.
    The tax return filing season is a huge and complicated 
operation. Taxpayers will file over 130 million tax returns 
this year, including 42 million e-filed returns. IRS employees 
will issue nearly 97 million tax refund checks, answer over 60 
million telephone calls from taxpayers, and serve nearly 6 
million taxpayers at IRS walk-insites. Inevitably, some 
problems will occur, hopefully with the expert oversight and advice of 
those testifying before us here today, these situations can be quickly 
addressed. I am pleased that for the first time this Subcommittee will 
have the opportunity to hear from the new IRS Taxpayer Advocate, and 
from the Treasury Inspector General for Tax Administration. Thank you, 
Mr. Chairman.
    [The opening statement of Mr. Coyne follows:]
   Opening Statement of the Hon. William J. Coyne, M.C., Pennsylvania
    With less than two weeks left before Monday, April 16th, it is 
timely that the Ways and Means Oversight Subcommittee review how the 
2001 tax return filing season is progressing.
    Reports are that all systems are up and running and that this 
filing season may be one of the best ever. The Commissioner is doing an 
excellent job in both reorganizing and modernizing the IRS and should 
be commended.
    The tax return filing season is a huge and complicated operation. 
Taxpayers will file over 130 million tax returns this year, including 
42 million e-filed returns. IRS employees will issue nearly 97 million 
tax refund checks, answer over 60 million telephone calls from 
taxpayers, and serve nearly six million taxpayers at IRS ``walk-in'' 
sites.
    Inevitably, some problems will occur. Hopefully, with the expert 
oversight and advice of those testifying before us today, these 
situations can be quickly addressed.
    I am pleased that, for the first time, the Subcommittee will have 
the opportunity to hear from the new IRS Taxpayer Advocate and from the 
Treasury Inspector General for Tax Administration.
    I also want to personally welcome the IRS Commissioner and the 
other witnesses appearing before us today.

                                


    Chairman Houghton. Thank you very much, Mr. Coyne. I would 
just like to say that we have several new Members. They may 
show up at any point: Mark Foley, Sam Johnson and also Earl 
Pomeroy. Karen Thurman, who was not a member last time, but was 
in the previous Congress, will be here also. So now, Mr. 
Commissioner, you are on. Do want to turn that microphone on?

 STATEMENT OF HON. CHARLES O. ROSSOTTI, COMMISSIONER, INTERNAL 
                        REVENUE SERVICE

    Mr. Rossotti. Is that better? Last year when I came before 
you, I said we had a clear direction for the IRS and had taken 
some important steps to improve the IRS. Now, for the first 
time, I can tell you that we have a real plan, a strategic plan 
that lays out how we will build on that foundation we have laid 
to make the IRS everything the American public has a right to 
expect it to be.
    On January 30, 2001, the IRS Oversight Board approved the 
IRS strategic plan. It follows closely the letter and spirit of 
the Restructuring Act and reflects the new and modernized IRS. 
The strategic plan shows how the IRS can dramatically improve 
service to taxpayers, ensure fairness and compliance with our 
tax laws, and moreover, meet all of these goals while 
continuing to shrink in size relative to the economy. The 
biggest challenge presented by this plan is that we have to 
continue to administer the world's largest and most complex tax 
system, while simultaneously reengineering and improving how 
the agency works at its most basic level.
    In other words, we must operate effectively and modernize 
at the same time. Our entire plan is based on this dual 
approach: strategies to improve performance over the next 2 
years, while modernizing the agency in the longer term. In 
connection with our mission and goals, we have developed 10 
strategies and for each of these, for 2001 and 2002, have 
defined specific priorities and responsibilities for carrying 
them out. For example, in the 2001 filing season, we are 
demonstrating how we can build on our positive trends in both 
meeting taxpayer needs, one of our strategies, and broadening 
the use of electronic interactions, one of our other key 
strategies.
    On the electronic front, so far this filing season, our 
online filing for home computers is up about 37 percent 
compared to last year. It has already reached a total volume of 
about 5 million in that category, which is what we had last 
year. In total, we expect to receive about 40 million returns 
electronically this year. There are some specific reasons for 
this. For example, in this filing season we have added 23 forms 
and schedules that can be filed electronically. Next year, in 
2002, there will be 38 more, which will bring, essentially, all 
forms and all schedules into the electronic filing program.
    I am also pleased to report that our website has received 
about 1.3 billion hits this fiscal year. In addition to the 
page hits, we have had about 103 million downloads. These are 
mostly forms the people get. That's almost twice as many--in 
fact, it is twice as many as last year--and as I like to say 
that is a lot of trips to the post office that people do not 
have to make.
    We have also recently announced a new feature where 
taxpayers who need an extension to file of course, all 
taxpayers are entitled to an automatic extension till August 
15th can now do that with a simple phone call, no paper, and 
they also get a confirmation. Another thing that we are 
piloting that has a lot of exciting potential for the small-
business community and for practitioners, is our Internet-based 
system for businesses to file and pay Federal payroll taxes 
online. This is called EFTPS online. It allows taxpayers to 
enroll once in the system and then to securely make Federal tax 
payments, and also check their payment history over the 
Internet. Using this system, they will also be able to schedule 
future payments through the Internet, and cancel payments if 
necessary.
    Let me also stress that during the past year we completed a 
comprehensive set of changes and upgrades to strengthen our 
security for the electronic filed returns. With respect to 
taxpayers who needed assistance from us during the filing 
season, we have made steady progress in providing telephone 
service, which is our single most important channel. Busy 
signals use to be a major problem. A few years ago there were 
400 million busy signals, which is more than there are people 
in the United States. Busy signals have been reduced to a 
minimal level on the order of four percent. At least people can 
now get through on the line. With respect to total calls 
answered, we have had answered, so far this filing season, 
about 51 million calls through March 23rd, which is about a 14 
percent total increase.
    With respect to taxpayers who actually want to talk to a 
live customer service representative, so far this filing 
season, about 66 percent of taxpayers have gotten through, 
compared to about 62 percent last year at this time. These are 
all upward trends. On the other hand, certainly this level of 
service is not up to the long-term goal, which is comparable to 
perhaps 90 percent in the private sector. We still have a ways 
to go.
    Moving to our longer-term modernization program, I think we 
have made progress on our three key change initiatives for 
modernization. In response to RRA 98, the new customer focused 
organization structure is in place now and largely implemented. 
There is a top management team, as well as a field organization 
in place for each of the four operating divisions and our 
functional units. We have also approved a set of balanced 
measures to measure the performance of this neworganization, 
and most of these measures will be in place, fully deployed, through 
most of the organization by the end of this fiscal year.
    These kinds of changes are very important in enabling us to 
tailor our services to taxpayer needs, as well as to focus our 
compliance programs where they will do the most good. For 
example, we recently rolled out a specialized part of our 
website for the small-business, self-employed community. In 
addition, for the large-business community, we have initiated 
two issue resolution programs that are reducing the amount of 
time it takes for large businesses to resolve tax issues with 
us.
    The third piece of modernization has to do with business 
systems modernization, our technology program. This program 
officially kicked off almost exactly 21 months ago, and we 
believe that we have made solid progress, although we have to 
acknowledge, this is an extremely difficult program. But in 
three key areas we have made progress. One is developing an 
agencywide vision and architecture, the second is building our 
program management capacity, and the third is delivering on 
some specific initial projects.
    With respect to the overall architecture, which is the road 
map of the future for modernizing our systems, we approved the 
enterprise architecture document earlier this year. Our 
management capability, which include such things as use of our 
lifecycle management methodology, has improved, although it 
still needs maturing.
    With respect to our first two projects, we will be 
delivering our first two projects shortly after the filing 
season in the next couple of months. One is a project which 
will enable us to build on the progress on phone service and 
improve it further, and the other is some better tools for our 
examiners that will be examining corporate income tax returns.
    Mr. Chairman, in spite of the progress that I have noted, 
it is clear that we are still not reaching the level in quality 
of service, that we think taxpayers deserve, nor, in fact, are 
we collecting all the taxes that are due efficiently. We have a 
lot to do.
    I can cite some of the things that still need improvement. 
I mentioned the phone service. It has significantly improved, 
but it is still not on the level of what taxpayers receive in 
the private sector. Because of our antiquated computer systems, 
even when taxpayers do get through to us, we sometimes cannot 
provide them with updated information on their accounts, which 
in turn, results in frustration from both the taxpayer and the 
IRS employees who want to help them.
    As a matter of fact, if I looked across all of our business 
processes, most of them operate too slowly or inaccurately or 
inefficiently. Many of our notices, which we send 100 million 
to taxpayers, are still confusing, and it is not just because 
of the writing. It is because we do not always have the right 
data to put on those notices.
    We are on the path of achieving the goal of 80 percent 
electronic filing by 2007, which is a part of RRA. However, it 
is going to be difficult to continue at a pace rapid enough to 
reach this goal. Finally, with respect to our financial 
statements, we are very pleased we received, for the first 
time, a clean opinion on all of our financial statements from 
GAO. But, they also noted that we continue to have significant 
material weaknesses in our financial management, and many of 
those weaknesses cannot be corrected except through business 
systems modernization.
    On the compliance side, we are also very concerned about 
the continued drop in audit and collection activity. I think 
the risks of these declines are not simply the dollar value of 
the taxes which are left uncollected. The greatest risk to me 
is that the average taxpayer, who honestly pays taxes, could 
lose confidence if the IRS fails to act effectively and 
efficiently to collect what is due from those who may not pay 
what they owe.
    I think the effect of the decrease in examination coverage 
is especially important with respect to fairness. Because it is 
relatively easy for the IRS to verify most of the income of 
average, lower or a middle income taxpayers, but it is much 
harder, and often requires an examination, to verify the income 
of higher income and certainly corporate taxpayers. I think I 
testified earlier that the drop in this coverage was caused by 
several factors, one of which is the long-term decline in 
staffing. Other factors include the need to assign compliance 
staff to customer service duties during the filing season, as 
well as some added responsibilities imposed by RRA.
    Finally, let me just note, with respect to the 
modernization program, and I am speaking of business systems 
modernization, that we are at a critical juncture. We are 
really starting to get into serious implementation of this 
program, which will require more funds. I am pleased to say 
that the modernization blueprint, which was outlined by the 
President in the budget blueprint earlier this year, did note 
they were going to include $397 million in investments for the 
ITIA fund to modernize IRS' computer systems.
    In conclusion, Mr. Chairman, I think we are on the right 
track, but that track is long and it is going to take a lot of 
sustained effort to get all the way around to where our 
strategic plan says we need to be. With then continued support 
of your Committee and the other Committees of Congress, we are 
confident, however, that we can achieve what we set out to do 
in our plan and make the IRS what it needs to be for the 
American people. Thank you.
    [The prepared statement of Commissioner Rossotti follows:]
   Statement of the Hon. Charles O. Rossotti, Commissioner, Internal 
                            Revenue Service
    Mr. Chairman and Distinguished Members of the Subcommittee, I am 
pleased to discuss the IRS' 2001 tax filing season, our FY 2002 budget 
request and the initiatives we are undertaking on behalf of America's 
taxpayers.
INTRODUCTION: A PLAN FOR TODAY AND THE FUTURE
    Mr. Chairman, last year when I came before you, I said we had a 
clear direction and had taken some important steps to improve the IRS. 
Now, for the first time I can tell you that we have a real plan that 
lays out how we will build on the foundation we have laid to make the 
IRS everything the American public has a right to expect it to be.
    On January 30, 2001, the IRS Oversight Board approved the IRS 
Strategic Plan. It follows closely the letter and spirit of the IRS 
Restructuring and Reform Act of 1998 (RRA 98) and reflects the new and 
modernized IRS. The strategic plan shows how the IRS can dramatically 
improve service to taxpayers and ensure fairness and compliance with 
our tax laws. Moreover, the Agency will meet these goals while 
continuing to shrink in size relative to the economy.
    The greatest challenge presented by the IRS strategic plan is that 
we must continue to administer the world's largest and most complex tax 
system while simultaneously reengineering and improving how the Agency 
works at its most basic level. In other words, we must operate 
effectively and modernize at the same time.
    Mr. Chairman, I want to emphasize the importance of this two-
pronged, or dual approach of strategies to improve performance over the 
next two years while modernizing the Agency in the longer term. Let me 
illustrate how this approach is now working. In conjunction with our 
mission and goals, we developed 10 major strategies. For each of these 
strategies, operational priorities and improvement projects for FY 2001 
and 2002 were defined and responsibilities assigned for carrying them 
out. Some of our major strategies include:
          Meet the Needs of Taxpayers. Each year, the IRS has millions 
        of interactions with taxpayers who need information or 
        assistance to file their returns or pay what they owe. The 
        taxpayer should always receive quality service from the IRS 
        that is helpful based on his/her particular situation and need. 
        Taken together, the fundamental changes underway in all aspects 
        of our operations will provide taxpayers accurate and prompt 
        information to assist them in filing, paying, and resolving 
        issues in a time and manner convenient for them. In the short-
        term, we will implement this strategy through actions such as 
        expanding phone-hours, adding more convenient locations and 
        providing additional assistors during peak hours.
          Reduce taxpayer burden. One of the themes underlying improved 
        IRS's business practices is to shift from addressing taxpayer 
        problems well after returns are filed to addressing them early 
        in the process, and in fact preventing problems wherever 
        possible. Over the next two years, we will make substantial 
        progress to reduce taxpayer burden although much more will be 
        possible through our longer-term business system modernization 
        efforts. Increasing our partnerships with states and 
        practitioners will be a major part of this strategy. In the 
        short-term, we can make improvements, such as expanding our 
        Voluntary Compliance Agreement Program and providing specific 
        information over the Internet to taxpayers groups. The new IRS 
        ``Small Business Self-Employed Community'' web page is an 
        excellent example of this strategy.
          Broaden the use of electronic interactions. Electronically-
        filed returns improve service for taxpayers and boost 
        productivity by reducing errors, speeding refunds, and reducing 
        labor costs. We will enhance technology to allow filing of a 
        full range of returns, eliminate requirements for separate 
        signature documents, tailor marketing and education programs to 
        attract taxpayers and practitioners with varying needs, and 
        broaden the number of payment options. Customer education and 
        assistance programs provided through the IRS web site, such as 
        the distribution of forms and publications and answers to tax 
        law questions, are growing rapidly. We are making excellent 
        short-term progress on this strategy. Examples include the 
        elimination of paper signatures for e-filed returns and 
        dramatically increasing the number of forms that can be filed 
        electronically.
          Address key areas of non-compliance. Research indicates that 
        there are major non-compliance problem areas. These include 
        abusive tax shelters and trusts as vehicles for managing assets 
        and for wealth transference. Unpaid employment and withholding 
        taxes by businesses have also increased and overpayment of 
        refunds due to erroneous return claims is high. We will make 
        progress in combating key areas of noncompliance over the next 
        two years as demonstrated by our recent actions on illegal 
        offshore trust programs. In 2002, the IRS will change its 
        processing procedures and begin processing and matching K-1s 
        (schedules filed by partnerships, trusts and S-corporations to 
        provide information on income/losses distributed by business 
        entities, to individual partners, beneficiaries and 
        shareholders).
          Stabilize traditional non-compliance areas. Regardless of how 
        successful we are in preventing taxpayer errors, intervention 
        through examination and collection actions and investigations 
        is necessary when noncompliance or non-payment is found or 
        suspected to be occurring. Since we have limited resources, it 
        is essential that we apply these resources where they will be 
        of most value. More focused and rapid intervention can 
        enormously improve the effectiveness and efficiency of our 
        activities, while improved case management tools can improve 
        the quality and speed of cases and ensure that taxpayer rights 
        are observed. The recent funding of the STABLE (Staffing Tax 
        Administration for Balance and Equity) initiative is key to the 
        IRS stemming and turning around the decline in collection and 
        exam activities.
          These major compliance improvements will require, however, a 
        fundamental redesign of our most complex business processes. 
        They are also very dependent on new technology from our 
        Business Systems Modernization program (BSM). Therefore, our 
        strategy is to stabilize and improve traditional compliance 
        programs in the near term, while working through BSM for long-
        term and fundamental improvements.
    Over the past year, the IRS also made steady progress on three key 
modernization programs. In response to RRA 98, the new customer-focused 
organization is currently being implemented, and a top management team 
is in place for each of the four Operating Divisions and functional 
units. We also approved balanced measures for much of the new 
organization and have slated approval of measure for the remaining 
organizational units for the current fiscal year. Both of these 
programs should start delivering benefits now.
    The third piece of modernization, the Business Systems 
Modernization program (BSM) is off to an excellent start. The 
Enterprise Architecture plan, which is the roadmap for modernizing the 
Agency's business systems and supporting information technology 
networks, was approved earlier this year. BSM is just beginning to 
deliver tangible improvements; it will deliver a growing number of 
benefits with each succeeding year for the remainder of the decade. 
Each of these programs is discussed in detail later in the testimony.
    Mr. Chairman, I want to stress that this dual approach will require 
sustained support from the Congress and the public, as the change will 
take time and will inevitably include setbacks along the way. It will 
also require investments, especially for business systems 
modernization, and adequate funding for current operations, such as 
customer service and compliance.
PROGRESS MADE: INITIAL SUCCESSES UPON WHICH TO BUILD
    Mr. Chairman, I would like to discuss some of the progress the IRS 
has made over the past year, particularly as it relates to how we are 
making it easier for all taxpayers to file their returns and pay their 
taxes and how we are ensuring the fairness of our tax administration 
system.
                          checkbox initiative
    Beginning this filing season, Paid Return Preparers can use the 
Third Party Authorization Checkbox on all Form 1040 Series returns with 
the exception of TeleFile. This checkbox indicates the taxpayer's 
desire to allow the IRS to discuss the tax return and attachments with 
the preparer while the return is being processed. This provides for a 
significant reduction in paperwork for millions of taxpayers. It also 
addresses a problem with which we have been grappling for years.
    Including a checkbox on the family of 1040 returns is a direct 
response to requests from our external stakeholders, such as the South 
Florida Citizen Advocacy Panel (CAP), National Society of Accountants, 
National Association of Tax Practitioners and National Association of 
Enrolled Agents.
    The checkbox designation should enable practitioners quickly to 
resolve questions concerning the processing of the taxpayer's return. 
It should also reduce the number of contacts necessary to resolve 
processing questions and eliminate the need for the submission of 
paperwork for a Power of Attorney, which is not required to resolve 
simple problems with a taxpayer's account. Our initiative also 
addresses the practitioner groups' concern that this designee not be 
afforded post-assessment correspondence or representation.
    Mr. Chairman, the IRS calculates that taxpayers will save an 
estimated 75,000 hours initially by not having to prepare a third party 
authorization disclosure form (Form 8821). Additional time will be 
saved because processing issues will be resolved immediately, thereby 
eliminating unnecessary post-filing contacts. However, we recognize 
that the net burden reduction, as currently calculated, will be 
somewhat smaller because there will be an increase in burden for 
reading and understanding Forms 1040 instructions for the new checkbox 
authority.
    We further expect over a million taxpayers to use the checkbox 
feature in lieu of filing Form 2848 (Power of Attorney and Declaration 
of Representative). Therefore, taxpayers will save an estimated 1.9 
million hours initially by not having to prepare Form 2848. Once again, 
the net burden reduction will be less because we must assume there will 
be an increase in the burden for reading Forms 1040 instructions and 
understanding the new checkbox authority.
    The burden reduction that will result from the checkbox initiative 
is even greater when one considers the 8 million notices related to 
math errors and return preparation that were issued in 2000. Twenty-
seven percent of these notices were related to returns prepared by paid 
preparers. The IRS estimates that taxpayers will save approximately 779 
thousand hours by referring notices to their designees rather than 
responding to the IRS in writing or by telephone. Similarly, we 
estimate that taxpayers will save more than a million hours related to 
correspondence by allowing IRS to resolve issues by contacting their 
designees.
                           redesigned notices
    As part of its continued effort to improve its correspondence to 
taxpayers, the IRS began sending out six redesigned notices, including 
those dealing with math errors, balance due, overpayments and offsets. 
The new notices should: (1) reduce the number of times taxpayers need 
to contact the IRS; (2) be easier to understand; and (3) facilitate 
resolution of inquiries. The combined yearly volume of these six 
notices is about 10.5 million.
    Following RRA 98's directions, the new notices also contain more 
information, including: (1) the formula for how the IRS computes the 
penalty or interest; (2) the section of law from which the penalty or 
interest is based; and (3) a table that details account information 
under each penalty or interest section to specific periods that the 
charges apply. Members of the Citizen's Advocacy Panel reviewed the 
notices before we released them in October 2000.
    Despite extensive testing, some of the first notices sent out were 
missing information. The IRS has since corrected errors in the 
programming for these notices and mailed explanations to taxpayers as 
appropriate.
    We are continuing our redesign efforts on 23 additional notices. We 
plan to release four of the notices in 2002 and the remaining 19 in 
2003.
                           change of address
    Due to a licensing agreement between the IRS and the U.S. Postal 
Service, taxpayers who move after filing their tax returns should 
receive future correspondence from the IRS on a more timely basis.
    Under this arrangement, the IRS will use the Postal Service's 
National Change of Address (NCOA) database to update the addresses in 
its own Master File of taxpayer data. This address updating process 
should also provide quicker resolution of undelivered refund problems.
    The IRS will check the names and old addresses in the NCOA weekly 
update files against the names and addresses in the IRS database. Where 
there is an exact match, the IRS will update its file with the 
taxpayer's new address. According to the Postal Service, there are 
about 800,000 address changes each week.
    In addition to helping IRS get refunds to taxpayers, this new 
program will permit the IRS to make earlier contacts with them to 
resolve issues such as delivery of a returned refund, possible 
unreported income, examination of a return, or collection of unpaid 
tax. The delay in delivery that can result from a letter going to an 
old address, then being forwarded, may cause a taxpayer's reply and a 
subsequent IRS letter to cross in the mail. Unraveling such situations 
can be time-consuming and frustrating for both the taxpayer and the 
IRS.
                 stabilization of compliance activities
    Earlier this year, Congress approved the staffing plan for the 
STABLE (Staffing Tax Administration for Balance and Equity) initiative. 
The funding was included in the Fiscal 2001 Appropriations bills.
    The STABLE staffing plan reflects the new modernized IRS and 
represents a careful judgment as to how these additional resources, 
together with our internal management improvements, can best be used to 
improve our service to taxpayers and compliance effectiveness.
    The two principles that guided the budget request were, first, 
allocate incremental resources directly to staffing front line 
positions. Second, these additional resources will provide a balanced 
improvement between service and compliance programs. With the increased 
staffing levels, we expect the IRS to be able to slightly increase 
levels of service and to stabilize the level of exam and collection 
activity while complying with the taxpayer rights provisions of the 
RRA.
    Our overarching goal is to achieve the greatest possible 
improvements in both taxpayer service and compliance efforts by 
determining how best to use the STABLE resources in conjunction with 
the base FY 2001 budget request. We believe that STABLE achieves this 
goal.
    In our reorganization effort over the last two years, we have 
carefully studied the use of nearly every position in the IRS. One of 
the key findings in this analysis is that the use of compliance 
personnel such as revenue agents and revenue officers on ``details'' to 
taxpayer service duties during the filing season is not efficient. This 
practice, while necessary as a short term solution to inadequate 
service, takes highly trained and high graded personnel away from 
important exam and collection casework during a substantial part of the 
year, causing reduced levels of productivity and delays in completing 
cases.
    Another key finding of the study is that the IRS provided very 
minimal levels of activity in assisting taxpayers to understand their 
tax obligations and avoid mistakes in filing, especially in the small 
business areas. Many stakeholders groups have stressed that this 
problem causes errors later in the process, which are expensive for 
both taxpayers and the IRS.
    In our new structure, instead of increasing the number of expensive 
and scarce compliance personnel, we have provided for additional 
positions in taxpayer service and education. A significant portion of 
the STABLE resources will be used to fill these positions. By hiring 
staff to perform these service and educational functions, we can avoid 
the need to use more expensive compliance personnel on details during 
the filing season, thus allowing us to accomplish two objectives 
efficiently: increase our level of taxpayer education and taxpayer 
service and increase the number of staff years actually applied to exam 
and collection casework.
    With this approach to the STABLE staffing, together with our 
reorganization and technology improvements, we expect to show 
measurable improvements in our key programs in FY 2001. Because of the 
time required to hire and train people, we will not achieve the full 
impact until FY 2002. Some of the improvements we expect in key areas 
in FY 2001 are:
           Increase the level of service on our toll free 
        telephone service from approximately 59.1 percent in FY 2000 to 
        approximately 63.4 percent in FY 2001, while also improving our 
        quality measures.
           Reverse the downtrend of the last five years in 
        compliance, increasing the number of overdue accounts closed by 
        our telephone and field collectors by 8.6 percent.
           Increasing the number of exams of individuals 
        conducted in person by about 6.2 percent, while also improving 
        quality.
    In examination, we will focus on the areas with the greatest risk 
of underreporting of income. For example, the number of exams of higher 
income individuals and corporations will increase more rapidly than the 
average.
    This additional staffing will allow us more quickly to resolve 
innocent spouse claims, offers in compromise cases and collection due 
process cases we completed--key taxpayer rights included in RRA 98. We 
will also increase our commitment to pre-filing assistance to taxpayers 
through communication and education programs and pre-filing agreement 
programs. These areas are of particular importance and concern for the 
small business community.
Targeting Our Resources
    We must promote fairness by combating key areas of non-compliance. 
To this end, the IRS must apply its limited resources where they will 
be of the most value. Some of the special problem compliance areas 
include: underreporting, non-filing and abuse of trusts and 
passthroughs; abusive corporate tax shelters; accumulations of unpaid 
trust fund taxes; and erroneous refund claims.
    Abusive corporate tax shelters continue to be an important 
compliance initiative for the IRS. From the information that IRS and 
Treasury receives from a variety of internal and external sources, we 
know that there are a significant number of transactions that have no 
legitimate business or economic purpose other than reducing taxes.
    These abusive corporate tax shelters could seriously undermine the 
tax system if all corporations believe they must engage in these 
transactions to keep up with the competition.
    We have a coordinated effort with Treasury to deal with this 
problem and our Office of Tax Shelter Analysis (OTSA) plays an 
important role in it. The IRS does not want to impede normal tax 
planning, and through the OTSA, we have available a means to separate 
the real problems from quite legitimate transactions. In addition, a 
``Tax Shelter Hotline'' and our commitment to issue more guidance in 
this area will help us respond to abusive transactions on a more timely 
basis.
    Promoters of abusive tax shelters are also using offshore tax 
entities in their tax schemes to unlawfully reduce or eliminate taxes. 
Last month, in the largest IRS enforcement action ever taken, law 
enforcement authorities in multiple states executed over three dozen 
search warrants and made four arrests as part of a series of 
investigations of alleged illegal offshore trust programs involving the 
diversion of millions of dollars of income for hundreds of clients.
    I want once again to express my appreciation for the fine work done 
by our Criminal Investigation Division, the United States Attorneys 
offices in Boston and San Francisco, the Tax Division of the Department 
of Justice, and the Costa Rican law enforcement authorities. Last 
week's historic enforcement activities send an unmistakable signal 
about IRS' commitment to pursue investigations of promoters and their 
clients who would try to move money off-shore to evade taxes.
    It further represents the IRS' continuing efforts to combat tax 
compliance problems caused by those who promote and participate in the 
use of trusts and offshore schemes designed to evade U.S. taxes.
Frauds Alerts: Buyer Beware
    In February 2001, The Internal Revenue Service issued a nationwide 
alert to taxpayers, warning them not to fall victim to a number of tax 
scams that are being promoted. These schemes take several shapes, 
ranging from promises of special tax refunds to illegal ways of 
``untaxing'' yourself. Taxpayers were told that they could report 
suspected tax fraud to the IRS by calling 1-800-829-0433.
    One of these illegal tax schemes involves telling employers that 
they do not have to withhold federal income tax or employment taxes 
from the wages paid to their employees. Using a bogus interpretation of 
the Tax Code, the con artists are selling the unsuspecting and the 
unscrupulous a phony and illegal scheme that in the long run will cost 
these employers a huge tax bill that can include stiff penalties and 
jail time.
    In addition to this warning, the IRS devoted a special consumer 
alert to this problem. We told working men and women that if they have 
concerns that their employer is failing to withhold these taxes to call 
our toll-free number at 1-800-829-1040. We are also asking our 
stakeholder groups to help us get the word out about this problem.
    Taxpayers can get more information on how the IRS is combating this 
bogus withholding scheme by going to our web site at www.irs and 
clicking on the ``Small Business and Self Employed Community'' page. 
From there, taxpayers can click on ``tax schemes'' and get all the 
necessary information. Taxpayers can also link to the IRS' Criminal 
Investigation home page and get a very detailed description of its 
employment tax enforcement program, including a breakdown of cases and 
a number of significant convictions of those who thought they could get 
away with evading their tax responsibilities.
    I want to stress that IRS Criminal Investigation works closely with 
all parts of the Agency to investigate and refer for prosecution 
individuals and companies who have willfully failed to file or pay 
employment taxes. In the past three years, 127 individuals were sent to 
federal prison, a halfway house or home detention on employment tax 
issues. Nearly 86 percent of those sentenced for evading employment 
taxes served an average of 17 months in confinement and were ordered to 
make restitution to the government for the taxes evaded plus interest 
and penalties.
Revenue Protection Strategy
    The IRS revenue protection efforts in 2001 will again identify and 
look at certain tax returns before issuing refunds. In addition to 
identifying questionable refunds, the IRS will continue its emphasis on 
improving compliance with the Earned Income Tax Credit (EITC) 
provisions of the Internal Revenue Code, including the use of our 
dependent database to identify questionable issues relating to 
incorrect claims on dependent exemptions, filing status and EITC 
credits.
    The Earned Income Tax Credit Preparer Outreach Program will also 
continue. As part of this program, IRS revenue agents will visit tax 
professionals nationwide prior to January 2001, to provide individual 
assistance and to answer any questions about EITC. Some of the visits 
will also include a review of files to determine if due diligence 
requirements for the preparation of EITC have been met.
                           2001 filing season
    The IRS is delivering a very successful filing season as it 
continues to meet the mandates that Congress set forth in RRA 98 and 
the challenges of modernization.
    By continually managing this change and risk in an orderly and 
integrated fashion, I am pleased to report that as we approach the home 
stretch, the 2001 tax filing season has been smooth and almost error 
free. The 2001 filing season continues to demonstrate how we can build 
on positive trends in service to taxpayers, especially as our major 
technology and organizational initiatives take effect.
    Projected net collections for FY 2001 will exceed the $1.9 trillion 
collected last year. During FY 2001, we also project to receive 215.4 
million returns, including over 130.3 million individual returns, and 
expect to issue over 96.8 million individual refunds. As of March 9, 
2001, the average dollar amount per refund is up over 5 percent over 
last year, and the average refund is $1,823.
Electronic Tax Administration
    Mr. Chairman, RRA 98 mandated that at least 80 percent of returns 
be filed electronically by 2007. Reaching this and the other Electronic 
Tax Administration (ETA) goals is an enormous challenge, but well worth 
the effort.
    The IRS' overarching goal is to conduct most of its internal and 
external transactions by electronic means. To meet this objective, we 
must make it not only technologically possible, but also attractive to 
the public to make a permanent change from paper to electronic means. 
Indeed, a robust ETA system helps form the foundation of a modernized 
IRS. It is key to easing taxpayer burden and can provide multiple 
benefits to taxpayers, practitioners and our tax administration system.
    Let me also stress that during the past year, the IRS completed a 
sweeping set of changes and upgrades to add an extra layer of 
protection for the millions of taxpayers using the e-file program. We 
have strengthened our system's security and we will remain vigilant to 
keep our e-filing processes the safest possible.
    The 2001 filing season statistics continue to demonstrate that an 
increasing number of taxpayers are taking the advantage of these 
initiatives and filing taxes electronically. Through March 15, 2001, 
over 29.3 millionindividual taxpayers filed using one of the three e-
file options; a 10 percent increase over the same period last year.
     Nearly 21.7 million taxpayers e-filed their returns 
electronically through an IRS-authorized Electronic Return Originator 
(ERO), an 11.2 percent increase over the same period last year.
     Approximately 4.2 million taxpayers filed their tax 
returns on-line via their home computer through a third party 
transmitter, On-line filing is running 37 percent ahead of last year 
and as of March 15, is already approaching the 2000 total volume of 5 
million.
     Almost 3.5 million taxpayers filed their returns over the 
telephone using the award wining TeleFile system. Oklahoma and Georgia 
joined Kentucky and Indiana in the Federal/State TeleFile option.
     Overall, 11 million taxpayers chose to file both their 
federal and state tax returns simultaneously in a single electronic 
transmission. This year, 35 states and the District of Columbia are 
participating in the program.
    Mr. Chairman, let me also note that paper and electronic return 
preparation and filing are also offered through IRS local offices as 
well as Volunteer Income Tax Assistance (VITA) and Tax Counseling for 
the Elderly (TCE) sites. Taxpayers who cannot afford either to pay a 
professional tax preparer or buy a personal computer and tax software 
may also go to local IRS offices to have their returns prepared. The 
tax software we use in our offices is competitively procured in the 
open market. Through this method, the IRS both electronically prepares 
and files simpler returns for lower-income taxpayers at their request.

                 New in ETA for the 2001 Filing Season

    In order to improve our ETA program and ease taxpayer burden, the 
IRS listened to taxpayers, industry and practitioners. We heard that we 
must make electronic filing more attractive and remove barriers. Let me 
briefly discuss our efforts this filing season to meet these concerns.
    First, the IRS is working to address the frustration that taxpayers 
and practitioners experience when they find they cannot file some forms 
electronically. For the 2001 filing season, we added 23 additional 
forms to the 1040-e-file program. These include Form 2106-EZ for un-
reimbursed employee business expenses; the Form 2688 application for 
additional extension of time to file; and Form 8379 for injured spouse 
claims.
    We plan to roll out the remaining 38 forms and schedules for the 
2002 filing season. This means we will open e-file eligibility to 99.1 
percent of all taxpayers, potentially adding 3.8 million new e-filers 
to the growing rolls. Equally important, it means that preparers will 
be able to go essentially 100 percent electronic for all of their 
customers by 2002.
    Second, the IRS is making electronic filing paperless by 
eliminating the requirement for a separate paper document with the e-
file return. In 2000, the IRS successfully tested the use of a Personal 
Identification Number (PIN) code as the taxpayer's signature, 
eliminating the need to file the paperjurat. This year's program 
extended the option to taxpayers nationwide, with some exceptions, and 
permits them to select a PIN, and then file electronically without any 
paper. So far, 4 million taxpayers have chosen this option.
    Third, this filing season, more electronic payments options have 
been made available to taxpayers, such as accepting debit payments 
through TeleFile and accepting credit cards for Forms 1040ES, estimated 
tax payments, and Forms 4868, extensions of time to file. As of March 
10th, 22,718 payments averaging $3,177 were made via credit card and 
another 24,064 payments averaging $1,026 were made by Automated 
Clearing House (ACH) Direct Debit where taxpayers can authorize either 
their checking or savings account to be debited.
    Fourth, our e-Services project under BSM will help us conduct most 
transactions with taxpayers and their representatives in an electronic 
format. By 2002, the e-Services' goals are to: (1) provide the 
capability to register new electronic return originators over the 
Internet; (2) permit delivery of transcripts to authorized parties 
electronically; and (3) allow third parties who are required to provide 
certain forms 1099 and information returns to check the taxpayer 
identification numbers for accuracy before submission.
    Fifth, contributing to this year's successful e-filing season is 
IRS' new marketing campaign, ``40 Million People Already Know e-file is 
the Way to Go.'' In conjunction with its advertising agency, and as 
authorized by RRA 98, the IRS developed a fully integrated campaign 
with TV, radio and print advertising. As the e-file program matures, 
our data- and market-driven marketing campaign is shifting away from 
merely promoting awareness of e-file to emphasizing its value, such as 
saving taxpayers time.

            ETA Also Easing Business Taxpayer Burden in 2001

    A strong ETA program must embrace the needs and expectations of all 
taxpayers, including business taxpayers. In 2001, the IRS continues to 
make progress serving the electronic tax administration needs of this 
important sector.
    For example, beginning last April, employers could file their Form 
941 on line, saving time and paperwork. And for the first time, 
companies and payroll service provider will be able to file both the 
Quarterly 941 and Annual 940 (Employer's Annual Federal Unemployment 
Tax Record) electronically. A direct debit payment was also made 
available through Form 941 TeleFile
    Another major ETA initiative eases the information-reporting burden 
for employers. Providers of certain information statements, including 
W-2s, now have the option of giving taxpayers the information 
electronically, instead of on paper.
    These new rules were a direct response to requests we received from 
lenders, educational institutions, employers and stakeholders who 
wanted the option to deliver these statements in an electronic format. 
Under the new option, providers will save the cost of processing, 
printing and mailing paper statements. And recipients will receive the 
information faster and more efficiently without the worry of mailing 
delays or lost statements.
    The Electronic Federal Tax Payment System (EFTPS) also continues to 
be a runaway success. In 2000, EFTPS topped all of its 1999 numbers for 
new enrollments, dollars and transactions. It processed more than 63 
million federal tax payments--a 14 percent increase over the previous 
year year. And EFTPS also received a staggering $1.5 trillion--a 15 
percent increase over the previous year. Payroll companies, tax 
practitioners and financial institutions have been instrumental in 
helping us grow this program and the use of electronic payments.
    Why has EFTPS been so successful? Over the years, EFTPS has 
delivered a high level of service and accuracy. It consistently exceeds 
industry standards, and delivers a 99.9 percent accuracy rate for 
payments appropriately applied.
    We developed the system with a focus on being able to handle 
significant volume with accuracy, integrating checks and balances to 
make sure information is correct and verified at each step of the 
process. EFTPS delivers a level of precision that can be compared to 
stringent banking and financial transaction standards for accuracy.
    This year, we are conducting an exciting new pilot program to test 
our new Internet-based application for businesses to pay federal taxes 
on line. This new feature, EFTPS-OnLine, allows businesses to enroll in 
the system, securely make federal tax payments and check their 
electronic payment history over the Internet. Using EFTPS-OnLine, 
businesses will be able to schedule future payments through the 
Internet and cancel payments if necessary. They will also have access 
to on-line help and ``how-to'' pages with step-by-step instructions.
    One of our primary EFTPS priorities is security and it continues 
with our new Internet feature. EFTPS-OnLine uses the strongest 
available security and encryption technology to ensure taxpayer privacy 
and protection. After evaluating the pilot results, we plan to make 
EFTPS-OnLine available to all business taxpayers and to individuals 
taxpayers who are required to make estimated quarterly payments.
    There are currently more than 3 million taxpayers enrolled in EFTPS 
and with the addition of the new Internet feature, we expect that 
number to continue to grow.

                             Web-Based Help

    The Internet continues to offer exciting new opportunities for 
easing taxpayer burden and improving service. The IRS web site, the 
Digital Daily (www.irs.gov), has already received almost 1.3 billion 
hits this fiscal year. According to the ``Lycos 50'', since almost the 
beginning of the year, the IRS has consistently ranked among the top 10 
user searches. As of March 21, 2000, it came in as Number 6.
    Anyone with Internet access can receive: tax forms, instructions, 
and publications; the latest tax information and tax law changes; tax 
tables and rate schedules; and hypertext versions of all taxpayer 
information publications, including the very popular Publication 17, 
``Your Federal Income Tax''; all TeleTax topics; answers to the most 
frequently asked tax questions; a library of tax regulations; and the 
weekly Internal Revenue Bulletin that contains all the latest revenue 
rulings, revenue procedures, notices, announcements, proposed 
regulations and final regulations. However, to ensure that taxpayer 
privacy is protected, our web site will not provide or receive 
individual taxpayer data until adequate safeguards are in place.
    Since coming on line in January 1996, taxpayers have downloaded 
over 412.9 million forms, publications and products. Through February 
2001, there have been over 103 million downloads as compared to 51.5 
million for the same period in 2000--an increase of almost 100 percent.
    The IRS web site also has a W-4 Calculator in its ``Tax Info for 
You'' section. In addition, the expanded use of online customer service 
technologies provides greater taxpayer access to IRS' help while on the 
Digital Daily.
    Earlier this year, the IRS launched its new user-friendly ``Small 
Business and Self-Employed Community'' web page that can be accessed 
from our web site. It was developed by our Small Business/Self-Employed 
Operating Division specifically to benefit the millions of small 
business owners, the self-employed and start-up businesses who often 
confront more complex tax issues than taxpayers who have their taxes 
withheld by an employer.
    This convenient ``one-stop shopping'' for assistance can provide 
most, if not all, of the immediate products and services that a small 
businessperson needs, such as a section on common problems, a calendar 
of important tax deadlines, helpful tax hints, forms and publications 
and a direct link to stakeholder sites, such as the National 
Association of Home Builders and the National Restaurant Association.
    I mention these two associations because for the first time ever, 
the IRS is providing industry-specific tax information for the 
construction and restaurant industries. For example, if a food server 
wants to know the deadline for reporting tips, he or she can go to our 
site and in two clicks, learn that Form 4070 should be filled out and 
turned into the employer by February 12th.
    In the near future, we will add more of these targeted areas to the 
web site, such as for the automotive and oil and gas industries. We 
will also add a Smart Q&A Wizard that will make it easier for taxpayers 
to search our growing database of frequently asked questions and get 
the information they need.
    The IRS web site will continue to evolve and improve in design, 
content and features. The biggest leap in the future will be from its 
current state as an information source to include a transactional-based 
portal.

                                CD-ROMs

    The Federal Tax Forms CD-ROM contains more than 600 tax forms and 
instructions for the current tax year, anarchive of forms and 
instructions dating back to 1992 and some 3,000 pages of topic-oriented 
tax information. Users can electronically search, view-on-screen, or 
print any of the items contained on the CDs. The two-issue subscription 
is conveniently available through the Digital Daily for $21. If ordered 
by fax, mail, or telephone, the cost is $26 (includes postage and 
handling).
    In conjunction with the Small Business Administration, the IRS also 
produced the latest edition of the joint small business CD-ROM, ``Small 
Business Resource Guide: What You Need to Know About Taxes and Other 
Topics.'' It has consistently received highly favorable reviews from 
small businesses and external stakeholders. The Year 2001 version of 
the CD-ROM is being made available free of charge, one-per-customer, by 
calling our toll-free number at 1-800-TAX-FORM. It can also be ordered 
on the IRS web site.
    The CD-ROM provides an array of helpful information for business 
operators, including actions to take before going into business and tax 
filing and reporting responsibilities when starting, expanding, closing 
and selling a business. In addition, it includes all of the business 
tax forms, publications and instructions for e-filing. The CD-ROM also 
allows users with Internet access to link to other helpful federal and 
state web sites.
Telephone Assistance
    Throughout the 2001 filing season, the IRS will provide telephone 
assistance 24 hours a day/7 days a week at 1-800-829-1040. After April 
16, we continue to offer around-the-clock service for refund and 
account callers, and service will be available for tax law assistance 
Monday through Saturday from 7:00 AM until 11 PM.
    For the filing season through March 9, approximately 65 percent of 
the taxpayers who wanted to talk to a customer service representative 
got through, compared to 61.7 percent last year at this time. In 
addition, 10.5 million of taxpayers used our automated services to get 
information such as refund status, an increase of 132 percent since 
last year, and the trend has been upward. In the last four weeks, the 
level of service averaged 68.9 percent. The upward trend in phone 
service is encouraging and shows that our investments in training, 
management and technology are beginning to pay dividends. However, I 
concur with Treasury Secretary O'Neill's characterization of IRS's 
current level of phone service as ``unacceptable.'' We still have along 
way to go before we can be satisfied with the quality of our phone 
service.
    The IRS will continue to implement many process and systems 
enhancements to improve both the convenience and the quality of 
telephone communications. These changes are major, affecting 
approximately 14,000-15,000 employees in more than 20 locations around 
the country. With the benefit of new call routing technology and new 
software planning tools, we are realigning the work assignments and 
training of many of these assistors so that the employees will have the 
right specialized training and knowledge to answer taxpayers inquiries 
efficiently and accurately. We will make increasing use of the 
technology to direct taxpayer call more accurately to the right 
assistor, and enable taxpayers in many cases to make uses of ``self-
service'' applications, either through the phone or the Internet.
    As these changes take place, the average complexity of calls 
answered by the Customer Service Representatives (CSRs) will continue 
to increase as: more of the simpler calls are routed to automated 
services; alternative language services are expanded; and CSRs handle 
topics previously referred to compliance personnel.
    During FY 2001, the IRS will introduce and test a new series of 
measures consistent with industry standards to improve monitoring of 
the delivery of the service experience and utilization of resources. 
The current measurement system will be maintained concurrent with this 
new effort through 2002 to allow IRS to solicit external expertise to 
validate and assess the new measures and develop an implementation 
plan. IRS will solicit external expertise to validate and assess the 
new measures and develop an implementation plan.
    Earlier this year, the IRS also inaugurated its San Patricio, 
Puerto Rico call site. Now that the center is fully operational, it 
will be able to take the majority of the Spanish-speaking traffic. Our 
Spanish-speaking customer service representatives in the States will 
still play a critical role, but creating this center will allow us to 
make the best use of all of our bilingual assistors. By staffing this 
call site, we have made real progress in reducing the current deficit 
of Spanish speaking customer service representatives..

                         Forms By Fax and Phone

    Taxpayers can receive more than 150 frequently used tax forms 7 
days a week, 24-hours-a-day from IRS TaxFax. Taxpayers can request up 
to three items per-call. Taxpayers use their fax machine to dial the 
service at 703-368-9694. The only cost to the taxpayer is the cost of 
the call. Taxpayers can also request forms and publications by calling 
1-800-TAX-FORM.

                        Recorded Tax Information

    TeleTax has 148 topics available 24 hours a day using a Touch-tone 
phone. Taxpayers can call (toll-free) 1-800-829-4477 to hear recorded 
information on tax subjects such as earned income credit, child care/
elderly credit, and dependents or other topics, such as electronic 
filing, which form to use, or what to do if you cannot pay your taxes. 
As of March 9, 2001, over 2.6 million have taken advantage of the 
service so far this filing season. Nearly 2.97 million taxpayers used 
TeleTax for the comparable period last year.

                      Automated Refund Information

    In FY 2000, more than 13.79 million taxpayers used the Automated 
Refund Information system on TeleTax to check on the issuance of their 
refund checks. As of March 9, 2001, the number stands at over 23.8 
million--up 73 percent from last year. Taxpayers may call 1-800-829-
4477 to check on their refund status Monday through Friday from 7 AM to 
11:00 PM if using a touch-tone phone, or 7:30 AM to 5:30 PM for rotary 
or pulse service.
Taxpayer Assistance Centers
    While many taxpayers prefer to use the telephone and the Internet 
to communicate with the IRS, our modernization studies and experience 
with the highly successful ``Problem Solving Days'' showed that some 
taxpayers need to meet in person with IRS representatives to get the 
assistance they need.
    For those taxpayers who prefer to visit an IRS office, walk-in 
service is available at more than 400 locations nationwide. At many 
sites, walk-in service will be offered on 12 Saturdays between January 
27 and April 14. So far this filing season, we have served over 3.37 
million taxpayers at all Taxpayer Assistance Centers--a 4.54 percent 
decrease from last year.
    The Saturday Service sites were selected based on their weekend 
accessibility, year-round operational status, and high traffic volume. 
They include non-traditional locations, such as shopping malls, 
community centers and post offices.
    With the help of the additional personnel provided for by the 
STABLE initiative, we are broadening the services available in our 
local offices so that taxpayers who wish to come in person will be able 
to resolve most tax account issues. We have defined a new job category 
called Tax Resolution Representatives. These employees will have the 
training and authority to provide ``one-stop service'' for a broad 
range of issues ranging from answering tax questions to resolving 
payment problems.
    We also believe that by energizing the VITA return preparation 
program and co-locating these activities at the Taxpayer Assistance 
Centers, the IRS will be able to focus on simple account and collection 
issues. In 2001, the Stakeholder Partnership, Education and 
Communications (SPEC) branch of our Wage and Investment Operating 
Division will work with more than 17,000 volunteer sites across the 
country to assist an estimated 4.6 million taxpayers. We will also work 
to better track the impact and benefits of the volunteer program.
SERIOUS CHALLENGES REMAIN
    Mr. Chairman, in spite of the progress the IRS has made since the 
enactment of RRA 98, it is clear that we are still not providing the 
level and quality of service that taxpayers deserve, nor are we 
collecting the taxes due efficiently.
    As previously discussed, the level of phone service--while 
improving--is still unacceptable and not on a level with what taxpayers 
receive in the private sector. We cannot provide taxpayers with up-to-
date information on their accounts, resulting in enormous frustration 
for both taxpayers and the IRS employees who want to help them. In 
fact, nearly all of our business processes operate too slowly, 
inaccurately and inefficiently. Many of our notices are still confusing 
and poorly written. Achieving the 80 percent electronic filing goal by 
2007 will be very difficult.
    The IRS is also deeply concerned about the continued drop in audit 
and collection activity. In fact, the GAO testified before the Senate 
Finance Committee in February 2000 that the current level of IRS 
enforcement activity is too low. Clearly, the declines we have 
witnessed in the past few years must stop or the fairness and 
effectiveness of our tax system will be undermined. The risks of these 
declines are not simply the dollar value of the taxes left uncollected. 
The greatest risk is that the average taxpayer who honestly pays taxes 
loses confidence if the IRS fails to act effectively and efficiently to 
collect from those who do not pay what they owe.
    To help address these problems, the President's budget includes 
follow-on funding for the STABLE initiative, begun earlier this year. 
These funds will complete the hiring of almost 4,000 staff and will 
enable the IRS to address the declines in audits and the drop in 
customer service that have occurred over the past several years.
    Mr. Chairman, the drop in exam and collection activity in FY 2000 
was caused by several factors, including the long-term decline in 
staffing, the need to assign compliance staff to customer service 
duties during the filing season, and added RRA 98 responsibilities.
    Between FY 1992 and 2000, the Agency's workforce fell by 17 percent 
while the number of tax returns filed (including supplemental 
documents, such as Forms 1040X, 4868, 2688, 1120X and 7004) increased 
13 percent to 230 million. RRA 98 also created very significant 
additional resource demands on the IRS Exam and Collection staffs. 
Expanded programs, such as the innocent spouse provisions, offers in 
compromise and due process in collection required more that 4,200 IRS 
staff annually for administration. Other provisions, such as the 
requirements for notifications of third parties, tacked on more time to 
complete each exam and collection case. More than 30 additional steps 
have been added to the completion of an exam.
    RRA 98 also had some very profound indirect impacts on IRS 
operations. Two provisions, in particular, have greatly affected the 
time required to conduct many activities. They are: Section 1203, 
commonly known as the ``ten deadly sins'' provision, and Section 1204, 
which broadly prohibited use of enforcement statistics in setting goals 
or making personnel evaluations at any level in the IRS.
    Section 1203 caused a great deal of concern, caution, and 
hesitation among front-line employees and their managers with respect 
to taking enforcement action. And Section 1204, prohibiting use of 
enforcement statistics, caused a great deal of confusion and hesitation 
among managers to use any quantitative data to evaluate operations or 
to direct employees with respect to matters of time and efficiency. The 
effect of Section 1204 has been magnified by the extensive number of 
investigations and disciplinary actions of managers that was undertaken 
in 1998 and 1999 for misuse of statistics. In addition, uncertainty 
over the reorganization, which flattened the organization and 
eliminated management layers, caused some temporary loss of focus. The 
effect of all these factors was to increase the time it takes to 
complete cases, reducing the number of cases completed per FTE by 20 to 
30 percent.
    In its March 2001 financial audit of the IRS' Fiscal Year 2000 
Financial Statements, the GAO pointed out the continued problem with 
the IRS' management of unpaid tax assessments. The GAO found that the 
IRS' ``inability to actively pursue significant amounts in outstanding 
taxes owed to the federal government continue to hinder IRS's ability 
to effectively manage unpaid assessments.''
    The GAO report pointed to a much larger and fundamental weakness 
that threatens the IRS' mission: the pressing need to overhaul IRS' 
systems and processes. The IRS core data systems that record taxpayers' 
tax accounts are fundamentally deficient. The IRS will never be able to 
perform its mission without replacing these systems. The solution to 
these problems is not simply to do more of everything in the way it has 
always been done. Instead the solution is to modernize the IRS to do 
things more efficiently and effectively.
    Replacing virtually the entire technology infrastructure in the 
next 10 years, while also delivering short-term service improvements 
demanded by taxpayers, employees, and the Congress, remains an enormous 
challenge fraught with risk. But we have no choice; we must move ahead 
for the good of America's taxpayers and the good of our Nation. The 
President's budget includes close to $400 million in investments to 
modernize the IRS' outdated computer systems. This multi-year project 
will provide the IRS with the modern tools needed both to deliver first 
class customer service to America's taxpayers and to ensure that 
compliance programs are administered efficiently.
    Mr. Chairman, there have also been some questions as to whether the 
``audit rate'' as publicly reported by the IRS understates the ability 
of the IRS to verify the accuracy of individual tax returns. Simply 
focusing on the audit rate does substantially understate the IRS' 
capacity to find errors in returns, especially in certain kinds of 
returns. In my many press interviews in the past few years in which 
this topic has come up, I have consistently made this point, often 
citing our computer matching program as an example of a technique that 
the IRS uses in addition to traditional audits.
    With the use of document matching and other return verification 
techniques for more that will eventually be enabled by new technology, 
it is my view that there is no need to return to the levels of 
individual audit coverage that existed even five years ago, which was 
three times the FY 2000 level. The IRS strategic plan and budget 
proposals as presented to the IRS Oversight Board do not call for this 
approach. However, our strategic plan sets forth an approach in the 
short run to stabilize our level of traditional compliance activities, 
such as individual audits, at or slightly above current levels and to 
focus them on the areas where they are most required. In the long run, 
we will rely on our business systems modernization program to increase 
the effectiveness and efficiency of these activities.
    The IRS has for many years relied on a range of techniques to 
verify certain items on tax returns. Each of these techniques is 
appropriate for particular classes or types of potential errors. With 
respect to Information Returns Processing, or document matching as it 
has often been called, this technique is very effective for verifying 
income items reported by third parties, including wages, interest, 
dividends and miscellaneous payments. It can also be used to verify 
gross sales of assets, but cannot be used to verify the gain or loss on 
such sales since we have no third-party reporting on the cost basis of 
assets. It is also of limited value in verifying some deductions, such 
as mortgage interest.
    Document matching is not useful for verifying business income, gain 
or loss on asset sales, or most itemized deductions. We estimate that 
the total personal income that cannot be verified by document matching 
represented about $1.2 trillion in FY 1998, or 19.7% of total reported 
personal income. An important role of audits is to verify these major 
categories of income and deductions.
    The significance of verifying income and deduction items through 
audits is illustrated by the fact that the average in-person audit of 
an individual return results in an assessment of approximately $9,540, 
while the average assessment from a document matching case is $1,506. 
In FY 2000, the IRS closed 277,212 in-person audits of individual 
returns and assessed $2.4 billion from this program; in the document 
matching program in FY 2000, the IRS closed 1,353,545 cases and 
assessed $2.1 billion.
    With respect the question of why document matching cases are not 
considered audits, the technical reason is that Section 7605(b) of the 
tax code generally limits the ability of the IRS to require a taxpayer 
to submit books and records for inspection by the IRS more than once. 
Since document matching cases do not require the taxpayer to submit 
books and records to the IRS, a document matching case does not 
preclude a subsequent audit. Revenue Procedure 94-68 specifically 
defines IRS taxpayer contacts, including document matching, which are 
not considered audits for the purpose of Section 7605(c). More 
generally, it is my understanding that some years ago the IRS proposed 
to change the definition of an audit to permit inclusion of the 
document matching cases in the overall reported number of audits and 
this proposal was criticized as possibly inflating IRS's statistics.
    Notwithstanding these previous issues, all of IRS statistics, 
including the number of document matching cases, are publicly reported 
and it is our goal to make these reports as informative and meaningful 
as possible.
TURNING THE CORNER
    Although overcoming these weaknesses is an enormous challenge, the 
IRS has achieved the first modernization milestones. If we continue to 
build on these initial successes, taxpayers and our tax administration 
system can begin to realize the benefits of modernization.
                      organizational modernization
    Following RRA 98's directions, the IRS designed and has made 
substantial progress in implementing a new organizational structure. It 
closely resembles the private sector model of organizing around 
customers with similar needs. The IRS created four customer-focused 
operating divisions to best serve taxpayers: Wage and Investment, Small 
Business and Self-Employed, Large and Mid-Size Business, and Tax Exempt 
and Government Entities. There are also a number of functional units, 
including Appeals, the Taxpayer Advocate Service, Criminal 
Investigation, and Communication and Liaison.
    The modernized IRS organization was officially inaugurated, or 
``stood up'', on October 1, 2000 and a top management team is in place 
for each of the operating divisions and business units. However, many 
challenges and much hard work remain as the different parts of the new 
organization are staffed and trained. The final stages of 
implementation, including the redistribution of workload, will require 
another two years through FY 2002.
    In the short-term, the reorganization should be largely invisible 
to taxpayers and tax practitioners. In the long-term, they will see the 
positive changes that modernization is intended to produce. The new 
organization will place a greater emphasis on pre-filing services and 
early resolution of complex issues. More resources will be devoted to 
pre-filing activities, such as education and outreach to help taxpayers 
comply with the tax law and get their tax returns right the first time. 
Post-filing activities will be geared to problem prevention with 
targeted enforcement activities for non-compliance. Most importantly, 
the focus and clear assignment of responsibility will result in faster 
action to fix problems and improve the way that business is done.
                 business systems modernization program
The Problem
    For an organization so critically dependent on technology, IRS' 
systems are woefully obsolete and inefficient. The facts cannot be 
disputed. The IRS is saddled with a collection of computer systems 
developed over a 35-year period. The most important systems that 
maintain all taxpayer records were developed in the 1960s and 1970s.
    In an age of faster and more powerful computers, taxpayers are 
shocked to hear that their most important personal financial data is 
stored and updated once a week on magnetic tape. Our jury-rigged system 
of computers poses other problems. As Money Magazine observed in its 
April 2001 edition, ``overlaying new software onto old has created a 
hodge-podge of data bases, many of which do not talk to one another. 
Until our consolidation as part of the Y2K program, there were 147 
mainframes and 8,700 software products.''
    The effect of this obsolete technology on service to taxpayers and 
productivity also cannot be disputed. As compared to what the private 
sector can offer, the IRS' services are wholly unsatisfactory.
    Many credit card companies and banks provide their customers with 
real-time account information; their phone representatives can often 
make adjustments on the spot. However, due to our archaic technology, 
IRS employees often do not have access to current taxpayer account 
information. Adjustments to a taxpayer's account may not take effect 
for up to 16 days because of delays in updating files and data among 
different systems cannot be synchronized. Payments and notices cross in 
the mail, often generating more notices and frustration.
    Indeed, the IRS has only a 40 percent rate for correctly resolving 
an account problem over the phone the first time e.g., a payment is not 
posted to a taxpayer's account or taxpayer does not understand why he 
or she received a bill for an estimated penalty. Our overall account 
quality is improving but in this filing season is still only 70 percent
    While the IRS Web site has proven to be an extraordinarily valuable 
source of information for taxpayers, we cannot yet use the Internet to 
provide taxpayers information about their returns or their tax 
accounts, or to exchange messages to resolve issues.
    Inadequate technology and the concomitant lack of accurate data 
also seriously hamper our ability to identify and collect unreported or 
unpaid taxes. Individual audits are not started until 14-20 months 
after a return is filed. When they are started, the information 
available to our auditors is limited, extending the time to complete 
the audits and increasing the burden on the taxpayer. Collection of 
outstanding balances of individual and business taxes is extremely 
slow, usually taking years rather than months as in the commercial 
world.
The Opportunity
    By taking full advantage of proven best business practices and new 
technology, we can greatly improve performance on all three of our 
strategic goals. The IRS can improve service to taxpayers and reduce 
their burden. The IRS can improve compliance and its collection 
activities, ensuring that the tax laws are fairly administered. And we 
can do this with limited increases in staff resources. Taxpayers will 
reap the benefits in a number of key areas, such as speed, access and 
accuracy. Let me briefly illustrate how this works in each of these 
three areas.
    Nearly all taxpayers will be able to file and pay electronically, 
regardless of the type of form or tax. Taxpayers filing electronically 
and having correct returns would receive refunds in their bank accounts 
within 2 to 3 days.
    We will emulate the best business practice of providing service to 
customers at times and through channels convenient to them, whether it 
is by phone, letter or on-line.
    The level of phone service would increase to 90 percent. (Level of 
service measures the relative success rate of taxpayers who call the 
IRS through toll-free services and wish to speak to an operator. It 
excludes calls routed to automated systems.) We would expand web-based 
services to include exchange of information and resolution of accounts 
through the Internet. First time resolution of account inquires would 
double from 40 to 80 percent. Taxpayers would receive consistent and 
accurate answers to their questions regardless of the 
communicationschannel they chose. IRS employees would also have access 
to comprehensive taxpayer histories, thereby increasing the accuracy of 
the information and the transactions contained in them.
    We also will provide more ways for taxpayers to resolve some issues 
by themselves, without requiring assistance from IRS staff. At the same 
time as we create the ability for taxpayers to check on such things as 
the status of their refunds and tax deposits through the automated 
systems on the telephone or the Internet, some in-person service 
requirements may be reduced. We are already beginning this process 
through such exciting initiatives as the EFTPS (Electronic Federal Tax 
Payment System) -OnLine program. It allows businesses to enroll in the 
system, securely make federal tax payments and check their electronic 
payment history over the Internet. And we have barely touched the full 
potential of electronic tax administration
    The effect on our compliance activities would also be profound. 
Third party matching data would be made available earlier. Assembling 
all available data about a taxpayer case for our employees will avoid 
the need to get duplicate data from taxpayers. With the advent of many 
new best private sector practices, such as risk-based compliance 
techniques, the IRS also has the opportunity to allocate its compliance 
resources more efficiently, both in specific cases and around patterns 
of non-compliance. And when intervention is called for, we can use 
analytically-based techniques to assist in determining the appropriate 
action.
    Most individual tax returns would be selected for audit within the 
same year and those audits will be completed more rapidly. ``No 
change'' determinations would be cut substantially.
    The collection time for outstanding balances would be reduced to an 
average of six months. Improved systems will allow us to identify much 
more quickly which taxpayer accounts need attention from either 
telephone or in-person collectors. They will provide much more complete 
and accurate information to the collectors before they even deal with 
the taxpayer, and computer tools will assist them in closing cases.
    These changes will also greatly increase our ability to 
``leverage'' staff and use them more effectively and efficiently, while 
reducing the amount of time we take from taxpayers.
    Our ability to ensure protection of taxpayer rights will be 
increased by building into the computer tools used by our employees the 
correct notifications and other protections prescribed by law.
The Solution
    As I discussed in the introduction to my testimony, we are making 
substantial progress on the short-term improvement projects that 
support our major strategies. The other part of that dual approach is 
the Business Systems Modernization (BSM) program. It was established to 
take the IRS to the next level and make longer term, fundamental 
changes to our business processes and practices while managing the 
inherent risks of the process. Over the remainder of this decade, it 
will deliver the major benefits to taxpayers and our tax administration 
system that modernization and RRA 98 are all about. And that process 
has already begun.
    Earlier this fiscal year, the IRS Executive Steering Committee 
approved the Enterprise Architecture. It is the roadmap for modernizing 
the Agency's business systems and supporting information technology 
networks. The Enterprise Architecture (Version 1.0) will guide the 
agency's business and technology improvements in the coming years. The 
approval of the architecture marks a major milestone in our progress 
towards the goals of Business Systems Modernization and will enable us 
to design and build new business and technology projects that will be 
the backbone of the modernized IRS.
    The IRS previously published a blueprint in 1997. It was the first 
comprehensive view of modernized tax systems and guided the IRS in 
efforts to update technology. The new Enterprise Architecture reflects 
the lessons learned since 1997 and incorporates elements of the IRS 
reorganization into the four new customer-oriented operating divisions. 
It is an evolving document designed for constant use, with updates 
scheduled for spring and fall 2001 and regular updates thereafter. This 
new blueprint will ensure that IRS business systems' technology is 
compatible. And it will enable IRS employees to do their jobs better 
and provide taxpayers better service.
    Because of the scale, complexity and risk of BSM, we can only carry 
out the plan by defining manageable projects, which are subject to a 
disciplined methodology. Each of these projects will be carried out 
through a step-by-step ``enterprise life-cycle'' in which successively 
greater amounts of detail are defined. The process requires that a 
vision and strategy phase be completed as a first step, prior to 
commencing tasks such as infrastructure development, information 
systems delivery, or process-reengineering. The final milestone in the 
cycle is an initial ``deployment'' of a project as an operational 
system. The IRS' Enterprise Program Management Office manages this 
process.
    Also key to BSM's success, is the Tax Administration/Internal 
Management Vision and Strategy Project. Through the project, we have 
instituted a practice that ensures the Operating Division Commissioners 
and staff develop and take ownership of a process and systems 
modernization approach that is consistent and integrated with the 
overall vision of the future IRS. The project's ultimate goal is to 
create an enterprise-wide view of tax administration that is reflected 
in BSM.
    The Business Systems Modernization Organization (BSMO) has 
nowidentified all the major initiatives for the next several years that 
link directly to our major strategies. Moreover, BSMO defined the major 
dependencies between and among projects and created a sequencing plan 
for their initiation, development, and deployment. It has also 
estimated the costs associated with each initiative and developed 
multi-year spending estimates consistent with this program. It now has 
a strategy for achieving the major goals of business systems 
modernization. The following are some of the key projects we will be 
working on during the next three years and beyond.
           Deployment of the Customer Communications 2001 
        Project--The Customer Communications Project is the first 
        deployment of a business capability under the BSM effort. It is 
        now in final testing before deployment in the third fiscal 
        quarter. The IRS will greatly improve the efficiency and 
        effectiveness of IRS' Automated Call Distributors (ACDs) and 
        provide customer service levels on a par with the private 
        sector. Hardware and software improvements will be made to the 
        telephone system that is used to receive, route and answer more 
        than 150 million taxpayer telephone calls each year. At a later 
        date, Internet access capabilities will be added. This project 
        will deliver direct benefits by increasing the number of calls 
        that can be answered with available staff and will be a 
        critical foundation element for subsequent projects, since 
        virtually all major systems require communication with 
        taxpayers.
           Development of the Customer Relationship Management 
        Exam (CRM Exam) Project--Development has already begun. Through 
        CRM, the IRS tackles some of the most complex tax calculations, 
        including carryback/ carryforward, the Alternative Minimum Tax, 
        and Foreign Tax Credit. This initiative will enhance the 
        revenue agent's capabilities, reduce exam time, produce 
        consistent results and reduce the burden on taxpayers who must 
        deal with the IRS on these complex tax issues.
           Development of the Security and Technology 
        Infrastructure Releases (STIR)--The design for STIR was 
        approved and development was initiated. This project provides 
        the essential underlying security infrastructure for the 
        planned 2002 project deployments of the Customer Account Data 
        Engine (CADE), Customer Communications (2002), and e-Services 
        and Customer Account Management System. Development, testing 
        and first release are expected by October 2001.
           The Customer Account Data Engine. (CADE) is the 
        cornerstone of the data infrastructure. It is designed to 
        provide a modern system for storing, managing, and accessing 
        records of taxpayeraccounts. CADE will create applications for 
daily posting, settlement, maintenance, refunds processing, and issue 
detection for taxpayer accounts and return data. The database and 
applications developed by CADE will also enable the development of 
subsequent modernized systems.
          CADE is scheduled to be released in stages, beginning first 
        with simple tax returns being moved into the new CADE system, 
        followed by increasingly complex taxpayer returns. As more 
        taxpayer account information is moved into the new CADE system 
        through these staggered releases, other modernized applications 
        will be put in place to provide the interfaces necessary for 
        IRS employees, and affected taxpayers, to access and carry out 
        transactions. System development, testing and initial 
        deployment are expected to be completed by January 2002.
           Development of the Enterprise Data Warehouse/
        Custodial Accounting Project (EDW/CAP)--Today, the IRS has a 
        variety of dedicated research databases, and also uses its 
        operational databases for operations research/analysis. The 
        timeliness, consistency and standardization of the data in 
        these separate systems do not support integrated analysis and 
        corporate-wide decision making. The inconsistent and redundant 
        data in stovepipe systems can result in inconsistent management 
        and reporting data.
          Through EDW/CAP project, the IRS will develop an integrated 
        enterprise data warehouse to support organizational data needs, 
        such as those that are critical to managing our new compliance 
        initiatives. For example, it will provide a single integrated 
        data repository of taxpayer account and payment/deposit 
        information, fully integrated with the general ledger. And it 
        will identify payment and deposit information at the point of 
        receipt. The operating divisions will be given access to 
        pertinent revenue, assessment, disbursement, and seized asset 
        information. In addition, it will provide the IRS with the 
        capability to maintain financial controls over the $2 trillion 
        of tax revenue received annually.
           The e-Services project will support our ability to 
        meet the overall goal of conducting most transactions with 
        taxpayers and their representatives in electronic format, as 
        required by RRA 98. By 2002, the e-Services will: (1) provide 
        the capability to register new electronic return originators 
        over the Internet; (2) permit delivery of transcripts to 
        authorized parties electronically; and (3) allow third parties 
        who are required to provide certain forms 1099 and information 
        returns to check the taxpayer identification numbers for 
        accuracy before submission.
          An important aspect of e-Services project is that it will be 
        one of the first projects to provide a practical and limited 
        application to define and test the design of our critical 
        security infrastructure for sending and receiving taxpayer data 
        internally and externally.
           Customer Account Management (Individual Assistance 
        and Self-Assistance Operating Models). In today's environment, 
        taxpayers are often unable to receive timely and accurate 
        responses to requests and inquiries. These operating models 
        will provide improved technology and business processes that 
        will enable the IRS to: better manage customer service 
        functions; maintain and utilize customer data to improve 
        taxpayer interactions with the IRS; provide comprehensive 
        account and tax law assistance to taxpayers and practitioners; 
        and manage the case work flow of customer inquiries. There is a 
        separate release strategy for each of the operating models 
        based on the customer segment that benefits the most from the 
        new capabilities.
           Tax Education (Direct and Indirect) Operating 
        Models. These models address improving business processes and 
        operational systems within the pre-filing business area (i.e. 
        before a return is filed). In the past, there has been minimal 
        investment in pre-filing activities, such as making educational 
        materials, information and forms more readily available. With 
        the organizational modernization, pre-filing activities will 
        become more prominent. The Tax Education Operating Models will 
        help taxpayers reduce or eliminate errors before they become 
        compliance problems by developing proactive and targeted 
        educational materials that are available 24/7 in various 
        formats from web-based products to published documents. 
        Utilizing third-party partnerships, the IRS will develop and 
        make available in plain language reliable educational 
        information, guidance and advice.
           Individual Assistance Operating Model for Reporting 
        Compliance. The current compliance environment has produced a 
        number of problems, such as extended cycle times, reduced 
        coverage and decreased customer and employee satisfaction. This 
        project will have a significant impact on the present Reporting 
        Compliance operational environment by providing: (1) robust, 
        issue driven compliance planning that utilizes outcome-based 
        improvement to ensure fair and effective selection of cases; 
        (2) highly automated decision engines for risk-based case 
        selection, treatment assignment and resource allocation to 
        decrease cycle time; (3) electronic case files with pre-
        identified issues to support productivity gains and increased 
        coverage; (4) case working tools, workflow management and 
        remote access to critical data; and (5) new technology and 
        processes to establish collectability, secure payments and 
        facilitate payment agreements at the closure of cases. The IRS 
        will deliver these new capabilities through four releases by 
        2006.
           Filing and Payment Compliance Operating Model. This 
        is an end-to-end strategy to resolve collection issues quickly 
        and fairly. It augments, refines and replaces existing 
        processes and technology to enable the IRS to interact with 
        taxpayers in a seamless and efficient manner. Protection of 
        taxpayer rights at all times is an important component of this 
        strategy. Taxpayers who are able to resolve their cases with no 
        direct IRS contact are provided various self-correct options. 
        Field or Collection Call center staff will assist taxpayers who 
        need help to resolve their delinquent tax cases. They will have 
        access to real-time data to ensure that appropriate actions are 
        taken and taxpayer rights are protected. The operating model 
        will decrease cycle time to approximately six months. We will 
        deliver this operating model through four releases by 2007.

               Establishing a Balanced Measurement System

    All federal agencies must have appropriate quantitative performance 
measures. They are required by the Government Performance and Results 
Act (GPRA) and are essential to any large organization's proper 
operation. An integral part of our overall modernization program is 
establishing balanced performance measures that support and reinforce 
the IRS' mission and strategic goals. However, because of past IRS 
experience with measurements and RRA 98 requirements (Section 1204), 
developing appropriate measures is an especially sensitive and 
difficult task.
    Critical to our efforts was establishing measurements based on what 
we needed and wanted to measure, rather than using what is most easily 
measured. Our balanced measurement system was designed to measure the 
progress we are making to achieve our three strategic goals: (1) 
service to each taxpayer; (2) service to all taxpayers and (3) 
productivity through a quality work environment.
    Also critical is ensuring that measures are aligned at all levels, 
from the top of the organization to the front-line employee. This does 
not mean that all of the organization's levels and components have 
precisely the same measurements. Obviously, this would be impossible. 
Rather, it means that the measures or evaluations are aimed at 
encouraging the type of behavior that will advance the organization's 
overall strategic goals, and do not encourage inappropriate behavior.
    In developing measures for each organizational level, it is 
important that each component of the balanced measurement system 
reflect responsibility at that level. At the top of the organization, 
management has control over strategies and allocation of resources. 
However, at the mid-level, managers have less control over these 
variables, but do exercise control over the effectiveness of training, 
coaching and guidance of employees. And at the individual level, each 
employee has control over his or her work and self-development.
    In the balanced measures system being implemented, there will be 
quantitative measurements keyed to each of the three strategic goals 
(service to each taxpayer; service to all taxpayers and productivity 
through a quality work environment) at both the strategic level and the 
operational level. In general, quantitative measures will not be used 
at the individual employee level.
    In September 1999, we issued a Balanced Measures Regulation to 
formally establish our new performance management system. The 
publication of the regulation, which followed a public comment period, 
set forth our structure for measuring organizational and employee 
performance.
    At the strategic level, our measures are designed to gauge overall 
performance on accomplishing the mission and strategic goals. This 
level is meaningful for the IRS as a whole, or for those parts of it 
that are responsible for providing a full range of services to large 
sets of taxpayers.
    We began identifying specific strategic measures in FY 2000 and 
will refine and finalize these measures in FY 2001. Experience has 
shown that the development of good performance measures is an evolving 
process that improves with time. Accordingly, we anticipate there may 
be changes to the specific measures. We expect, however, that the 
strategic intent behind these measures will remain firm.
    At the operational management level, our measures are focused on 
successfully executing our core business functions within the 
organizational units. At this level, we derive the balanced measures of 
organizational performance as follows: customer satisfaction, business 
results and employee satisfaction. This can be easily contrasted with 
measuring at the individual level.
    All quantitative measurements assess organizational performance, 
not individual performances. It is impossible to capture in any 
quantitative measurement system all that is important in evaluating an 
individual. As of January 2000, we redefined the system for setting and 
measuring performance expectations for nearly all managers and 
executives to align with the balanced measurement system.
    For front-line employees, we do not use quantitative measurements 
to evaluate performance, except in certain submissions processing 
functions. In most cases, it is not practical to quantify the 
performance of an individual employee in a meaningful and appropriate 
way. Instead, we incorporate the desired activities and behavior 
consistent with the strategic goals into the ``critical elements'' of 
each employee's position description.
    We began to implement the balanced measures system at the 
operational level in 1999, starting with the three functions, Customer 
Service, Examination, and Collection, that most directly affected large 
numbers of taxpayers and employees. We implemented the operational 
measures for these functions within the existing organizational 
structure and have now transferred these measures to the new 
organization.
    Since that time, we approved additional balanced measures for Large 
and Mid-Size Business, Tax Exempt and Government Entities, Taxpayer 
Advocate Service, Information Systems, Criminal Investigation, Appeals, 
and for additional Submission Processing and Customer Service product 
lines within the Wage and Investment and Small Business/Self Employed 
Operating Divisions. We have slated balanced measures for the remaining 
organizational units for approval in fiscal year 2001. In the interim, 
we are using 64 indicative measures and workload indicators in our 
annual performance plan as we complete our measures development.
    However, we still have work to do. We must agree on a final set of 
Agency-wide strategic measures and then begin implementing a 
comprehensive suite of strategic measures covering all taxpayer 
segments. Most importantly, we must continue to learn how to use 
balanced measures as a tool to achieve a high level of performance for 
all three of our strategic goals.
    Development of the balanced measurement system and, even more so, 
learning the new ways of working will take years. By focusing our 
attention on what is important for achieving our strategic goals, we 
will stay on the right path and continue our progress.
 clean financial opinion as reported by lawrence w. rogers, former irs 
      chief financial officer and currently, acting director for 
            administrative accounting, systems and policies
    Mr. Chairman, due to the combined efforts of the IRS and the 
General Accounting Office, I am pleased to report that the GAO rendered 
an ``unqualified'' or clean opinion on the IRS' FY 2000 Financial 
Statements. This includes both the Revenue and Administrative accounts.
    The GAO's opinion means that the IRS properly accounted for $8.3 
billion in appropriated funds; over $2 trillion in revenues collected; 
and over $190 billion in refunds. In his message opening the FY 2000 
Treasury Accountability Report, Secretary O'Neill stated that ``Good 
stewardship of taxpayer resources is a responsibility I take very 
seriously.'' At the IRS, we also want to ensure that every manager and 
employee takes that responsibility seriously.
    In fact, the success on the financial opinions can be greatly 
attributed to the hard work and dedication of the IRS staff; the 
significant improvements made to IRS' internal controls; and management 
focus placed on the financial audits. I would also be remiss if I did 
not recognize the hard work of our GAO auditors who provided us with 
such excellent advice.
    Congress, too, has played an important role in insuring that the 
financial audit is an important factor when evaluating agency 
performance. And we thank you for your strong, vigorous and continued 
leadership in this area. In last year's appropriations hearings, the 
Chairman of the House Appropriations Subcommittee on Treasury, Postal 
Service, and General Government also stressed the importance of a clean 
financial audit for IRS. Planning is already underway to insure that we 
maintain the same level of commitment for the FY 2001 and all future 
audits.
    To achieve the clean financial opinion, the IRS made significant 
improvements in several areas. Specifically, we:
           Implemented reconciliation procedures for IRS fund 
        balances and ensured prompt review/reconciliation was 
        performed;
           Revised our reporting and disclosure for the 
        statement of net cost to properly classify IRS programs;
           Improved management of property and equipment (P&E) 
        inventories;
           Improved our review and management of suspense 
        accounts;
           Reduced the number of computer security weaknesses;
           Addressed issues related to safeguarding taxpayer 
        data; and
           Improved our ability to substantiate unpaid 
        assessments.
    However, long-standing inadequacies in our financial reporting 
systems must still be addressed through the broader efforts to 
modernize the IRS' systems and organization as mandated by RRA 98. The 
ultimate key to better financial management at the IRS is improved 
technology. A complete description of our efforts and response to the 
GAO report may be found in Appendix A.
BUDGET SUPPORT FOR MODERNIZATION
    The IRS modernization program, and particularly, Business Systems 
Modernization, is at a critical juncture. The President's budget 
request funds two major initiatives that will greatly help the IRS. 
First, the budget includes close to $400 million in investments to 
modernize the IRS' outdated computer systems. This multi-year project 
will provide the IRS with the modern tools needed both to deliver first 
class customer service to America's taxpayers and to ensure that 
compliance programs are administered efficiently.
    Second, the President's budget also includes follow-on funding for 
the STABLE initiative, begun in 2001. These funds will complete the 
hiring of almost 4,000 staff and will enable the IRS to address the 
declines in audits and the drop in customer service that have occurred 
over the past several years. Further details on the President's request 
on the IRS will be included in the formal budget transmission to occur 
next week.
    Mr. Chairman, in conclusion, I believe that the IRS is on the right 
track. We have demonstrated both the ability to make some short-term 
improvements in service, and more importantly, the ability to produce a 
viable and cogent strategic plan that will guide our efforts to make 
changes in the entire way we do business and provide service to 
taxpayers. With your continued support and support of the American 
people, I am convinced more than ever that we can succeed.
Appendix A--2001 Financial Audit
GAO Findings
    The IRS believes that the GAO report is generally accurate and we 
have submitted a number of specific comments that we believe expand 
upon the information contained in the report, rather than challenge its 
findings.

                  Management of Unpaid Tax Assessments

    First, to address the issues related to Trust Fund Recovery Penalty 
(TFRP) processing (e.g., delays in posting, related tax liabilities, 
etc.) an IRS task group was established to review and recommend 
necessary changes. This group developed programming requirements to 
design an automated TFRP system that allows for systemic links. Phase I 
initial programming has been completed. Phase II will be implemented in 
FY 2002 to systematically accept downloads of data and cross-reference 
payments received for assessments made.

                         Controls Over Refunds

    The GAO observes that the IRS does not always review Earned Income 
Tax Credit (EITC) claims in time to identify invalid claims. The IRS 
believes that this observation should be placed in the proper context.
    The IRS has succeeded in several of its initiatives to prevent 
erroneous EITC refunds from being issued. Specifically, the IRS: (1) 
used its dependent database to identify questionable issues relating to 
EITC; (2) implemented the new legislation requiring re-certification 
before the taxpayer can claim EITC on the current tax year due to 
improperly claiming EITC in the previous year; (3) banned taxpayers 
from claiming EITC for either two or ten years after the tax year where 
there was a determination that the taxpayer's claim was due to 
intentional disregard of the rules and regulations, or fraud; and (4) 
implemented an automatic freeze on refunds where there is an open 
examination.
    The results of our efforts are clear. Since 1999, the IRS worked 
over 55,000 re-certification cases. Our case reviews also resulted in 
7,680 two-year bans and 62 ten-year bans for processing year 2000, and 
337 two-year bans and two 10-year bans for processing year 2001 (as of 
mid-February).

                      Property and Equipment (P&E)

    The IRS agrees with most of the GAO's comments regarding Property 
and Equipment. However, we do not believe that the report puts into 
proper perspective the substantial progress IRS achieved during FY 
2000. We believe it is important to highlight the fundamental changes 
in the P&E management of IRS.
    Prior to October 1999, there were multiple information systems 
organizations in IRS besides the Chief Information Officer (CIO). This 
was a major contributing factor to the lack of accountability and 
commitment in maintaining an accurate and complete Information 
Technology (IT) inventory, thus, resulting in the long-standing 
property material weakness.
    Today, the IRS has one information systems organization with total 
responsibility for the IT inventory. Since October 1999, the 
Information Systems organization has made significant progress in 
improving how the inventory is managed and maintained.
    To implement the GAO recommendation that ``systems and controls be 
in place for FY 2000,'' the IRS devoted P&E employee resources to 
undertake and accomplish the task. The IRS had already established the 
Financial and Management Controls Executive Steering Committee (FMC 
ESC). It is chaired by IRS Deputy Commissioner Bob Wenzel and is the 
major coordination point in the IRS for improving financial management 
systems. The FMC ESC established the Property Subcommittee, consisting 
of executives of the offices of the CIO, Chief Financial Officer (CFO), 
and Procurement. This Subcommittee met weekly and made decisions to 
ensure systems and controls for P&E were developed and functioning for 
FY 2000 and the future. This Subcommittee will continue to function 
until all property issues are resolved.
    The IRS also established the Asset Management Modernization Project 
Office whose full time job is to implement industry ``best practices'' 
and deploy new automation tools. A complete discussion of these and 
other improvement projects can be found in our response letter.
    In summary, we believe that through the major automation and 
process improvements I have outlined, the IRS significantly reduced the 
long-standing material weaknesses identified by GAO. With continued 
executive support and dedicated staff resources, the momentum attained 
to date can be sustained, and the underlying deficiencies in IRS' 
property management eliminated.

              Manual Tax Receipts and Taxpayer Information

    On October 30, 2000, the IRS established a Subcommittee on Security 
under the FMC ESC. The Subcommittee provides an agency-wide senior 
executive forum to address, and to make decisions on, security policies 
and priorities. It focuses on efficiently and effectively implementing 
and communicating these policies and priorities throughout the IRS. The 
Director of the Office of Security is the Chair of the Subcommittee.

                           Computer Security

    Recognizing the critical need to enforce federal law and 
regulations concerning privacy and non-disclosure of confidential tax 
information, the IRS created the Office of Security to establish and 
enforce standards and policies for all major security programs 
including, but not limited to, physical security, data security, and 
systems security. The OS provides the IRS with a proactive, independent 
security group that is directlyresponsible for the adequacy and 
consistency of security over all IRS' operations.
    Our security approach is consistent with GAO's September 1996 
report, Information Security: Opportunities for Improved OMB Oversight 
of Agency Practices, which noted that, ``Such a program can provide 
senior officials a means of managing information security risks and the 
related costs rather than just reacting to individual incidents.''
    Using a security framework, we are setting priorities for resources 
and we are measuring and demonstrating success in improving the overall 
security posture of the IRS. We are also taking a proactive approach by 
conducting security reviews at the computing centers and campuses. Our 
Office of Security works closely with local and Headquarters management 
to develop solutions, monitor implementation, and conduct on-going 
reviews to ensure weaknesses do not recur.

                   Revenue Reporting and Distribution

    In its report, GAO notes that there are continued weaknesses in 
fundamental internal controls. To address this issue, the IRS 
implemented procedural changes to ensure expedited processing of 
million-dollar returns. We also provided procedures to monitor timely 
posting of returns and to identify taxpayers who had not yet filed 
their returns. This will ensure processing prior to the end of the 
certification period.
    The GAO also noted there was a delay in posting to the Highway 
Trust Fund and the Airport and Airway Trust Fund in the amounts of $346 
and $34 million, respectively. There are three reasons why amounts 
received in a quarter are certified in a subsequent quarter: (1) late 
filed returns; (2) processing delays (lack of documentation, etc); and 
(3) subsequent activities. In the above cases, we needed additional 
documentation and returns were filed late. It should be noted that 
there is no penalty for late filing provided the taxpayer has submitted 
his or her payment on time.

  IRS' Structuring of Installment Agreements and Compliance With the 
                         Internal Revenue Code

    The IRS has made considerable improvements on the structuring of 
installment agreements. In FY 1999, twenty percent of the unpaid cases 
examined were non-compliant with the Code. In FY 2000, the non-
compliant percentage dropped to two percent. To ensure that agreements 
are compliant, the IRS issued guidance to its employees. We are also 
developing training on processing new installment agreements.
    Furthermore, the IRS is revising its guidelines to reemphasize the 
necessity of ensuring that installment agreements cover all outstanding 
taxes. If this cannot be accomplished, the case will then be handled in 
accordance with Offer-in-Compromise procedures. The IRS will also 
continue to monitor and enforce the guidelines on installment 
agreements.
Federal Tax Liens
    The GAO has noted significant improvement in the IRS' processing of 
federal tax liens. To better refine the processing of liens, the IRS: 
(1) issued guidance to its employees and provided additional training; 
(2) instituted monitoring and enforcement of the processing guidelines 
for liens; and (3) centralized the control of the federal tax lien 
process to one site. Previously, the process had been decentralized to 
each of the 33 IRS districts.
Long-Term Efforts
    A major concern shared by the IRS and taxpayers is privacy and 
security, both internal and external. Let me restate the IRS' 
commitment to recognizing taxpayer privacy to the maximum extent 
possible in all Service initiatives. Given the vulnerability of modern 
electronic information systems to cyber attacks, hacking, and natural 
disaster, we are focusing resources on risk management processes, 
secure messaging and authentication, physical security, cyber attack 
response capability and disaster recovery measures.
    The IRS will make substantial progress in improving its stewardship 
of assets over the next two years, although much more will be possible 
through our longer-term business system modernization efforts. The 
following are some of the ways we will implement this strategy.

                                Privacy

    The IRS will incorporate privacy protection principles into all of 
its programs and policies. We will enhance the privacy impact 
assessment methodology, applying it to all stages of a system's 
development and requiring it as a part of a system's certification.

                                Security

    The IRS will establish a Critical Infrastructure Plan to ensure 
that information systems critical to the financial security of the 
United States survive. The IRS will also continue to work with the 
computing centers to enhance their physical security to Level V, the 
Department of Justice's highest physical security designation. In 
addition, we will assist service and computing centers in conducting 
integrated disaster recovery exercises. Furthermore, the IRS will 
review the state of its security and focus on providing solutions to 
identified vulnerabilities and completing security certifications of 
sensitive systems. The IRS will bring the Computer Security Incidence 
Response Center to full operational capability and will provide 
oversight of selected IRS program areas to ensure practices are 
consistent with policy and guidance.

                        Property Management (IT)

    The IRS will enhance and enforce policies and procedures to ensure 
accountability for use of information technology (IT) property. There 
will also be a transition from the current internally developed IT 
property tracking system (Integrated Network and Operations Management 
System--INOMS) to a Commercial Off-the-Shelf (COTS) solution. The IRS 
will connect the IT asset system with the non-IT property management so 
there is one comprehensive property system throughout the IRS.

                           Financial Systems

    The IRS will implement a Joint Financial Management Improvement 
Program (JFMIP) approved financial management system. We will select a 
COTS product that best satisfies our internal management needs through 
an enterprise resource-planning product. Our first phase of 
implementation will be replacement of the core financial system, with 
planned future implementation of other internal management modules.

                             Strategic Plan

    The Strategic Plan stresses that the IRS must demonstrate effective 
stewardship of the assets and information entrusted to it by improving 
our internal processes for information management, financial 
management, and asset management.

                               Conclusion

    To summarize, the Internal Revenue Service is committed to 
improving financial management. We view all of these actions as 
necessary to build upon current processes and systems to provide the 
best financial information possible that meets statutory and policy 
requirements. Additionally, it must be stressed that the long-term 
solution to many of the issues identified through the audit process can 
only be addressed by the design and implementation of new or enhanced 
automated systems that will be developed over the next several years.

                                


    Chairman Houghton. All right. Thanks very much. Before we 
go to the questions, I would like to introduce our newest 
Member, Earl Pomeroy, who is a very distinguished man for many 
reasons, one of which is he is my neighbor down the hall here. 
Anyway, Earl, and also Karen Thurman, who was on this Committee 
two Congresses ago, not last Congress, and now again. Thanks 
very much, Karen, forbeing here.
    I would just like to ask a question and then I will turn it 
over to Mr. Coyne, and we will go back and forth here. You have 
talked about this electronic filing and I think it was you that 
put out this goal of 80 percent filing electronically by the 
year 2007; is that right or was that before you?
    Mr. Rossotti. Well, it was included in the Restructuring 
Act. I think the origin of it might have been the Presidential 
commission that studied the IRS, but in any case, it was 
included in the Restructuring Act as a goal.
    Chairman Houghton. Tell us a little bit about that. Is that 
going to be a stretch? How does it look? What are the 
incentives? Just give us a feel for it.
    Mr. Rossotti. It is definitely going to be a stretch in 
terms of timing. We actually have to average 20 percent-a-year 
growth between now and 2007 approximately to get there. We did 
hit 20 percent this year. We may be slightly under 20 percent 
this coming year. I think the important thing, and I think some 
or the other folks who are going to testify later will say 
this, is that it will not happen automatically. It will not 
happen just because it is currently going up at 20 percent. We 
have to take some aggressive steps and we are.
    I mentioned in my testimony, one of the key things was the 
ability to file all forms and returns electroncially. Right 
now, you cannot file all returns because there are certain 
schedules and forms that are not accepted. That particularly 
affects practitioners, because 55 percent of the returns are 
prepared by practitioners and many of them tell us they do not 
want to file some of their returns electronically and some of 
them on paper. That is one obstacle we are trying to remove.
    Another issue was that electronic filing was not entirely 
paperless. You had to file a separate form with your signature 
document. We came up with a strategy this year that eliminated 
that requirement. You could supply us with a self-selected 
identification number and two pieces of information from your 
prior-year return. That has had some startup issues, especially 
with some of the practitioners, but nevertheless we think it 
will work with some fine-tuning and that will eliminate that 
issue.
    Another issue has to do with practitioners having 
sufficient incentive just to change the way they do business. 
In our modernization program, one of the things we are going to 
be doing in an early implementation, we expect by 2002, is to 
provide some additional services to some practitioners who work 
with us electronically. This will include not just filing the 
returns, but being able to communicate with us, for example, to 
get transcripts of tax returns and eventually to settle their 
accounts. This will essentially provide a broader reason for 
people to do business electronically with us.
    Then, finally, there is the marketing and promotional 
activities, like any product. You have to promote it and we are 
continuing to do that. We have a lot of things that we have to 
do. I have only mentioned a few of them. It will not happen 
automatically.
    On the other hand, the trends in favor of us are just 
cultural. The newer generation of people, like my two children, 
they are around 30 years old and I do not know that they have 
ever bought a postage stamp. I think they do everything by e-
mail and computers. They are the kind of generation that is 
going to automatically generate an interest in things 
electronic.
    Chairman Houghton. Thanks very much. Mr. Coyne.
    Mr. Coyne. Thank you, Mr. Chairman. Commissioner, welcome 
and thank you for your testimony. Is there a difference between 
the level of funding for 2000 between what the chairman of the 
oversight board would like and what the IRS has submitted to 
the administration?
    Mr. Rossotti. Well, I am afraid the administration has not 
submitted its budget yet, so I do not think I can really go 
into what the President's budget is going to be until it is 
submitted.
    Mr. Coyne. But as far as your request to the administration 
for funding from the IRS, is there a difference between yours 
and what Mr. Levitan would like?
    Mr. Rossotti. Well, Mr. Coyne, I think we ought to wait a 
little until we see the President's budget. I think Mr. 
Levitan, in their public meeting, had made some comments about 
what they perceive to be the differences between their view on 
certain items and what they believe the administration was 
going to have. I think I would be best advised to wait until 
the President's budget is submitted before commenting on the 
budget, other than mentioning that they did say in the 
blueprint they would include $397 million for the modernization 
fund.
    Mr. Coyne. It has been reported that over the last several 
years audit and collection levels at the service has declined. 
Could you point out to us here today what the major areas of 
noncompliance have been?
    Mr. Rossotti. Well, of course, one of the things is we have 
not had for a long time, a very good up-to-date, accurate 
assessment of how the compliance levels have trended. We are 
relying on some old estimates. I think, as we noted in our 
strategic plan, there are really problem areas of noncompliance 
across the spectrum. There is going to be, in fact, a hearing 
at the Senate Finance Committee this week on one area, which 
are the sort of organized tax avoidance schemes, such as these 
abusive trusts and devices such as that, which are sold to 
taxpayers, alleging that they can avoid taxes, and we think--we 
do not know what the numbers are, but there could be many 
billions of dollars of taxes that are not paid on that kind of 
scheme.
    There are significant problems that we have in collecting 
employment taxes. We are behind in some areas because of the 
inventories that have a build up of collections. We have, as 
you know, in some cases, refunds that get through that should 
not get through, both based on the earned-income tax credit as 
well as other refunds. At the other extreme in the corporate 
area, we have had some major initiatives recently in the last 
year to deal with abusive corporate tax shelters, which are a 
different kind of tax shelter. They are kind of technical 
devices. So if you really look across the board, there are wide 
ranges of areas of noncompliance, and we are trying to be very 
focused with the limited resources we have on each of those.
    Mr. Coyne. Later on today, the Treasury's Inspector 
General, Mr. Williams, is going to testify, and I quote from 
his testimony, that ``over a 4-day period during this current 
filing season, their auditors made 368 random test calls to the 
IRS' toll-free number, and were unable to gain access 37 
percent of the time. When successful in getting through, 
however, the IRS incorrectly responded to 47 percent of the 
questions. The topics for the test calls were obtained as the 
most frequently requested requests of callers.'' Could you 
address that?
    Mr. Rossotti. Well, as I said in my testimony, we certainly 
believe we made progress in both the quantity, access and 
quality of calls. But we are far from satisfied with where we 
are. By looking at the entire filing season rather than just 4 
days, we know what the access is. If someone wants to talk to a 
person and tries to get through, right now, for the season as a 
whole, the access is about 66 percent. In other words, about 
two-thirds of the time, which is not too different from what 
they found.
    In terms of quality, we have a very complete system that 
tracks in a statistical way actual calls that are made by 
taxpayers that we have up in Philadelphia, as a matter-of-fact, 
not in Pittsburgh, but it happens to be in Philadelphia, a site 
that actually randomly samples all calls that are made and 
listens into them, because we can do that electronically, and 
through a statistical means actually rates the accuracy of the 
calls.
    I can give you the statistics for the whole filing season. 
On tax law calls, the accurate response rate was 74.5 percent 
for the filing season so far. On accounts calls, which are 
people calling about their account, it was 86 percent. Neither 
of those is an acceptable level, although, especially in the 
accounts, we have improved drastically or at least 
significantly over what it was last year. I think in terms of 
where we are going with this, we want to try to get to a 
commercial level of access, which would be more in the 90 
percent range, and certainly, a significant improvement.
    In terms of both of those, there are two key things that we 
are doing besides just better management and better training. 
One of them is the technology program; in fact, a near-term 
technology program will provide us additional capacity to 
answer calls and some additional ability to route calls more 
precisely. We are also completely reorganizing our whole 
telephone operation, in the sense that we have about 25 
different call sites where there are people who answer calls.
    In the older structure, we tried to answer pretty much all 
the different kinds of calls, which, if you think about it, is 
an enormous range across the tax laws as well as accounts. What 
we are doing is working on a plan which we call center 
optimization, which looks across the whole network, across the 
whole country, and tries to figure out where we can specialize 
both the sites and the people in the sites, so that they will 
become more knowledgeable about the specific kinds of questions 
they need to answer and then direct the calls to the right 
kinds of people.
    We are convinced that this is the only way we will get 
completely up to the level of accuracy we need to, because it 
is just too difficult to answer the entire range of calls in so 
many different places. This is an example of something where we 
are doing short-term things, as we are doing this filing 
season, but we are also making some fundamental changes to 
really reorganize the way the whole thing works in order to get 
both access and quality up to the levels that we want.
    Mr. Coyne. Thank you.
    Chairman Houghton. Mr. Portman.
    Mr. Portman. Thank you, Mr. Chairman, and thank you, 
Commissioner, for being with us again. I think this 
Subcommittee is very cognizant of your challenge to both 
reengineer the IRS, while maintaining the taxpayer service as 
necessary to operate a very complicated system and a very 
complicated Tax Code.
    If I could focus on a couple areas, one is with regard to 
electronic filing, I am concerned that you are saying it would 
be very difficult to meet the goal, but you think the goal is 
very important for both taxpayer service and also for the IRS 
itself, to be able to operate efficiently and more accurately. 
It seems to me, looking at your data, that you have done a 
pretty good job with regard to folks who file their own 
returns. In fact, we have about a 37-percent increase on home 
computers, for instance, this year, which is impressive, only 
about 10 percent, though, among practitioners.
    We are going to hear from some practitioners later and I 
want to pose some questions to them if I can come back. I have 
to step out for awhile for another meeting. I hope to be back. 
What can you do to improve that rate among the practitioners? 
As you know, more than half the returns are filed by 
practitioners. You mentioned we can put all forms and all 
schedules on, rather than the forms we currently have online, 
but specifically with regard to practitioners, what are your 
ideas for the next few years?
    Mr. Rossotti. Well, I think there are really three things 
we are trying to do concretely. One of them is to be able to 
file all the 1040 forms online because they do not want to do 
some of them on paper and some of them electronically. The 
first time I ever met with a practitioner on this subject when 
I came into office, that was one of the first things I heard. 
It has taken us some time, but by 2002 we will be there.
    The second thing is getting rid of the papers, the 
signature document. We came up with a scheme this year. There 
is some maturity, some perfection we need to do on that, and we 
will be working with the practitioners this year to gain their 
experience and improve it next year.
    The third thing is to broaden their ability to interact 
with us electronically, beyond just filing returns, into 
dealing with us on other subjects. I think I mentioned that 
briefly in an answer to the Chairman's question. In our 
modernization program, our e-services project is aimed squarely 
at that point. It is directly aimed at enabling us to have, in 
a secure way, the ability to communicate with practitioners. If 
we can succeed in our schedules, we will be rolling out the 
first part of that capacity in 2002, and perhaps, the remainder 
in 2003.
    Within the next 2 years, I think we will have dramatically 
increased the attractiveness of our offerings to practitioners.
    Mr. Portman. Commissioner, can I interrupt you just for a 
second? I have got a couple of questions I would like to get at 
and my orange light is going to come on in just a second. If 
you can get back to me in writing, that would be great with 
regard to any other point on practitioners, specifically with 
regard to the PIN numbers. There has been some information that 
has recently come to our attention, Federal Computer Week just 
said there is a lot of complaints about the new system, 
enabling taxpayers to select their own PIN. We think there is 
about a 20 percent error rate that you have acknowledged with 
regard to PIN numbers, and we understand that there are a lot 
of taxpayers who have been required to file their signatures 
the old-fashioned way, by mail, in addition to filing returns 
electronically.
    I know you have tried several PIN systems in recent years. 
They all seem to have some inherent problems and complexities. 
If you could sort of cut through some of the red tape for us on 
that and give us what the best systems might be over the next 
couple of years, that would be very helpful to me and I think 
to the Subcommittee.
    [The following was subsequently received:]

    Currently, IRS offers the Self-Select PIN program for 
signing the 1040 Individual Income Tax Return electronically, 
using a self-selected five-digit personal identification 
number. The Self-Select PIN is totally paperless. The PIN 
eliminates the need to send in Form 8453 and Form 8453OL. There 
have been over 8.8 million returns filed electronically using 
the Self-Select PIN.
    However, the IRS has not yet determined which system would 
be best for the next couple of years. IRS is exploring the 
feasibility of reinstating the Practitioner PIN program. Under 
this program, the taxpayer self-selects his or her own personal 
identification number and personally inputs the PIN as his or 
her electronic signature. The difference between the two 
programs is that the Practitioner must maintain an 
Authentication Worksheet for a period of 3 years. The worksheet 
has the taxpayer's PIN listed along with his or her pen and ink 
signature confirming that the PIN he or she selected will serve 
as their electronic signature. The Self-Select PIN does not 
require a Worksheet. Instead, it requires two pieces of 
information from the taxpayer's prior year tax return--Adjusted 
Gross Income and Total Tax---to authenticate the taxpayer. 
Reinstating the Practitioner PIN program, as well as 
maintaining the Self-Select PIN program, will provide 
practitioners with a choice between the two systems depending 
on their business and client's needs.

                                


    Mr. Portman. States, as you know, require the taxpayer to 
retain a signed copy of their returns. It has to be produced if 
the IRS conducts an audit. That is what we kind of came up with 
in the commission a few years ago, and we talked about that in 
this Subcommittee at various hearings. That seems a lot less 
complex to me still, and I wonder why the IRS has not gone to 
that.
    [The following was subsequently received:]

    Although some states may allow taxpayers to file returns 
electronically and retain the signature on a paper copy, IRS 
does not consider this appropriate for electronic filing of 
federal tax returns. States can be reasonably confident that 
the information filed with them is the same as on the federal 
tax return. However, in the federal environment, we are not 
provided with this same level of confidence. Administration of 
the tax laws would likely be more difficult if taxpayers 
retained the signed copy of their returns. If necessary, the 
Service would need to use other means to prove that a return 
filed electronically without a signature was, in fact, the 
taxpayer's return.

                                


    Mr. Portman. Now, my orange light is on. Let me skip over 
my questions on the telephone side and just to say quickly 
there that you had done well in going from 50 percent to about 
two-thirds. The error rate is still disconcerting, and one of 
the issues I would love to get back in writing, would be to 
move to an e-mail system where you are able to respond to more 
than just tax law questions by e-mail, but actually respond to 
specific questions on specific accounts. I know there are some 
security issues with that and some modernization issues with 
that, but it seems to me that would enable your people to have 
a little more time to respond and come back with a response 
that was, frankly, a little more accountable to them and a 
little more thoughtful, which might lower that rate of 
inaccuracy that Mr. Coyne talked about.
    [The following was subsequently received:]

    Currently, IRS has two Modernization projects underway that 
will provide web-based account customer service. The first 
project, Internet Refund application, is an automated 
application that will provide English and Spanish refund status 
information for our customers over the Internet during next 
year's filing season. Although the initial version of the 
application will not support e-mail, it will include ``what-to-
do-next'' templates and checklists with information taxpayers 
should have available when calling or writing IRS to facilitate 
resolution of refund problems. IRS will pursue e-mail 
capability in the future iterations.
    The second project, Electronic Account Resolution, will 
offer practitioners the capability to resolve account-related 
issues electronically using a secure internet application. The 
first implementation of Electronic Account Resolution is 
scheduled to occur in September 2002. Our Electronic Tax 
Administration Office has used the Practitioner Secure 
Messaging System (PSMS) Prototype as the basis for determining 
the requirements for the Electronic Account Resolution.

                                


    Mr. Portman. The final question I have for you is with 
regard to the oversight board. How is it working? I met with 
the oversight board. I know you have spent a lot of time with 
them, which I appreciate greatly. Chairman Levitan testified 
yesterday before the Oversight Committee. I wonder if you would 
give us a brief overview of the oversight board?
    Mr. Rossotti. My sense is that the oversight board has 
taken its responsibilities very seriously, very much in the 
spirit of the Restructuring Act, and has put in a great deal of 
serious time learning about the IRS. They were appointed in 
September. They organized at the first meeting. They have had 
three full-scale meetings, each about two days, the most recent 
one about 2 weeks ago which included a public meeting, and then 
they have three Subcommittees that have been organized that 
have focused on key areas.
    I think at this point they are up and running in a full-
scale way. They focused a lot of their attention on the 
strategic plan in the budget, and as I mentioned in my 
testimony, in January they actually approved the strategic 
plan. I think that was an appropriate focus for them and 
something they contribute a lot of value to. Now they have been 
focusing on the budget to support the strategic plan, and they 
have issued a report on that. I think they are going to issue 
some more reports, including the testimony. The Chairman 
testified yesterday and I believe he is going to testify 
Thursday.
    My sense is this board is doing what the Congress intended 
it to do, which is to get into an in-depth understanding of the 
IRS' problems. They certainly have been candid about 
identifying our problems if you heard the testimony yesterday, 
but they have also been very constructive about laying out what 
they think needs to be done. Just speaking personally, I have 
been involved with a number of boards, both being on them and 
presenting to them and so forth, in different contexts, but I 
think this is one of the most substantive kinds of meetings 
that I have ever been engaged with.
    I mean, they have been very substantive, very intense. You 
were there at one of them for a period. They are fully capable 
because of their backgrounds, to really know what questions to 
ask in-depth about almost any subject about the IRS. And they 
have not hesitated to do that. They have also met with all the 
outside stakeholder groups and with GAO. The Comptroller 
General came over to meet with them. I believe if you wanted to 
have one body that has devoted the time and has the expertise 
to understand what is going on about the IRS, you have that in 
the IRS Oversight Board.
    Mr. Portman. Thank you, Mr. Chairman.
    Chairman Houghton. Well, I will bet you are very proud of 
that; rather than asking where is it, it is how is it doing.
    Mr. Portman. More fun to ask that.
    Chairman Houghton. I would like to ask Mr. Pomeroy if he 
has a question.
    Mr. Pomeroy. I do, Mr. Chairman, and thank you. I would 
just begin by saying Commissioner Rossotti has come to North 
Dakota, and I never would have thought there was anyone who 
could make people stand and cheer the IRS, but by golly he did. 
It was a wonderful presentation. That kind of segues into the 
point that I want to make. There is a lot of debate around tax 
policy. There always will be. Unfortunately, sometimes I think 
frustration at the structure of the Tax Code, or disappointment 
about the impact of the Federal government's revenue demands on 
taxpayers, is ultimately channeled into frustration on the 
service and the outstanding professionals that run the Internal 
Revenue Service.
    I so appreciate your background, Commissioner, coming from 
such demonstrated levels of success in the private sector at 
senior levels of management, to look at the system during this 
critical period of time and evaluation. My question is whether 
or not the resources are there, allowing you to get the tasks 
we, under statute, demand that you perform, done and done well? 
Obviously, the numbers cited by Ranking Member Congressman 
Coyne are disturbing, and would be a reflection of whether--
raise significant questions in terms of whether the resources 
have been there as needed.
    I guess, to put a point on my question, it is my 
understanding that the service has sought a $9.7 billion 
increase for the upcoming fiscal year. That amount itself has 
generated controversy with the oversight board believing that 
more was appropriate, I understand. Any idea how you are going 
to fare in the upcoming President's budget?
    Mr. Rossotti. Again, as I said to Mr. Coyne, I think I am 
best advised not to be commenting on the President's budget 
until it is released. I do not think I should do that. I will 
say, just to back up one step, that in 2001, which is the 
fiscal year we are in now, Congress passed a budget that after 
a lot of debate and a lot of work that was, from my point of 
view, a budget that enabled us to make significantly more 
progress then we had for a number of years in the two key 
areas.
    One is, as I just mentioned, we have to operate. We have to 
have some staff. We have to have trained people. This is the 
first year we are actually out hiring some people to replace 
people that left and to make some modest increases and also to 
move our modernization. That is good and we want to try to 
continue that in 2002. Without getting into details, because it 
has not been announced yet, I think the 2002 budget that will 
be released, will allow us to continue to make progress in both 
of these areas. I think there will always be room for debate 
about how fast we make progress and how much we have, but I 
think we will be able to make progress in 2002, as well as we 
have been in 2001.
    Mr. Pomeroy. Good. I would hope that the request from the 
IRS is met in the President's budget, and I will be looking 
specifically at whether the funding matches the $9.7 billion 
request. As I look at that, I will note that this advisory 
board that has taken its responsibilities, as you mentioned, 
very substantively, and have no stake other than sound 
administration of the service itself, I believe you were $500 
million low in that request. So we will have some benchmarks to 
evaluate whether or not the resources are there.
    Regardless of how you feel about the tax code or tax 
policy, you represent an agency that has to get its work done. 
And if it does not, literately discredits the entire Federal 
government in a way that is more fundamental than what most 
agencies would. Thank goodness for your distinguished 
leadership, and I mean it, at doing the best possible under the 
circumstances, but you need resources and I hope that they are 
there for you. Thank you. I yield back, Mr. Chairman.
    Chairman Houghton. Thanks very much. Mr. Weller.
    Mr. Weller. Thank you, Mr. Chairman and Mr. Commissioner. 
Good to see you again. I look forward to working with you. I 
know when I came in, and I apologize for running late, but my 
friend and colleague, Rob Portman, was discussing with you the 
progress on electronic filing, something that reduces a lot of 
paperwork and we all hope moves forward in simplifying the tax 
filing process for taxpayers in this new economy.
    One of the concerns that has been raised to me by some who 
are in the business of helping prepare tax filing, as well as 
individual taxpayers, I know Mr. Portman referred to the PIN 
issue, but others have said that also the Social Security 
number becomes a problem, as well. I was wondering, do you have 
any idea what percent of electronic filings, where there is a 
complication, results from a number that does not match up?
    [The following was subsequently received:]

    Our Electronic Filing program is designed to perform a 
matching process with the social security number (SSN) and name 
(combined is known as a (TIN)) provided by the taxpayer against 
the SSN and name information maintained by the IRS. The Social 
Security Administration (SSA) provides the IRS with weekly 
updates of SSNs and matching names. If, during the initial 
validation process of electronic filing, the SSN and associated 
name on the tax return does not match the information on file 
with the IRS, the return is rejected to the preparer with an 
explanation of the errors. Electronic Filing information, as of 
April 10, 2001, reveals approximately three million rejects, (a 
single return may have multiple rejects as the primary and 
secondary taxpayers, as well as dependents are checked) because 
of mis-matching information between what was on the returns and 
the information on the IRS master file from SSA records.

                                


    Mr. Rossotti. I can get you that number. I do not have it 
off the top of my head. Let me just point out that verifying 
social security numbers is not something that is unique to 
electronically filed returns. It is exactly the same, whether 
they are filed on paper or electronic. The only difference is 
that it is quicker to identify the problem electronically, 
which actually helps people, because we identify that rather 
than sending them a piece of paper in the mail telling them 
their social security number is wrong.
    The reason we do that is really is part of the compliance 
program. I think the Congress, the IG and GAO and everyone has 
recognized that this is an important thing to do, to verify all 
the social security numbers for people who claim dependents or 
EITC qualifying child, those sorts of things. This is something 
that is really not related to electronic filing as much as it 
is making sure the returns are accurately filed. I can get you 
the numbers. I will get back to you with the specific numbers 
about how many returns have social security number----
    Mr. Weller. Because I have been hearing numbers of up to 10 
percent of those electronic filings being rejected because of 
social security numbers. Now, whether those numbers are 
accurate, I wanted to hear from you.
    Mr. Rossotti. We will get you those numbers. My only point 
is the same issue applies whether taxpayers file electronically 
or on paper and it is just quicker to identify them 
electronically.
    Mr. Weller. Have your people ever sat down with the Social 
Security Administration and tried to figure out a way to ease 
that process? Because I realize it occurs probably when people 
marry, a woman may take her husband's name and a change in 
status, what kind of conversation do you have with Social 
Security?
    Mr. Rossotti. We actually do that on a regular basis. I was 
just talking about it with some people this morning and the 
kind of issues that come up are small issues. One example that 
I heard, for example, is that some people were getting names 
rejected because the social security number--in earlier periods 
they had not allowed hyphens in certain people's names and then 
they went and cleaned up the names to put the hyphens in. That 
was a good thing for them to do, but it did not match what 
people put on their returns in some cases. There are all these 
little issues, but in total they add up. We are working with 
the Social Security Administration to figure out ways to make 
it as easy as possible for people to make the corrections, and 
also make sure our files match.
    Mr. Weller. I would appreciate it if you could share with 
the Subcommittee, just to follow up on this question, where you 
are in the progress, what the status of your conversation/
cooperation with the Social Security Administration would be. 
They are not far from you and to try to solve that problem, 
just to simplify the process of filing taxes.
    [The following was subsequently received:]

    IRS has established a working relationship with the social 
security Administration (SSA) to resolve the difference between 
IRS taxpayer information and the SSA social security number and 
name data. Jointly, IRS and SSA make every effort to insure 
that the TIN information on file with the IRS is accurate. All 
changes to IRS programming that require validation of taxpayer, 
taxpayer spouse, or taxpayer dependents are coordinated with 
SSA before implementation. All decisions that impact taxpayer 
Social Security numbers and name are made jointly between IRS 
and SSA. The IRS also has procedures in place to use prior year 
return information to validate spouse and dependent information 
where the information IRS has is different from SSA 
information. As of the first of April, the IRS identified over 
five hundred thousand cases where the information on the tax 
return did not match the SSA information on file with the IRS. 
Through this matching program, the IRS has ``validated'' three 
hundred thousand of these. Each of the 300,000 records has been 
marked and the IRS and SSA will contact these taxpayers this 
summer in an effort to correct this discrepancy.
    In addition, IRS will continue to meet with SSA to discuss 
issues concerning the date of birth and name control mismatches 
and the accuracy of Citizenship Codes that can also cause 
returns to reject.

                                


    Mr. Weller. Let me shift over to a kind of a different 
subject, and that is you come out of the business sector. You 
are a successful businessman. What is your philosophy about 
government agencies competing with private businesses in 
supplying services and products?
    Mr. Rossotti. Well, I think that, by and large, it is not a 
wise thing for the government agencies to get into business and 
compete with the private sector. We have enough to do just with 
what our mission is.
    There are some gray areas. There were some issues about 
exactly how far we should go in order to promote electronic 
filing, offering additional services, and we have made a 
determination. As a matter of fact, it was included in the 
Restructuring Act guidance that we should work with the private 
sector and foster competition rather than get into that 
business. For example, we have no intention of getting into the 
tax software business that distributes software.
    Mr. Weller. That was the question I wanted to follow up. So 
you have on plans to provide specific software to taxpayers 
that would than obtain that through the private sources.
    Mr. Rossotti. Yes, that is correct.
    Mr. Weller. You do not want to compete it?
    Mr. Rossotti. That is correct. As a matter of fact, we had 
a discussion on that subject with the House Appropriations 
Committee, the last October hearing, and there is some report 
language in our appropriation bill that asks us to provide a 
report to the Committee, which we will, but as I testified at 
that point, we do not plan and we do not think it would be wise 
for us to get into that. But we are trying to figure out ways 
that we could encourage the competition as was specifically 
required in RRA to drive the costs down as much as we can for 
the taxpayer, but that would be within the realm of the private 
sector, not by the IRS getting into the business.
    Mr. Weller. Thank you, Commissioner. I look forward to 
working with you, and look forward to hearing your report. 
Thank you very much.
    Chairman Houghton. Thanks, Mr. Weller. Mrs. Thurman.
    Mrs. Thurman. Thank you, Mr. Chairman.
    Commissioner Rossetti, I am glad to be back on this 
Committee. Certainly, we have been through a couple of good 
taxpayer rights bills over the last couple of years together. 
So it is nice to be back here again.
    I have a couple of questions that I would like to talk 
about. Over the last couple of weeks, we have been, obviously, 
doing some tax bills, and there has been a lot of concern about 
the earned income tax credit and being fraudulent. I know we 
have put a lot of work into doing this.
    I noticed it was kind of a secondary in your prepared 
remarks to us as compared to a story that actually was in the 
Wall Street Journal yesterday talking about businesses and tax 
shelters. So can you kind of bring me up to date where we are 
on the earned income tax credit and what you are seeing in the 
other filings that seem to go kind of unnoticed on occasion?
    Mr. Rossotti. Well, I think, as I said in my opening 
statement and in our strategic plan, there are compliance 
problems across the entire spectrum. There really are, and they 
affect all types of returns and all types of taxpayers.
    With respect to the earned income credit, that remains a 
problem. We issued a report last year that tried to quantify 
that. We have a little better quantification on that than we do 
in some other areas, and we did find that there were about, 
after everything was said and done--and this was for the filing 
season '98, so it is kind of old data before we had done some 
new initiatives, but at that time, there was about $7.5 billion 
of erroneous claims out of $30 billion.
    I stress that we use the term ``erroneous claims'' or 
``over-claims'' because we do not really know in all cases what 
causes these claims. Some of them may very well be deliberate. 
Some of them could be simply the fact that there is a complex 
set of calculations in the EITC. So we do not know exactly what 
causes them, but we do know what the amount of them was, and 
that is a significant amount of money. We do have a special 
appropriation from Congress to work on it.
    We have one new feature that we have implemented this year 
to try to deal with it which is called the dependent database, 
which was authorized by law and gives us data from the States 
on who the custodial parents are, and we can use that to match 
with taxpayers claiming the EITC.
    We are working on that, but as you noted in your question, 
it certainly is not the only area of non-compliance. Ranging 
from these abusive trusts to the corporate tax shelters to the 
employment taxes, no matter where you go, you find it. 
Obviously, the majority of taxpayers in every one of these 
groups is very compliant and very honest, but there are those 
who try to take advantage of it, and we try to do what we can.
    Mrs. Thurman. I do appreciate that answer because it always 
comes back to us like somebody is doing something that they are 
not supposed to be doing on either one of those questions on 
any one of those sides.
    The second thing that I would like to ask you is--actually, 
there are two, before I run out of time. One was there was a 
notice in the FNA Today that was talking about the IRS 
electronic newsletter that was dated April 1st dealing with 
taxpayers and preparers are actually misrepresenting 
instructions used in a notice 703. This has to do with Social 
Security benefits, and I just was kind of going to ask, can you 
give us some idea of the extent of this problem, how many 
taxpayers are making this mistake, and more importantly, 
something that we might be able to help on is do you think it 
would be fair for us to be forcing these folks to pay penalties 
and interest due to the lack of a clarity of a notice that IRS 
actually sent out.
    [The following was subsequently received:]

    Unfortunately, the IRS currently does not have a tracking 
tool that will provide the number of taxpayers that were misled 
by the language on Notice 703. The issue was discovered through 
research by IRS technical staff. As a result, the language of 
Notice 703 will be revised.
    Penalties will only be assessed on those taxpayers in this 
circumstance that have made the same error in a previous tax 
year. Normally, only interest will be assessed.

                                


    Mrs. Thurman. Second, different subject, but just in case 
we run out of time, when I was on this Committee before, there 
was a piece of legislation that was passed specifically to deal 
with the complexities of the IRS Code. I think what we finally 
came up with was that after the bill was passed out of the 
Committee, it would go to the Joint Tax Committee, and then in 
consultation with you all, that it was to try to help us 
streamline this and make this the least complicated form that 
we could come out with.
    I would like to kind of get an update on where we are in 
that area as well.
    Mr. Rossotti. Let me answer that question first.
    Yes, you are correct. That is exactly what was passed, and 
we have been following that.
    The way it works is that when there is a specific proposal 
for a Tax Code change--and I think there is a threshold of how 
significant it is--the Joint Committee staff gets together with 
us through our legislative affairs office and we send them an 
analysis. We have been doing this now, I guess, for at least 2 
years.
    Mrs. Thurman. You just send them an estimate, but do you 
have conversation about ways of writing this, so that it 
achieves the same in, but makes it less complicated?
    Mr. Rossotti. Well, that is not exactly what we are 
required to do.
    We provide them a specific statement as to what additional 
complexity, what changes, or what the impact is going to be. It 
is kind of like an impact statement.
    For example, it says such and such a change that it is 
going to require changing these forms. There are going to be so 
many more line items or so many less line items, and here is 
how many taxpayers are going to be affected, and that sort of 
thing. We provide that to the Joint Committee staff and then 
they provide that to the Ways and Means Committee and the 
Finance Committee for inclusion in the Committee reports. We 
have been doing this since that provision went into effect.
    Mrs. Thurman. I guess the follow-up question on that, then, 
was has our Tax Codes gotten less complicated because of that.
    Mr. Rossotti. I am afraid I could not say that. I do not 
think it has gotten less complicated.
    I think that there was one occasion, I do know, in which 
there was a proposal to change the way capital gains were 
treated. In fact, I remember calling Chairman Archer on this 
particular point myself and saying this is really going to 
cause a significant problem. I think the Chairman figured out a 
way to save that so it would not have that particular impact. 
So, at least at a certain level, it has had some beneficial 
impact, but, of course, there have been no really big tax bills 
enacted since that provision was implemented either.
    Mrs. Thurman. Well, they have come out of this Committee. 
The other issue was on the 703.
    Mr. Rossotti. I am afraid I am going to have to get back to 
you on that first question because I do not have the answer. I 
will have to get back to you on it. I just do not have the 
answer in my head.
    Mrs. Thurman. I would love to hear from you because it does 
deal with the Social Security benefit taxable income, and if we 
are in a situation where we have given now some bad information 
or makes it complicated, then I would really like to be able to 
look at this penalty issue.
    Mr. Rossotti. We will get back to you. I just do not have 
the information readily available.
    Chairman Houghton. Thank you, Mrs. Thurman. Mr. Coyne.
    Mr. Coyne. Commissioner, as part of the reforms 2 years 
ago, there was what was called the 10 Deadly Sins provision 
that was in there, and one of them had to do with the willful 
failure to file any return after the due date for filing 
returns and extensions for employees. Are you familiar with 
that?
    Mr. Rossotti. Yes, I am.
    Mr. Coyne. Have you had to enforce that at all?
    Mr. Rossotti. Yes, sir. As a matter of fact, last year we 
provided a complete report to the Congress. So I can give you 
an update on all of the provisions, all of the sections, not 
only that one section of 1203(b). I think that we have a great 
deal of experience trying to administer that provision.
    Mr. Coyne. So you have submitted that as part of a report?
    Mr. Rossotti. We submitted it last year, and I have got an 
update that I can give you this year, if you like, on the whole 
section.
    Mr. Coyne. OK, that would be good.
    Mr. Rossotti. It gives all the statistics on how many 
investigations there have been and how many people have been 
dismissed for violations of various subsections.
    Mr. Coyne. Thank you. Thank you.
    Chairman Houghton. Mr. Commissioner, thanks very much. We 
are delighted that you have been here with us.
    Now I would like to call the second witness, Nina Olson, 
National Taxpayer Advocate Service. She is an old hand, having 
been in this office for a little over a month.
    So, Ms. Olson, you will never be more objective than you 
are now. So we would love to hear your testimony.

    STATEMENT OF NINA E. OLSON, NATIONAL TAXPAYER ADVOCATE, 
                    INTERNAL REVENUE SERVICE

    Ms. Olson. Thank you, sir.
    I am pleased to appear before you today to address the 2000 
filing season. As you know, this is my first appearance before 
you as the National Taxpayer Advocate. I come to this position 
with over 25 years of front-line experience in tax practice and 
procedure, and yet, during my first 30 days on the job, I have 
learned an enormous amount about how the IRS works.
    I already knew from my private practice that IRS employees 
are dedicated public servants. They are a valuable resource for 
anyone trying to identify and resolve taxpayer problems. I 
would like to acknowledge with gratitude my predecessor, W. Val 
Overson, the first National Taxpayer Advocate, and the Deputy 
National Taxpayer Advocate, Henry O. Lamar.
    I know that the National Taxpayer Advocate's independence 
and authority are a matter of interest to this Subcommittee. So 
I will address this issue first.
    The Commissioner of Internal Revenue delegated certain 
authorities to the National Taxpayer Advocate on January 17th, 
2001. Some TAS employees may prefer more authority than will be 
re-delegated to them. I have made it clear to my employees that 
I will not hesitate to seek additional authorities if we need 
them. However, I am keenly aware that if we become a shadow 
IRS, we may lose our effectiveness as an advocate for systemic 
change.
    Some doubt our independence. I have no such doubt. I 
believe it is appropriate for the Taxpayer Advocate Service to 
be located within the IRS. TAS is not TIGTA or the GAO. The 
National Taxpayer Advocate is not a watch dog. She is an 
advocate before, during, and after the filing season.
    For at least the last two filing seasons, IRS compliance 
personnel were detailed to the customer assistant sites or 
telephone lines in order to assist more taxpayers. Whenever 
operational personnel are detailed out of their original areas, 
response times in those areas lengthen. If the delay is more 
than 30 days over normal processing time, the matter will meet 
Taxpayer Advocate criteria.
    We are concerned that the number of cases arising from 
delays of more than 30 days may prevent us from assisting 
taxpayers we are uniquely designed to help, mainly those 
suffering from some form of financial hardship or irreparable 
harm.
    No review of the filing season would be complete without 
mentioning the earned income credit. The statute and procedures 
developed to reduce error and fraud in this program must also 
protect the rights of taxpayers. If we subjected middle-class 
and more affluent taxpayers to the kind of intrusive inquiries 
we routinely subject a taxpayer to in an EIC audit, the entire 
EIC audit program would be shut down in response to taxpayer 
complaints.
    Last month, I observed the operation of the dependent 
database. Once the database is refined, it should significantly 
lessen the number of eligible taxpayers examined, have a 
chilling effect on those taxpayers contemplating fraud, and 
provide an opportunity to better educate those taxpayers who 
are being examined.
    The Taxpayer Advocate Service recognizes the importance of 
electronic tax administration to the integrity of the tax 
system. However, we are concerned that taxpayers who face 
language or literacy barriers, or who do not have ready access 
to computers, will be left behind in the push for electronic 
filing.
    We are mindful of Congress' direction that the IRS not 
interfere with the free operation of the market. We also do not 
believe that the IRS should enter the business of tax return 
preparation.
    As I outline in my written comments, I believe there is a 
middle ground, but before we reach it, we must answer this 
question. To what extent should the tax system protect a 
vulnerable population in the tax preparation arena? This is not 
a decision the IRS can undertake without further guidance from 
Congress.
    Every filing season results in a host of document-matching 
procedures and taxpayer notices. Taxpayers and practitioners 
alike are confused by the various forms these communications 
may take. We sympathize with the taxpayer's frustration in 
determining his or her rights related to IRS notices, including 
the right to appeal.
    We have addressed these issues in our administrative and 
legislative recommendations and will continue to be active in 
this area.
    The Taxpayer Advocate Service's dual mission of problem 
resolution and systemic advocacy involves a delicate balancing 
act with almost irreconcilable tension, but this tension can be 
a source of creativity for all. By being independent, but 
remaining inside the IRS structure, the National Taxpayer 
Advocate has access to all IRS employees. This places an 
obligation on TAS employees to persuade and negotiate, but that 
is the job of an effective advocate.
    Mr. Chairman, I thank you for this opportunity to come 
before this Subcommittee, and I welcome your questions.
    [The prepared statement of Ms. Olson follows:]
   Statement of Nina E. Olson, National Taxpayer Advocate, Internal 
                            Revenue Service
    Mr. Chairman and Distinguished Members of the Subcommittee:
    I am pleased to appear before you today and to address the 
Subcommittee on matters relating to the 2001 filing season. As you 
know, this is my first appearance before this Subcommittee in my 
capacity as National Taxpayer Advocate. I started my employment with 
the Internal Revenue Service on March 1, 2001, a little over a month 
ago, in the middle of the 2001 filing season. I have spent the last 30 
days travelling the country, visiting service centers to observe the 
return submission process, and meeting with Taxpayer Advocate Service 
field employees and managers as well as employees and management of IRS 
operating and functional divisions. I emerge from this ``on-boarding'' 
process extremely pleased with the Service's progress in re-engineering 
its systems and its corporate culture. I believe that the Internal 
Revenue Service will continue to progress in this regard, however 
haltingly it may appear at times.
    Although I come to this position with over 25 years of front-line 
experience in tax practice and procedure, during the last 30 days I 
have learned an enormous amount about the internal workings of the IRS, 
including its information technology systems. I know from my private 
practice that IRS employees are among the most dedicated of public 
servants. I also know that they are a valuable resource for anyone 
trying to identify and resolve taxpayer problems, making them essential 
to the mission of the Taxpayer Advocate Service. Thus, I am firmly 
committed to maintaining open lines of communication between my office 
and all functions of the IRS, whether located here in the Washington, 
DC area or in any of the field offices. To that end, I have held and 
will continue to hold Town Hall Meetings on my trips to the field. I 
will also continue to reach out to taxpayers, practitioners, and 
consumer and business groups, as my predecessor did before me.
    I would like to publicly acknowledge, with gratitude, my 
predecessor, W. Val Oveson, the first National Taxpayer Advocate. Mr. 
Oveson came on board when the Taxpayer Advocate Service was more a 
concept than a reality. With the able assistance of the Deputy National 
Taxpayer Advocate, Henry O. Lamar, he carved this organization out of 
whole cloth to become the organization of dedicated and professional 
public servants that it is today. I can only try to imagine the effort 
it took to get the Taxpayer Advocate Service off the ground. Mr. Oveson 
has left the new National Taxpayer Advocate a truly wonderful gift--an 
up and running organization poised to undertake the challenging and 
interesting work ahead. I am the humble recipient of that gift, and I 
am forever grateful. I am also appreciative of Mr. Lamar's fine 
leadership of the Taxpayer Advocate Service during the period following 
Mr. Oveson's resignation and prior to my reporting to duty. His ongoing 
support in his role as Deputy National Taxpayer Advocate will be 
invaluable to me.
    I look forward to presenting you with the Report on the FY 2002 
Objectives of the Taxpayer Advocate Service on or before June 
30th, 2001. The Taxpayer Advocate Service is entering an 
exciting period, with challenges related to delegation of additional 
authorities, the revision of the content and format of the Annual 
Report to Congress, a pilot 4-year integrated training program, and 
improved procedures for monitoring and gathering case data.
    With regard to the Annual Report, we at the Taxpayer Advocate 
Service take seriously Congress' charge to us that we give you 
suggestions, based on our and other's first-hand, front-line experience 
with taxpayer problems. We are in the process of redesigning the Annual 
Report, so that the final product will not only provide you with its 
current elements, including legislative recommendations, but also 
illustrative examples and a substantive discussion and analysis of each 
recommendation's impact on information and business systems, as well as 
privacy considerations. We may use the legislative recommendations to 
highlight developing issues, exploring and suggesting a range of 
solutions for your consideration. In short, we at the Taxpayer Advocate 
Service want the Annual Report to be a useful working document, 
providing you with valuable, practical information.
2001 Filing Season: General Comments
    The 2001 filing season is a remarkable one for me, in part because 
I have experienced it from differing vantage points--initially as a 
private tax attorney and a low income taxpayer clinic director and now 
as an employee of the Internal Revenue Service. It is also unique on a 
personal level, in that it is the first filing season in 25 years in 
which I have prepared and filed no tax returns other than my own. In 
each of the prior 25 years, I have prepared between 25 and 200 returns 
for compensation. My comments thus reflect my past experience as a 
private practitioner, as well as the perspective of the National 
Taxpayer Advocate.
    The Taxpayer Advocate Service (TAS) has an odd relationship with 
the filing season. We do not prepare or process income tax returns. Nor 
are we set up to answer customer service questions. There are, however, 
several discrete areas associated with the filing season for which TAS 
is responsible or which significantly impact TAS operations.
Manual Refunds: Requests and Processing
    Taxpayers experiencing significant hardship and who need their 
refunds immediately, may contact the Taxpayer Advocate Service and 
request our assistance in expediting their refunds. The manual refund 
process may help in documented situations of hardship (e.g. eviction, 
medical coverage) and where we have the ability to intercept the 
automated refund process. Manual refunds can be issued by electronic 
funds transfer or regular paper checks. We secure authorized 
signatures; obtain documentation of the hardship; check for outstanding 
debts, which might offset the refund; and monitor the account to 
prevent erroneous or duplicate refunds from occurring. When these steps 
are not followed, the taxpayer can face financial responsibilities for 
a duplicate refund including interest. We exercise great care to ensure 
we do not create more costly and devastating taxpayer problems. We also 
recognize that IRS officials may incur financial responsibilities 
resulting from the issuance of erroneous refunds.
    The Taxpayer Advocate Service is currently monitoring its issuance 
of manual refunds to ensure that second, erroneous refunds are not 
issued. We are increasing our access to various databases so that we 
may better identify situations when a manual refund will be offset by 
existing federal or state agency debts. Although field advocate 
employees review these procedures as part of their own filing season 
readiness, the TAS is also incorporating a review of these procedures 
in our 2002 Service-wide filing season preparations.
Social Security Number Problems
    This past year the TAS identified a potential disruption of service 
to many of the two million taxpayers who have name and social security 
number mismatches on a joint income tax return. Frequently, the 
mismatch occurs because taxpayers neglect to inform the Social Security 
Administration of a name change following a change in marital status. 
We suggested that the proposed implementation of 1996 legislation, 
which required the IRS to strengthen validation procedures for social 
security numbers, would cause taxpayers concern and undue alarm. As 
described by Acting National Taxpayer Advocate Henry O. Lamar in our 
2000 Annual Report, IRS Operations and the Taxpayer Advocate Service 
worked together to develop what we call a ``soft'' notice for taxpayers 
with secondary social security number problems. This notification 
allows taxpayers time to correct their official records before filing 
their next tax return. Thus, we were able to prevent taxpayers' 2000 
refunds from being frozen without an opportunity to correct the 
information. This is an excellent example of how the TAS is able to 
work within the IRS in a nonadversarial manner in order to advocate on 
behalf of taxpayers.
Taxpayer Advocate Caseload
    The filing season impacts TAS in another way: for at least the last 
2 filing seasons, IRS personnel normally assigned to front line 
compliance positions were detailed to the customer assistance sites or 
phone lines for the worthy objective of assisting more taxpayers during 
filing season and improving its customer service level. Unfortunately, 
whenever other operational personnel are detailed out of their original 
areas, response times in those areas inevitably lengthen. If the delay 
is more than 30 days over normal processing time, the matter will 
automatically meet TAS case criteria, as set forth in Internal Revenue 
Code Section 7811.
    The Taxpayer Advocate Service is currently preparing an analysis of 
its FY 2000 and 2001 monthly receipts inventory. We will identify the 
types of cases that are coming to TAS and their criteria for 
eligibility. We expect that this analysis will point up some of the 
deficiencies in our own case-tracking system and the current 
limitations of our case management system. We will use this information 
to address inconsistencies (or recommend design improvements) in our 
own databases, and we will work with both the Wage & Investment and 
Small Business/Self Employed Operating Divisions to determine how we 
can avoid unnecessary ``overflow'' referrals. To some extent this 
overflow will be mitigated by the hiring of Tax Resolution 
Representatives under the STABLE initiative, thereby freeing up 
compliance employees to do their own work. We also expect to see a 
positive impact on our overflow case inventory as the Service improves 
its monitoring and measurement of the level and delivery of service.
    TAS is also reviewing our intake procedures to make sure we are 
accepting those cases in which we can actually ``add value'' to the 
taxpayer's case. In fact, we have identified ``Reducing Inappropriate 
TAS Caseload'' as a strategic goal. We are concerned that the dominance 
of cases arising from delays of more than 30 days or from multiple 
unsuccessful taxpayer contacts with the IRS actually prevents us from 
assisting the one category of taxpayers who TAS is uniquely designed 
and mandated to help, namely those suffering some form of financial 
hardship or irreparable harm. Over the next year, we will make a 
concerted effort to educate taxpayers about our unique role within the 
IRS and also review our case acceptance procedures. Finally, we will 
initiate an education campaign within the IRS to ensure that IRS 
employees understand the criteria for case referral and feel 
comfortable referring appropriate cases to TAS.
Earned Income Credit
    No review of any filing season would be complete without mentioning 
the Earned Income Credit (EIC). Over the years I have been a consistent 
advocate for the rights of low income taxpayers, and I have personally 
represented hundreds of such taxpayers in EIC examinations, refund 
claims, audit reconsiderations, and Tax Court cases. I will be vocal in 
my advocacy that the statute and procedures developed to reduce error 
and fraud in this program must also protect the rights of taxpayers. 
Too often, taxpayers who file for the EIC do not have professional 
representation and because of the burdens of poverty, language or 
literacy barriers cannot make an effective case for themselves. It is 
my firm belief that if we subjected middle class and more affluent 
taxpayers to the kind of intrusive inquiries we routinely subject a 
taxpayer to in an EIC audit, the entire EIC audit program would be shut 
down in response to taxpayer complaints.
    Last month I spent several days at two service centers, observing 
the return submission and processing pipeline as well as the operation 
of the Dependent Database (DDB). The DDB is a very sophisticated and 
valuable tool for EIC administration. It is essentially a series of 
rules that, when applied to a taxpayer's return, will identify those 
returns that present the possibility of taxpayer error or, more 
seriously, an attempt at fraud. The IRS employee reviewing these 
returns can determine which rules are implicated and can tell the 
taxpayer what information should be submitted to support the claim. 
This single bit of information alone will resolve many cases, since 
pre-2001 the IRS could not necessarily tell the taxpayer what 
information triggered the return review. However, the system is only as 
accurate as the underlying databases. If the databases are not 
regularly (or correctly) updated, we will be needlessly contacting 
taxpayers and causing them undeserved aggravation.
    Another problem with the DDB is that it will sometimes flag the 
second-filed return in a dueling claims situation. In certain 
circumstances it is still possible for a noncustodial parent to file 
electronically and receive a refund, including the EIC, causing the 
second-to-file custodial parent's return to be audited. This occurs 
when there is nothing in the DDB to trigger an examination of the 
noncustodial parent's return; that is, no rules are apparently 
violated. Obviously in this situation, we will lose revenue and 
needlessly distress the custodial parent.
    Representatives of the Taxpayer Advocate Service will be working 
with the DDB design team to explore solutions to this and similar 
limitations. It is my belief, however, that the DDB, once refined, will 
significantly lessen the number of eligible taxpayers examined, have a 
chilling effect on those taxpayers contemplating fraud, and provide an 
opportunity to better educate those taxpayers who are being examined.
Electronic Tax Administration and the Information Age Gap
    The Taxpayer Advocate Service recognizes the importance of 
electronic tax administration to the integrity of the tax system. We 
stand completely behind the Service's efforts to modernize the return 
submission and processing pipeline. However, we are concerned that one 
category of taxpayers will be left behind in the push for electronic 
filing. Today, low income taxpayers have several options for filing a 
tax return. They may file a paper return and wait an average of 4 to 6 
weeks for a refund. They might seek out a return preparer, pay one fee 
for return preparation, another fee for electronic submission, and a 
third fee for a refund anticipation loan, if they need their refunds 
immediately.
    Low income taxpayers can also visit a Volunteer Income Tax 
Assistance (VITA) site, or, if they are elderly, a Tax Counseling for 
the Elderly (TCE) site. Such taxpayers may also be able to utilize 
TeleFile, or visit an IRS Taxpayer Assistance Center. Finally, if the 
taxpayer has access to a personal computer, he or she can file 
electronically through the e-file program, even accessing filing 
software from the IRS website. Thus, on the surface it appears that low 
income taxpayers have a multitude of filing options.
    Taxpayer Advocate Service employees, VITA and TCE volunteers, and 
low income taxpayer clinics have all expressed concern about the impact 
of refund anticipation loans (RALs) on low income taxpayers. One 
particularly compelling example of the RAL's detrimental impact 
involves a taxpayer who uses his RAL as a down payment for an 
automobile and makes one or two additional payments before he learns 
that his refund is denied. The automobile is repossessed, the taxpayer 
loses the monthly payments he's made, he owes the financing company for 
a vehicle he does not have and, if the company forgives the balance of 
the loan, the taxpayer has cancellation of indebtedness income. 
Taxpayers do not necessarily distinguish the IRS from the parties 
driving this scheme. Such practices have a negative impact on tax 
compliance.
    I believe that the Customer Account Data Engine (CADE) now under 
development and testing by the Internal Revenue Service, will 
ultimately remove most if not all of the demand for RALs. CADE 
applications for refund processing should enable taxpayers to receive a 
deposit of their refunds within 2 to 3 days of final return processing. 
Further, the IRS and Financial Management Services (FMS) are now able 
to establish deposit accounts for taxpayers who do not have bank 
accounts. These deposit accounts can receive direct deposits of tax 
refunds.
    Although I applaud and support these efforts, I do not believe our 
inquiry should end here. Low income taxpayers may not have access to 
VITA sites (which are not necessarily located where low income 
taxpayers live or work); VITA sites may not be equipped with computer 
equipment appropriate for electronic return filing; low income 
taxpayers may not have access to personal computers or be computer 
literate; and finally, the TeleFile system does not accept a return 
from a single taxpayer who claims a dependent. These factors, combined 
with the sheer complexity of determining filing status and entitlement 
to dependency exemptions and the EIC, demonstrate that low income 
taxpayers will continue to require the assistance of return preparers 
in the future.
    It is interesting to note that of 576,351 1999 Form 1040 returns 
claiming EIC with math errors, 44% of those returns showing 
computational errors were commercially prepared. In addition, 
commercially prepared returns accounted for 55% of the math error 
adjustments in which the EIC was partially or fully disallowed. 
Essentially, taxpayers whose income is so low as to be eligible for the 
Earned Income Credit are a captive market for return preparers who are 
not very accurate or who are not making the proper inquiries of their 
clients in order to accurately complete the returns.
    The Taxpayer Advocate Service is concerned that down the road, as 
RALs become relatively obsolete, some commercial return preparers will 
seek to recover the lost revenue through increased electronic filing 
fees and/or return preparation fees. We are mindful of Congress' 
direction in Section 2001(a)(3) of the IRS Restructuring and Reform Act 
of 1998 that the IRS not interfere with the free operation of the 
market. We also do not believe that the IRS should enter the business 
of tax return preparation. However, I would like to suggest that there 
is a middle ground.
    Congress, for example, could investigate whether low income 
taxpayers operate within a free and open market or if that particular 
market segment is imperfect and requires some corrective action. 
Congress could determine that a taxpayer who is eligible for EIC in 
order to maintain a baseline standard of living should not see his EIC 
reduced by large return processing or preparation fees.
    One solution to this dilemma is to establish National Filing Days, 
similar to National Problem Solving Days, during the filing season. The 
National Filing Days could be located at public schools or houses of 
worship, be staffed by volunteers, offer on-site electronic return 
submission and direct deposit accounts. Congress could also establish a 
separate grant program for administrative expenses (including computer 
equipment) incurred by VITA initiatives. Thus, free tax return 
preparation would be available to low income taxpayers where they live 
and worship.
    Other less complicated measures can address the more obvious 
consumer abuses. The Taxpayer Advocate Service is currently suggesting 
that the IRS incorporate a consumer alert into appropriate brochures 
and publications. This caveat would state in clear and simple language 
that taxpayers who pay for their return preparation should receive a 
copy of their returns, signed by the preparer. For that matter, members 
of Congress can include this information in their constituent 
communications. The notice might include a toll-free number so that 
taxpayers could report their preparer to the IRS if he or she refuses 
to sign the return. This program dovetails into the Service's current 
efforts to educate return preparers about the EIC substantive and due 
diligence requirements. It will enable the Service to actually locate 
those preparers most in need of education.
    I must emphasize, though, that to some extent the solution to the 
low income taxpayer return preparation dilemma rests on a judgment call 
by Congress. Does the tax system have some responsibility to protect a 
vulnerable population from questionable market practices in the tax 
arena? This is not a decision the Internal Revenue Service can 
undertake without further guidance from Congress, given the directive 
in RRA 98 that the IRS refrain from interfering in the commercial 
return preparation marketplace.
Taxpayer Advocate Service Independence and Authorities
    The final issues I would like to address are not related to the 
filing season specifically. As you know, the Commissioner of Internal 
Revenue Service delegated certain authorities to the National Taxpayer 
Advocate on January 17, 2001. These authorities, once delegated to the 
field, will enable TAS employees to resolve taxpayer problems more 
quickly. In many cases, the delegated authorities should eliminate the 
need to refer the case back to the originating function. Generally, the 
delegated authorities provide to the TAS the authorities that former 
Problem Resolution Officers derived from their district directors. We 
hope to have a redelegation, implementation, and training plan in place 
by July 1, 2001.
    I am aware that some TAS employees will be dissatisfied with the 
redelegation order. These dedicated employees would like very much to 
resolve a taxpayer's case entirely within the Taxpayer Advocate shop. 
In some instances, this may be the appropriate result. I have made it 
clear to my employees that if, after we have tested these new 
authorities, we find that we need additional authorities, I will not 
hesitate to seek them. But I am keenly aware that if TAS takes on more 
IRS authorities, it risks becoming a ``shadow IRS'' and it loses its 
effectiveness as an advocate for systemic change. That is, after all, 
the ultimate goal--to work with the other IRS operating and functional 
divisions in identifying and mitigating individual and systemic 
taxpayer problems.
    Some commentators doubt the Taxpayer Advocate Service's ability to 
maintain its independence while remaining part of the Internal Revenue 
Service. I have no such doubt. I believe that it is appropriate for the 
National Taxpayer Advocate and the Taxpayer Advocate Service to be 
located within the IRS. The Taxpayer Advocate Service is not TIGTA or 
the GAO. The National Taxpayer Advocate is not a watchdog. Rather, she 
is an advocate.
    Congress has charged the National Taxpayer Advocate with the 
mission of assisting taxpayers with their problems and assisting the 
IRS and Congress in mitigating those problems. It is indeed a very 
difficult mission, with almost irreconcilable tensions built into it. 
But I believe that this tension can be a source of creativity for all 
of the participants. By being independent but remaining inside the IRS 
structure, the NTA is a player at the table with access to all members 
of the IRS management team as well as the field employees. This 
relationship places a strong obligation on TAS employees to persuade 
and negotiate, and to have courage in the face of opposition or 
bureaucratic obstacles. But that is the job of an effective advocate.
    I am committed to seeing that each and every member of the Taxpayer 
Advocate Service is trained and supported so that he or she can well 
serve the taxpayer, the Internal Revenue Service, its Oversight Board, 
and the Congress. I look forward to this challenge.
    Mr. Chairman, thank you for this opportunity to come before this 
subcommittee and discuss these matters.

                                


    Chairman Houghton. Well, thanks very much. I appreciate it. 
Mr. Coyne, would you like to ask a question?
    Mr. Coyne. Thank you, Mr. Chairman.
    The Taxpayer Advocate's office in the past has had the 
problem with the innocent spouse provision, and I was just 
wondering if you could update us at this point on what the 
status of the large numbers of those instances are.
    Ms. Olson. We pulled an inventory on March 23rd of our 
cases. Nationwide, Taxpayer Advocate cases were approximately 
2,000, out of about 50,000 cases, or one out of 25 or 4 percent 
of our caseload. I honestly do not know yet whether that seems 
a large number or small number.
    What I found very interesting is that of those 2,000 cases, 
95 percent of them related to the criteria that we use to 
accept a case resulting from unreasonable delays, more than 30 
days; something unresolved by the time it was promised; or 
systemic failure. The cases were not related to the criteria 
that we use for the immediate and irreparable harm, the 
significant hardship type criteria. Those counted for only 10 
percent of the cases.
    We found that the average processing of those cases was 
over 180 days, and, interestingly, we found that very few of 
the cases dealt with tax years after the restructuring act. 
Almost 20 percent of them dealt with 1980s cases, where the 
underlying tax liability was in the 1980s, and 60 percent of 
them dealt with the years 1990 through 1997.
    We found some interesting information that we are using to 
think about recommendations for the innocent spouse program. 
Currently, all innocent spouse cases by the operation unit are 
being reviewed, every single one of them. And the Service did 
that, obviously, to ensure that with a new statute there was 
some continuity and consistency in the decision. But we do need 
to ask, should we be doing this, because that review adds 2 or 
3 months.
    We also found that there was a long delay, often 2 months, 
when a case was actually closed, and the decision had been 
made. Two or 3 months were related to an accounting function of 
trying to separate out the accounts from the innocent spouse 
and the non-electing spouse, and we couldn't close the case 
finally until we had done that actual accounting separation.
    Let's see if there is anything else. We found that in our 
particular cases, for many of the cases that were categorized 
innocent spouse, there was no 8857 form, the request for 
innocent spouse relief, that had yet been filed. Somebody had 
just called us saying we are an innocent spouse. So the 
paperwork hadn't even begun, and yet they are on our system as 
an innocent spouse case.
    We also found that a large number of cases were categorized 
as innocent spouse, and they were injured spouse, and we had 
not made that determination.
    Finally, we found that some cases were categorized as an 
innocent spouse case that are really more an erroneous type 
offset.
    So that has led me to believe that in just our own data we 
need to go in and look at how we are categorizing these cases 
and then to really see what is going on in the national program 
about innocent spouse.
    Mr. Coyne. On another subject, on the earned income tax 
credit, in your testimony you point out, and I quote, ``It is 
interesting to note that of 576,000 1990 Form 1040 returns 
claiming EITC with math errors, 44 percent of those returns 
showing computational errors were commercially prepared. In 
addition, commercially prepared returns accounted for 55 
percent of the math error adjustments in which the EITC was 
partially or fully disallowed.'' And I think that goes to your 
earlier comment in your testimony where you point out about the 
necessity to be as fair with EIC filers as you would be with 
moderate- and low-income filers in other circumstances. Thank 
you.
    Chairman Houghton. Thanks very much. Mrs. Thurman.
    Mrs. Thurman. Thank you, Mr. Chairman.
    First of all, Ms. Olson, I just want to tell you that if I 
don't say this, my office will absolutely have a fit. So let me 
just say on behalf of my congressional staffers who work very 
hard in trying to also solve people's problems, they have been 
very impressed with the Taxpayers' Advocates. They have been 
very forthcoming. I have actually had the opportunity to sit 
with one just recently on a case that my office has been 
involved in on an estate tax issue, and they have been 
knowledgeable and yet trying to--you know, this is--what you do 
is not easy. It is not an easy job when you are trying to make 
it work and sometimes that just doesn't happen. And you can see 
it in them, and I appreciate their concern.
    Ms. Olson. Thank you. I will pass that on to them.
    Mrs. Thurman. In saying all of that, and as kind of the 
question that I asked the Commissioner, and certainly because 
of being one that would be right down there in the front-line 
with some of these folks, I really do look forward to any 
recommendations, as you have put out and as was put out 
recently in your report, things that we can do to make it easy. 
I guess I thought we had gone a little bit further a couple of 
years ago when we thought that when this Committee did a tax 
bill that there would be a lot more conversation, not just how 
many taxpayers or--you know, I really would like to hear the 
complexity because it certainly sounds to me--and with your 
background and working with low-income families that the 
complexity is as much of a problem as any real fraud and abuse 
that seems to be spouted every so often when we try to get into 
a tax fight up here.
    Ms. Olson. I think that we are looking at our annual 
report, and we have engaged in discussions with your staff as 
to how we can turn this into a tool for you all. We are hoping 
that this year we will provide examples in our legislative 
recommendations so that you can see what has brought us to make 
this recommendation. For certain recommendations, we hope to do 
an analysis of the information system impact, just simply 
saying this will save money, this will save time and effort, 
this will be an easy thing to do.
    We will be looking at privacy considerations because I 
think that that is something that we don't spend enough time 
about, and we may have some insight on that from the field, 
maybe even just the appearance of privacy. There may be 
something that is perfectly legal, but it sends shivers up 
taxpayers' spines. So I think we have really heard from you 
your expectations of this document.
    I will say that we are--and I have utilized my liberty, my 
honeymoon period as the new Advocate to come in and suggest 
that we revisit some of our legislative recommendations over 
the last 3 years. And you may find the Taxpayer Advocate 
Service being so independent that they are reversing some of 
their own legislative recommendations.
    Mrs. Thurman. Well, and I think one of the other services 
that has been provided for people that don't know this is just 
the ability for them to come into our Web sites and be able to 
go out to you all or even to IRS to find out some answers and 
questions has been an enormous help for us to send people, you 
know, and then they eventually probably end up back talking to 
us.
    Ms. Olson. Right.
    Mrs. Thurman. But at least it is available to them, and I 
know that the Taxpayers' Advocate group from Jacksonville were 
in a couple of months ago, I guess even prior to your 
appointment. But they have really given us some help in that 
way, too.
    I really think that you can offer us, instead of us even 
slamming people that you are trying to help, that we really 
figure out what we have done to cause a problem out there, so I 
appreciate the work that you all do. Thank you.
    Ms. Olson. Thank you.
    Chairman Houghton. Thanks, Mrs. Thurman.
    Ms. Olson, I think I only have one further question. We are 
going to be hearing from taxpayer preparer groups and their 
continued need for tax simplification. If there is one area you 
think needs to be simplified in this brief tenure you have had 
here, what would you think it would be?
    Ms. Olson. I think there are two specific areas where we 
see problems that also taxpayer practitioner groups do. One 
obviously is the areas that impact all taxpayers, dependency 
exemptions, filing status, and then if you go into the low-
income population, the earned income credit. And they do seem 
to be linked, and we do seem to spend an inordinate amount of 
time wrestling with these very basic issues that touch almost 
every single taxpayer. What status do you claim? Are yousingle, 
married filing jointly, head of household?
    I think that there is a lot out there. We have certainly 
made some recommendations about how you can unify the various 
definitions, conform the definitions, and keep different 
provisions for where there are true policy reasons for keeping 
those definitions. And I think that we can make those changes. 
Certainly my report, the annual report, will reflect some very 
specific recommendations on those issues.
    The second one is penalty and interest reform, and my 
advocates, we have been polling the field asking for examples 
from the frontline employees of where they see cases where they 
feel that the taxpayer should be given relief in the interest 
situation, where the tax debt has accrued interest. And we just 
can't get there under the current statute.
    And we have certainly been looking at penalty reform over 
the years and have made a recommendation about that. And so we 
hope that over the course of the year we will be able to give 
you some very concrete examples of things that might help in 
crafting legislative fixes for these issues. And as you see in 
our report, penalties and interest is the top most litigated 
issue in our list of ten most litigated issues. It is not the 
underlying tax that they are going to court about.
    Chairman Houghton. Well, thanks very much.
    Ms. Olson. Thank you.
    Chairman Houghton. We appreciate this.
    Mrs. Thurman. Mr. Chairman.
    Chairman Houghton. Yes, go ahead, Mrs. Thurman.
    Mrs. Thurman. I have to ask you this because I just--the 
great staff that I have over here said you need to ask her 
about this.
    Ms. Olson. OK.
    Mrs. Thurman. And it actually deals with a Second Circuit 
Court of Appeals ruling, and it is called the mail box rule. 
Evidently, there is a misconnect, just so you will know, 
between some of the--our Florida office and out of here. So if 
you would let your Florida office know about this, I could get 
a constituent very happy. Thank you.
    Chairman Houghton. OK. Thanks very much.
    Ms. Olson. I am familiar with that, yes.
    Chairman Houghton. OK. Well, thanks very much, Ms. Olson. 
We are delighted to have you here.
    OK. Now we have our next panel: Hon. David Williams, 
Inspector General, Treasury Inspector General for Tax 
Administration, Department of Treasury; and James R. White, 
Director of Tax Policy and Administration Issues of the General 
Accounting Office.
    Well, gentlemen, thanks very much for being with us. Mr. 
Williams, would you like to testify?

STATEMENT OF HON. DAVID C. WILLIAMS, INSPECTOR GENERAL FOR TAX 
        ADMINISTRATION, U.S. DEPARTMENT OF THE TREASURY

    Mr. Williams. Thank you, sir. Mr. Chairman and Members of 
the Subcommittee, I appreciate the opportunity to appear here 
today to discuss the 2001 tax filing season and the IRS' 
continuing efforts to improve taxpayer service.
    The IRS is experiencing success in processing tax returns 
and issuing refunds. The IRS also continues to provide 
substantive information to taxpayers on its Web site. This 
filing season alone, the Web site received over 986 million 
accesses. While these are bright spots to recognize, the IRS is 
faced with the challenge of processing a greater number of 
returns around April 15th, since many taxpayers have chosen to 
file later than expected.
    Electronic returns, while significantly up, have not 
reached the anticipated level. Challenges also continue to 
exist regarding the performance of and the plans to enhance 
customer service. The IRS acknowledges the need for customer 
service improvements. Our audit results also show the need for 
improvement.
    Over a 4-day period during this filing season, our auditors 
made 368 random test calls to IRS toll-free numbers and were 
unable to gain access 37 percent of the time. When successful 
in getting through, the IRS incorrectly responded to 47 percent 
of the questions. The topics of the test calls were obtained 
from the IRS' list of frequently asked questions. We also 
encountered a similar situation when we visited 47 taxpayer 
assistance centers in 11 States. The IRS did not provide 
auditors with the correct answers 49 percent of the time. In 
the majority of our contacts, we were served within 15 minutes 
and were treated courteously. However, in over 10 percent of 
the contacts, the IRS did not provide an adequate professional 
response.
    Dramatic improvements in customer service are heavily 
dependent on the success of the IRS systems modernization 
initiatives. Among the benefits taxpayers are expected to 
receive from systems modernization initiatives are: better and 
quicker access to tax help; readily available, accurate, and 
current account information; more electronic filing 
capabilities; more refund in days instead of weeks; and 
expanded self-service options over the telephone and the 
Internet.
    To accomplish modernization, the IRS contracted with a 
consortium of experienced information technology companies led 
by a major integrator. This contract, known as the PRIME, is a 
multi-billion-dollar contract over a 15-year period. Since it 
began 2 years ago, about $400 million has been spent on systems 
modernization. And while the basic architecture and program 
management processes have been established to guide the 
modernization, thus far most of the ongoing systems projects 
are taking longer and costing more than originally estimated. 
As a result, benefits to taxpayers have yet to be realized.
    The customer communications project is intended to be the 
first major systems modernization accomplishment. This project 
is designed to route taxpayer calls to a customer service 
representative who is best qualified to answer the taxpayer's 
question anywhere in the United States and will also provide 
expanded self-service telephone and Internet services. Although 
progress has been made on the project, deliverables originally 
scheduled for 2001 have been scaled back significantly, 
including the ability to route calls to the best qualified 
person. Also, implementation dates for the deliverables have 
steadily slipped and cost overruns have occurred. As a result, 
the expectation of answering an additional 9.6 million calls 
during the 2001 filing season will not be realized, nor will 
the telephone assistors be freed up for other work.
    This situation in part is due to the decision to move the 
project's development stage before completing critical 
foundational products, such as the risk management plan and 
security testing schedules, initial software design failures, 
and virtually no allowance for unplanned events. The project 
has special significance since it is the first systems 
modernization deliverable for taxpayers' benefits. In this and 
other instances, the PRIME and the IRS have overestimated their 
ability to deliver products on schedule and within cost 
estimates.
    I would be pleased to respond to questions that you have at 
the appropriate time.
    [The prepared statement of Mr. Williams follows:]
  Statement of the Hon. David C. Williams, Inspector General for Tax 
            Administration, U.S. Department of the Treasury
    Mr. Chairman and members of the Subcommittee, I appreciate the 
opportunity to appear here today to discuss the 2001 tax filing season 
and the IRS' continuing efforts to improve taxpayer service.
    The IRS is experiencing success in processing tax returns and 
issuing refunds. The IRS also continues to provide substantive 
information to taxpayers on its Web Site. This filing season alone, the 
Web Site has received over 986 million accesses. While these are bright 
spots to recognize, the IRS is faced with the challenge of processing a 
greater number of returns around April 15th since many 
taxpayers have chosen to file later than expected. Electronic returns, 
while up significantly, have not reached the anticipated level. 
Challenges also continue to exist regarding the performance of and 
plans to enhance customer service.
    The IRS acknowledges the need for customer service improvements. 
Our audit results also show the need for improvement. Over a four-day 
period during this filing season, our auditors made 368 random test 
calls to the IRS' toll-free number and were unable to gain access 37% 
of the time. When successful in getting through, the IRS incorrectly 
responded to 47% of the questions. The topics for the test calls were 
obtained from the IRS' List of Frequently Asked Questions.
    We also encountered a similar situation when we visited 47 Taxpayer 
Assistance Centers in 11 states. The IRS did not provide auditors with 
correct answers 49% of the time. In the majority of our 90 contacts, we 
were served within 15 minutes and were treated courteously. However, in 
over 10% of the contacts, IRS did not provide an adequate professional 
response.
    Dramatic improvements in customer service are heavily dependent on 
the success of the IRS' systems modernization initiative. Among the 
benefits taxpayers are expected to receive from systems modernization 
initiatives are:
     Better and quicker access to tax help;
     Readily available, accurate and current account 
information;
     More electronic filing capabilities;
     More refunds in days instead of weeks; and
     Expanded self-service options over the telephone and the 
Internet.
    To accomplish modernization, the IRS contracted with a consortium 
of experienced information technology companies, led by a major 
integrator. This contract, known as the PRIME, is a multi-billion 
dollar contract over a 15-year period. Since it began 2 years ago, 
about $400 million has been spent on systems modernization. While the 
basic architecture and program management processes have been 
established to guide the modernization, thus far, most of the ongoing 
modernization projects are taking longer and costing more than 
originally estimated. As a result, benefits to taxpayers have yet to be 
realized.
    The Customer Communications Project is intended to be the IRS' 
first major systems modernization accomplishment. This Project is 
designed to route taxpayer calls to a Customer Service Representative 
who is best qualified to answer the taxpayer's question, anywhere in 
the United States, and will also provide expanded self-service 
telephone and Internet services.
    Although progress has been made on this Project, deliverables 
originally scheduled for 2001 have been scaled back significantly, 
including the ability to route calls to the best-qualified person. 
Also, implementation dates for those deliverables have steadily slipped 
and cost overruns have occurred. As a result, the expectation of 
answering an additional 9.6 million calls during the 2001-filing season 
will not be realized, nor will telephone assistors be freed up for 
other work. This situation is due, in part, to:
     The decision to move to the Project's development stage 
before completing critical foundational products, such as the risk 
management plan and security testing schedules,
     Initial software design failures, and
     Virtually no allowance for unplanned events.
    This Project has special significance since it is the first systems 
modernization deliverable for the taxpayer's benefit. In this and 
several other instances, the PRIME and the IRS have overestimated their 
ability to deliver projects on schedule and within cost estimates.
    I'd be pleased to respond to any questions that you have at the 
appropriate time.

                                


    Chairman Houghton. Thanks very much. Mr. White.

STATEMENT OF JAMES R. WHITE, DIRECTOR, TAX ISSUES, U.S. GENERAL 
 ACCOUNTING OFFICE, ACCOMPANIED BY RANDOLPH C. HITE, DIRECTOR, 
  INFORMATION TECHNOLOGY SYSTEMS ISSUES, AND ROBERT F. DACEY, 
             DIRECTOR, INFORMATION SECURITY ISSUES

    Mr. White. Mr. Chairman and Members of the Subcommittee----
    Chairman Houghton. Do you want to put the microphone on? 
Thank you.
    Mr. White. Mr. Chairman and Members of the Subcommittee, we 
are pleased to be here today. As requested, our testimony deals 
with three related subjects: IRS' performance during the 2001 
tax filing season, the status of IRS' business 
systemsmodernization effort, and the security of IRS' electronic filing 
system. It is fitting to discuss these topics together. The only 
contact most Americans have with IRS comes during the filing season. If 
the promise of IRS' modernization is to be realized, that is, if 
taxpayers are to receive better service in future filing seasons, then 
IRS must succeed at modernizing its information systems and ensuring 
the security of tax data.
    With respect to this year's filing season performance, as 
shown by Figure 1 and also on page 11 of my statement, IRS had 
received roughly 50 million tax returns by March 16th. The 
white bars are total returns, starting in 1997. Our preliminary 
analysis of data available to date shows several positive 
aspects to the filing season as well as some concerns.
    First, IRS' reorganization into four operating divisions 
has been virtually invisible to taxpayers. Neither positive nor 
negative effects on service are evident--not surprising, given 
the newness of the divisions.
    Second, IRS has processed tax returns and issued refunds 
without significant problems and has seen a continued increase 
in the percentage of returns filed electronically, as shown by 
the gray bar in Figure 1. The rate of growth in the number of 
electronically filed returns is important because Congress set 
a goal that IRS receive 80 percent of all returns 
electronically by 2007. IRS has projected growth in 
electronically filed returns of about 20 percent this year; 
however, the actual increase to date has been only about half 
that. IRS had tried to make electronic filing more convenient 
this year by allowing more filers to sign their returns with a 
PIN number. While used by millions of taxpayers, the PIN 
program has encountered some problems, however. Many taxpayers 
have had their returns rejected, for example.
    Third, as shown in Figure 2 on page 19 of my statement, IRS 
has done a better job of answering the telephone this year 
compared to last. Figure 2 shows level of service or the 
percentage of calls that are answered. Because IRS rerouted a 
substantial number of calls this year to improve service, we 
adjusted the 2001 base to allow for valid comparison to 2000. 
The comparison to 1998, however, is less certain. In any case, 
however, there are concerns about assistor productivity, 
including concerns about the amount of time taken by assistors 
between calls. Even with the improved service this year, 
further improvement in telephone assistance is needed if IRS is 
to achieve its goal of providing top-quality service.
    Fourth, the quality of tax law assistance of walk-in sites 
remains poor, as TIGTA reports. IRS has changed the way it has 
organized and staffed to provide walk-in assistance and is 
planning to make changes to improve service during the 2002 
filing season.
    Turning now to business systems modernization, we have long 
held that IRS needs to establish fundamental modernization 
management controls before it begins to build and implement 
modernized systems. IRS has made important progress in 
developing and implementing these capabilities, but it still is 
not where it needs to be. In Figure 3, also on page 31 of my 
statement, the bottom four horizontal timelines represent four 
key ongoing systems acquisition projects. The stars on those 
lines show where detailed design and development began on those 
projects. The fact that IRS has moved past those stars without 
all the needed management controls implemented means the risk 
associated with those projects is now considerably greater. At 
these later stages in a project's life cycle--that is, after 
detailed design and development has begun--any systems rework 
is much more expensive and time-consuming. Given that IRS needs 
additional money for modernization and is seeking congressional 
approval of these funding needs, this is an opportune time to 
ensure that IRS addresses these risks. And just today, the 
Commissioner told us he is taking steps to pull back on some 
projects in order to focus on these concerns.
    Finally, with respect to the security of IRS' electronic 
filing systems and electronically transmitted taxpayer data, 
our review last year showed that IRS had ineffective controls 
to ensure security. We demonstrated that individuals both 
inside and outside of IRS could gain unauthorized access to 
IRS' electronic filing systems and view, modify, copy, or 
delete taxpayer data. According to IRS officials, IRS moved 
promptly to correct the access and control weaknesses we 
identified before this filing season. It developed plans to 
improve security over its electronic filing systems and 
internal networks and said that it had substantially 
implemented those plans.
    Mr. Chairman, this concludes my statement. We would be 
happy to answer any questions.
    [The prepared statement of Mr. White follows:]
    Statement of James R. White, Director, Tax Issues, U.S. General 
                           Accounting Office
    Mr. Chairman and Members of the Subcommittee:
    We are pleased to participate in the Subcommittee's hearing on the 
Internal Revenue Service's (IRS) 2001 tax return filing season. As 
requested by the Subcommittee, our testimony deals with three related 
subjects: (1) the status of the 2001 filing season, (2) the status of 
IRS' business systems modernization effort, and (3) the security of 
IRS' electronic filing system. It is fitting to discuss these three 
topics together. The only contact most Americans have with IRS comes 
during the filing season, when they file their returns, call IRS for 
help, or visit an IRS walk-in site for assistance. If the promise of 
IRS' modernization is to be realized, that is, if taxpayers are to 
receive better service in future filing seasons, IRS must succeed at 
modernizing its information systems and ensuring the security of tax 
data.
    Our statement is based on (1) the preliminary results of our review 
of the 2001 filing season being done at the Subcommittee's request, (2) 
past and ongoing reviews of IRS' systems modernization effort, and (3) 
information in our recently-issued report on the security of IRS' 
electronic filing systems.1
    Our testimony makes the following points:
           Although the 2001 filing season appears to be 
        running smoothly, there are some matters that require further 
        attention. First, not unexpectedly, IRS' reorganization has had 
        little effect on taxpayers this year, but several challenges 
        remain if the reorganization is to ultimately improve taxpayer 
        service. Second, although the percentage of returns filed 
        electronically has increased, the rate of increase is below 
        expectations. Third, in an effort to make electronic filing 
        truly paperless, IRS now allows electronic filers to ``sign'' 
        their returns with a Personal Identification Number (PIN). 
        Although many taxpayers have successfully used a PIN, many 
        others who tried to do so had their returns rejected for 
        reasons that are still not clear. Fourth, data obtained from 
        IRS indicate that taxpayers are having an easier time reaching 
        IRS to ask questions about the tax law, their accounts, and 
        their refunds; but IRS still has concerns about the 
        productivity of its telephone assistors. And, fifth, IRS' walk-
        in sites are continuing to provide poor tax law assistance this 
        year. Although IRS has changed the way it is organized and 
        staffed to provide such assistance, it has deferred making 
        changes to improve the quality of that assistance until fiscal 
        year 2002.
           With respect to business systems modernization, we 
        have long held that IRS needs to establish fundamental 
        modernization management controls before it begins to build and 
        implement modernized systems. IRS has made important progress 
        in developing and implementing these capabilities, but it is 
        still not where it needs to be. We are therefore concerned that 
        IRS is allowing its system acquisition projects to get ahead of 
        its capabilities for managing them and ensuring that modernized 
        systems deliver promised value, on time and within budget. 
        While allowing acquisition and building management controls to 
        proceed concurrently introduces an element of risk when systems 
        acquisition projects are in their early, formative stages, the 
        risk is considerably greater when projects enter their later 
        phases (detailed design and development). At these later 
        junctures in a project's life cycle, system rework, due to not 
        employing disciplined modernization management controls, is 
        much more expensive and time-consuming than it is earlier. 
        Given that IRS needs additional money to invest further in 
        modernization, both near-term and longer term, and is seeking 
        congressional approval of these funding needs, this is an 
        opportune time to ensure that IRS addresses these risks.
           Our review of IRS' electronic filing systems last 
        year showed that IRS had ineffective controls to ensure the 
        security of those systems and electronically-transmitted 
        taxpayer data. We demonstrated that individuals, both inside 
        and outside of IRS, could gain unauthorized access to IRS' 
        electronic filing systems and view, modify, copy, or delete 
        taxpayer data. Although IRS said that it had not evidence of 
        any such intrusions, it did not have adequate procedures to 
        detect intrusions if they had occurred. According to IRS 
        officials, IRS moved promptly to correct the access control 
        weaknesses we identified before this filing season. It 
        developed plans to improve security over its electronic filing 
        systems and internal networks and said that it had 
        substantially implemented those plans. Sustaining effective 
        computer controls in today's dynamic computing environment will 
        require top management attention and support, disciplined 
        processes, and continuing vigilance.
Preliminary Data on the 2001 Filing Season Show Mixed Results
    At the Subcommittee's request, we are reviewing IRS' performance 
during the 2001 filing season. Our testimony today on the 2001 filing 
season focuses on four specific areas--the effect of IRS' recent 
reorganization on the filing season, IRS' performance in processing 
returns and refunds, the ability of taxpayers seeking help to reach IRS 
by telephone, and the quality of service being provided taxpayers who 
visit an IRS walk-in site. Our preliminary analysis shows mixed 
results; there are several positive aspects of this filing season as 
well as several concerns. Specifically,
           not unexpectedly, given its newness, IRS' 
        reorganization has had little effect on taxpayers this year; 
        but several challenges remain if the reorganization is to 
        achieve its ultimate goal of improving customer service;
           IRS has processed income tax returns and refunds 
        without any significant problems and has received a growing 
        percentage of returns electronically; but the rate of growth in 
        electronic filing is less than expected, and many taxpayers 
        encountered problems in trying to file their electronic returns 
        with a PIN;
           IRS has done a better job of answering the telephone 
        when people call for assistance, but there are continuing 
        concerns about declines in the productivity of telephone 
        assistors that have prevented further improvements in service; 
        and
           IRS changed the structure and increased the staffing 
        of its field assistance program in an effort to provide better 
        service, but remains concerned about the quality of tax law 
        assistance being provided by its walk-in sites.
    Our preliminary analysis is based primarily on data provided by IRS 
that we did not verify. However, those data generally came from 
management information systems that we have used in the past to assess 
IRS operations.
IRS' Reorganization Has Had Little Effect on Taxpayers This Year; 
        Several Challenges Remain If the Reorganization Is to Achieve 
        Its Ultimate Goal
    This year marks the first filing season since IRS reorganized into 
four operating divisions based on the type of taxpayer. The 
responsibilities of one of those four divisions, the Wage and 
Investment (W&I) Division, include processing individual income tax 
returns and assisting taxpayers at walk-in sites and over the 
telephone.2 Other than some persons having to mail their 
returns to different service centers than in the past, IRS' 
organizational changes appear not to have altered the way individual 
taxpayers are interacting with IRS this filing season. For example, 
taxpayers are calling the same telephone numbers for assistance that 
they called last year and are generally visiting the same walk-in sites 
to pick up forms or get help preparing their returns.
    We have also seen no evidence that the reorganization itself has 
led to significant changes in the level of service being provided 
taxpayers this filing season. That is not unexpected. The 
reorganization provides a focus on taxpayer segments that IRS expects 
will help it better understand taxpayers' needs and identify changes to 
its systems and procedures for meeting those needs. Because the 
reorganization has just been completed, IRS generally has not yet 
identified those changes in its systems and procedures that may better 
serve taxpayers. In the long term, IRS must overcome several challenges 
if it is to realize the full potential of its reorganization, in terms 
of improved taxpayer service.
    Identifying needed changes and determining whether new approaches 
to serving taxpayers are successful and worth expanding requires real-
time, reliable program performance data. As we will be discussing 
later, IRS has made and is making several changes to the measures it 
uses to assess its performance in processing returns and refunds and 
serving taxpayers. IRS plans to have most of these new and revised 
measures in place this fiscal year and collect sufficient information 
to set targets or goals for the measures in fiscal year 2002. We 
support IRS' efforts to improve its performance measures. The new and 
revised measures could provide useful information in helping IRS assess 
its performance. Because trend data on the new measures will not be 
available until 2002, there will be limited ability to compare IRS 
year-to-year performance.
    IRS also has to do a better job of assessing the information it 
does collect. As we discuss in a report on IRS' telephone assistance 
that we will be issuing to the Subcommittee later this month, although 
IRS has undertaken efforts to analyze its performance in providing 
telephone assistance and identify ways to improve that performance, its 
analyses did not cover all of the key management decisions and other 
key factors that affect telephone performance. For example, in studying 
the productivity of its telephone assistors, IRS considered the average 
time taken to handle a call but not the time in-between calls. Without 
such a comprehensive analysis, IRS management lacks information that 
would be useful when making decisions about how to improve performance. 
We recognize that collecting and analyzing performance data is costly. 
However, not having timely, reliable, and comprehensive performance 
data to support management decision making and aid congressional 
oversight can also be costly.
    Having real-time, reliable data to support decision making also 
requires that IRS successfully modernize its information systems. We 
will be discussing IRS' progress in that regard later.
IRS' Processing of Returns and Refunds Appears To Be Proceeding 
        Smoothly, But Preliminary Data on Electronic Filing Raises Some 
        Questions
    Although there is much analysis still to do, our preliminary review 
has not identified any significant problem that has adversely affected 
IRS' ability to process returns and refunds. IRS has developed several 
new or revised measures for assessing its processing performance this 
year. However, meaningful performance data related to those measures 
will not be available for analysis until later in the year, and, as 
discussed earlier, there will be limited opportunities to compare IRS' 
performance with prior years. One indicator of IRS' performance that 
has not been revised is the percentage of individual income tax returns 
filed electronically. That indicator shows that the upward trend in 
electronic filing is continuing although at a slower rate of increase 
than expected. IRS has undertaken several initiatives this year to 
enhance the processing of individual income tax returns. Although it is 
too soon to assess the results of those initiatives, there are 
indications that one initiative--allowing electronic filers to ``sign'' 
their returns with a PIN--has encountered some problems.
IRS' Tax Processing Systems Appear To Be Operating Without Significant 
        Problems
    For the first time in several years, the information systems that 
IRS uses to process returns and remittances are not affected by 
extensive Year 2000 changes, consolidation of computer operations, or 
replacement of critical equipment, prompting us to anticipate few 
problems this year. That appears to be the case so far this filing 
season. Except for some problems associated with IRS' effort to allow 
electronic filers to ``sign'' their returns with a PIN, which we will 
discuss later, we have seen no evidence that IRS is not processing 
returns or issuing refunds as quickly as it has in the past.
    Given the volume of tax returns and remittances and the programming 
changes that IRS makes annually to its systems, some ``glitches'' are 
to be expected. In that regard, IRS experienced minor programming 
issues during start-up related to notices, and the programming was 
corrected. For example, in one case, fewer than 8,000 payment due 
notices were not mailed timely, which may have resulted in taxpayers 
being assessed penalties and interest due to no fault of their own. To 
remedy the situation, when the notices were mailed, IRS included a 
statement that said that the notice had been delayed due to technical 
difficulties and that the payment due date was extended with no impact 
on the amount due.
IRS Has Developed Several New or Revised Measures for Assessing Its 
        Processing Performance
    IRS has developed several new or revised measures for gauging its 
performance in processing returns, refunds, and remittances. This is 
part of an agency-wide effort to develop a system of balanced measures 
to help IRS achieve its mission of providing America's taxpayers with 
top quality service by helping them understand and meet their tax 
responsibilities and by applying the tax law with integrity and 
fairness to all.
    The new or revised measures are described in table 1.

   TABLE 1: NEW OR REVISED PERFORMANCE MEASURES FOR RETURNS PROCESSING
------------------------------------------------------------------------
                  Measure                            Description
------------------------------------------------------------------------
Letter Accuracy (new).....................  Percent of letters issued by
                                             the Submission Processing
                                             function that are
                                             incorrect.
Notice Accuracy (revised).................  Percent of notices issued by
                                             the Submission Processing
                                             function that are
                                             incorrect.This measure was
                                             revised to include only
                                             notices for which
                                             Submission Processing is
                                             identified as the owner and
                                             to include systemic errors.
Deposit Accuracy (new)....................  Percent of payments applied
                                             in error by, for example,
                                             issuing a refund to a
                                             taxpayer who overpaid when
                                             the taxpayer wanted any
                                             overpayment credited to
                                             next year's tax bill.
Deposit Timeliness (new)..................  Interest value of money not
                                             deposited by the close of
                                             business the business day
                                             after receipt, per $1
                                             billion in deposits.
                                             Measure assumes an 8
                                             percent interest rate.
Refund Timeliness (revised)...............  Percent of refunds not
                                             issued in 40 days or less.
                                             IRS changed the date it
                                             uses to start computing the
                                             time it takes to issue a
                                             refund.
Refund Accuracy (revised).................  Percent of returns with an
                                             IRS-caused error in the
                                             entity information (e.g.,
                                             name or Social Security
                                             number) or refund amount.
                                             IRS revised this measure to
                                             include systemic errors.
Refund Interest (new).....................  Amount of interest paid per
                                             $1 million in refunds
                                             issued.
Productivity (new)........................  Weighted volume of documents
                                             processed per staff year
                                             expended at the Submission
                                             Processing Centers
------------------------------------------------------------------------
Source: IRS data.

    One performance measure that IRS revised for the 2001 filing season 
is ``refund timeliness''. IRS' goal is to issue a refund on paper 
returns within 40 days. Before this year, IRS used the date the 
taxpayer signed the return as the start date for determining the number 
of days before it issued the refund. Under the revised measure, IRS is 
using the date that IRS received the return. According to IRS, the way 
it previously measured timeliness was flawed because the taxpayer could 
have signed the return several days before mailing it--something that 
could cause IRS to miss its 40-day goal but over which IRS had no 
control. IRS had originally decided to use the postmark date as the 
starting date for its computation. However, IRS subsequently determined 
that it would be labor intensive and costly to use the postmark date--a 
date that IRS does not currently record for returns received by the 
filing deadline of April 15. Instead, IRS decided to use the IRS-
received date, which is the date that the document is received at a 
submission processing center's loading dock--a date that IRS already 
records. Because that date could be several days later than the date 
the taxpayer signed the return, IRS has, in effect, increased its 
chances of meeting the 40-day goal. To maintain something of a level 
playing field and to better enable IRS to compare this year's 
performance with prior years', it seems that, at a minimum, IRS should 
have adjusted its 40-day goal downward to approximate the number of 
days it ``saved'' by changing the computation start date.
    We will continue to monitor IRS' progress in benchmarking its new 
or revised performance measures and will report the status of IRS' 
efforts in our final report on the 2001 filing season.
Use of Electronic Filing Continues an Upward Trend, But at a Reduced 
        Rate of Increase
    One indicator of IRS' performance in processing returns that has 
not changed is the percentage of individual income tax returns that 
have been filed electronically. Pursuant to a provision in the IRS 
Restructuring and Reform Act of 1998, IRS' goal is to have 80 percent 
of all returns filed electronically by 2007. Electronic filing has 
several advantages for taxpayers and IRS. For example, IRS acknowledges 
receipt of an electronic return, electronic filers receive their 
refunds faster, up-front mathematical checks and other filters in the 
electronicfiling system help to reduce the number of taxpayer errors 
that IRS has to correct after the return is filed, and returns filed 
electronically bypass the error-prone manual procedures that IRS uses 
to process paper returns.
    As noted in our report on the 2000 filing season, the number of 
individual income tax returns filed electronically increased 
substantially--about 20 percent--in both 1999 and 2000, bringing the 
total to 35 million returns.3 IRS' projection for this year 
was 42 million returns--another 20-percent increase. However, filing 
data as of March 15, 2001, indicate that IRS may fall short of that 
projection.
    As shown in table 2, about 29.3 million returns had been filed 
electronically as of March 16, 2001. Although that is a 10.2-percent 
increase compared to the same time last year, the rate of increase is 
considerably lower than last year. The rate of increase over the last 
month of the filing season would have to increase substantially for IRS 
to achieve its projected growth of 20 percent for the year. Figure 1 
shows how the numbers of returns filed overall and electronically have 
changed over the past 5 years. Table 2 provides more detailed 
information on filings for the past 3 years.
Figure 1: Individual Income Tax Returns Received IRS in Total and 
        Electronically
        
        

         TABLE 2: INDIVIDUAL INCOME TAX RETURNS RECEIVED BY IRS
                     [Number of returns in millions]
------------------------------------------------------------------------
                                 1/1/   1/1/   Percent    1/1/   Percent
                                99 to  00 to   change:   01 to   change:
          Filing type           3/19/  3/17/   1999 to   3/16/   2000 to
                                  99     00      2000      01     2001
------------------------------------------------------------------------
Paper.........................  34.4   32.1   -6.7       28.9   -10.0
Electronic....................  .....  .....  .........  .....  ........
Traditional a.................  16.8   19.6   16.7       21.7   10.7
On-line b.....................  1.6    3.1    93.8       4.2    35.5
TeleFile c....................  4.5    4.1    -8.9       3.5    -14.6
Subtotal......................  22.9   26.6   16.2       29.3   10.2
Total.........................  57.3   58.7   2.4        58.2   -0.9
Percentage of total filed       39.9   45.4   .........  50.3   ........
 electronically.
------------------------------------------------------------------------
Note: Subtotals, totals, and percentages may not compute due to
  rounding.
a Traditional electronic filing involves the transmission of returns
  over communication lines through a third party, such as a tax return
  preparer or electronic transmitter, to an IRS service center.
b On-line returns are prepared and transmitted by the taxpayer through
  an on-line intermediary using a personal computer and commercial
  software.
c Under TeleFile, certain taxpayers who are eligible to file a Form
  1040EZ are allowed to file using a toll-free number on touch--tone
  telephones.
Source: IRS' Management Information System for Top Level Executives.

            IRS Has Initiatives Underway to Improve Processing
    IRS has several initiatives underway to improve the processing of 
individual income tax returns. These initiatives include (1) allowing 
electronic filers to ``sign'' their returns with a PIN, thus reducing 
some of the paper processing associated with electronic filing; (2) 
validating spouses' Social Security numbers (SSN), thus ensuring more 
accurate returns; and (3) enabling taxpayers to authorize IRS to 
discuss their returns with their paid preparers, thus expediting the 
resolution of certain issues that arise during processing. Although it 
is too soon to assess the affect of these initiatives, there is some 
information that the PIN initiative, while used by millions of 
taxpayers, has encountered some problems.
Allowing Electronic Filers to Use a PIN
    A major criticism of the electronic filing program over the years 
has been that it is not entirely paperless. For example, all electronic 
filers, except those who filed by telephone (i.e., TeleFile) had to 
send IRS a signature document. According to IRS, feedback from the tax 
practitioner community indicated that making electronic filing 
paperless would significantly increase taxpayers' and tax 
practitioners' willingness to file electronically. For the past 3 
years, IRS has allowed taxpayers to pay their taxes electronically, 
thus eliminating the need for taxpayers to send IRS checks and paper 
vouchers. But until this year, most electronic filers still had to send 
IRS a form with their signature.
    For the 2001 filing season, IRS instituted the self-select PIN 
program that makes it possible for taxpayers who file on-line or 
through a tax practitioner to ``sign'' their returns electronically and 
thus file a totally paperless return. The self-select PIN program, so 
named because taxpayers select their own 5-digit PIN, replaces the two 
alternative signature options that IRS tested last year. The major 
difference between the self-select PIN program and the alternative 
signature options tested last year is that virtually all taxpayers 
filing through a practitioner or on-line this year can file a totally 
paperless tax return. Last year only certain taxpayers could do so. 
Before IRS will accept an electronic return with a PIN, the taxpayer 
must include in his or her electronic submission two pre-identified 
pieces of information from the previous year's tax return. This 
information is required to help IRS assure that taxpayers filing with a 
PIN are who they say they are. If IRS determines that the information 
is correct and the submission passes other up-front checks that have 
been in place for several years, the electronic submission is accepted 
and the return is considered filed; otherwise the submission is 
rejected.
    As of March 11, 2001, about 5.9 million returns had been filed 
electronically using the self-select PIN. Of those 5.9 million returns, 
about 3.3 million were filed through practitioners and about 2.6 
million were filed on-line. For the same time period last year, about 
4.7 million returns were filed using the two alternative signature 
programs.
    One intriguing part of the PIN usage this filing season is that as 
of March 11, 2001, about 64 percent of the electronic returns filed on-
line had a PIN compared to about 16 percent of the returns filed 
electronically through practitioners. IRS intends to conduct focus 
groups with tax practitioners later in the year, and one of the issues 
to be discussed is what prevented practitioners from using the self-
select PIN. IRS officials said that they believe large tax 
practitioners are not using the PIN more extensively because many of 
their customers are first-time clients and neither the customer nor the 
practitioner has ready access to the necessary data from last year's 
return. Without that information, the practitioner may simply file the 
return electronically with the paper signature document.
    According to a representative of the largest tax preparation 
company, returns filed electronically using self-select PINs have 
higher reject rates--about twice as high as the reject rates they 
usually experience on electronic submissions--causing additional burden 
on the taxpayer and the practitioner. As a result, the company had been 
advising its clients to use the self-select PIN with caution. Data 
obtained from IRS indicated that of about 6.8 million reject conditions 
identified on electronically filed returns as of March 15, about 1.5 
million involved problems related to PINs.4 A representative 
of the National Association of Enrolled Agents told us that one of the 
problems associated with the self-select PIN program is that many 
taxpayers and practitioners don't understand what information is needed 
to use a PIN.
    We will continue to monitor the use of PINs and the issues 
surrounding that program as we proceed with our assessment of the 
filing season. As part of that effort, we will attempt to determine to 
what extent, if at all, PIN-related problems caused taxpayers to not 
file electronically.
Validating Secondary SSNs
    During its processing of tax returns, IRS validates SSNs on the 
returns. If IRS determines that an SSN is invalid, it can disallow the 
related exemption or deny a claimed earned income credit or child tax 
credit.5 That, in turn, can change the taxpayer's tax 
liability and reduce or eliminate any refund the taxpayer might be 
expecting. In past years, IRS has validated primary6 and 
dependent SSNs. This year, IRS has expanded its SSN validation effort 
to include secondary SSNs.
    Because of a concern that taxpayers are treated fairly in the 
validation process, the Committee on Government Reform sent a letter to 
the Commissioner of Internal Revenue in January 2001 requesting 
information about this initiative. In his February 2001 response, the 
Commissioner said that IRS has an extensive, multi-step process to 
determine the acceptability of a secondary SSN. If an individual fails 
to furnish a correct secondary SSN, IRS said it would disallow the 
exemption but would not alter the joint filing status claimed on the 
return.
Authorizing IRS to Discuss Returns with Preparers
    IRS added a checkbox to the individual income tax forms that are 
being filed this year that enables taxpayers to
    authorize IRS to discuss their returns with their paid preparers. 
By being able to contact the return preparer directly, IRS believes 
that it can expedite the resolution of certain issues that arise during 
processing, such as math errors and missing information on the return, 
and thus reduce taxpayer burden. In testimony before the House 
Government Reform Committee last year, the Commissioner of Internal 
Revenue estimated that about 2.5 million notices generated from returns 
processing were related to returns prepared by paid practitioners.
Level of Telephone Service Has Improved, But Declines in Assistor 
        Productivity and Delays in Modernization Prevent Further 
        Improvement
    Millions of taxpayers call IRS each year with questions about the 
tax law, their accounts, and their refunds. One important indicator of 
IRS' performance in assisting these taxpayers is ``level-of-service'', 
which is computed by dividing the number of calls answered by the 
number of call attempts. We have adjusted computation of that indicator 
this year to allow a more accurate comparison with IRS' performance in 
past years, although a completely accurate comparison is not possible 
because data for one of IRS' phone lines does not show the extent to 
which taxpayers hung up before being served. The adjusted indicator 
shows that IRS has been answering a greater percentage of calls this 
filing season than it did last year. However, declines in the 
productivity of telephone assistors and delays in modernization have 
prevented even further improvement. Further improvement is needed if 
IRS is to achieve its goal of providing telephone assistance comparable 
to that provided by leading public and private telephone customer 
service organizations. In an effort to facilitate that kind of 
comparison and better gauge its performance in assisting taxpayers, IRS 
is putting in place some new measures of telephone service.
            According to Data From IRS, the Accessibility of IRS' 
                    Telephone Service Has Improved
    Taxpayers calling on IRS' toll-free assistance lines can obtain 
needed information by talking to an assistor or by using an automated 
``interactive application.'' However, unlike last year, taxpayers 
calling on the assistance lines in 2001 are given the option of being 
routed to another telephone line, the Tele-Tax line, for an automated 
response to an inquiry about their refund.7 IRS is routing 
refund inquiry calls to the Tele-Tax line in an effort to improve 
taxpayer service. According to IRS, in previous years, these calls 
would have been answered by a similar automated refund inquiry service 
on the assistance lines. Sending these calls to Tele-Tax frees up the 
assistance lines for calls that require an assistor's help, making it 
less likely that taxpayers calling on these lines will get a busy 
signal.
    Because of this change in routing, the level-of-service computation 
has to be adjusted to properly compare IRS' performance this year with 
last year. As computed in previous years, level of service reflected 
IRS' performance on its toll-free assistance lines. Because refund 
inquiries were answered by automated systems on the assistance lines in 
previous years, they were included in computing level of service. Even 
though those inquiries are no longer being answered on the assistance 
lines, they should be included in computing level-of-service for 
comparability.
    Although including the Tele-Tax refund inquiries in the computation 
of level of service makes the measure more comparable to previous 
filing seasons, it is not completely comparable because it assumes that 
all of the callers who were routed to Tele-Tax were actually served. 
Unlike data for the assistance phone lines, data for the Tele-Tax line 
does not allow IRS to determine whether taxpayers hung up before 
completing an automated service, calls that IRS refers to as 
``abandoned''. Calls to the assistance phone lines that are abandoned 
are not counted as ``calls answered'' in computing level of service.
    While the adjusted level-of-service computation is not completely 
comparable to previous years, it does indicate that level of service 
has improved relative to 2000. Other information from IRS supports this 
view. According to IRS data, for example, the level of service through 
March 10, 2001, for calls routed to assistors was somewhat higher than 
for a comparable period last year and the number of calls receiving 
busy signals on the assistance lines during the first 11 weeks of the 
filing season had declined from about 5.4 million in 2000 to about 3.1 
million in 2001. IRS data also indicate that there have been virtually 
no busy signals on the Tele-Tax line this filing season.
    As shown in figure 2, as of March 17, 2001, IRS' level of service, 
including the refund inquiries answered through the Tele-Tax line, was 
76 percent--13 percentage points above last year.
Figure 2: Toll-Free Telephone Level of Service for the First 11 Weeks 
        of the 2001, 2000, 1999, and 1998 Filing Seasons
        
        
    Table 3 contains more detailed information behind the level of 
service computations depicted in figure 2.

 TABLE 3: TOLL-FREE TELEPHONE LEVEL OF SERVICE FOR THE FIRST 11 WEEKS OF
              THE 2001, 2000, 1999, AND 1998 FILING SEASONS
                              [in millions]
------------------------------------------------------------------------
                                               Filing season
        Telephone service        ---------------------------------------
                                    2001 a      2000      1999     1998
------------------------------------------------------------------------
Call attempts...................
Excluding refund calls routed to  18.7        28.4      41.4     29.2
 Tele-Tax.
Refund calls routed to Tele-Tax   11.6        ........
 in 2001.
Total call attempts.............  30.2        28.4      41.4     29.2
Calls answered..................  ..........  ........  .......  .......
Automated.......................  1.6         7.5       6.6      Not
                                                                  availa
                                                                  ble
Assistor........................  9.7         10.4      13.2     Not
                                                                  availa
                                                                  ble
Refund calls routed to Tele-Tax   11.6        ........  .......  .......
 in 2001.
Total calls answered............  22.9        17.9      19.8     21.5
Level of service................  76%         63%       48%      74%
------------------------------------------------------------------------
Note: Totals may not compute due to rounding.
a The level-of-service computation for 2001 is not completely comparable
  to the computation for the other years because the Tele-Tax data does
  not account for taxpayers who may have abandoned their calls before
  getting an answer.
Source: GAO analysis of IRS data.

    Figure 2 and table 3 indicate that the level of service this year 
is higher than in 1998. However, because available data for those years 
are not comparable, we do not know if that is an accurate 
representation.
            Assistor Productivity Decline and Modernization Delays Have 
                    Prevented Further Phone Service Improvement
    Taxpayer access to telephone assistors is less than it could be 
because (1) telephone assistor productivity--measured by IRS as how 
quickly assistors complete telephone calls--has declined for the third 
filing season in a row and (2) implementation of a modernization 
project has been delayed. Increases in assistor productivity could lead 
to further improvements in telephone service by allowing assistors to 
answer more calls, thus reducing the extent to which taxpayers receive 
busy signals or are kept on hold. Implementation of the modernization 
project could lead to improved service by freeing up assistors to 
handle more calls.
    As we discuss in a report to be issued to the Subcommittee later 
this month, the productivity of telephone assistors declined during the 
1999 and 2000 filing seasons. According to IRS officials, although some 
of the decline in 2000 was caused by assistors handling more of the 
types of calls that take longer to answer, four policy changes that had 
the unintended effect of lowering productivity in the 1999 filing 
season continued toadversely affect productivity in the 2000 filing 
season. Specifically, in 1999, IRS (1) discontinued automatically 
routing another call to an assistor immediately upon completion of a 
call; (2) increased restrictions on using productivity data when 
evaluating assistors' performance; (3) disproportionately diverted 
staff from peak demand shifts to other shifts when it implemented 24-
hour-a-day, 7-day-a-week assistance; and (4) discontinued measuring the 
productivity of individual call sites.
    According to IRS officials, these factors have continued to 
negatively affect productivity in the 2001 filing season. The officials 
said that although some of the decline can be explained by assistors 
answering more complex calls, assistors clearly are not using their 
time efficiently. In that regard, according to IRS, site visits it made 
earlier this year indicated that assistors who were directly monitored 
(i.e., someone sitting with them) spent about half as much time 
wrapping up a call after the taxpayer had hung up than assistors who 
were remotely monitored. IRS, in conjunction with the National Treasury 
Employees' Union, has taken steps intended to improve productivity. For 
example, IRS has conducted a series of training sessions at call sites 
designed to assist supervisors in ensuring assistors use their time 
productively, particularly with respect to the time they spend wrapping 
up calls. According to IRS officials, data shows that productivity has 
improved during the year as a result of these efforts.
    Delays in implementing a modernization project has also prevented 
further improvements in telephone service. IRS' Customer Communication 
Project is one of the most important first steps in improving customer 
service as envisioned in IRS' modernization plans. As a key part of 
IRS' strategy for improving level of service, Customer Communications 
enhancements are designed to free-up assistors to handle more calls by 
routing and answering more calls through automation. However, one of 
the enhancements designed to significantly improve level of service 
will not be implemented until May or June 2001--at least 3 months later 
than expected and too late to provide the expected benefits this filing 
season.
    Under this enhancement, IRS expected to implement a telephone voice 
recognition capability in February 2001. Voice recognition would allow 
callers with rotary-dial telephones to interact with IRS' automated 
routing and answering system in the same way as touch-tone callers do. 
Also, voice recognition would require callers with a touch-tone phone 
to use the automated system even if they do not respond to phone menu 
prompts to press the appropriate touch-tone key. According to IRS, a 
significant number of callers, whether they have rotary-dial telephones 
or not, do not respond to the prompts; assistors must answer these 
calls to determine what the taxpayer is calling about and then route 
the call to the most appropriate source of assistance. Voice 
recognition would have allowed IRS to offload some of this workload 
from live assistors and answer more calls.
    According to the Treasury Inspector General for Tax Administration 
(TIGTA), the Customer Communication Project fell behind schedule, in 
part, because some key work products were not timely completed and 
several identified barriers to deployment, such as an inadequate 
database to track modernization project risks and the need to complete 
the security certification process, had not been overcome.8
            IRS is Putting in Place New Performance Measures for 
                    Telephone Operations
    According to IRS officials, its current level of service measure is 
not strategically aligned with those used by world-class customer 
service organizations, and does not focus efforts at enhancing the 
customer's experience or clearly show how human capital and technology 
investments affect performance. Therefore, IRS is planning to replace 
its current level of service measure with two primary measures of 
service, one for measuring IRS' success at providing taxpayers access 
to assistors, and another for measuring IRS' success at serving 
taxpayers though automated services. Also, IRS intends to gather data 
on other new measures, including measures of how long taxpayers have to 
wait to speak to IRS assistors.
    We support IRS' efforts to improve its performance measures, 
particularly efforts to better gauge how well IRS serves taxpayers and 
how its performance compares to that of leading private and public 
telephone customer service organizations. However, unless IRS maintains 
its current measures while transitioning to its new measures, it will 
not have comparable data to monitor performance from one year to the 
next. We recognize that there is a cost associated with maintaining 
current measures while developing new measures, and we recognize that 
doing so may not always be feasible. However, without comparable 
historical performance data, IRS will be unable to assess the results 
of past efforts to improve performance, such as the 1999 policy changes 
discussed earlier.
IRS Has Deferred Making Changes to Improve the Quality of Tax Law 
        Assistance Provided by Walk-in Sites Until Fiscal Year 2002
    IRS changed the way it was organized and staffed to provide face-
to-face assistance for the 2001 filing season. Despite these changes, 
there are continuing concerns about the quality of tax law assistance 
being provided. According to IRS officials, the staffing and training 
challenges associated with the restructuring made it impractical for 
IRS to make changes to improve the quality of tax law assistance this 
fiscal year. Instead, IRS, with the help of a contractor, is studying 
how the quality of face-to-face assistance should be measured and 
improved, with the expectation of making changes for the 2002 filing 
season.
            IRS Has Changed the Way Its Taxpayer Assistance Centers Are 
                    Organized and Staffed
    Taxpayers can obtain forms, get answers to questions about the tax 
law and their accounts, and get help in preparing their returns at 
about 400 Taxpayer Assistance Centers (TAC), which were formerly known 
as walk-in sites. Before IRS' reorganization, the TACs and associated 
staff reported to 33 district offices. According to IRS officials, 
differences in the way TACs were organized and operated within each 
district caused inconsistencies in the assistance provided to 
taxpayers. To provide more consistency in field assistance, the 400 
TACs now report to the W&I Division's Field Assistance unit, through a 
network of 7 area and 34 territory offices. As of March 17, 2001, 
according to IRS, the TACs had assisted about 3.4 million taxpayers, 
compared to about 3.9 million taxpayers as of the same time last year.
    According to IRS, it began the year with about 1,000 technical 
employees in field assistance and had hired another 504 as of March 16, 
2001. Of those 1,504 technical employees, 1,041 are in a new position--
taxpayer resolution representative (TRR)--that IRS had established as 
part of its reorganization. Persons filing these positions will be 
required to assume some functions previously done by compliance staff, 
such as office audits, in addition to their taxpayer assistance duties.
    Although IRS is filling the TRR positions primarily from qualified 
staff in related job series, additional training is required. According 
to officials, IRS is surveying the new staff to assess the training 
gaps and prioritizing the delivery of abbreviated training to fill the 
gaps. Not all of the gaps were filled in time for the 2001 filing 
season. For example, about 100 staff placed in TRR positions in January 
2001, who needed the full 6 weeks of required first-year training, 
received only 3 weeks of that training.
    Considerable hiring and training is also required for new managers 
in the Field Assistance unit. Managers of the former walk-in sites were 
compliance staff who generally moved to the new Small Business and Self 
Employed Division as part of IRS' reorganization. As of December 31, 
2000, IRS had filled 29 of the 34 territory manager positions and 154 
of the 226 group manager positions authorized. According to IRS 
officials, about one-half of the new managers had no field assistance 
experience and some had no managerial experience.
            IRS and TIGTA Reviews Show That TACs Provide Poor Quality 
                    Tax Law Assistance
    According to W&I field assistance officials, the quality of tax law 
assistance provided to taxpayers who walk into one of IRS' TACs this 
year is about as poor as the quality reflected by IRS' own reviews last 
year.
    IRS employees posing as taxpayers conducted 272 visitations to TACs 
before the 2000 filing season and another 272 during the filing season. 
IRS' final report on the combined results found, among other things, 
that although 92 percent of the ``assistors spoke to reviewers in a 
pleasant manner and tone of voice,''
           81 percent of the reviewers' questions were not 
        answered correctly; and,
           21 percent of the reviewers were denied service.
    Officials based their characterization of the quality of this 
year's field assistance on reviews of quality during late January and 
early February 2001 by TIGTA. According to TIGTA, its review of TAC 
quality involved 90 contacts in which tax law questions were posed to 
IRS representatives. In 7 of those 90 contacts (8 percent), service was 
denied (i.e., the TIGTA reviewers were not given an opportunity to 
speak with an assistor). When service was provided, TIGTA's reviewers 
received inaccurate answers 48 percent of the time. Although TIGTA's 
results might indicate that service quality, although not good, has 
improved compared to the results of IRS' reviews last year, such a 
comparison cannot be made because TIGTA used a different methodology 
from the one used by IRS. One of the recommendations resulting from 
IRS' quality reviews during fiscal year 2000 was that IRS develop a 
comprehensive, year-round quality review program for walk-in offices. 
The recommendation anticipated changes in the scope of the reviews, the 
selection and training of reviewers, the review checksheet, and the 
relevant database. In that regard, field assistance officials informed 
us that IRS, with help from a contractor, is studying how field 
assistance quality should be measured and improved. According to IRS 
officials, because of that study and the staffing and training 
challenges associated with the restructuring, IRS decided not to 
conduct its own review of quality during the 2001 filing season and to 
defer making changes to improve the quality of tax law assistance 
provided by TACs until fiscal year 2002, after the results of the 
ongoing study are known.
Despite Important Progress, IRS Has Yet to Fully Implement the 
        Capabilities Needed to Effectively Manage the Business Systems 
        Modernization Program
    We turn now to business systems modernization (BSM)--IRS' multiyear 
program to put in place the technology that will support revamped 
business processes. This multi-billion-dollar program, which began a 
little over 2 years ago and has thus far received congressional 
approval to obligate about $450 million,9 is vital to 
achieving IRS' new, customer-focused vision and enabling IRS to meet 
performance and accountability goals. BSM consists of a number of new 
systems acquisition projects that are at differing stages of 
acquisition and implementation, as well as various program-level 
initiatives intended to establish the capacity for IRS to effectively 
manage the projects.
    We have long held--and communicated to IRS--the importance of 
establishing sound management controls to guide its systems acquisition 
projects; to its credit, IRS has made important progress in this area. 
Nevertheless, IRS is starting to let project acquisitions get 
perilously ahead of controls--proceeding in some cases with detailed 
systems design and development without having the capacity in place to 
help ensure that projects perform as intended and are completed on time 
and within budget. We remain concerned that at these later stages in 
systems' life cycles, the risk of rework due to missing modernization 
management controls increases, both in terms of probability and impact. 
Given that IRS expects to totally exhaust congressionally-approved BSM 
funding by about November 2001, and thus is seeking additional money 
for fiscal year 2002, this is a good time to ensure that the overdue 
modernization management controls are emphasized as a BSM priority.
    Beginning in 1995, when IRS was involved in an earlier attempt to 
modernize its tax processing systems, and continuing since then, we 
have made recommendations to implement fundamental modernization 
managementcapabilities before acquiring new systems. We concluded that 
until these controls were in place, IRS was not ready to invest 
billions of dollars in building modernized systems.10 
Although IRS has since taken steps that have partially addressed our 
set of recommendations, important ones remain unfulfilled. In general, 
the areas in which we found controls to be lacking and made 
recommendations to fill these voids fell into five interrelated and 
interdependent information technology management categories, as shown 
in figure 3--investment management, system life-cycle management, 
enterprise architecture management, software acquisition management, 
and human capital management.
Figure 3: Information Technology Management Control Areas Needing 
        Attention
        
        
    In December 1998, IRS hired a systems integration support 
contractor to, among other things, help it develop and implement these 
program capabilities. Subsequently, the Commissioner adopted a 
modernization strategy that appropriately required, for example, (1) 
the use of incremental investment decision making, (2) adherence to a 
rigorous systems and software life-cycle management method, and (3) 
development and implementation of an enterprise architecture or 
modernization blueprint to guide and constrain the content, sequencing, 
and integration of systems investments. This approach, however, 
involved development of these kinds of program-level management 
capabilities while simultaneously proceeding with project acquisition, 
in anticipation that program controls would be in place and functioning 
when these projects reached their later, less formative stages. Figure 
4 illustrates this approach.
Figure 4: Concurrent Development of Program-Level Controls and Projects


    During BSM's first 18 months, progress in implementing these 
management controls was slow, while at the same time project 
acquisitions moved rapidly. At that time we reported to IRS' Senate and 
House appropriations subcommittees that projects were getting ahead of 
the modernization management capacity that needed to be in place to 
manage them effectively. In response to our concerns and the 
subcommittees' direction, IRS appropriately pulled back on the projects 
and gave priority to implementing needed management capacity.
    Despite this shaky start to implementing management controls, IRS 
has since made important progress in its modernization management 
capacity. For example, last year we reported that IRS (1) largely 
defined and implemented its system life-cycle methodology that 
incorporates software acquisition and investment management processes, 
(2) defined program roles and responsibilities of IRS and its 
modernization contractor and began relating with the contractor 
accordingly, (3) began formally managing modernization risks in an 
effort to proactively head off problems, and (4) made progress toward 
producing the first release of its enterprise 
architecture.11
    In addition, we recently reported that IRS had taken steps to 
address our recommendations aimed at strengthening management of 
individual BSM projects.12 For instance, it started to 
manage the Custodial Accounting Project13 as an integral 
part of the modernization program. On another project, the Security and 
Technology Infrastructure Release,14 IRS assessed security 
threats and vulnerabilities, analyzed the resulting risk in terms of 
probable impact, and planned to reevaluate project requirements in 
light of this risk analysis. Recently, IRS hired experienced technical 
and managerial executives and augmented existing modernization staff 
with experienced IRS information systems personnel.
    We are concerned, however, because projects are entering critical 
stages without certain essential management controls in place and 
functioning. In particular, in our ongoing work for IRS' appropriations 
subcommittees, we found that IRS is proceeding with building systems--
including detailed design and software development work--before it has 
implemented two key management controls. First, IRS has yet to develop 
a sufficiently defined version of its enterprise architecture to 
effectively guide and constrain acquisition of modernization projects. 
Second, it has not yet implemented rigorous, disciplined configuration 
management practices. Both of these are requirements of IRS's own 
systems life-cycle methodology and are recognized best practices of 
successful public and private-sector organizations. This increases the 
risk of cost, schedule, and performance shortfalls. We have discussed 
these missing controls with the Commissioner and his BSM executives; 
they have stated that they plan to have them in place by the end of 
June 2001.
    Timing is critical. While the lack of controls can be risky in 
projects' early stages, it introduces considerably greater risk when 
these projects enter design and development. To mitigate this added 
risk, IRS needs to fully implement the remaining management controls 
that we have recommended. Figure 5 illustrates the growing risk that 
accompanies project development in its later stages.
Figure 5: Increased Risk Associated With Inadequate Controls at Later 
        Stages of Project Development
        
        
    The timing of this hearing is appropriate for ensuring that IRS 
implements the remaining needed modernization management controls. 
While Congress has appropriated about $578 million for this program to 
date, it also took steps to limit the agency's ability to obligate 
funds until certain controls were in place by establishing a multiyear 
capital account--the Information Technology Investments Account--to 
fund IRS systems modernization initiatives. IRS has received about $450 
million of this total, and has submitted a plan to Congress to spend 
the remainder over the next 7 months. In addition, IRS plans to include 
$396 million in funding for BSM in its upcoming fiscal year 2002 budget 
request. This is, then, an opportune time to ensure that IRS addresses 
these outstanding risks as a condition of future funding.
IRS Had Ineffective Controls to Ensure the Security of Electronic 
        Filing Systems And Electronically-Transmitted Taxpayer Data
    As a major steward of personal taxpayer information, IRS has a 
demanding responsibility in collecting taxes, processing returns, and 
enforcing the nation's tax laws. In conducting its work, IRS must 
obviously depend to a great extent on interconnected computer systems. 
Due to the nature of its mission, IRS collects and maintains a 
significant amount of personal and financial data on each American 
taxpayer. These data typically include the taxpayer's name, address, 
SSN, dependents, income, deductions, and expenses. The confidentiality 
of this sensitive information is important because American taxpayers 
could be exposed to a loss of privacy and to financial loss and damages 
resulting from identity theft and financial crimes should this 
information be disclosed to unauthorized individuals.
    Computer security is an important consideration for any 
organization that depends on information systems and computer networks 
to carry out its mission or business. However, without proper 
safeguards, systems and networks pose enormous risks that make it 
easier for individuals and groups with malicious intent to intrude into 
inadequately protected systems and use such access to obtain sensitive 
information, commit fraud, disrupt operations, or launch attacks 
against other computer networks and systems. And the number of 
individuals with the skills to accomplish this is increasing; 
intrusion--or hacking--techniques are readily available and relatively 
easy to use.
    We recently examined the effectiveness of key computer controls 
designed to ensure the security, privacy, and reliability of IRS' 
electronic filing systems and electronically filed taxpayer data during 
last year's tax filing season. Our recent report discusses the computer 
control weaknesses that we found, along with actions that IRS says that 
it took to correct these weaknesses before this year's filing 
season.15 What we found to date concerning IRS' electronic 
filing program can illustrate the challenges that many organizations 
are facing.
    In an attempt to meet the 80-percent electronic filing goal 
provided for in the IRS Restructuring and Reform Act of 1998, IRS has 
aggressively marketed the electronic filing program and has authorized 
private firms and individuals to be electronic filing trading partners. 
These partners include electronic return originators, who prepare 
electronic tax returns for taxpayers, and transmitters, who transmit 
the electronic portion of a return directly to IRS. Except for TeleFile 
taxpayers, who file their returns using the telephone, IRS does not 
allow individual taxpayers to transmit electronic tax returns directly 
to the agency; they must use the services of an IRS trading partner. 
Figure 6 demonstrates the path that an electronically filed tax return 
took from the taxpayer to IRS during the time of our review.
Figure 6: Electronic Filing Journey, 2000 Filing Season


    During the 2000 filing season, IRS did not implement adequate 
computer controls to ensure the security, privacy, and reliability of 
its electronic filing systems and the electronically-transmitted tax 
return data that those systems contained.
    We demonstrated that individuals, both internal and external to 
IRS, could gain unauthorized access to IRS' electronic filing systems 
and view, modify, copy, or delete taxpayer data. Our successful access 
did not require sophisticated techniques. Last May, for example, we 
were able to access a key electronic filing system using a common 
handheld computer. We could gain such access because IRS at that time 
had not
           effectively restricted external access to computers 
        supporting the electronic filing program through effective 
        perimeter defenses;
           securely configured its electronic filing operating 
        systems, which used several risky and unnecessary services;
           implemented adequate password management and user 
        account practices (for example, we successfully guessed many 
        passwords and noted user IDs and passwords posted conspicuously 
        on a monitor);
           sufficiently restricted access to computer files and 
        directories containing tax return and other data (for example, 
        all users had the ability to modify numerous sensitive data and 
        system files, and certain users with no ``need to know'' had 
        access, contrary to policy); or
           used encryption to protect tax return data on 
        electronic filing systems (as is required by IRS' Internal 
        Revenue Manual).
    Further, these weaknesses jeopardized the security of sensitive 
business, financial, and taxpayer data on other critical IRS systems 
that were connected to electronic filing computers through its 
servicewide network because IRS personnel turned off (bypassed) network 
control devices that were intended to provide security between 
electronic filing systems and other IRS systems. Although IRS stated 
that it did not have evidence that such intrusions had actually 
occurred or that intruders had accessed or modified taxpayer data, it 
did not have adequate procedures to detect such intrusions if they had 
occurred. For example, IRS did not (1) record certain key events in 
system audit logs, (2) regularly review those logs for unusual or 
suspicious events or patterns, or (3) deploy software to facilitate the 
detection and analysis of logged events. Consequently, IRS did not 
recognize or record much of the activity associated with our tests.
    These serious access control weaknesses existed because IRS had not 
taken adequate steps during the 2000 filing season to ensure the 
ongoing security of electronically transmitted tax return data on its 
electronic filing systems. For example, IRS had not followed or fully 
implemented several of its own information security policies and 
guidelines when it developed and implemented controls over its 
electronic filing systems. It decided to implement and operate its 
electronic filing computers before completing all of the security 
requirements for certification and accreditation.16 Further, 
IRS had not fully implemented a continuing program for assessing risk 
and monitoring the effectiveness of security controls over its 
electronic filing systems.
    According to IRS officials, IRS moved promptly to correct the 
access control weaknesses we identified before the current filing 
season. It developed plans to improve security over its electronic 
filing systems and internal networks and said that it has substantially 
implemented those plans. In his response to our report, the 
Commissioner said that ``electronic filing systems now satisfactorily 
meet critical federal information security requirements to provide 
strong controls to protect taxpayer data.'' Sustaining effective 
computer controls in today's dynamic computing environment will require 
top management attention and support, disciplined processes, and 
continuing vigilance.
    Application controls also need to be designed and implemented to 
ensure the reliability of data processed by the systems. IRS believes 
that electronically filed tax returns are more accurate than paper 
returns and has implemented many application controls designed to 
enhance the reliability of data processed by its electronic filing 
systems. However, we identified additional opportunities to strengthen 
application controls for IRS' processing of electronic tax return data. 
Based on IRS statistics, it processed electronic tax returns and paid 
refunds of about $2.1 billion without receiving required authenticating 
signatures or electronic PINs from taxpayers. Data validation and 
editing controls did not detect certain erroneous or invalid data that 
could occur in tax returns. In addition, weaknesses in software 
development controls increased the risk that programmers could have 
made unauthorized changes to software programs during the 2000 filing 
season.
    Further, taxpayers who filed electronically may not have been aware 
that transmitters, who actually send the data to IRS and may be unknown 
to the taxpayers, could have viewed and modified their data and that 
such data are transmitted to IRS in clear text--human readable form. 
This is because IRS decided to (1) not allow taxpayers to file most 
electronic returns directly to IRS, (2) require taxpayers who elected 
to file electronically to use the services of third-party transmitters, 
and (3) not accept electronic tax returns in encrypted form. In 
addition, taxpayers may not have been aware that IRS has no assurance 
of the security of its electronic filing trading partners' systems. 
Other than providing guidance about protecting certain passwords, IRS 
did not prescribe minimum computer security requirements for 
transmitters and did not assess or require an independent assessment of 
the effectiveness of computer controls within the transmitters' 
operating environment.
    We provided specific technical recommendations to improve access 
controls over IRS' electronic filing systems and networks. We also 
recommended that IRS complete the certification and accreditation of 
its electronic filing systems, assess security risks and routinely 
monitor the effectiveness of security controls over electronic filing 
systems, improve certain data reliability and integrity controls, and 
notify taxpayers of the privacy risks of filing electronically. IRS 
agreed with our recommendations and said that it implemented most of 
the improvements, including correcting critical vulnerabilities, before 
this year's filing season. IRS further said that the actions it has 
taken demonstrate a systematic, risk-based approach to correcting 
identified weaknesses. Such an approach will continue to be important 
in ensuring that corrective actions are effective on a continuing basis 
and that new risks are promptly identified and addressed.
    Mr. Chairman, that concludes our statement. We would be pleased to 
respond to any questions that you or other members of the Subcommittee 
may have at this time.
----------
    1 Information Security: IRS Electronic Filing Systems 
(GAO-01-306, Feb. 16, 2001).
    2 The other three operating divisions are: (1) Small 
Business and Self Employed, serving fully or partially self-employed 
individuals and businesses with assets of $5 million or less; (2) Large 
and Mid-Size Business, serving businesses with assets over $5 million; 
and (3) Tax Exempt and Government Entities, serving pension plans, 
exempt organizations, and governments.
    3 Tax Administration: Assessment of IRS' 2000 Tax Filing 
Season (GAO-01-158, Dec. 22, 2000).
    4 The number of reject conditions cannot be equated to 
the number of electronic submissions that were rejected because one 
submission can have more than one reject condition.
    5 IRS considers an SSN invalid if it is missing from the 
return or if the SSN and associated name on the return do not match 
data in the Social Security Administration's records.
    6 On a joint return, the person whose name appears first 
on the return is considered the primary taxpayer. The other person is 
considered the secondary taxpayer.
    7 In addition to automated refund information, Tele-Tax 
provides recorded information on about 150 tax topics.
    8 Progress in Developing the Customer Communications 
Project Has Been Made, But Risks to Timely Deployment in 2001 Still 
Exist, TIGTA, Reference No. 2001-20-055, Mar. 12, 2001.
    9 IRS requested and Congress established a multiyear 
systems modernization account and funded it with about $578 million via 
IRS' fiscal years 1998, 1999, and 2001 appropriation acts. To date, IRS 
has received approval from Congress to obligate about $450 million from 
the account.
    10 Tax Systems Modernization: Management and Technical 
Weaknesses Must Be Corrected If Modernization Is to Succeed (GAO/AIMD-
95-156, July 26, 1995).
    11 Tax Systems Modernization: Results of Review of IRS' 
Third Expenditure Plan (GAO-01-227, Jan. 22, 2001).
    12 See, for example, IRS' Custodial Accounting Project 
(GAO-01-444R, Mar. 16, 2001) and GAO-01-227, Jan. 22, 2001.
    13 The Custodial Accounting Project is expected to 
provide a single data repository of taxpayer accounts and tax payments 
as well as related tax revenue accounting and reporting capabilities. 
IRS also plans for this project to, among other things, automatically 
reconcile accounts and payments, post updates to IRS' general ledger, 
and produce revenue accounting reports.
    14 This project is the common integrated infrastructure 
to support and enable modernization business systems applications. As 
designed, it consists of a combination of custom and commercial off-
the-shelf software, hardware, and security solutions, integrated to 
form the technical foundation upon which modernized business systems 
applications will operate.
    15 GAO-01-306.
    16 Accreditation is the formal authorization for system 
operation and is usually supported by certification of the system's 
security safeguards, including its management, operational, and 
technical controls. Certification is a formal review and test of a 
system's security safeguards to determine whether or not they meet 
security needs and applicable requirements.

                                


    Chairman Houghton. Thanks very much. Well, Mr. Williams, 
based on what you said, do you think the 2001 filing season was 
successful?
    Mr. Williams. I am sorry, Mr. Chairman.
    Chairman Houghton. Based on the information you have given 
me, do you think the 2001 filing season was successful?
    Mr. Williams. Yes, generally I think it has been a 
successful filing season. The numbers are up. I think IRS has 
met the goals. The 1040 are being processed in a timely 
fashion, so far as we know.
    We have some concerns with regard to enforcement and 
customer service, but the filing season itself we felt good 
about the IRS' performance.
    Chairman Houghton. OK. The accuracy of the tax law 
questions when TIGTA called the IRS telephone assistance line 
was less than 50 percent. And these questions came from the IRS 
list of frequently asked questions. What are we goingto do to 
solve this problem?
    Mr. Williams. The modernization that is moving in our 
direction we feel very good about. We think that it is very 
difficult to train low-paid and seasonal workers to answer 
complex tax law questions. The modernization will bring to them 
automated tools that will both allow the account to be 
accessible in a way that has accurate and current information, 
and it will provide the answers to the kinds of questions that 
are posed by taxpayers. So we feel that that is certainly part 
of the solution.
    The IRS is moving, although we are not very comfortable 
with the pace, with regard to simplifying notices and working 
on forms to simplify those as well. There are taxpayer 
education programs and programs for preparers that we think 
will be very helpful, too. And then the IRS needs to continue 
advising you of efforts to simplify the taxpayer burden with 
regard to legislation. You asked IRS to begin that, and they 
have given you the first few products. We need to aggressively 
continue letting you know where IRS just can't get the job done 
in terms of explaining to the customers.
    Chairman Houghton. All right. Thank you. Now, very briefly, 
Mr. White, you talked about the security issue. Has the GAO 
been able to test the new security measures?
    Mr. White. Mr. Chairman, let me bring up Mr. Dacey. He is 
the Director of Information Security Issues at GAO.
    Mr. Dacey. Mr. Chairman, no, we have not. We plan to do 
that as our normal follow-up process.
    Chairman Houghton. When will that be?
    Mr. Dacey. That will be some time this late summer or fall.
    Chairman Houghton. All right. And when you do that, will 
you report to the Committee? Will you report to the 
Commissioner? What will you do with that information?
    Mr. Dacey. When we finish that, we will go through our 
normal process of reporting that out in our reports.
    Chairman Houghton. Well, I would be interested--I don't 
know if the rest of the panel would--in getting that 
information. If you could pass it along to us, it would be 
appreciated. Mr. Coyne, would you like to ask questions?
    Mr. Coyne. Thank you, Mr. Chairman.
    Mr. Williams, I wonder if you could outline for us what 
portions of your funding, the IG's funding, and staffing are 
allocated to the following compartments: systemic problems at 
the IRS as one category; complaints about high-level IRS 
employee actions; and, number three, fraud and abuse in the tax 
system itself. Are you able to break down what your commitments 
are to those?
    Mr. Williams. Yes, sir, I am. We have about 1,000 people, 
and our funding, of course, is largely in support of those 
efforts.
    With regard to attacking the systemic problems and the root 
causes for issues that come forward and trying to make 
recommendations for those, we have about 375 of our FTE 
dedicated to that. They produce about 160 reports a year.
    With regard to our fraud efforts, of the 1,000 we have 
about 475 of our FTE dedicated toward attacking fraud and 
abuse. They conduct about 4,000 investigations a year.
    With regard to complaints and allegations that we have 
regarding our GS-15s and SES'ers and Presidential appointment 
level personnel, we have about 8 percent of our resources on 
that, and we manage about 540 complaints annually. That has 
been the history of our short existence in the first 2 years.
    Mr. Coyne. So the last one you put in percentage terms 
instead of employee terms? Eight percent, did you say?
    Mr. Williams. Yes, sir.
    Mr. Coyne. Eight percent of the personnel?
    Mr. Williams. Yes. Our investigators--8 percent. Our 
investigators manage that, and within their case inventory are 
a mixture of general kinds of investigations and high-level 
investigations.
    Mr. Coyne. All right. Thank you.
    Chairman Houghton. Mrs. Thurman.
    Mrs. Thurman. Thank you, Mr. Chairman. I have a couple of 
questions.
    In your testimony, Mr. White--I had to figure out who was 
writing this--you talk about the folks that are actually giving 
this information, either the telephone--and the problems that 
have caused. Can you give me who this person might be, what 
kind of background, what kind of training, what kind of 
training goes into this person? Because I noticed here it said 
that in some cases they couldn't even get the 6 weeks' training 
that was necessary. I need to know a little bit about who this 
person is that may be answering these questions.
    Mr. White. Yes, there are different kinds of assistance 
there. The IRS has about 10,000 telephone assistors, and then I 
think the type of assistance you are referring to there is the 
walk-in assistance. A lot of those people are moved over from 
other spots in IRS, and they are now taxpayer resolution 
representatives.
    Mrs. Thurman. So they have some background in the law, they 
have----
    Mr. White. They have some background, but IRS has also 
recognized that there are training needs associated with these 
people. They need a fairly broad-based knowledge of IRS and IRS 
processes in order to deal effectively with taxpayer problems. 
And so far what we have found is in standing up these new 
positions and filling these new positions, while they have been 
trying to meet training needs, there still are unmet training 
needs there.
    Mrs. Thurman. So maybe one of the recommendations is to 
make sure before we put them out, they are on the frontline or 
answering phones or whatever, that they should be given some 
kind of training before we let that happen? Because the next 
follow-up question I have, especially based on some of the 
issues that we have heard from other folks, either the 
Taxpayer's Advocate and/or the Commissioner, I mean, if I am a 
taxpayer and I call these lines or I go in for this assistance, 
I mean, I am assuming that the information that I am getting 
back is correct. And I make a determination based on that 
information on how I might file. And if my filing is not 
correct or the information I was given was incorrect, and I 
don't meet--and all of a sudden I get audited or there is a 
penalty or whatever, I mean, how do we correct that part for 
the taxpayer who actually may end up getting the wrong 
information and they end up having to pay the penalties?
    Mr. White. Part of the correction there is the 
responsibility of middle-level managers at IRS, and in order to 
better manage that program, they need, first of all, 
information, about what performance actually is, and then they 
need to do the kinds of studies to be able to link IRS' 
training efforts, for example, to the quality of answers. Are 
assistors getting the right kind of training so that they can 
give better answers? And that requires an in-depth evaluation 
of the performance data to make those kinds of linkages. It is 
not easy to do, but that is the responsibility of middle-level 
management.
    Mrs. Thurman. But are you seeing that happening now?
    Mr. White. We see continued needs for that kind of 
evaluation. With respect to telephone assistance, for example, 
we are issuing a report to this Subcommittee later this week 
where we recommend that the Commissioner ensure that exactly 
those kinds of performance evaluations are done.
    Mrs. Thurman. I just had a situation in my office where 
somebody was given some information of not to pay by a tax 
preparer. I don't know where they got this information if they 
didn't have this final piece of paper that tells them what the 
valuation of their property was. So for 4 years, they didn't 
pay anything. All of a sudden now they are sitting here with, 
you know, $100,000 worth of penalties anddidn't even include, 
you know, what their estate tax would have been. And these folks are 
making $14,000 a year. Needless to say, they are in a real bind.
    But it just strikes me that if we are giving wrong 
information and--I mean, you know, where do we go to make this 
work? I don't know. And how do we make sure that the taxpayer 
is not getting the penalty for an answer that was given 
incorrectly?
    Mr. White. It is a good question. Again, I think part of 
the response there is that better information systems are 
needed at IRS. They need to be able to track those kinds of 
cases. They need to have the data on how many cases are taking 
that long to resolve. And then with that kind of data, they can 
do the sort of analysis to try to figure out what the causes 
are, and with that information then presumably managers could 
take informed action to fix the problems.
    Mrs. Thurman. So then based on what, I guess, some of us on 
this side have asked about with this next budget coming up, is 
there a number, I mean, based on what has been submitted and--I 
mean, have you all looked at what the cost of doing this would 
be? And when we make a recommendation to, you know, the 
appropriators to make sure that this is covered, is there a 
magical number out there that makes this work?
    Mr. White. I don't think there is a magical number for the 
sort of evaluation of performance that we are talking about. 
There clearly is a cost to doing those kinds of evaluations. So 
it is a management----
    Mrs. Thurman. And then the training.
    Mr. White. Yes. There is a cost there as well, and 
ultimately it is a management judgment that has to be made by 
higher-level management at IRS about how much of this is worth 
doing.
    Mrs. Thurman. I will be interested to see the budget to see 
if it reflects some of the issues that you have raised here 
today as far as training and personnel and what we are doing. 
So I hope we will have an opportunity to look at that when it 
comes in.
    Chairman Houghton. Thanks very much. Gentlemen, we 
appreciate your being here with us. I would like to call the 
next panel: Mark Ernst, president and chief executive officer 
of H&R Block, who comes from Kansas City; and Claudia Hill, 
Chair of the Government Relations Committee, the National 
Association of Enrolled Agents, from Cupertino, California.
    Mr. Ernst, delighted to have you here with us. Would you 
like to testify?

   STATEMENT OF MARK A. ERNST, PRESIDENT AND CHIEF EXECUTIVE 
           OFFICER, H&R BLOCK, KANSAS CITY, MISSOURI

    Mr. Ernst. Thank you, Mr. Chairman, Members of the 
Subcommittee, and thanks for inviting us.
    As you know, Mr. Chairman, H&R Block prepares about one in 
seven individual income tax returns--over 16 million, which 
works out to about 37,000 per congressional district. We serve 
clients at 9,000 offices in the United States, and we publish 
Kiplinger TaxCut software as well as offer online tax 
preparation and electronic filing.
    We are reshaping the company to also offer clients 
financial planning, mortgages, savings and investment products, 
so they can combine tax compliance with an annual financial 
checkup. And to expand our business services, we have built a 
national accounting practice anchored by RSM McGladrey.
    My comments this afternoon can be boiled down to four 
points:
    First, the filing season has gone very well, but not 
without some problems. We want to highlight three and hope to 
work with the IRS to fix them.
    Second, because we are likely to fall short of the 2007 
electronic filing goal set by Congress in 1998, we urge 
elevated efforts by the IRS and tax professionals, and we 
recommend a more dramatic incentive to taxpayers in the form of 
a 3-year refundable credit to accelerate electronic filing.
    Third, IRS reform is progressing well, and we are impressed 
by Commissioner Rossotti's success. To maintain that momentum, 
we hope that Congress will follow the recommendation of the IRS 
Oversight Board to ensure adequate funding.
    And, fourth, IRS can operate more effectively if it enlists 
more help from its external stakeholders.
    First, on the filing season, although the season does not 
end for another 13 exciting days, we have enough information to 
report that it has been successful. Our experience in working 
with the IRS has been very positive. The e-file system has 
worked well across all service centers, and we have experienced 
very little down time.
    As of March 15th, our return preparation is up 
approximately 2 percent and electronic filing is up about 8 
percent. Over 87 percent of our returns are electronically 
filed. Electronic filing through our TaxCut software and Web-
based tax preparation is up 58 percent over last year.
    But every season has glitches. Three from this year are 
particularly noteworthy.
    First, the IRS needs to aggressively enforce its new rules 
requiring tax practitioners to use a client's W-2 in order to 
e-file.
    Enforcement delays this year gave unfair competitive 
advantages to firms that improperly used pay stubs or leave-
and-earnings statements to prepare substitute W-2s.
    Despite warnings that this might occur, the IRS response 
was too little and too late. More needs to be done next year so 
compliant taxpayers and practitioners won't be hurt.
    Second, the IRS needs to improve the debt indicator.
    When the debt indicator works, taxpayers learn whether any 
delinquent State or Federal taxes, student loans, or child 
support payments will be offset against their refunds. The 
program helps taxpayers by making them aware of problems they 
need to resolve. It helps tax preparers and lenders by 
clarifying risk, which helps lower the cost of refund 
anticipation loans. And it helps the IRS by increasing 
electronic filing and improving compliance.
    But when errors occur, as they did this year when all 
Social Security numbers were not included in IRS offset screens 
until February 1st, all suffer. The firms participating in this 
year's DI test incurred significant losses, which eventually 
get passed through as higher fees or discourage electronic 
filing.
    We look forward to working with the IRS to make the DI 
program run more effectively when it is renewed, as we hope it 
will be, in 2002.
    The third glitch involves difficulties using PINs in place 
of paper signature documents to authenticate electronic filing.
    The PIN program needs to be redesigned because the reject 
rate caused by taxpayer-provided information that doesn't match 
data in IRS computers is unacceptably high. The reject rate 
this year for self-prepared returns, using software or online 
applications, has been 20 percent compared to a normal reject 
rate of 12 to 13 percent. Almost all the difference is related 
to PIN rejects.
    Whether this occurs because taxpayers or tax practitioners 
enter the wrong data or because the IRS has wrong data in its 
computers, the program is in trouble if e-filers using a PIN 
have a greater likelihood that their returns will be rejected.
    Second, on electronic filing generally, we need to face the 
fact that 3 years after Congress set twin goals of 
electronically filing all computer-prepared returns by 2002 and 
electronically filing 80 percent of all tax and information 
returns by 2007, projections are that America will not meet 
these targets.
    The IRS and practitioners must redouble our efforts to 
convert paper filers. We need more promotion and marketing, 
more cooperation from CPA firms, a more workable PIN program, 
and friendlier standards to encourage more professionals to 
enlist as authorized e-filers.
    But because the present arsenal of incentives may not be 
adequate, we recommend a more dramatic jump-start, which is the 
enactment of a $10 to $15 refundable tax credit for a limited 
period of time for taxpayers who choose electronic filing.
    Third, on the budget for 2002, we are concerned about 
reports that the administration may not endorse the IRS 
Oversight Board's recommended budget, especially the personnel 
and technology initiatives.
    We believe the IRS should have the funds it needs to do its 
job. Too much is at stake to shortchange computer updates or 
risk breakdowns, especially when Congress is about to add new 
provisions to the tax code.
    And, finally, on working with the IRS, we continue to find 
a welcome spirit of partnership. The new national accounts 
manager system works well. We get excellent help in solving 
problems, and IRS staff, especially in the Electronic Tax 
Administration area, are responsive and diligent.
    Mr. Chairman, we look forward to working with the 
Subcommittee to ensure that for most Americans the tax-filing 
experience is, if not enjoyable, at least tolerable. We 
appreciate the chance to be here today and welcome your 
questions.
    [The prepared statement of Mr. Ernst follows:]
Statement of Mark A. Ernst, President and Chief Executive Officer, H&R 
                      Block, Kansas City, Missouri
    Mr. Chairman and Members of the Subcommittee:
    I'm Mark Ernst, President and Chief Executive Officer of H&R Block. 
We appreciate the opportunity to discuss the 2001 tax filing season. 
With me is Robert Weinberger, our Vice President for Government 
Relations.
    About H&R Block. H&R Block, founded in 1955 and headquartered in 
Kansas City, is America's largest tax return preparation company. Over 
175,000 individuals take our tax training courses annually. With more 
than 9,000 U.S. offices, we handled over 16 million individual returns 
in 2000, which is one in seven received by the IRS and about 37,000 per 
Congressional district. We are leaders in electronic filing, 
originating over half the practitioner e-filed returns that the IRS 
receives. We publish Kiplinger TaxCut tax preparation 
software, which has over 1.6 million users, and we author the annual 
``H&R Block Income Tax Guide.'' Internationally, we prepare tax returns 
at over 1,200 offices in Canada, Australia, and the United Kingdom.
    In the past several years, we have reshaped the company to offer 
our clients--many of whom view a stop at H&R Block as an annual 
financial check-up--more than tax services. We also offer financial 
planning, mortgages, and savings and investment products. And to expand 
our business services, we have built a national accounting practice 
anchored by RSM McGladrey.
    Filing Season News. We're offering a number of innovations this 
year to make online tax preparation and e-filing more appealing. In 
addition to our online program for do-it-yourself tax filers, we offer 
``Electronic Refund Advances''  that allow online e-filers to get a 
loan in the amount of their refund in as little as 24 hours. Our 
``Professional Review''  allows taxpayers who use our do-it-yourself 
program to have an experienced H&R Block tax professional review, sign, 
and guarantee their return. ``Ask a Tax Advisor'' enables any taxpayer 
to connect with a Block tax professional by phone, e-mail, or online 
chat for immediate answers to specific tax questions. And our new 
``Professional Tax Service'' allows customers to enter their tax 
information in our online tax organizer and then send it to an H&R 
Block tax professional, who will prepare, sign, and guarantee the 
taxpayer's federal and state return.
    We're also aiding clients with ``Express IRAs'' to convert refunds 
in a tax-advantaged way into retirement savings. And this year, in 
cooperation with the U.S. Department of Health and Human Services, we 
advised clients of their potential eligibility for free or low-cost 
state children's health insurance programs (SCHIP) and how to get more 
information. We've been told that calls to the ``Insure Kids Now'' 800-
number in January-February tripled over last year.
    We continue to emphasize the multiple benefits of e-filing while 
reducing cost as a possible barrier. This year, we did not charge 
additional fees for e-filing in 80% of our offices, we participated in 
the IRS's PIN, DI, and Web hyperlink programs, we distributed 500 IRS 
public service announcements promoting e-filing to local TV stations 
with whom we place our ads, and we offered additional services to 
online and software clients that created value-added incentives to e-
file--and that suggest a future in which combinations of new technology 
and traditional service will enable customers to be served when, where, 
and how they choose.
    Filing Season Results. Although the main 2001 tax filing season 
does not end for 13 exciting days, we have enough information to report 
that it has generally been successful. Our own experience in working 
with the Service has been very positive. The e-file system has worked 
very well this year across five service centers. We experienced very 
little IRS down-time as compared to previous years.
    Our return preparation as of February 28 is up 2.4%, and e-filing 
is up 7.8%, as nearly 90% of our returns are e-filed. E-filing through 
our Kiplinger TaxCut software and Web-based tax preparation 
is up about 60% over last year.
    Filing Season Problems. Given the range of disruptions that might 
occur, we count ourselves lucky when things go so well. That said, we 
believe more can be done to make the next filing season even better. No 
system that processes 1.2 billion tax and information returns, issues 
97 million refunds, answers over 100 million assistance calls, and 
collects almost $2 trillion annually--much of it in a 105-day filing 
season--will ever be error-free. Let me identify three glitches in an 
otherwise good season--in shorthand LES, DI, and PIN:
        LES/W-2 Requirements: Under new IRS rules, tax preparers need a 
        client's W-2 form before electronically filing his taxes. Some 
        firms, however, improperly use pay stubs or leave and earnings 
        statements (LES) to prepare substitute W-2s. Their clients file 
        earlier and get refunds sooner, which is a competitive 
        advantage over firms that comply with the rules. We alerted the 
        IRS to the potential for this problem prior to tax season. We 
        hoped that swift enforcement would address it.
          Delays, however, blunted any impact until after February 16, 
        following the early peak of the filing season, costing many 
        honest firms tax business and income. One of our company-owned 
        districts near a military base in North Carolina, for example, 
        saw business plummet by nearly 50% during what should have been 
        our busiest time of the season. If the IRS expects firms to 
        follow the rules, it must enforce the law against those who do 
        not. The IRS was ill-prepared to deal with violators, despite 
        advance warnings, and when it acted it did too little, too 
        late. More needs to be done for next year.
        Debt Indicator (DI): This is the second year of a test of a 
        Debt Indicator in which, at the taxpayer's instruction, IRS and 
        the Financial Management Service electronically signal the 
        representatives of taxpayers who use bank products (like refund 
        anticipation loans) if offsetting obligations (delinquent 
        federal or state taxes, student loans, or child support 
        payments) will reduce refunds. The information helps taxpayers 
        and enables lenders to avoid making loans for which they will 
        not be repaid which, in turn, enables them to pass reduced 
        costs through to clients in the form of lower fees charged.
          Last year, the program worked fairly well although there were 
        some problems. In anticipation of the DI, the provider of bank 
        products for H&R Block led the industry in lowering fees. For 
        taxpayers, the private sector and the IRS, it should have been 
        a ``win-win'' with e-filing up, bank fees down, and compliance 
        improved. But IRS didn't get the DI working properly until well 
        into the tax season.
          This year, again, there were problems. Social Security 
        numbers ending in 00 to 32 were not included in IRS offset 
        screens until February 1. Returns reported as having no offset 
        had offsets taken when refunds were processed. The result was 
        unhappy taxpayers and significant losses for participating 
        firms.
          When it works well, the DI program benefits taxpayers, tax 
        preparers, lenders, and the IRS. Unfortunately, when errors 
        occur, all suffer. We believe the program is worth continuing 
        and look forward to working with the IRS to ensure better 
        execution.
          One use of a DI--supporting RAL transactions--may decline as 
        the IRS fulfills its strategic plan to speed refunds to all e-
        filers within 48-72 hours. We welcome faster refunds as a solid 
        plus for taxpayers, a strong incentive to e-filing, and a 
        showpiece of IRS's computer modernization program. But if the 
        IRS wants to win taxpayer confidence in electronic 
        notifications and two-way e-transactions--both e-filing and e-
        responses--it must make its responses reliable so taxpayers are 
        not confused.
           PINs. Practitioners welcomed the IRS allowing 
        taxpayers to use a self-selected personal identification 
        numbers (PIN) in place of paper form 8453 that is otherwise 
        required to be sent by mail with a signature to authenticate an 
        e-filed return. To obtain a PIN, the taxpayer must provide his 
        correct name, SSN, date of birth (now required only for on-line 
        filers), AGI, and total tax from last year's return.
          This year, thousands of PIN applications submitted with 
        correct ``shared secrets'' information were rejected, costing 
        tax professionals time and income as they worked to correct the 
        rejects, and angering many customers who anticipated easier 
        filing and faster refunds. Some preparers abandoned the program 
        as it became easier to use the paper 8453 form instead of 
        having to deal with a PIN reject and asking the client to 
        return to file an 8453.
          Under the online e-filing program, for self-prepared returns 
        using software or online applications, the reject rate this 
        year has been about 20% compared to our normal e-file rejection 
        rate for TaxCut and online customers of about 12-13%. 
        Almost all of the difference is attributable to PIN rejects.
          One problem is that IRS records are sometimes wrong. As a 
        result, a taxpayer may enter the correct AGI and total tax but 
        the IRS system says it's wrong. IRS also has potential errors 
        in its records of citizenship, marriages, decedents, and name, 
        SSN, and DOB as received from the Social Security 
        Administration.
          The IRS believes the majority of PIN rejects are caused by 
        customer error. But whether the problem is with the 
        practitioner, the taxpayer, or the IRS, one fact remains: If 
        you e-file using a PIN, your return is more likely to be 
        rejected. We hope to work with the IRS to solve this problem so 
        that filers won't abandon PINs and e-filing in frustration next 
        year.
          If PINs, intended to make e-filing easier, make it harder, 
        more complex, more expensive, and less satisfying, the entire 
        e-filing program will be endangered. We look forward to helping 
        the IRS find error-free, non-paper, simple signature 
        authenticators that work to encourage, not discourage, e-
        filing.
    In highlighting these points, we don't want to detract from the 
larger conclusion that the filing season is going well and IRS's 
overall record is good. We hope to work with the IRS to mend these 
problems next year.
    IRS Reform. In the last year, the IRS's four new divisions ``stood 
up,'' a landmark in continuing reform, and the IRS Oversight Board 
began its work. Commissioner Rossotti has continued impressive 
initiatives to improve the agency's performance, modernize technology, 
and improve customer service. We think he's doing a great job.
    Electronic Filing Shortfall. The IRS has increased its e-filing 
promotion to achieve Congress' twin goals of e-filing all computer-
prepared returns by 2002 and e-filing 80% of all tax and information 
returns by 2007. But the early numbers this year are slightly below IRS 
projections and the projections are that the targets will not be met 
unless more Americans overcome apprehensions and more practitioners 
enlist.
    Our suggested priorities, many already a part of the IRS strategy, 
remain: (1) a continuing focus on private-sector cooperation, through 
the Electronic Tax Administration Advisory Committee, through 
industry's Council on Electronic Revenue Communication Advancement 
(CERCA), and especially with accounting firms who will soon be able to 
e-file all forms and attachments; (2) expanding IRS's already-strong 
marketing and promotion; (3) universal PINs to enable paperless 
filing--if the information needed to validate the PIN does not itself 
become a hurdle and if IRS rejects are not so numerous as to make the 
PIN counterproductive; (4) streamlining the application process to make 
it easier for tax practitioners to become Electronic Return Originators 
(EROs) and easing suspension rules for EROs--high ERO application 
standards and stringent suspension rules are barriers that deter 
participation in the program; and (5) continued reform of old rules for 
the e-filing program.
    E-Filing Jump Start. Despite our optimism and support, we may face 
the uncomfortable reality that for many Americans, the incentives to e-
file--beyond a faster refund--are simply not compelling. Before 
reaching that conclusion, we believe both the IRS and tax professionals 
can try harder to persuade taxpayers of the benefits of e-filing. And 
Congress can help.
    We recommend a three year refundable tax credit of $10-25 to 
encourage e-filing and to provide the dramatic pull needed to convert 
more American taxpayers and enable the IRS to meet your goals for 2002 
and 2007.
    The IRS Restructuring and Reform Act of 1998 allows IRS to pay 
``appropriate incentives,'' and the Clinton Administration last year 
proposed a $10 tax credit for those who e-filed in 2002-6. We prefer 
incentives that go to taxpayers, not to e-file originators or 
transmitters.
    Complexity. In three of the last five years, we sent the Ways & 
Means Committee, the Senate Finance Committee, the Treasury, and the 
IRS ten modest suggestions for Tax Code simplification, several of 
which have now been enacted. We look forward to working with you on 
your efforts to simplify the tax law, especially as it affects average 
American families.
    Check Box. This year, the IRS allows taxpayers to check a box to 
allow their tax preparer to be contacted by the IRS for additional 
information. The idea is good but it only authorizes contact with tax 
preparers, not tax preparation companies. We recommend modifying the 
program to allow us to help clients with in-office personnel rather 
than bring back the actual tax preparer since we have both seasonal and 
year-round tax preparers.
    IRS Liaison. This year, the IRS installed an accounts manager 
system for its largest external customers to serve as our ombudsman in 
solving various problems. The program has worked well and it deserves 
high marks. We found other IRS staff responsive and diligent, 
especially in the area of electronic tax administration.
    Most IRS interaction with practitioner groups comes through formal 
advisory committees or public liaison meetings. Outreach and 
information sharing have increased. Status reports and briefings are 
excellent.
    As a large customer, we also work directly with senior IRS 
officials to manage an ongoing agenda. We are often an early-warning 
system for the IRS, spotting problems before they generally appear. We 
hope to expand our contacts to improve cooperation, reduce bumps in the 
next filing season, and participate in the IRS's planning process. The 
problems that inevitably occur each filing season, especially as new 
programs are implemented, can be reduced if private-sector partners 
have a greater opportunity to discuss ideas in the planning stage to 
identify issues and share perspectives.
    FY 2002 Budget. While the President will not submit his detailed 
IRS budget until April 9, early reports indicate that the 
Administration will not support the full $10.26 billion recommended by 
the IRS Oversight Board. Plans to hire 4,000 new employees would be 
trimmed by 1,400 and a $1 billion fund for two years of technology 
modernization would be cut to $400 million.
    We strongly support the agency receiving the funds it needs to do 
its job, especially in modernizing outdated technology, so that the 
risk of any system breakdown is reduced. IRS reform and restructuring 
requires dependable financial support to enable the agency to fulfill 
its strategic plans for better customer service, faster return 
processing, more effective law enforcement, and modernized technology.
    Conclusion. Mr. Chairman, there are many other areas I could 
comment on, and I will be happy to respond to your questions. We look 
forward to working with the Subcommittee to ensure that for most 
Americans the tax filing experience is, if not enjoyable, at least 
tolerable. We are working to ensure that lessons from this tax season 
will help us all achieve smoother filing next year, with refunds issued 
promptly, and with the IRS continuing on the path of reform.

                                


    Chairman Houghton. Thanks very much. Ms. Hill.

    STATEMENT OF CLAUDIA HILL, CHAIR, GOVERNMENT RELATIONS 
COMMITTEE, NATIONAL ASSOCIATION OF ENROLLED AGENTS, CUPERTINO, 
                           CALIFORNIA

    Ms. Hill. Mr. Chairman, members, my name is Claudia Hill--
--
    Chairman Houghton. Would you put the microphone on?
    Ms. Hill. OK. Thank you. Mr. Chairman, members, and staff, 
my name is Claudia Hill, and I am an enrolled agent from 
Cupertino, California, in private practice. I work primarily 
with individuals, small business, and I am an electronic 
filer--some. Some.
    On behalf of my more than 10,000 enrolled agent colleagues 
in the National Association of Enrolled Agents, I would like to 
express my appreciation for our ability to present testimony at 
this hearing today and to express my appreciation for your 
interest in hearing what the taxpayers have to say about 
dealing with the filing season.
    I have several comments. The first one has to do with the 
IRS budget. Over the last decade, the IRS has been asked to do 
more with fewer resources. While theoverall budget has grown in 
recent years, by many measurements it has declined. At the same time, 
Congress has demanded and the Commissioner has delivered a greater 
emphasis on taxpayer service. While much of the technology 
infrastructure for a modern accounts management system has yet to be 
delivered, our members report that IRS is generally doing a more 
professional job of handling case management issues and general tax 
questions from taxpayers.
    Unfortunately, we have also witnessed a corresponding 
decline in service at the audit and collection levels. 
Experienced IRS employees in these areas have been reassigned 
to cover the phones and help with tax returns during filing 
season. It is our belief that adequate resources for the IRS 
make a difference in the public satisfaction with the IRS 
specifically and the Federal government in general. We also 
believe it is essential that IRS be given adequate resources to 
maintain an enforcement presence.
    Taxpayers need to know that there is a consequence to non-
compliance. When audit collection efforts are reduced as 
greatly as they have been in recent years, it sends an 
ambiguous message about our voluntary tax system. Some people 
start thinking the system really is voluntary. As a front-line 
practitioner, we then must deal with taxpayers who want to play 
audit roulette or engage in illegal tax schemes.
    As to modernization, this is the first filing season since 
the IRS completed its business restructuring in an effort to 
organize around its customers. NAEA members are beginning to 
see some positive returns. Access to information has been 
dramatically enhanced with the continued improvement of the IRS 
Web site. The new small business self-employed Web site is a 
marvel of accessibility and usability. The new criminal 
investigations site gives practitioners a resource to point to 
when we find taxpayers who don't believe the IRS is using 
compliance resources to fight abusive trust and employment tax 
avoidance schemes. More forms are capable of being filed 
electronically than ever before, and access to forms and 
information on the Web is available through public libraries, 
through home computers. It has been a great, a very good 
improvement.
    The communications and public liaison efforts of the IRS 
have been greatly enhanced to inform and advise the public on a 
broad range of issues, and partnerships between the IRS and the 
public on a broad range of association needs, taxpayer needs 
are developing and longstanding issues are being resolved in a 
timely and cost-effective manner.
    The ability of the agency to collect more accurate data 
more efficiently and then to be able to use that better data 
will help taxpayers deal with the Service and practitioners 
deal with the taxpayers and the IRS. We look forward to the day 
when we can resolve problems online, when we can use 
information that we have gathered electronically and 
communicate with the IRS electronically. Our message to 
Congress is to stay the course with these investments in 
technology and insistence with customer service, make sure the 
IRS and its partners deliver benefits to taxpayers and 
practitioners on schedule.
    Every year we survey our members on the problems of the 
filing season, and the number one response we get from our 
members is tax law complexity. We then ask our members to 
choose the most complex item in the Internal Revenue Code. We 
have dubbed their selection ``the tax headache of the year.'' 
For the second time in 2 years, the overwhelming response has 
been the individual alternative minimum tax. It is affecting 
more of our population, including senior citizens, farm 
families, middle-income taxpayers, U.S. taxpayers living and 
working overseas, employees expected to bear the majority of 
their own employment-related expenses, and workers with 
incentive stock options.
    Now, how can one type area of the tax code affect such a 
wide variety of taxpayers? Because in the last 15 years, the 
regular tax system has been changed, rearranged, and indexed, 
without attention to the AMT system running silently beneath 
it. Unfortunately, as the economy has changed, more taxpayers 
have found themselves pulled into an AMT trap. Quick examples 
of people that are affected this year, which you may have seen 
in some of the media:
    A senior citizen who had to take money out of a pension 
plan to pay for medical expenses to care for his wife with 
Alzheimer's. He found himself in AMT because the AMT does not 
allow a complete deduction for medical expenses as the regular 
tax system does, nor does it allow the deduction for his 
property taxes or his State income taxes.
    We saw taxpayer farmers affected. A few years ago, Congress 
saw the need to help balance out their income when they have 
volatile income from year to year by offering what is called a 
3-year special income averaging. Unfortunately, there was no 
provision when income averaging using that method dipped below 
the AMT to allow the benefit. The taxpayer pays the AMT.
    U.S. citizens residing outside our country who are 
encouraged to file in the U.S. and use the credits for foreign 
taxes paid are allowed to offset 100 percent of their regular 
tax but not all of their alternative minimum tax. In essence, 
they are double taxed.
    Chairman Houghton. Ms. Hill, could I just interrupt just a 
minute? Your time has expired, so if you could wind up your 
testimony as fast as possible, I would appreciate it. Thank 
you.
    Ms. Hill. OK. We have seen numerous issues on this. I will 
just name two other complexity issues and then be available for 
questions.
    More complexity having to do with phase-outs and the earned 
income credit. There are over 20 commonly encountered aspects 
of individual returns that require phase-outs. These add 
complexity and they give a perception of unfairness with the 
law. When it comes to the EIC, the fraud in this program is 
anembarrassment to practitioners, the public, to Congress, and the IRS.
    We believe that this might be addressed by dealing with 
whether or not there should be regulation of all commercial 
preparers, at least registration of them, as is done with the 
electronic return originator program.
    That concludes my testimony, and I would be happy to answer 
any questions.
    [The prepared statement of Ms. Hill follows:]
   Statement of Claudia Hill, Chair, Government Relations Committee, 
     National Association of Enrolled Agents, Cupertino, California
    I am honored Mr. Chairman to present this testimony on behalf of 
the National Association of Enrolled Agents (NAEA). There are 
approximately 35,000 Enrolled Agents, more than 10,000 of whom are 
members of our organization. Enrolled Agents represent over 5 million 
taxpayers and small businesses at all administrative levels of the IRS, 
including tax preparation. In order to be enrolled before the 
Department of Treasury, a practitioner must pass a detailed exam 
covering the administrative procedures and practical tax laws affecting 
real people and small businesses, or have significant experience 
working at the IRS. In addition to demonstrating ongoing competency 
each year through continuing education requirements, our members must 
undergo a thorough background check and abide by a strong code of 
conduct. Our members are proud to be the federal tax code specialists.
    The Subcommittee has asked us to comment on the state of the filing 
season, and we are happy to report that from the perspective of 
frontline practitioners the state of the filing season is generally 
good. The IRS seems to be providing a basic level of service to more 
taxpayers with generally fewer resources at the same time that they 
manage annual tax code changes. They seem to be making progress with 
their strategic initiatives such as 80 percent electronic filing and 
business organization restructuring, while technology modernization has 
yet to materialize in terms of deliverables to taxpayers or frontline 
IRS employees. On the other hand, as there are in any undertakings as 
complex as filing season, there are some problems.
    Before I touch on a number of specific problems our members have 
discovered with the current filing season, I would like to discuss a 
number of issues that affect the job IRS is doing with the filing 
season and with taxpayers service and compliance in general.
Resources
    Over the last decade, the IRS has been asked to do more with fewer 
resources. While the overall budget for the agency has grown in recent 
years, by many measurements it has declined.
    First of all, the number of full time employees available to handle 
the workload for more taxpayers and more transactions has gone down 
over the last 10 years. At the same time, Congress has demanded and the 
Commissioner has delivered a greater emphasis on taxpayer service. 
While much of the technology infrastructure for a modern accounts 
management system is yet to be delivered, the IRS is generally doing a 
more professional job of handling case management issues and general 
tax questions from taxpayers. For example, our members continue to 
experience helpful and knowledgeable IRS employees. Generally, we have 
seen a strong positive change in attitude with employees at the agency.
    Unfortunately, we also have witnessed a corresponding decline in 
service at the audit and collection functions. Experienced IRS 
employees in these areas are being reassigned to ``cover the phones'' 
and help with tax returns during filing season.
    While at first glance, audits and collections activities do not 
seem to fit into the definition of ``service,'' resources available in 
these areas often assure the timely resolution of costly disputes for 
middle-income and small business taxpayers. An enrolled agent from 
North Carolina recently wrote to us telling of an incident where the 
single remaining auditor in Durham has been reassigned temporarily to 
customer service and will not be able to complete any ongoing audits 
until after April 16th. Without adequate resources, audits, which 
should take hours, spread out to days and even weeks. Meanwhile 
taxpayers are left with the uncertainty of knowing where they stand 
with the IRS. Other relief measures such as offers in compromise and 
innocent spouse claims are delayed to the point that many taxpayers are 
harmed needlessly.
    It is our belief that adequate resources for the IRS make a 
difference in the public's satisfaction with the IRS specifically, and 
the federal government in general. We also believe it is essential that 
IRS be given adequate resources to maintain an enforcement presence. 
Honest taxpayers need to know that there are consequences for non-
compliance. When audit and collection efforts are reduced as greatly as 
they have been in recent years, it sends an ambiguous message about our 
voluntary tax system. Keep in mind, more citizens interact with the IRS 
than any other agency of the federal government. Their budget should 
reflect this reality.
Modernization
    This is the first filing season since the IRS finished its business 
reorganization. The purpose behind this complex and expensive 
undertaking is to organize the IRS around its customers so that they 
can better respond to the needs and track non-compliance of particular 
taxpayer groups. NAEA members are beginning to see some positive 
returns:
           Access to information has been dramatically enhanced 
        with the continued improvement of the IRS web site. The 
        incredible number of taxpayers and professionals visiting and 
        using this site attests to the needs it has met.
           The Small Business/Self Employed Web site is a 
        marvel of accessibility and usefulness. We hope to see it 
        expanded and that other divisions will embrace this concept of 
        providing information out where taxpayers and tax practitioners 
        can access it easily.
           More forms are capable of being e-filed than ever 
        before. We expect 99% of all forms to be capable of being e-
        filed by next filing season. Changes in the number of 
        occurrences in which a form may be e-filed have also had a 
        positive impact on the ability of taxpayers to e-file.
           Two hundred NAEA members are currently working with 
        the IRS on a secure messaging system pilot program. It has 
        taken longer than we expected for a variety of reasons, among 
        them security concerns and the meshing of various computer 
        systems and software, but this has been a project to which NAEA 
        has been committed for a long time. It is meeting certain needs 
        effectively for the practitioner community and we are gratified 
        with the progress made thus far.
           The Communications and Public Liaison effort at IRS 
        has been greatly enhanced. We are seeing the leveraging of the 
        information systems of practitioner groups, the small business 
        community and other business organizations to inform and advise 
        the public on a broad range of issues. This is smart thinking 
        and we applaud those who have run counter to the old IRS 
        culture of ``no comment.''
           Partnerships between IRS and professional societies 
        and trade associations are making it possible for us to develop 
        solutions to long-standing issues in a timely and cost-
        effective manner.
    While the business modernization seems to be taking its first 
tentative steps toward delivering value to taxpayers, it is clear that 
its full promise will not be delivered until the IRS and its 
contractors complete the information systems modernization. Our 
understanding is that a great deal of the initial planning and 
designing stages for the first projects are almost completed, and that 
IRS and its private sector partners are about to begin building key 
elements of the project. Unfortunately, we have yet to see benefits 
delivered in the field.
    The ability of the agency to collect more accurate data more 
efficiently and then to be able to better manage taxpayer data is key 
to the future of the IRS. Taxpayers will see their refunds faster. 
Practitioners and individual taxpayer will be able to resolve more 
problems with one or two calls instead of dozens. Additionally, the new 
system will allow taxpayers and practitioners more options for solving 
problems like 800 lines and on-line access and management of accounts. 
The IRS will be able to spot non-compliance faster making it cheaper 
for both taxpayers and the IRS to resolve these problems. Currently, it 
takes the IRS over 18 months to reconcile tax returns with information 
from 3rd parties such as W-2 and 1099 information. Modern systems and 
business practices should shorten this cycle considerably.
    Our message to Congress is stay the course in these investments and 
make sure the IRS and its partners begin delivering benefits to 
taxpayers on schedule.
Complexity and the ``Tax Headache of the Year''
    Every year, we survey our members on problems with the filing 
season. Separate from this effort, we ask our members to choose the 
most complex item in the Internal Revenue Code. We have dubbed their 
selection the ``Tax Headache of the Year.'' For the second time in two 
years, the overwhelming response in both cases has been the same--the 
individual alternative minimum tax. We believe the message is clear: 
Complexity is the number one tax filing season problem.
    Why is the AMT the ``Tax Headache of the Year?'' Our members tell 
us of increasing numbers of their clients who were blindsided this year 
by falling into this insidious alternative tax system. Here are a few 
examples:
    One of our enrolled agents in Youngstown, Ohio wrote to us to say 
how deeply troubled she was to see an elderly client ``clobbered by the 
AMT.'' The taxpayer was caring for his wife with Alzheimer's, and had 
to withdraw extra pension money to pay medical bills. The AMT 
calculation required him to add-back into AMT a portion of his 
otherwise deductible medical bills and his state income and property 
taxes. This caused the AMT to exceed the regular tax. He didn't think 
it was a good alternative!
    In my state of California, I find that many middle-income taxpayers 
fall unwittingly into the AMT because of the high cost of property 
taxes on their homes and equally high state income taxes. When these 
taxpayers also happen to be employees who incur ordinary and necessary 
business expenses and whose employers either do not reimburse expenses 
or use ``not accountable plans,'' they are injured even more, since 
those miscellaneous deductions are also added back to the AMT base. 
None of these items, normally allowable deductions, are permitted 
against AMT.
    Our members are reporting that more and more farm families are 
being hit with the AMT. Congress saw a need to provide farmers a 
special income averaging method a few years ago. Unfortunately, when 
that method lowers the regular tax below AMT, the taxpayer loses the 
benefits, and must pay the higher AMT.
    U.S. taxpayers living outside our country are provided in the law a 
means to avoid double taxation through the use of foreign tax credits 
(FTC). Once again, AMT undermines the intent of fairness Congress 
intended with the credit system, by allowing the FTC to offset no more 
than 90% of the AMT while the regular tax can be completely offset. The 
taxpayer is injured once again.
    Although Congress may be considering an extension allowing use of 
non-refundable child and education related credits against AMT, general 
business credits still cannot be used against the AMT. In example, for 
taxpayers that are affected, the benefits of the low-income housing 
credit are not allowed against the AMT--a Code provision that is 
essential for providing affordable houses in high-cost states.
    With increasing emphasis on equity-based compensation, the use of 
employee stock options as part of a worker's compensation package has 
become mainstream. Nearly 30 percent of those surveyed as part of the 
35th Index of Investor Optimism reported that they or their spouse had 
received options at some point in their career. Of this group, 43 
percent said options were part of their 2000 compensation and comprised 
approximately 11 percent of their total income last year. However, 
during this past year a hidden danger of employee stock options became 
apparent. When an employee exercises their right to acquire incentive 
stock options at a price below the fair market value of the shares on 
the date of exercise, the ``virtual income'' (difference in values) is 
included in the AMT base but not in the regular tax base. The date of 
exercise value sets the preference--regardless of what eventually 
happens with the value of the shares if they are not disposed of in the 
same calendar year as exercise. If the employee chooses to hold the 
stock for the one year period prescribed in the law to obtain capital 
gains treatment of the income, they may find themselves expected to pay 
taxes on income they never really receive.
    There have been many accounts in the media recently of taxpayers 
that have been injured by this ``preference'' because of dramatic 
volatility in the stock market this past year. We have heard from 
taxpayers and their advisors with egregious examples of phantom income 
far exceeding any economic benefit the taxpayers will ever receive, 
being taxed due to the provisions of the Alternative Minimum Tax 
(specifically IRC 55 and 56 and Regs. Sections 1.421 and 1.422). A 
taxpayer from San Luis Obispo, CA wrote,
          ``Ideally, ISOs works for both employer and employee. It 
        gives the employee an incentive to stay with the company and it 
        gives the company ways to reward the employee without 
        increasing salary costs--I exercised the stock options not 
        realizing that the price of the stock on the day I exercise 
        will be used to figure out my income WHETHER I ACTUALLY SELL 
        THE STOCK OR NOT. Now that the value of our stock has been 
        depressed over 60%, I am being taxed on income that was never 
        realized and have what is call a PHANTOM INCOME. This made my 
        effective tax rate to be 290%!''
    This certainly was not what Congress intended. We hear of people 
mortgaging or selling their homes to pay their year 2000 AMT. Others 
are so distraught they fear filing their 2000 tax returns because they 
cannot pay the liability. This certainly was not what Congress 
intended.
    Over three years ago, the National Commission on Restructuring the 
IRS found a direct connection between the complexity of the Internal 
Revenue Code and the difficulty of tax law administration and taxpayer 
frustration. The AMT tops our list of complex provisions, but our 
members cited two more that definitely cause problems each filing 
season and need your intervention to resolve.
    As frontline practitioners, we believe Congress could provide 
significant relief and make the job of the IRS easier by making 
immediate changes in three areas. First, Congress needs to repeal the 
alternative minimum tax for individuals. Second, phase-outs and phase-
ins need to be standardized. And finally, it needs to simplify the 
rules for qualifying for the Earned Income Credit.
    There are over twenty commonly encountered aspects of individual 
returns that require phase-out calculations. To mention a few: limits 
for deductible IRA contributions, limitations on the use of education 
credits, child credits, elderly credits, personal exemptions, itemized 
deductions, passive activity losses and credits. When taxpayers are 
told Congress has provided incentives or rate reductions for their 
benefit, and realize when they actually file their returns that they 
don't ``qualify'' for the benefits, they feel deceived.
    Each year the IRS lists the top errors in filed returns. Earned 
Income Credit issues make up almost half their list. Our members 
concur, and express dismay at the number of taxpayers that come to them 
asking for their assistance in ``working the system'' to obtain 
benefits to which they are not entitled. Our members don't participate 
in such activities. They are held to strict codes of professional 
conduct, from our own organization and from the IRS. This is not the 
case for the vast number of paid-preparers in this country.
    These three changes would provide significant relief to taxpayers, 
as well as allow the IRS to free up resources within the agency for 
other purposes. In addition to improving tax administration, reducing 
taxpayer burden by simplifying the tax laws will lower taxpayer 
frustration and improve voluntary compliance.
    Finally, we urge you to consider registration of all commercial tax 
preparers. This would level the playing field so that return preparers 
who submit paper returns are held to the same high standards as 
Electronic Return Originators and as Circular 230 practitioners--
Enrolled Agents, CPAs and attorneys.
Electronic Filing and the Current Filing Season
    In an effort to make electronic filing ``paperless'' IRS offered a 
program that would eliminate the need for taxpayers to send in a 
signature document through the use of an electronic signature Personal 
Identification Numbers (PIN). The program is not truly ``paperless'' 
since the practitioners that offer this service must retain a signature 
document and copies of the W-2 forms. However, numerous problems have 
been experienced this filing season with the PIN. Although most of the 
issues could be categorized as related to the start-up of the program, 
many of our members have pointed out that the current requirements for 
using taxpayer PINs are complicated enough that it is often easier to 
have taxpayers sign the form 8453 instead. Additionally, some 
practitioners report that as many as 10 percent of their e-filed 
returns have been rejected this year because of PIN problems.
    A new addition to the individual tax forms this year is the ``check 
the box'' limited authorization for paid preparers. We believe this 
addition will be beneficial for taxpayers and the IRS as their 
telephone assistors become better informed as to the types of inquiries 
it is to permit. An important step in streamlining the ability to 
resolve issues with the largest account management intensive 
organization in the country, the IRS. This leads into the final point I 
would like to raise today. Despite the recent reorganization efforts 
and technology improvements, and sometime because of them, the IRS 
continues to have severe problems with basic account management. Simple 
problems with client returns often entails hours or days of senseless 
struggle to get the right information to the right person at the 
agency. Faxed information is never received. Phone calls go unanswered. 
Valuable time is spent on hold waiting to talk to a person at the 
agency, who then has difficulties resolving problems quickly for lack 
of training and basic technology tools. The IRS is doing better, but it 
is a long way from resolving this basic problem first identified by the 
National Commission on Restructuring the IRS. Congress needs to stay 
the course with adequate resources for technological enhancements and 
strong oversight.
    I appreciate the Committee giving the National Association of 
Enrolled Agents the opportunity to talking about the 2001 filing season 
today. Commissioner Rossotti has a tough job and the organization is 
generally doing the best it can with the limited resources it has.
    Thank you.

                                


    Chairman Houghton. Thank you very much, Ms. Hill.
    I would like to ask a brief question of Mr. Ernst, so thank 
you very much for being here. We have talked a lot about 
security. We talked about it with the Commissioner. We talked 
about it amongst ourselves. And we know that the e-filed 
returns are a tough area to keep secure. How do you keep those 
returns secure in your office?
    Mr. Ernst. Well, we use a number of different methods to 
submit returns, both on the Internet and through our software 
products at retail and through our offices. In our office 
network, we have differing levels of restricted access and 
security controls for individuals who work for us. All returns 
go through a private network to a central location that is 
secure that we maintain. We do extensive testing of security at 
that facility as it aggregates returns from around the country 
from our various offices. Annually, we test our online 
electronic filing system for what we call ``hacker attacks'' or 
by attempting to break into the system ourselves in advance of 
the filing season and then on a random basis during the filing 
season to ensure that people cannot access our electronic 
filing system before or at the point we submit returns to the 
IRS filing centers.
    In addition to that, we maintain client records in a 
central data warehouse for ongoing storage purposes, and from 
that we have extensive controls around who within our 
organization can even access those records. And we keep it 
separate from our e-file system so that people can't get 
through our e-file system into those records.
    So we have built a fairly elaborate security system around 
the return data, both at the point of access initially when we 
acquire the data and when it is transmitted to our central 
repository before submission to the IRS.
    Chairman Houghton. Thanks very much. Mr. Coyne.
    Mr. Coyne. Thank you, Mr. Chairman.
    Ms. Hill, as you know, too often people who file for the 
EIC have their returns completed by practitioners that are paid 
filers. It is a very high percentage, I believe 44 percent. And 
also too often these filers, when there is a mistake, it 
ispointed out that it is fraud and abuse on behalf of the filer, the 
taxpayer that causes these mistakes and is not attributable in many 
instances to the fact that such an overwhelming number are filed by 
practitioners.
    Is it your testimony--I think I heard you say that one way 
to correct that is to make practitioners register?
    Ms. Hill. Well, first of all, a few years ago Congress did 
respond to the issue of preparers by having a special penalty 
for preparers of the EIC returns for due diligence. I believe 
the issue with electronic filing--not electronic filing but 
earned income credit has to do with the complexity of the 
provisions. There is a built-in incentive in the way that it is 
currently structured to falsify one's filing status. We have 
numbers of letters from our Members who say that people come 
into their office and expect them to play a game where two 
people who may be married to each other, at least parents of 
children, each want to file as head of household and reap 
maximum benefits to the earned income credit, when if they were 
filing as married, they would not get the same dollar amount or 
possibly not even be entitled to it. So there is a built-in 
incentive in the way it is structured to encourage people to 
falsify their status.
    Now, when someone comes into an office and tells a preparer 
here is their position, preparers that are regulated, CPAs and 
attorneys and enrolled agents, have a due diligence standard 
both to the IRS and to their professions that they cannot 
prepare those returns. And our Members complain that they are 
injured by the number of other paid preparers who are willing 
to do this, because the people leave the office and have it 
done somewhere else.
    Mr. Coyne. So do you think that there is a way to help out 
here by requiring registration beyond what already is required?
    Ms. Hill. I believe that if there was a registration 
similar to what is used with the electronic return originators, 
IRS would have a much quicker access in instances where they 
find lack of diligence with preparers. They would be able to 
encourage education where currently in most States--there are 
only two States that even encourage education of paid 
preparers.
    Mr. Coyne. Thank you.
    Chairman Houghton. Mrs. Thurman.
    Mrs. Thurman. Ms. Hill, just maybe to follow up on Mr. 
Coyne's question, because you make it sound like a lot of the 
earned income tax credit people that are trying to get these 
benefits are out here trying to game the system. What do you 
think is the real percentage of people trying to do that?
    Ms. Hill. I believe there are errors both directions, 
really. I believe there are a lot of honest mistakes with 
misinterpretations. A major misinterpretation that was 
available in January of this year when the preparers were 
trying to understand was called the high income and the 
household decision as to whether or not--who could take the 
child as a dependent and claim the EIC.
    I am not convinced that that was adequately resolved. So we 
may have returns in the system this year that expect it to not 
be available, but they were.
    Mrs. Thurman. Mr. Ernst, what is your feeling about this 
issue?
    Mr. Ernst. Well, I agree. This is a very complicated area 
of the law, and, in fact, much of what the IRS now requires in 
terms of due diligence has been modeled after the work that we 
originated in trying to address this issue at the front lines 
of our own system working with clients.
    Number one, many households in America do not fit the neat 
requirements that the tax law tries to describe. You know, 
household formation and deformation occurs with fluidity in 
America in a number of these situations. And so the issue often 
is not one of people trying to game the system per se, although 
that certainly occurs. Often it is about honest differences in 
households that don't fit neatly inside of the definitions that 
practitioners are asked to help our clients comply with.
    Mrs. Thurman. So would you say, then, on the other side of 
this, since we don't hear as much about this, the complexity of 
some of the tax shelter issues, some of the things that were 
brought up in the Wall Street Journal and some of the other 
issues, is it the same kind of situation?
    Mr. Ernst. I certainly don't think it is a situation where 
there is a loophole that practitioners are out helping 
taxpayers exploit, which is I think what you allude to. I think 
it is more of a situation of who qualifies as the primary 
support for a child, which is a key element in determining who 
gets to claim that child, and, therefore, who qualifies for the 
EITC can change because different family situations and 
differences of opinion of who is providing what kind of support 
are often dumped on our desks, and we are asked to sort that 
out and figure out who qualifies for what kind of credits.
    Mrs. Thurman. So there is kind of a difference going on on 
the other side.
    First of all, let me suggest to you that I thank you for 
doing what you have done with the Department of Health and 
Human Services on the SCHIP program. I think that is a 
wonderful thing that you have done there. We need--Ms. Hill, 
you might want to let your folks know about that, because I 
think it really was a really good way to get across to low-
income folks that need this program that that is available to 
them.
    Ms. Hill, I thought your testimony particularly on the AMT 
and your--you know, you kind of gave us an outline of several 
different people and how they interacted with the AMT. If we 
were not able to do anything about the AMT, which is looking 
less and less this year in some of these tax bills, some of the 
areas that you described--the medical issue and some of those--
if there were something we could do, because certainly these 
stories are just really very compelling. Could you give us, 
besides the one that you mentioned on the health care, the 
gentleman that took money out, where some others areas with AMT 
are where you can see some extreme problems that we are facing 
that we might be able to help in maybe a separate kind of bill? 
And, Mr. Ernst, if you would like to jump in there, too, I 
would appreciate it, because I think these examples are 
extremely--just kind of pull at your heart when you read this 
as compared to what is going on right now in total repeal.
    Ms. Hill. A lot of the media coverage right now has to do 
with incentive stock options. The taxpayers who did not 
understand equity-based compensation, who thought that this was 
the best thing in the world, and all of a sudden they find out 
later that the amount of value on the day they exercised stock 
got to be included in their alternative minimum taxable income, 
even though the stock may have little or no value currently. I 
don't think the law ever intended this. The concept of the 
alternative minimum tax, back when it was restructured in 1986, 
had to look at the economic income, and the concept is it 
realized or recognized. And when you never realize it, should 
it ever be recognized gets to be the issue on this.
    I don't know that there is something that can quickly be 
done to resolve that. I think to affect the largest number of 
people--and I certainly wouldn't want to eliminate equity-based 
compensation and incentive stock options from the system. But I 
think you can affect the largest number of people by looking at 
the benefits of eliminating those Schedule A itemized deduction 
type preferences.
    For example, medical expenses, people don't do them to 
create a tax shelter. Having children and not being able to 
take the exemption for your children against alternative 
minimum tax, children are not a tax shelter.
    So small steps, eliminating the children--putting the 
children back into the exemption base for AMTI, allowing the 
non-refundable credits to be used, that provision sunsets at 
the end of this year. If something isn't done, all the talk of 
families who are benefiting from the child credit, the 
dependent care credit, will get no benefit at all. They will 
see their taxes increase.
    Mr. Ernst. You know, we would be happy to offer you a 
number of those types of situations that we think could have 
the greatest impact at the least amount of cost.
    Mrs. Thurman. Mr. Chairman, I noticed in their testimony--
and it is one of the things that I am very concerned about, and 
maybe Ms. Hill said it--the credibility that we have, and when 
you take something, what you have been promised or what you 
believe is out there to be promised, and then to run up against 
this, we have a problem in what we are saying to folks at home. 
And I think that is a realconcern for some of us, and 
especially in some of these situations that I think have been described 
today. So we thank you for bringing those to our attention.
    Ms. Hill. Thank you.
    Chairman Houghton. Well, thanks. Yes, AMT started out as a 
beauty queen, and now it has ended up as a monster. Obviously, 
this whole wave is coming in, and we have got to be careful.
    Any ideas, any thoughts you have on this, because we are 
going to be wrestling with this, whether it is this year or 
this month or maybe next year, and we have got to have the best 
advice you possibly can give.
    Ms. Hill. It is insidious. It mutated.
    Chairman Houghton. Yes.
    Ms. Hill. That is what happened.
    Chairman Houghton. Absolutely. Well, thank you very, very 
much. We certainly appreciate it.
    [Whereupon, at 4:05 p.m., the hearing was adjourned.]
    [Submission for the record follows:]

American Institute of Certified Public Accountants,
                                  Washington, DC 20004-1081
                                                     April 17, 2001
The Honorable Amo Houghton, Jr.
Chairman
Subcommittee on Oversight
Committee on Ways and Means
1136 Longworth House Office Building
Washington, D.C. 20515

RE: Hearing on the 2001 Filing Season Held on April 3, 2001

    Dear Mr. Chairman:
    The American Institute of Certified Public Accountants (AICPA) 
appreciates the opportunity to submit this letter for inclusion in the 
Subcommittee on Oversight's record for the hearing on the 2001 filing 
season, held on April 3, 2001.
    The AICPA is the national, professional organization of certified 
public accountants comprised of more than 350,000 members. Our members 
advise clients on federal, state, local, and international tax matters 
and prepare income and other tax returns for millions of Americans. 
They provide services to individuals, not-for-profit organizations, and 
small and medium-sized businesses, as well as America's largest 
businesses. It is from this broad base of experience that we offer our 
comments on the 2001 filing season.
    There has been a great deal of discussion during the 2001 filing 
season surrounding the recent lack of IRS enforcement activity. We are 
concerned with the negative impact this publicity is likely to have on 
voluntary compliance. As we have said before, it is vital to our 
voluntary compliance tax system that this reduction of audit and 
collection activity must be reversed immediately, and that the 
resulting increase in enforcement be widely publicized. If the IRS is 
unable to actively administer and enforce the tax law, serious damage 
to the effectiveness of our tax system results. Those who normally 
flaunt the law will continue to do so at no risk; those who in the past 
have reluctantly complied only because of a fear of enforcement may 
become noncompliant; and, normally compliant taxpayers will lose faith 
in the system and may be tempted to become noncompliant as well. For 
our voluntary tax compliance system to operate effectively, taxpayers 
must perceive that everyone pays their fair share, and that if they do 
not do so voluntarily, they will be forced to do so by the IRS.
    To date the AICPA has heard very little from our members regarding 
the 2001 filing season. It appears that this year's filing season is 
progressing without any major problems. Historically we have not 
solicited input from our members regarding the positives and negatives 
of a filing season until after the season has ended; and therefore, it 
is not unusual to receive little feedback at this point unless a major 
systemic problem has occurred. However, one issue of concern that has 
come to our attention revolves around the electronic filing of 
partnership returns. We discuss this issue in greater detail below. In 
addition, for the benefit of the Subcommittee, we are pleased to 
provide some general observations on filing season issues related to 
electronic filing of individual returns, the Service Center 
realignment, fiscal year reform for small businesses, and tax 
simplification.
Electronic Filing of Partnership Returns
    As you are aware, section 1224 of the Taxpayer Relief Act of 1997 
modified section 6011(e) to require partnerships with more than 100 
partners to file their returns on magnetic media (which the IRS and 
Treasury have interpreted to mean electronically). The effective date 
of this provision applied to partnership tax years beginning after 
December 31, 1997. However, the final regulations are effective for 
partnership taxable years ending on or after December 31, 2000. Thus, 
returns for partnerships with more than 100 partners with December 31, 
2000 year-ends will be the first returns required to be filed 
electronically under this provision.
    Unfortunately, the AICPA and its members have been frustrated in 
our efforts to resolve a myriad of issues that have developed as CPAs 
prepare to file these Forms 1065 electronically. Although we 
acknowledge and appreciate the efforts of the IRS's Electronic Tax 
Administration (ETA) personnel during this process, these employees do 
not appear to have the authority or the ability to resolve many of the 
issues we have raised in a timely manner. For example, many issues will 
require systems changes that cannot be made at this time, or even in 
the near future. Furthermore, there was already insufficient 
coordination between the Service, practitioners and the major software 
developers, resulting in software that does not support all forms and 
schedules necessary for electronic filing. This leaves practitioners 
and partnerships in a position where they cannot file the entire return 
electronically, raising the question of whether or not the IRS will 
allow unsupported forms and schedules to be filed on paper while the 
bulk of the return is filed electronically. The answer we are given by 
the IRS, quite simply, is ``it depends on which form or schedule is 
involved.''
    The confusion and uncertainty revolving around the electronic 
filing of partnership returns has led to a great deal of frustration on 
the part of our members. Many have applied for extensions of time to 
file for partnership returns that would have otherwise been timely 
filed. Of greater concern, however, is the impact of these problems on 
future electronic filing programs for business returns. Taxpayers 
should not be expected to, much less required to file returns 
electronically until the IRS has a system in place to handle these 
returns. The IRS should work closely with the practitioner community 
and the software developers to ensure that future programs can satisfy 
those needs. Without effective decision making, adequate resources, and 
a good working partnership with the practitioner community, we believe 
that the future of electronic filing of business returns will be 
disappointing and mutually frustrating to the business community and 
the IRS.
Electronic Filing of Individual Returns
    Commissioner Charles O. Rossotti testified at the Subcommittee's 
hearing on April 3, 2001 that ``Electronically-filed returns improve 
service for taxpayers and boost productivity by reducing errors, 
speeding refunds, and reducing labor costs.''
    He also described improvements the IRS has made, or expects to 
make, in the electronic filing area, including (1) expansion of the 
types of forms and schedules accepted by the 1040-e-file program for 
next year; (2) the Service's apparent success in testing of a Personal 
Identification Number (PIN) code as to the taxpayer's signature, 
eliminating the need to file the paper jurat; and (3) the testing of an 
Internet-based pilot program for businesses to pay federal taxes on 
line.
    Although Commissioner Rossotti feels confident that expansion of 
the 1040-e-file program will open up eligibility to 99.1 percent of all 
individual taxpayers by the 2002 filing season, we must remain cautious 
in an environment where the experiences of AICPA members with 
electronic filing have historically been disappointing. During prior 
filing seasons, we have expressed disappointment in the inability of 
the electronic filing program to accept all forms and all schedules. 
This inability to accept all forms and all schedules, including white 
paper schedules, elections and related compliance disclosures, has been 
seen by us as the greatest barrier to widespread use of electronic 
filing by AICPA members (who tend to prepare the most complex returns). 
Given that effective disclosure is key to the modern tax reporting 
system, it is unrealistic to believe that electronic filing can be used 
for complex returns until all forms and all schedules, including white 
paper schedules, elections and compliance disclosures, can be filed 
electronically.
    Many CPA tax return preparers cannot be certain that all of the 
individual returns they prepare can be filed electronically. Given that 
uncertainty, the vast majority of these preparers have elected not to 
use the electronic filing system at all, because to file some returns 
electronically, but not all, would require two separate return 
processing, review and filing procedures in their offices, increasing 
their workloads and costs. Only when it is clear that all forms and all 
schedules can be accurately filed electronically will most CPAs begin 
the natural migration from filing paper returns to filing electronic 
returns.
    The AICPA fully supports expanding electronic filing. However, we 
remain concerned that electronic tax administration in general, and 
electronic filing in particular, fall short of the IRS's long range 
goals of converting manual processes to electronic format. We are 
dissatisfied with attempts both to partner with the IRS in promoting 
electronic filing to our membership and in explaining to the IRS the 
effects of the current system's limitations on our constituency. As the 
Service shifts its focus from the electronic filing of individual 
returns to the electronic filing of business returns, involving, 
listening to, and responding to the various stakeholder groups will be 
all the more critical. Unfortunately, our experience to date as a 
stakeholder group in this matter has not been positive.
Service Center Realignment
    The Internal Revenue Service Centers are in the throes of a massive 
realignment, with redistribution of the Service Centers' workload 
scheduled to be completed by 2002. On October 1, 2000, the Service 
Centers were converted to ``campuses.'' Individual master filing 
submission processing will eventually be handled by Andover, Atlanta, 
Austin, Fresno, Kansas City, Memphis, Brookhaven, and Philadelphia. The 
Ogden and Cincinnati campuses are scheduled to become processing 
centers for business master file submissions. Five of the campuses will 
handle account management and compliance service functions for the IRS 
Small Business/Self-Employed Division, and the remaining five will 
handle similar functions for the IRS Wage and Investment Division.
    It is extremely important that the ongoing transition of Service 
Center workflow should appear as seamless as possible to the taxpaying 
public. However, the preliminary feedback we are receiving from CPAs 
during the 2001 filing season indicate that the realignment is causing 
some confusion among some taxpayers and practitioners. Part of this 
confusion arises from the largely unexplained changes in IRS filing 
addresses. We believe that the Service Center realignment, like the 
future of electronic filing, is a matter that the Subcommittee on 
Oversight should closely monitor.
Fiscal Year Reform for Small Businesses
    There is an unintended problem created by the current tax rules 
requiring year-end conformity for a majority of businesses reporting 
their results to owners for inclusion in the owner's annual tax 
calculation. Because they apply to every small business in the country, 
these rules create unnecessary, disruptive and unproductive demands on 
the majority of businesses and their advisors during a few months every 
year. The unevenness of the workload during December and the 
traditional January-April filing season is substantial. This ``workload 
compression'' often negatively affects those who can least afford it--
start-up businesses and small businesses that create a solid foundation 
for the American economy. The requirement that these entities use a 
calendar year end for tax purposes means that in addition to other 
unavoidable calendar year-end responsibilities, they must also close 
their books, produce annual financial statements for their banks, 
conclude financial statement audits or reviews, and prepare tax returns 
and tax information for their owners (partners and S corporation 
shareholders) by April 15.
    Workload compression is an unnecessary burden on small businesses, 
and can be alleviated with modest changes to the tax system. In order 
to mitigate this burden, the AICPA recommends amending the Internal 
Revenue Code to allow qualified small businesses to elect a year-end 
with any-month ending from April through December.
Tax Simplification
    For many years, the AICPA has been outspoken with respect to the 
need to reduce tax law complexity, especially from the perspective of 
the administrability of the tax law. We believe that these issues have 
a direct impact on the nation's filing season each year. Congress 
recognized the tax administrability issue when it wrote section 4021 of 
the IRS Restructuring and Reform Act of 1998 (RRA '98) which states 
``It is the sense of Congress that the Internal Revenue Service should 
provide the Congress with an independent view of tax administration, 
and that during the legislative process, the tax-writing committees of 
Congress should hear from front-line technical experts at the Internal 
Revenue Service with respect to the administrability of pending 
amendments to the Internal Revenue Code of 1986.'' As the Subcommittee 
on Oversight reviews the results of the 2001 filing season, we urge the 
panel to remain cognizant of the difficult task Congress imposes on the 
Service through the enactment of complex and constantly changing tax 
laws.
          * * * * *
    The AICPA appreciates this opportunity to offer our comments on the 
2001 filing season. We would be pleased to discuss this letter with the 
Subcommittee on Oversight. If you have any questions, please contact me 
at (661) 663-8815 or [email protected]; Deborah J. Pflieger, Chair of our 
Relations with IRS Committee, at (202) 414-1018, or 
[email protected]; or Benson S. Goldstein, AICPA 
Technical Manager, at (202) 434-9279 or [email protected].
            Sincerely,
                                         Pamela J. Pecarich
                                     Chair, Tax Executive Committee

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