[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]



 
  FREE ELECTRONIC FILING AND NATIONAL TAXPAYER ADVOCATE ANNUAL REPORT

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

                                HEARING

                               before the

                       SUBCOMMITTEE ON OVERSIGHT

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                           FEBRUARY 13, 2003

                               __________

                            Serial No. 108-5

                               __________

         Printed for the use of the Committee on Ways and Means












                       U. S. GOVERNMENT PRINTING OFFICE
87-113                         WASHINGTON : 2003
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                      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
J.D. HAYWORTH, Arizona               KAREN L. THURMAN, Florida
JERRY WELLER, Illinois               LLOYD DOGGETT, Texas
KENNY C. HULSHOF, Missouri           EARL POMEROY, North Dakota
SCOTT McINNIS, Colorado              MAX SANDLIN, Texas
RON LEWIS, Kentucky                  STEPHANIE TUBBS JONES, Ohio
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia

                    Allison H. Giles, Chief of Staff
                  Janice Mays, Minority Chief Counsel

                                 ______

                       Subcommittee on Oversight

                    AMO HOUGHTON, New York, Chairman

ROB PORTMAN, Ohio                    EARL POMEROY, North Dakota
JERRY WELLER, Illinois               GERALD D. KLECZKA, Wisconsin
SCOTT McINNIS, Colorado              MICHAEL R. McNULTY, New York
MARK FOLEY, Florida                  JOHN S. TANNER, Tennessee
SAM JOHNSON, Texas                   MAX SANDLIN, Texas
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia

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 February 6, 2003, announcing the hearing.............     2

                               WITNESSES

Internal Revenue Service:
  Hon. Robert E. Wenzel, accompanied by Terry Lutes, Director, 
    Electronic Tax Administration................................     6
  Nina E. Olson, National Taxpayer Advocate......................    30

                                 ______

Electronic Tax Administration Advisory Committee, Kevin Belden...    19
Free File Alliance, Michael F. Cavanagh..........................    25

                       SUBMISSION FOR THE RECORD

Americans for Tax Reform, Grover Norquist, statement.............    44






















  FREE ELECTRONIC FILING AND NATIONAL TAXPAYER ADVOCATE ANNUAL REPORT

                              ----------                              


                      THURSDAY, FEBRUARY 13, 2003

             U.S. House of Representatives,
                       Committee on Ways and Means,
                                 Subcommittee on Oversight,
                                                    Washington, DC.

    The Subcommittee met, pursuant to notice, at 3:00 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) 225-1721
FOR IMMEDIATE RELEASE
February 06, 2003
No. OV-1

                     Houghton Announces Hearing on

                  Free Electronic Filing and National

                    Taxpayer Advocate Annual Report

    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 Free Electronic Filing and the 
recently issued Annual Report of the National Taxpayer Advocate. The 
hearing will take place on Thursday, February 13, 2003, in the main 
Committee hearing room, 1100 Longworth House Office Building, beginning 
at 3:00 p.m.
      
    In view of the limited time available to hear witnesses, oral 
testimony at this hearing will be from invited witnesses only. 
Witnesses will include Internal Revenue Service (IRS) Acting 
Commissioner Robert Wenzel, the National Taxpayer Advocate Nina Olson, 
Electronic Tax Administration Director Terence Lutes, and Electronic 
Tax Administration Advisory Committee Chairman Kevin Belden. 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 Subcommittee will hold a hearing to evaluate the legislative 
recommendations of the National Taxpayer Advocate and the leading 
problems faced by taxpayers, as described in the Taxpayer Advocate's 
Annual Report. In addition, the Subcommittee will hear testimony from 
IRS officials concerning the IRS Free Filing initiative. Free Filing, a 
partnership with the private sector consortium of electronic tax 
preparers is designed to increase the number of taxpayers filing 
electronically.
      
    In announcing the hearing, Chairman Houghton said: ``We will hear 
about the new initiative that allows more taxpayers to file their taxes 
for free over the Internet. This will substantially increase the number 
of people filing their taxes electronically--benefiting taxpayers and 
the IRS. I also look forward to a discussing ways to improve our tax 
laws and streamline the functioning of the IRS with Nina Olson, 
National Tax Payer Advocate.''
      

FOCUS OF THE HEARING:

      
    The hearing will focus on the IRS Free Filing initiative, 
electronic tax administration, and the National Taxpayer Advocate's 
annual report.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Please Note: Due to the change in House mail policy, any person or 
organization wishing to submit a written statement for the printed 
record of the hearing should send it electronically to 
[email protected], along with a fax copy to 
(202) 225-2610, by the close of business, Thursday, February 27, 2003. 
Those filing written statements who wish to have their statements 
distributed to the press and interested public at the hearing should 
deliver their 200 copies to the Subcommittee on Oversight in room 1136 
Longworth House Office Building, in an open and searchable package 48 
hours before the hearing. The U.S. Capitol Police will refuse sealed-
packaged deliveries to all House Office Buildings.
      
    Note: All Committee advisories and news releases are available on 
the World Wide Web at http://waysandmeans.house.gov.
      
    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four 
business days notice is requested). Questions with regard to special 
accommodation needs in general (including availability of Committee 
materials in alternative formats) may be directed to the Committee as 
noted above.

                                 

    Chairman HOUGHTON. The hearing will come to order. Good 
afternoon everybody, and we are delighted that you are here. I 
am flanked by two very distinguished people--not franked--and 
we are going to learn about an innovative agreement that the 
Internal Revenue Service (IRS) has entered into with the 
private sector to bring free electronic filing to millions of 
taxpayers this year, the Free File Initiative, and I want to 
believe that both government and taxpayers are going to 
benefit. Many taxpayers will no longer have to pay an average 
of $12.50 per return to e-file, and they will receive tax 
refunds on an average of 14 days instead of 4 to 6 weeks. The 
government is going to benefit from reduced errors in 
processing costs. Last year, 47 million taxpayers filed their 
tax returns electronically, and the initiative should lead to 
many millions of additional e-filed returns.
    So, before us today on our first panel is one of America's 
most dedicated public servants, Bob Wenzel, who is now the 
Acting Commissioner of the IRS. Mr. Wenzel was nearing what he 
thought was the end of a 35-year career with the IRS when the 
outgoing Commissioner, Charles Rossotti, asked him to 
reconsider his retirement plans and twisted his arm a little 
bit. So, to his credit and to our great benefit, Mr. Wenzel 
took up Mr. Rossotti's offer and served an additional 5 years 
as Deputy Commissioner. It has now been over 40 years since Bob 
Wenzel first joined the IRS. Few individuals can point to such 
a long and distinguished career in public service. He is a 
great example for us all.
    Now, also on our agenda is a review of the National 
Taxpayer Advocate's (NTAs) annual report to Congress. As was 
the case last year, Nina Olson's report is an excellent and 
invaluable resource, and due to the leadership of Ms. Olson and 
her predecessors, the Taxpayer Advocate has become the tax 
system's most effective guarantor of taxpayer procedural 
rights. She has brought us a number of thoughtful 
recommendations that we are going to review today.
    So, now I would like to yield to a good friend of mine, the 
new Subcommittee Ranking Member and the best-looking Ranking 
Member we have had in many years since Mr. Pickle, Mr. Pomeroy 
of North by-God Dakota.
    [The opening statement of Chairman Houghton follows:]
 Opening Statement of the Honorable Amo Houghton, a Representative in 
  Congress from the State of New York, and Chairman, Subcommittee on 
                               Oversight
    Good afternoon. Today we are going to learn about an innovative 
agreement that the IRS has entered into with the private sector to 
bring free electronic filing to millions of taxpayers this year: the 
``Free File'' Initiative. Both government and taxpayers will benefit. 
Many taxpayers will no longer have to pay an average of $12.50 per 
return to e-file and they will receive tax refunds in an average of 14 
days, instead of four to six weeks. The government will benefit from 
reduced errors and processing costs. Last year, 47 million taxpayers 
filed their tax returns electronically, and the Initiative should lead 
to millions of additional e-filed returns.
    Before us today on our first panel is one of America's most 
dedicated public servants, Bob Wenzel, who is now the Acting 
Commissioner of the IRS. Mr. Wenzel was nearing what he thought was the 
end of a thirty-five year career with the IRS when incoming 
Commissioner Charles Rossotti asked him to reconsider his retirement 
plans. To his credit--and to our great benefit--Mr. Wenzel took up Mr. 
Rossotti's offer and served an additional 5 years as Deputy 
Commissioner. It has now been over 40 years since Bob Wenzel first 
joined the IRS. Few individuals can point to such a long and 
distinguished career in public service. He is truly an example for us 
all.
    Also on our agenda is a review of the National Taxpayer Advocate's 
Annual Report to Congress. As was the case last year, Nina Olson's 
report is an excellent and invaluable resource. Due to the leadership 
of Ms. Olson and her predecessors, the Taxpayer Advocate has become the 
tax system's most effective guarantor of taxpayer procedural rights. 
She has brought us a number of very thoughtful recommendations that we 
will review today.
    I would now like to yield to a good friend of mine, the 
Subcommittee's Ranking Member, Mr. Pomeroy from North Dakota.

                                 

    Mr. POMEROY. Mr. Chairman, I am overcome by an introduction 
of that nature. I want to congratulate you as you begin another 
year as Chairman of this Subcommittee on Oversight, and your 
agenda for the very first meeting, I think, is consistent with 
the leadership you have brought to oversight using the powers 
of this Subcommittee to explore how we can improve the Tax 
Code, how we can make it easier for individual tax filers, and 
how we can capture their feedback through the Taxpayer Advocate 
position, always working to improve the Tax Code, make it more 
fair and easier to comply with for the taxpayers of this 
country.
    I know of your own interest, Mr. Chairman, in tax 
simplification, and in a place where there are often many 
partisan issues that divide us, this ought to be our 
overarching topic that unites us, and I am very much looking 
forward to participating in bipartisanship initiatives with you 
as we seek to improve the Tax Code.
    I appreciate your recognition of Mr. Wenzel in light of the 
long and illustrious career he has offered on behalf of all of 
us. Congratulations to you, and it is a capstone achievement to 
serve as Acting Commissioner. Have you had that opportunity in 
the past, Mr. Wenzel?
    Mr. WENZEL. First time.
    Mr. POMEROY. Well, it is a very appropriate capstone on a 
career of great public distinction, and we appreciate your 
efforts. With that, let's hear from our witnesses, Mr. 
Chairman.
    [The opening statement of Mr. Pomeroy follows:]
 Opening Statement of the Honorable Earl Pomeroy, a Representative in 
                Congress from the State of North Dakota
    I am honored to have been elected as the Ranking Member on the Ways 
and Means Oversight Subcommittee. Working with Chairman Houghton, on a 
bipartisan basis, we will monitor the tax, health, Social Security, 
trade and human resource issues within the Committee's jurisdiction. 
This is a challenge I proudly accept.
    It is appropriate that our first hearing of the 108th Congress 
focus on the Internal Revenue Service. Clearly, the IRS must administer 
our tax laws in a fair and efficient manner and the Subcommittee is 
responsible for overseeing its operation. I look forward to today's 
discussion of the IRS' new tax return ``Free File Program'' and the 
Taxpayer Advocate's annual report to the Congress.
    The Free File Program is designed to provide low-income taxpayers 
with a no-cost way to prepare and electronically transmit their tax 
returns to the IRS. I support this initiative which is new for the 2003 
tax return filing season. As we proceed, I want to make sure that 
taxpayers have easy access to the Free File Program and that the 
initiative works as intended.
    Finally, I am pleased to receive the Taxpayer Advocate's Annual 
Report on IRS operations. I look forward to working with the 
Subcommittee to address the issues raised by this study. I am 
particularly interested in pursuing the legislative recommendation 
designed to better enable married couples, who own a farm or other 
small business, to file a simplified tax return. By simplifying the 
process of reporting, both spouses will be eligible for Social Security 
and Medicare benefits and avoid tax penalties for incorrect filings. I 
will continue to seek the assistance of my local Taxpayer Advocate from 
Fargo, North Dakota as the Subcommittee considers this issue.
    I thank Chairman Houghton for scheduling this important hearing and 
look forward to the testimony of the hearing witnesses.

                                 

    Chairman HOUGHTON. Thank you very much. Would you like to 
make an opening statement, Mr. Portman?
    Mr. PORTMAN. Mr. Chairman, I appreciate just a very brief 
one to say I am very excited about the Free Filing initiative. 
The IRS Commission, which met for 2 years on the issues of how 
to reform the IRS, determined after a lot of research on the 
filing problems that it was far more effective and efficient to 
file electronically. In fact, we found that not only was it 
less than half the cost of filing by paper, but the error rate 
was so much less. At that time the error rate was 22 percent; 
11 percent by the taxpayer, 11 percent by the IRS. The error 
rate with electronic filing was 1 percent or less. That alone 
has significant cost savings not just for the IRS, but also for 
the taxpayer the downstream costs were enormous. So, I am just 
delighted that after going back and forth on this issue for 
really the last 4 years, we finally have an understanding with 
the private sector that we will be able to offer free filing 
that covers 60 percent of all taxpayers.
    This is a breakthrough, Mr. Chairman, and I think 
absolutely essential if we are going to come close to meeting 
our target, which is quite ambitious, of 80 percent of filers 
are filing electronically. We are now, I think, at about 36 or 
37 percent. We will hear more about that.
    I just wanted to commend the Service for finally working 
with the private sector, and commend the private sector folks 
who have been part of this in coming up with an arrangement 
which I think will be very helpful to meeting our shared goals. 
Thank you, Mr. Chairman.
    Chairman HOUGHTON. Thank you very much. Ms. Tubbs Jones, 
would you like to make a statement?
    Ms. TUBBS JONES. Well, I would like, thank you, Mr. 
Chairman. I would like--good afternoon. This is my first 
Subcommittee on Oversight hearing. I have managed to visit 
Health today, this afternoon, and I am serving on Social 
Security and Select Revenue Measures. I am glad to have an 
opportunity to meet you, Mr. Wenzel, and you, Mr. Lutes, as 
well; look forward to having an opportunity to get to know this 
process a little more. I get lots of IRS calls in my 
congressional office, so I will be glad to know who I can pick 
up the phone and call and get some results. So, thank you very, 
very much. Mr. Chairman, looking forward to serving with you, 
sir.
    Chairman HOUGHTON. Thank you very much.
    Mr. Kleczka.
    Mr. KLECZKA. Mr. Chairman, I don't have any opening comment 
except to say it is good to be back to the Subcommittee on 
Oversight after an absence serving on the Committee on Budget, 
so, Mr. Chairman, you will have to put up with me for a couple 
of years.
    Chairman HOUGHTON. Okay. That is great. Well, now I would 
like to call the first panel, who are already there. Mr. Robert 
Wenzel, who, as we said earlier, is the Acting Commissioner, 
and then Mr. Terry Lutes, who is Director of the Electronic Tax 
Administration (ETA) of the IRS. I don't think you are going to 
be giving any testimony, but you will be here; is that right, 
Mr. Lutes?
    Mr. LUTES. Yes.
    Chairman HOUGHTON. Okay. Mr. Acting Commissioner, the floor 
is yours.

      STATEMENT OF THE HONORABLE ROBERT E. WENZEL, ACTING 
 COMMISSIONER, INTERNAL REVENUE SERVICE, ACCOMPANIED BY TERRY 
         LUTES, DIRECTOR, ELECTRONIC TAX ADMINISTRATION

    Mr. WENZEL. Mr. Chairman and distinguished Members of the 
Subcommittee, thank you for this opportunity to discuss the 
joint IRS-private sector Free File Initiative. Also let me 
thank you, Mr. Chairman and Members of the Subcommittee, for 
your leadership and efforts to promote electronic filing and 
make it available to more taxpayers.
    As you mention, accompanying me today is Mr. Terry Lutes, 
our IRS Director of Electronic Tax Administration.
    As you know, the IRS Restructuring Reform Act of 1998 
mandated that at least 80 percent of individual tax returns be 
filed electronically by the year 2007. We have certainly made 
progress toward that goal. Last year 35.6 percent of individual 
returns were e-filed, and this year we expect the number to 
climb to over 40 percent. Nevertheless, even with a 16-percent 
annual growth rate, the IRS would fall short of the 80-percent 
goal.
    Now, to meet this ambitious objective, we must make it not 
only technologically possible, but also attractive for 
practitioners and taxpayers to make a permanent change to 
electronic filing. Cost to the taxpayer has been a barrier to 
further e-file growth. For years the IRS and the tax community 
would grapple with this issue and had very little success 
resolving it. That has changed dramatically with Free File.
    Free File's roots can be found in the President's fiscal 
year 2002 management agenda, which championed e-government 
services. We were also guided by two principles; that is, no 
one should have to pay to file, and secondly, the IRS should 
not get into the software business. Through Free File, 
America's taxpayers can now access free online tax preparation 
and electronic filing services through irs.gov, or 
firstgov.gov. Free File will be available this year through 
April 15, and some companies will also offer free services 
through October 15 for taxpayers needing an extension.
    The partnership agreement requires that the Alliance as a 
whole provide free tax preparation and filing to at least 60 
percent of individual taxpayers, or approximately 78 million 
Americans. Many are taxpayers who prepare their own taxes and 
still file paper returns.
    Initial Free File reports are very encouraging. As of 
February 5, Alliance Members have processed and transmitted 
almost 639,000 tax returns. This represents approximately 23 
percent of the total 2.9-million-e-filed returns.
    Mr. Chairman, we are also absolutely committed to 
protecting taxpayers privacy and confidentiality. Taxpayer 
information and data will be protected, and the Alliance 
members must adhere to IRS' strict privacy standards. We even 
required each participating company to obtain both a privacy 
and security seal certification.
    We also took into consideration taxpayers who do not have 
access to a computer. Low income should never be a barrier to 
quality service, including free electronic filing. Free tax 
preparation and e-file are available in many communities at our 
Volunteer Income Tax Assistance and Tax Counseling for the 
Elderly sites. Volunteers there help prepare basic tax returns 
for low-income taxpayers, the disabled, the elderly and non-
English speakers. Individual taxpayers with incomes of $35,000 
or less can also receive free income tax return preparation and 
e-file help at IRS tax assistance centers around the country. 
We extend this courtesy return preparation to all taxpayers 
also qualifying for the earned income tax credit (EITC).
    Mr. Chairman, I also would like to stress that taxpayers 
are under no obligation to purchase any product from the 
software company or to use refund anticipation loans. Obtaining 
a fee-based product is a decision left to the individual 
taxpayer. The Internal Revenue Service as well as many of the 
Alliance company Web sites also reminds taxpayers that those 
who e-file and use direct deposit often receive their refunds 
in 10 days or less.
    Mr. Chairman, in conclusion, Free File is a breakthrough 
for America's taxpayers. We are putting e-file within reach of 
millions more taxpayers and delivering on our President's 
commitment to put the needs of citizens first. This new program 
may be called Free File, but what it gives to millions of 
taxpayers and our government is invaluable. Thank you.
    [The prepared statement of Mr. Wenzel follows:]
   Statement of the Honorable Robert E. Wenzel, Acting Commissioner, 
                        Internal Revenue Service
INTRODUCTION
    Mr. Chairman, and distinguished Members of the Subcommittee, thank 
you for this opportunity to discuss the joint IRS-private sector ``Free 
File'' initiative. Accompanying me today is Mr. Terry Lutes, IRS' 
Director of Electronic Tax Administration.
    Before I begin my formal testimony, let me thank you, Mr. Chairman, 
for your leadership and efforts to promote electronic filing and make 
it available to more taxpayers. Working closely with you, the 
Subcommittee, the Administration and the private sector, we are making 
steady progress to achieve congressionally mandated e-file goals and to 
provide service to taxpayers on a par with the very best private sector 
companies. Free File is a big step in that direction.
BACKGROUND
    On January 16, 2003, the Treasury Department, the Office of 
Management and Budget (OMB) and the IRS launched a free on-line tax 
preparation and filing service called Free File. It was made possible 
through a partnership agreement between the IRS and the Free File 
Alliance, LLC--a private sector consortium of tax software companies. 
It could not have come a minute too soon.
    The IRS Restructuring and Reform Act of 1998 (RRA 98) mandated that 
at least 80 percent of individual tax returns be filed electronically 
by 2007. Electronic filing's benefits are clear and compelling. 
Taxpayers and the IRS find it more convenient and economical and less 
time consuming to do business electronically rather than sending paper 
through the mail. Moreover, the government saves money, but the real 
benefits are conveyed to the taxpayer. They include reduced preparation 
time, faster refunds, accuracy of returns and acknowledgment of return 
receipt.
    We have certainly come a long way from e-file's humble beginnings. 
It began as a pilot program in 1986 in three metropolitan areas with 25 
thousand returns filed electronically--a miniscule .02 percent of all 
returns filed. However, e-file's growth literally exploded, and last 
year, 35.6 percent of returns were e-filed. This year, we expect that 
over 40 percent of all individual returns will be filed electronically.
    Taxpayers can now e-file from their home computers or by using an 
authorized provider. For those eligible, TeleFile, the IRS file-by-
telephone system, is the easiest way to go. To attract potential e-
filers, we have added new features and enhancements, such as direct 
deposit of refunds and payments by credit cards or electronic funds 
withdrawal. Taxpayers in 37 States and the District of Columbia can e-
file their Federal and State tax return in one transmission to the IRS. 
Taxpayers who need a filing extension can get one automatically by 
making a simple telephone call. We are systematically removing the last 
few barriers to e-file to open up eligibility to almost every taxpayer. 
For example, we recently published final regulations replacing the 
temporary ones published last year, enabling virtually all 1040 forms 
and schedules to be filed electronically, without any paper signature 
document.
    Mr. Chairman, I also want to note that the IRS is making progress 
to better serve the business community's electronic tax administration 
(ETA) needs. During FY 2002, over $1.6 trillion came in electronically 
through the Electronic Federal Tax Payment System, which now includes 
an online option. In FY 2002, we received more than 3.16 million 941 e-
file program returns (Employer's Quarterly Federal Tax Return) and 
863,000 returns for 941 TeleFile and On-Line Filing Programs. In FY 
2002, over 320,000 businesses used the 940 e-file Program (Employers 
Annual Federal Unemployment Tax Return), and more than 21,000 
partnerships chose 1065 e-file (U.S. Return of Partnership Income) in 
FY 2002.
    We are also working on new initiatives to develop and mature other 
additional electronic products and services for this important taxpayer 
segment. For example, later this spring, businesses will be able to 
apply for an Employer Identification Number online through irs.gov. We 
are also building a new e-file system that will grow and serve 
taxpayers for years to come. Scheduled to start in 2004, it will 
address the current system's limitation. For example, it will accept 
complex business returns, such as 1120s (corporate income tax returns), 
eliminate software barriers and resolve standardization issues, such as 
reject code and validations.
    Clearly, we have made considerable progress towards RRA 98's ETA 
goals. In addition, improved electronic exchange of information with 
taxpayers and practitioners also advances all three of the IRS' 
strategic goals: service to each taxpayer, service to all taxpayers and 
productivity through a quality work environment. In its December 2002 
report to you on the 2002 Filing Season, the General Accounting Office 
stated:

        ``The number of individual tax returns filed electronically 
        grew from about 40.2 million in 2001 to about 46.9 million in 
        2002, an increase of about 16.5 percent, and the percentage of 
        individual tax returns filed electronically reached 35.9 
        percent. This 16.5-percent increase over the number of returns 
        received electronically in 2001 was more than the IRS's goal of 
        15 percent and continued the upward trend in the number of 
        returns filed electronically since 1995. IRS took some positive 
        steps, including an increased focus on taxpayers and tax 
        practitioners who prepare returns on computer but file on 
        paper, that helped it achieve that increase and that could lead 
        to further increases in the future.''

    Nevertheless, even with a 16 percent annual growth rate, the IRS 
would fall short of Congress' extremely challenging 80-percent goal. To 
meet this ambitious objective, we must make it not only technologically 
possible, but also attractive to both practitioners and taxpayers to 
make a permanent change from paper to electronic filing. For example, 
to build practitioner interest, the IRS will offer later this year a 
suite of electronic services, such as disclosure authorization, 
transcript delivery and account resolution, to tax practitioners who 
file a certain number of returns electronically. The Electronic Tax 
Administration Advisory Committee (ETAAC) observed in its 2002 report 
to Congress that these types of e-services are a major incentive for 
practitioners to e-file their clients returns. The Administration also 
undertook several initiatives to build taxpayer interest. For example, 
in addition to Free File, the President proposed a major incentive in 
his FY 2004 budget that would extend to April 30 the due date for 
returns filed and paid electronically.
    However, e-file cost was a far more complex problem. IRS research 
and GAO reports identified cost as an impediment to further e-file 
growth. Notwithstanding the many advantages of preparing and filing a 
tax return electronically, some taxpayers are deterred by cost, or find 
it prohibitive. For years, the IRS and the tax community would grapple 
with this issue and had little success resolving it. That changed 
dramatically with Free File.
    Free File's roots can be found in the President's FY 2002 
Management Agenda. It contained five Government-wide initiatives, one 
of which was to expand electronic government. The overarching goal was 
to ``champion citizen-centered electronic government that will result 
in major improvement in the Federal Government's value to the 
citizen.''
    Subsequently, in November 2001, OMB's Quicksilver Task Force 
established 24 e-government initiatives as part of the President's 
Management Agenda. These initiatives were designed to improve 
government-to-government, government-to-business, and government-to-
citizen electronic capabilities.
    One initiative instructed the IRS to provide free online tax return 
preparation and filing services to taxpayers. In accordance with this 
OMB directive, the IRS began working in partnership with the tax 
software industry to develop a solution. Two principles would guide its 
development: no one should be forced to pay extra to file his or her 
return and the IRS should not get into the software business.
    The IRS believes that private industry, given its established 
expertise and experience in the field of electronic tax preparation, 
has a proven track record in providing the best technology and services 
available. Rather than entering the tax software business, IRS' 
partnership with private industry will: (1) provide taxpayers with 
higher quality services by using the existing private sector expertise; 
(2) maximize consumer choice; (3) promote competition within the 
marketplace; and (4) meet these objectives at the least cost to 
taxpayers.
DELIVERING FOR TAXPAYERS
    The President stated in the preface to his Management Agenda that 
``good beginnings are not the measure of success. What matters in the 
end is completion. . . . Not just making promises, but making good on 
promises.'' That is exactly what the Free File partnership did--it made 
good on its commitment and delivered for taxpayers.
    Through the Free File Alliance, LLC (the Alliance), America's 
taxpayers can now access free, online tax preparation and electronic 
filing services through our redesigned Web site at www.irs.gov, which 
received 3.2 billion hits last year, or by going to www.firstgov.gov. 
These free services will be available this year through April 15, 2003. 
Some companies will also offer free services through October 15, 2003 
to accommodate taxpayers who may need an extension.
    The partnership agreement requires that the Alliance as a whole 
provide free tax preparation and filing to at least 60 percent, or 
approximately 78 million American taxpayers. The primary candidates for 
Free File are those taxpayers who prepare their own taxes and still 
file paper returns. Last filing season, the IRS received nearly 85 
million paper returns and nearly 47 million e-filed returns.
    Each participating software company sets its own eligibility 
requirements. Generally, these requirements may be one, or any 
combination of the following: (1) age; (2) Tax Year 2002 Adjusted Gross 
Income; (3) eligibility to file Form 1040EZ; (4) eligibility to claim 
the Earned Income Credit; (5) State residency; and (6) active duty 
military status (if applicable). Unless noted, if the taxpayer is 
married and filing jointly, only one taxpayer must meet the eligibility 
requirement.
    Initial Free File reports are most encouraging. As of February 5, 
Alliance members have processed and transmitted almost 639,000 tax 
returns. This represents approximately 23 percent of the total 2.8 
million on-line e-filed returns. The Alliance partners will report the 
number of Free File returns to us on a monthly basis.
    Mr. Chairman, I want to stress that Free File differs markedly from 
the free e-filing that some companies offered to select taxpayer groups 
for several years. It is far better in a number of key areas.
    First, it is a multi-year agreement between the IRS and the Free 
File Alliance that provides free services to millions more taxpayers. 
Previously, free offers were not consistently available and were 
subject to modification or discontinuation from year to year.
    Second, taxpayers will have easier access. The Free File Web page 
hosted on irs.gov provides in a single location a list of all free 
offerings.
    Third, Alliance members will offer both free preparation and e-file 
service. The taxpayer will incur no cost. Previously, some companies 
charged for preparation (filling out forms and tax calculations) while 
offering the transmission free, or provided the preparation free while 
charging for transmission, or some variation thereof. Under the Free 
File Agreement, both are free to eligible taxpayers.
    Fourth, there will be oversight. The Alliance will be managed by 
the Council for the Electronic Revenue Communication Advancement 
(CERCA). The IRS will also monitor the progress of each Alliance 
member. Should any problems develop, the members are required to alert 
the IRS. If appropriate, the IRS will remove the company from the 
online listing until the problem is resolved.
HOW DOES FREE FILE WORK
    Before I discuss the actual workings of Free File, I want to 
reemphasize that the IRS does not formally or tacitly endorse any of 
the products or services that any of the Alliance companies may offer 
taxpayers. This is a private matter between the companies and 
taxpayers. Moreover, using Free File is not contingent on a taxpayer 
accepting any of these offers. The key word in Free File is ``free.''
    Upon arrival to the Free File page within irs.gov, the taxpayer 
must determine eligibility for using a particular company's free 
service. This can be done two ways. First, the taxpayer may browse the 
complete listing of Alliance members and their free services. Or, a 
taxpayer can use a ``questionnaire'' application (the Free File Wizard) 
designed to assist the taxpayer to identify those free services for 
which he or she may qualify.
    Each Alliance member will identify its company name and will have a 
simple description of the criteria for using its free service. Each 
Alliance member's company or product name will also be linked to 
additional information about the company and/or services. Not all 
taxpayers will be eligible for these free services.
    Upon determining eligibility, the taxpayer can link directly to 
that Alliance member's free service by clicking their ``Start Now'' 
link. Upon doing so, taxpayers will be notified they are leaving the 
irs.gov Web site and are entering the Alliance member's Web site.
    The company's software will prepare and e-file the taxpayer's 
returns using proprietary processes and systems. The company will then 
transmit the electronically-filed return to the IRS using the 
established e-file system, which uses secure telephone lines. Lastly, 
the company will e-mail the taxpayer an acknowledgment file, notifying 
the taxpayer that the return has been either accepted or rejected.
    As part of the Agreement, Alliance members will provide appropriate 
customer service to their clients. Taxpayers who have service questions 
or are experiencing problems with the services being offered by a 
particular Alliance member's software should contact the customer 
service function of that particular company. In the event a taxpayer 
contacts the IRS first, our customer service representatives will have 
contact information for each Alliance member and if necessary, will 
refer accordingly.
    Mr. Chairman, I want to underscore that Free File's benefits are 
identical to those of e-file. They bear repeating: (1) reduced tax 
return preparation time; (2) faster refunds; (3) accuracy of returns; 
and (4) acknowledgement of return receipt. In other words, the use of 
free tax preparation software is comparable to the Alliance members' 
paid products.
TAXPAYER SECURITY AND PRIVACY
    Mr. Chairman, privacy and security are paramount considerations in 
all of IRS' electronic services, including Free File. We are absolutely 
committed to protecting taxpayer privacy and confidentiality. Taxpayer 
information and data will be protected and the Alliance members must 
adhere to IRS' strict privacy standards. To ensure taxpayer data 
safety, we required each participating company to obtain both a privacy 
and security seal certification.
    These programs, administered by third party providers, certify that 
taxpayer return information will be protected from unauthorized access 
during the tax preparation process. We also encourage taxpayers to 
visit the company's privacy and security policy located on their 
commercial Web site.
    Indeed, taxpayer security and privacy are woven throughout the Free 
File process. Tax return preparation is accomplished using proprietary 
software approved by the IRS. Transmittal is through the established 
IRS e-file system. As I mentioned, each Alliance member must obtain a 
third party privacy and security certification. Alliance members must 
also comply with all Federal rules and regulations on taxpayer privacy 
for paying and free customers. These rules prohibit use of tax return 
data for purposes not specifically authorized by the taxpayer.
    Finally, the information taxpayers provide through the Free File 
Wizard will be used solely to help taxpayers select a free service; 
thereafter it will be deleted. The IRS only retains the officially-
filed return information.
TAXPAYERS WITHOUT HOME COMPUTERS
    Mr. Chairman, as I previously discussed, Free File is premised in 
part on the principle that no one should have to pay to file a return. 
That includes taxpayers who do not have access to a computer. Low 
income should never be a barrier to quality service, including free 
electronic filing.
    Free tax preparation and e-file are available in many communities 
through the Volunteer Income Tax Assistance (VITA) and Tax Counseling 
for the Elderly (TCE) programs. Volunteers help prepare basic tax 
returns for low-income taxpayers, persons with disabilities, the 
elderly, and non-English speaking people. Taxpayers can call 1-800-829-
1040 to find their nearest VITA or TCE site. They may also call AARP--
the largest TCE participant--at 1-877-227-7669 to see if there is a Tax 
Aide site in their community.
    However, Free File will not normally be used at VITA sites for a 
number of reasons. First, we train our thousands of volunteers to use 
one standard software package, versus the many different ones offered 
by the Alliance companies. This consistency is both cost efficient and 
produces a much higher accuracy rate in the volunteers' preparation of 
taxpayer returns. In fact, we currently enjoy a 98 percent accuracy 
rate at the VITA sites. Second, we transmit large batches of e-file 
returns at VITA sites; usually 50-100 at a time. Free File is oriented 
towards the individual taxpayer and was not intended for such high 
volume use. Third, some VITA sites do not have access to the Internet 
so Free File is not an option.
    Individual taxpayers with incomes of $35,000 or less can also 
receive free income tax return preparation and e-file help at IRS Tax 
Assistance Centers (TACs). We extend this courtesy return preparation 
service to all taxpayers qualifying for the Earned Income Tax Credit, 
without placing the government in competition with private industry. 
All of these returns are e-filed; we do not deal with paper individual 
returns. Taxpayers whose income or preparation needs exceed the basic 
service will receive service options, such as referrals to local 
volunteer organizations.
    To better serve low-income taxpayers, the IRS' Stakeholder 
Partnership, Education and Communication (SPEC) organization is 
establishing extensive partnerships with external groups such as local 
governments, non-profit organizations, private for-profit businesses, 
and others to create community coalitions. We are focusing our limited 
resources on providing technical expertise and training while 
encouraging the community partners to supply resources such as 
volunteers, space and computer equipment. This business model has 
rapidly gained national recognition and acceptance.
    Our goal is to make our partners as self-sufficient as possible and 
to identify those organizations that could make available needed 
resources. This new approach allows the IRS to expand access to low-
income taxpayers, provide greater free tax return preparation and 
filing, and sustain these services over time.
    Mr. Chairman, as previously noted, taxpayers are under no 
obligation to purchase any product from the software company (some 
participating companies do not offer such services) or to use Refund 
Anticipation Loans. Obtaining a fee-based product is a decision left to 
the individual taxpayer. The IRS, as well as many of the Alliance 
company Web sites, also remind taxpayers that those who e-file and use 
direct deposit often receive their refunds in 10 days or less.
CONCLUSION
    Mr. Chairman, in conclusion, Free File is a breakthrough for 
America's taxpayers. We are putting e-file within reach of millions 
more taxpayers and delivering on the President's commitment to put the 
needs of citizens first. In addition, we are following up on our 
commitment to provide taxpayers with top quality service. And we are 
making the best use of the taxpayers' dollars by processing returns 
faster and at a lower cost. This new program may be called Free File, 
but what it gives to millions of taxpayers and our government is 
invaluable. Thank you.

                                 

    Chairman HOUGHTON. Thank you very much, Mr. Commissioner. 
Just a couple of comments here. First of all, we are going to 
have to push this thing along a little bit because we have 
three panels. The first is you, Mr. Commissioner, and then I 
think we have probably a series of votes coming up. Then 
second, if I understand correctly, there is an IRS Web site 
that is to be shown; is that right?
    Mr. WENZEL. Yes. With your permission, we would like to 
give you a brief demonstration of our site.
    Chairman HOUGHTON. All right.
    Mr. LUTES. Okay. Thank you. What I am going to do is just 
walk you through it. I think there were screen prints made, 
copies were made available, of what I am going to show. First 
of all, during--throughout the filing season when you go to 
www.irs.gov, a site which got over 3\1/2\ billion hits last 
filing season, and we expect that to grow this year, on the 
front page folks are going to see the link to the Free Filing 
offering.
    By clicking on the Free Filing offering, you go to what we 
call the Free File splash page. I am not going to go through 
this page in detail; however, there are a number of links here 
about the information you need before you start preparing a 
return, things you should know. There is a one, two, three as 
to what the steps are of the electronic filing process, to help 
folks understand, and then there is a series of frequently 
asked questions around privacy, security, the nature of the 
contract and the agreement we have with the industry and so 
forth.
    When you are ready to prepare the return you click start, 
and it will take you to this page, and you have a couple of 
choices here as to how to use it.
    What I am going to take you to first is the ``guide me to a 
service.'' There are 17 companies that have agreements with the 
Free File Alliance to provide services for this filing season. 
How do taxpayers sort through those companies to determine 
those that they are eligible for, because each company 
determines on its own which taxpayers it wants to cover with 
its offering? By going to ``guide me to a service,'' there is a 
series of six questions the taxpayer would answer, and if they 
answered those questions correctly, and then clicked the submit 
button, it will then list the offers that they are eligible to 
use, and then they can click on the company and begin the 
return. I will show you how that happens in just a moment.
    The other way to do this, you can either scroll down the 
page and see the listing of companies, or if you click ``browse 
all the services,'' you lose the top part, and it is easier to 
browse, and then you look at the companies, and you can read 
about the companies, who they are covering. You can bring up 
just a longer description of the companies. When you have 
selected the company you want to use, either from the wizard or 
from this list, you click start now, and an important thing I 
want to illustrate is you get a disclaimer that makes it clear 
to the taxpayer that you are no longer going to be in a 
government site. These are commercial products. The same 
commercial products that millions of people paid to use last 
year are being made available for free, but it is through the 
commercial providers. We want taxpayers to understand. Then 
they click to leave the IRS site, and then they go to the 
company site.
    Basically, that is the way the process works, and we just 
wanted to illustrate that we think we have designed this in a 
way that makes it easy for taxpayers to use and understand how 
the process will work. Thank you.
    Chairman HOUGHTON. Thank you very much, Mr. Lutes. That is 
great.
    Now, let me just ask a quick question, and then I want to 
pass it along to the others. Why did you choose 2007 to get the 
80 percent? What are the factors that are now impeding you from 
reaching that goal?
    Mr. WENZEL. That is a good question because I think that 
when that was part of the restructuring format of 1998, there 
was a lot of discussion with the Congress and the IRS. The 
thinking was that might be a realistic year to achieve that 
kind of percentage. Back then it was our best thinking that 
while it was a very, very ambitious goal, and we certainly, at 
this point in time, see it as a real stretch for us to reach 
that number. We felt it was the right thing to achieve, and by 
that year.
    Chairman HOUGHTON. Well, it is always good to shoot high, 
and obviously that is what you did, but, why not 75 percent, or 
why not 50 percent or something? What led you to believe that 
in that 10-year period you could do this?
    Mr. WENZEL. I think that when we looked at what we 
experienced--e-file started in the IRS in the filing season 
calendar year 1986. That first year there was approximately 
26,000 returns that were filed. Then we started to see the 
growth and the acceptance by the public through--from that year 
forward. We looked at the opportunities that we had with 
additional incentives that we thought we could put out in terms 
of encouraging people to convert from the paper filing to 
electronic filing. The goal, as you know, is also for business 
returns, so it is all types of tax returns filed with the IRS. 
Our best feeling was, at the time, that 80 percent, four out of 
five returns by that year would be filed electronically.
    We have--as I mentioned, in terms of what our current track 
is, in terms of reaching that goal, if it stayed the way it is, 
with what we expect this year, again we expect a significant 
growth, we are predicting about 54-million individual returns 
will be filed electronically as compared to 47 million last 
year. So, that is another significant growth. We still will not 
reach the 80 percent, and we continue to work with the industry 
to find new and, innovative ways to reach our 80-percent goal.
    For example, in the President's fiscal year 2004 budget, 
there is a provision that would extend the filing season from 
April 15 to April 30 for any individual who would file their 
tax return with us electronically. We predict, if that should 
pass, that would provide a significant incentive for people 
that still file on paper to file electronically. Of note, 
approximately 132 million form 1040s, individual tax returns, 
will be filed that calendar year, and when you look at when 
those returns are filed, of significance is that a very high 
percentage, almost half, are coming around April 15. Both 
refund returns and also, of course, the balance due tax returns 
are there. We feel that with--the additional 2 weeks from April 
15 to April 30, we will reach that group of taxpayers that wait 
until the end of the due date or near the end of the due date. 
That will encourage them to maybe file electronically and help 
us along toward that 80-percent goal.
    Chairman HOUGHTON. Thanks very much.
    Mr. Pomeroy.
    Mr. POMEROY. Thank you, Mr. Chairman.
    I want to echo my friend Rob Portman's comments about this 
being a good thing and commending you for establishing these 
partnerships that basically facilitate greater access of the 
American public to e-filing; the greatest benefit, internal 
math checking to make certain a return is filed correctly, and 
sparing the time and disruption that an incorrect return would 
result, as well as quickly accelerating the receipt of the tax 
return.
    What can an e-filer expect by way of time line on a tax 
return?
    Mr. WENZEL. If an e-filer files a tax return with us and 
also opts to use the direct deposit provision, and they are 
entitled to a refund, they will probably receive that refund 
check--I should say not the check, but the refund deposit in 
their bank account within 10 days.
    Mr. POMEROY. I think that is terrific.
    Now, I used to be an insurance commissioner, so policing 
marketplace activity is something that comes naturally to me, 
and I don't mean in any way to impugn any untoward business 
practice on your partners, your private sector partners who 
have done so much to advance this service, but there are some 
oversight questions appropriately directed at their marketplace 
activities. Are you aware of whether or not loans are being 
made, loan services are being made relative to the return by 
any of your participating partners?
    Mr. WENZEL. Yes, there are several that are offering that 
service. If an individual opts to use that service--it is not 
required, it is still a free service to file the return.
    Mr. POMEROY. Mr. Commissioner, I note that you indicate on 
page 5 of your testimony that the IRS does not formally or 
tacitly endorse any of the products or services that any of the 
Alliance companies may offer taxpayers. I will agree with you 
on formally, but I don't agree with you on tacitly. As a 
taxpayer, if I, through the IRS Web site, find myself 
essentially in a private product of preparing my tax return as 
a part of a public-private partnership, I do think that there 
is a tacit acknowledgment by the IRS that the services sold in 
conjunction with the private partner are acceptable for public 
consumption.
    It is my view that loan activity for the dependency of a 
return that at maximum is 10 days is highly suspect. If this 
was an insurance product put before me, I would say, uh-uh. You 
don't sell this unless there is confusion in the marketplace, 
because no one would reasonably conclude that they need that 
loan for that period of time.
    Have you scrubbed the products, Mr. Commissioner, to make 
sure that they pass the smell test for the American consumer?
    Mr. WENZEL. Congressman, the refund anticipation loan has 
been part of this e-file program for some time, and, our view 
of that is that we emphasize as much as we can as how quick a 
refund check could come back if you use direct deposit.
    Mr. POMEROY. I think you are turning the refund around so 
quickly that you just really wouldn't need one of those.
    Mr. WENZEL. That is the emphasis that we continue to try to 
make everyone aware of. Our experience has been that the 
consumer, our taxpayer, still has opted to use the----
    Mr. POMEROY. Well, consumers can be confused Mr. 
Commissioner. Have you ever sat down with your vendors and 
said, what is the compelling market need for a product of this 
nature?
    Mr. WENZEL. In terms of me personally, in the acting 
capacity that I have been in, I have not done that.
    Mr. POMEROY. I would like the Service to do that due 
diligence. In my opinion, the marketplace is owed a wide 
variety of products, and consumers can make their choice. On 
the other hand, if something on its face really looks as though 
it probably doesn't serve a valuable purpose to the consumer, 
we can draw a conclusion that this is sold only by consumer 
confusion, and we ought not allow products of that nature.
    For example, in insurance, I would refuse to approve for 
the marketplace illusory policies, policies that appeared to 
provide something, but took it all away with loopholes. This, 
in my opinion, is kind of an illusory policy. It looks like you 
are getting a loan, but, heck, you are going to get your refund 
in 10 days. You probably won't get your loan proceeds until 5, 
6, 7 days, so you are spending some money for just a very 
short, literally maybe a weekend's worth of time, and it just 
isn't worth it.
    What I would like the Service to do--I see I am out of 
time, and I would just submit for you--I know we want to move 
this hearing along--several specific items where I would like 
the Service at the end of this tax year to survey its vendors 
and get us the information. We would like to find out, for 
example, the number of people that have purchased these refund 
anticipation loans from the vendors and such other services as 
the vendors are marketing.
    I just think it is important to keep an eye on this 
activity. Again, I don't mean to impugn anything on the 
valuable private partners to this initiative. We just want to, 
as part of our due diligence, make sure the products are 
appropriate for the American public. Thank you very much.
    Mr. WENZEL. Congressman, we look forward to providing you 
with the information that you requested.
    [The information follows:]

                                           Internal Revenue Service
                                               Washington, DC 20224

Answer: First, we should make it clear that companies involved in the 
Free File alliance are not our ``vendors.'' Rather, we have an 
agreement with them that is not contractual in nature. This is a 
partnership agreement intended to provide the opportunity for free 
filing of Federal income tax returns over the Internet to as many 
people as possible. The nature of the agreement was to take the same 
product that millions of people have paid for and to make those 
products available for free.
    Taxpayers who use tax preparation software generally want to 
receive their refunds as quickly as possible. We have made strides over 
the past several years to accelerate the delivery of tax refunds 
through the electronic filing system. However, some taxpayers have 
traditionally sought refund anticipation loans as a way to get their 
refunds even faster. The practice of using tax refunds as loan 
collateral goes back many years, predating the advent of electronic 
filing. We anticipate that with the rollout of the Customer Account 
Data Engine over the next several years taxpayers will be able to 
receive refunds in a week or less, thus, reducing the demand for refund 
anticipation loans.

                                 

    Chairman HOUGHTON. Okay. Thank you very much, Mr. Pomeroy.
    Mr. Portman.
    Mr. PORTMAN. Thank you, Mr. Chairman. Commissioner Wenzel, 
you were rather generous in your response to our earlier 
question about how the IRS came up with this 80 percent, 
because we came up with it for you. He was pretty nice to you 
actually, Amo, on that one. We came up with it not so much in 
the legislation, but it came out of the Commission's work, 
again, 2 years of studying this and trying to set an ambitious 
but, we thought, realistic goal.
    We are disappointed we are not further along, because we 
think electronic filing is both good for the tax system and 
also very good for the taxpayer. We also did not put in place 
any penalties for the IRS not achieving that goal. We 
established it as a goal, not a mandate, and we thought it was 
appropriate to encourage it.
    One of the sticking points had been this notion of getting 
folks who have relatively simple returns particularly into the 
electronic system in a free way, and the cost, which I think 
only averaged last year about $12 or $13, but that cost alone 
kept people from filing electronically. Instead they went 
through the paper route with all the error associated with that 
on their part and the IRS part, and all the additional costs, 
all the additional costs to you to have additional people to 
open those forms and work through the system, and all the 
downstream costs we talked about earlier to the taxpayer where 
the taxpayer ends up getting, because of a mathematical error 
or some other error, a phone call from the IRS or a letter from 
the IRS. It begins sometimes a string of back-and-forth that 
sometimes our congressional offices get involved with, which is 
enormously frustrating to taxpayers and to the system, and 
costly.
    So, it is a good thing, and the question is how are we 
going to do that? I know the private sector was very concerned, 
as was I, frankly, about the IRS competing with the private 
sector, that you are not really in the software business, and 
you are not likely to be as successful, frankly, or as 
innovative as the private sector in coming up with new ways to 
encourage people to file electronically.
    So, again, I commend you for working out an arrangement 
with the private sector where they are going to offer this as a 
free service at least to folks who are up to the 60th 
percentile on income. I think it will be a major push if we 
advertise it properly, and that is what I love about your Web 
site, which has been very successful, and I think both the 
private sector and you ought to redouble our efforts in term of 
letting people know how this is simpler, easier and better for 
them.
    A couple of questions, if I might. First on the error rate. 
What is the error rate now on paper returns?
    Mr. WENZEL. The error rate on the paper returns continues 
to run as high as 22 percent as you previously mentioned, and 
it really hasn't changed that much in years. It still could 
vary.
    Mr. PORTMAN. Roughly of that 22-percent error, which is an 
enormously high number, roughly half of that is attributable to 
the taxpayer; is that correct?
    Mr. WENZEL. What has generally been the trend is taxpayer 
error return, third-party preparation error, or the IRS making 
the mistakes.
    Mr. PORTMAN. A lot of it is transposing the numbers by your 
folks.
    Mr. WENZEL. Transposition of the numbers.
    Mr. PORTMAN. Hit return. You are then putting it into the 
computer rather than having it come straight through on an 
electronic form.
    Mr. WENZEL. That is correct, Congressman. It is the key 
entry that has a tendency to make a mistake.
    Mr. PORTMAN. How about the error rate on the electronic 
filing?
    Mr. WENZEL. The electronic error rate, again, the numbers 
that you mention are right on in terms of somewhere--1 percent 
or less. It is a very, very low rate.
    Mr. PORTMAN. It is an incredible savings and difference.
    On the refund anticipation loans, that is one issue out 
there the private sector is now going to have an opportunity to 
have people go through your site through and then to a free 
service to file, and the notion that my colleague from North 
Dakota mentioned, which I agree with, is you don't want to have 
people who are going to get a quick refund on average 10 to 14 
days be pressured into getting into these refund anticipation 
loans, which is not necessarily good for the taxpayer. On the 
other hand, I am not sure it is as big a problem as we are 
making it out to be, because I don't think many people do that.
    Do you have any data on how many folks who file 
electronically actually seek a refund anticipation loan?
    Mr. WENZEL. I don't have that in front of me. Do you?
    Mr. LUTES. Yes. I can address it in general terms. What we 
capture is information about financial products related to the 
return. There is an financial product indicator that comes to 
us electronically. However, financial products include a 
variety of services, not only refund anticipation loans. For 
refund anticipation loans, we do know is that the majority of 
those are by taxpayers who go to a tax professional. The refund 
anticipation loans on online products, which these are offering 
online Web products, according to the industry is less than 1 
percent.
    The other thing I would say in response to the question is, 
if you go to the sites and you look to the 17 sites, they vary. 
They are commercial sites; they vary. Some will have a line 
item on the front page that talks about the fact that you can 
get a quick loan. However, many of the sites, if you look at 
their front page, three levels down, emphasize you are 
electronically filing; you are going to get your refund much 
faster as a result of the electronic filing. They really 
emphasize that. For those taxpayers who then do want it faster, 
they offer the service. I think there is going to continue to 
be some demand until we are able to deliver our modernization 
so we can deliver refunds even faster than the 10 days.
    Mr. PORTMAN. So, you think that 1 percent figure is 
accurate, that only 1 percent of taxpayers who file 
electronically actually seek a refund anticipation loan?
    Mr. LUTES. It is 1 percent who file electronically using 
the online, using Web or the shrink wrap products. Those who 
file electronically using a practitioner, the number is higher.
    Mr. PORTMAN. My time is up, but certainly more information 
as to the speed at which someone can get a refund is going to 
affect that, and I assume that that is something that you can 
communicate. Again, I commend you for this program, and I yield 
back my time, Mr. Chairman.
    Chairman HOUGHTON. Thanks.
    Mr. Kleczka.
    Mr. KLECZKA. Thank you, Mr. Chairman. Mr. Lutes, one quick 
follow-up question to the whole issue of tax refund loans. What 
is the average charge for these loans? Let's say I did a paper 
return. Do you know what that firm might be charging, because 
the refund might be a heck of a lot longer than the electronic?
    Mr. LUTES. It varies very widely if you are using a tax 
professional, depending upon the complexity of the return if 
you are looking at the entire charge. Usually the refund 
anticipation loans typically--and I don't know that this is 100 
percent the rule--but typically there is a flat fee that is 
charged, and I have seen some in the range of $60, $50, but 
usually I think it would be safe to say that $50 to $70 range 
would be the charge.
    Mr. KLECZKA. Have you seen any higher or done on a 
percentage?
    Mr. LUTES. I really can't answer that question because I 
haven't gone through and looked at all the pricing, because one 
of the things to remember is the idea of using a tax refund as 
collateral for a loan predates electronic filing. It has been 
around for years. What we actually see, we can see on the on-
line sites, if we go and look site by site at what is there. In 
the practitioner office we don't have any real system for 
collecting that data. What we do, though, is emphasize in our 
guidelines for electronic filing originators they have to apply 
be approved, and we can suspend them.
    One of the things that we monitor is people who are 
implying that what folks are getting is a faster refund. We 
make it clear that they have to communicate clearly to the 
taxpayer it is a loan, and there is a fee. This is not IRS 
doing this. This is a bank.
    Mr. KLECZKA. I think it would be wise for the Service to 
look at not only the fee being charged for the electronic file, 
but all firms charging a fee, just to make sure that our 
taxpayers aren't being gouged. Thanks.
    Chairman HOUGHTON. Okay. Mr. Johnson is not here. Ms. Tubbs 
Jones.
    Ms. TUBBS JONES. When you are new, you can't even find the 
microphone, but I am going to get it together here.
    I think also it might be interesting to kind of take a look 
at the agreements with the companies to--or I would like to 
have a copy of the agreement. I am not saying in terms of 
review. I don't want to tarry on that part of the conversation. 
I am sure that a number of my colleagues have asked enough 
questions. I guess what I would be interested in knowing is you 
said that there will be--there are locations where taxpayers 
can get volunteers to help them with these services. How is 
that set up?
    Mr. WENZEL. We have had a voluntary income tax preparation 
activity for many years, I would say, approximately 30 years, 
throughout the country. The AARP is one of the principal 
organizations that assist us, retired accountants or just 
volunteers that belong to that organization come in and we 
train them. There are college students, a whole range of 
individuals that this time of year realize how important it is 
to meet one's financial responsibility to our country and want 
to offer assistance. Those sites are staffed by these 
volunteers evening hours, during the day, during the week, but 
especially on Saturdays.
    Ms. TUBBS JONES. How do--say, for example, if I wanted to 
know who was doing volunteer IRS, filing or assistance with 
filing in my congressional district, who could give me that 
information?
    Mr. WENZEL. We try to publicize that through our own 
www.irs.gov Web site in terms of where the locations are. We 
solicit the support of the volunteer organizations to reach out 
and also publicize that. The media is very cooperative in 
publicizing locations, times and dates.
    Ms. TUBBS JONES. What else did I have? I probably had some 
more questions, but since we are near the end of the time, I am 
just going to pass on that so that they can be gone since 
everybody else is gone. Okay.
    Mr. PORTMAN. [Presiding.] I thank my colleague from 
Cleveland, and, Mr. Wenzel, we appreciate your testimony. Thank 
you, Mr. Lutes. Appreciate your testimony, and the program will 
now go to the next panel.
    Kevin Belden will come forward; Michael Cavanagh. 
Gentlemen, thank you very much. Chairman Houghton has gone to 
vote so he can come back and be with us toward the end of this 
panel. We do have another panel: Ms. Olson, who is going to be 
joining us for the third panel. We have a vote now, which will 
be separated by about a 20-minute period until the next vote, 
which is a motion to recommit, so we thought it would be best 
to try to keep this moving.
    Mr. Belden, thank you very much for being here. Mr. Kevin 
Belden is Chairman of the Electronic Tax Administration 
Advisory Committee (ETAAC). Then Mr. Michael Cavanagh. Thank 
you for being here. Mr. Cavanagh is the manager of the Free 
File Alliance.
    I would like to remind the witnesses that we have a 5-
minute rule on testimony; however, we might be a little 
generous with that since Members have all gone to vote. If you 
could please direct your testimony to me, and, again, Mr. 
Houghton should be returning shortly. Mr. Belden.

      STATEMENT OF KEVIN BELDEN, CHAIRMAN, ELECTRONIC TAX 
   ADMINISTRATION ADVISORY COMMITTEE, AVERILL PARK, NEW YORK

    Mr. BELDEN. Mr. Chairman, Members of the Subcommittee and 
distinguished guests, my name is Kevin Belden. I am honored to 
serve again this year as Chairman of the IRS's Electronic Tax 
Administration Advisory Committee. Other panelists are 
presenting detailed information this afternoon about the 
genesis, the characteristics and benefits of the Free File 
initiative. My remarks will focus more on addressing Free File 
in the larger context of congressional goals for electronic 
filing.
    We are approaching the midpoint between 1998, when those 
goals were established, and 2007, when the target was to be 
achieved. The goals have been powerful motivators for focusing 
IRS resources on electronic filing initiatives. While the IRS 
has made considerable progress at the current rate of adoption, 
electronic filing rates will fall short of the target.
    Initial IRS efforts focused on expanding the availability 
of electronic filing particularly for individuals. Those were 
necessary first steps, but we have since learned that offering 
electronic filing options does not by itself lead to their use. 
The vast majority of individual tax filers are able to file 
electronically, yet just under 36 percent of all individual 
returns were electronically filed this past year.
    The key challenge to increasing electronic filing is to 
stimulate demand by taxpayers and by tax preparers. To do so 
the IRS will need to overcome increasingly challenging barriers 
to adoption. Those barriers include cost of electronic filing, 
the continued preference for paper filing, lack of awareness of 
electronic filing alternatives, and concern about privacy and 
security. Some of these barriers can be addressed through 
education and marketing, but the bottom line is that the 
benefits offered today by electronic filing are not 
sufficiently compelling for all taxpayer and practitioner 
segments. More needs to be done to increase the value of 
electronic filing for these segments.
    There are approximately 52-million individual tax returns 
filed each year by taxpayers who prepare and file their own tax 
returns. The new Free File Alliance initiative primarily 
targets this group of taxpayers. This innovative approach 
allows each of the players in the tax administration value 
chain to focus on what they do best. The IRS will receive more 
electronic returns while avoiding the cost of developing its 
own online filing product. The IRS can then focus its efforts 
on modernizing its back-end systems and electronic filing 
platforms to provide greater value and increased electronic 
services, each of which will increase and stimulate the demand 
for service. The initiative preserves and strengthens 
government and industry cooperative relations, which have led 
in large part to the electronic filing gains achieved to date.
    However, the Free File Alliance initiative alone will not 
solve the problem of attaining the 80-percent electronic filing 
target by 2007, in the opinion of the ETAAC. Cost is only one 
of the inhibitors to electronic filing, and access to a 
computer and the Internet is an impediment for many of the 
target population. In addition, many in that segment are 
comfortable with manual preparation and may be resistant to 
change.
    Product offerings in future years will need to incorporate 
free State filing. Since a number of States are offering free 
online income tax filing of State tax returns, the Free File 
Alliance members view them as competitors and are not inclined 
to cooperate in offering free combined filing of Federal and 
State returns in those States.
    Addressing this challenge will lead to greater use of Free 
File Alliance products in the future. Many of the essential 
elements for rapidly expanding electronic filing participation 
are falling into place.
    Mr. PORTMAN. Mr. Belden.
    Mr. BELDEN. Yes.
    Mr. PORTMAN. I am sorry to interrupt you. We had hoped that 
Mr. Houghton would be back. He is not as fast a sprinter as we 
thought. I am going to sprint over and vote, and we will be 
back. If you could stop there at your testimony, and then we 
can pick up when you come back. We will be recessing just for a 
short period of time until Mr. Houghton comes back.
    Mr. BELDEN. Be glad to. Thank you.
    [Recess.]
    Chairman HOUGHTON. [Presiding.] Okay. Let's continue the 
hearing. Mr. Belden, good to see you, and I am sorry we weren't 
here earlier. Anyway, we are delighted to have you here, and 
maybe you want to continue your statement.
    Mr. BELDEN. Yes, Mr. Chairman. I was just making the point 
that while ETAAC is extremely supportive of the Free File 
Alliance, that it in and of itself is not going to completely 
solve the 80 percent--the problem of achieving the 80-percent 
goal. Cost is only one of the inhibitors to electronic filing, 
and access to a computer and the Internet is an impediment for 
many in the target population segment. In addition, many in 
that segment are comfortable with manual preparation and may be 
resistant to change.
    Product offerings in future years will need to incorporate 
free State online filing since a number of States are offering 
free online income tax filing of State tax returns. The Free 
File Alliance members view them as competitors and are not 
inclined to cooperate in offering free combined filing of 
Federal and State returns in those States.
    Addressing this challenge will lead to greater future use 
of Free File Alliance products. Many of the essential elements 
for rapidly expanding electronic filing participation are 
falling into place. The IRS is modernizing its core tax 
administration systems to make them more capable, flexible and 
responsive. New electronic service delivery channels are being 
implemented, including secure Web portals for access to 
electronic services, and taxpayer account information by IRS 
employees and trusted third parties.
    E-services are highly anticipated and will be much 
appreciated by the professional tax community. The IRS is also 
implementing the first of a series of modernized electronic 
filing platforms. These modern new electronic filing platforms 
are based on industry-accepted standards for data-sharing and 
communication, making them cost-effective for the IRS and 
attractive for the software developers and the tax 
practitioners.
    The growth of the Internet and the development of new 
business models have prompted a change in the way we think 
about tax administration. The new view, which you might think 
of as end-to-end electronic tax administration, acknowledges 
that third parties in the tax business are the IRS's partners 
in serving a common customer, the taxpayer. In this vision 
taxpayers would have multiple choices in terms of how they 
interact with the IRS and what value-added services they choose 
to use. They would not be e-filers, but e-customers.
    Tax practitioners would choose from a variety of third-
party software products offering highly interactive e-services 
made possible through online communication with IRS systems. A 
full range of these services would be available, allowing each 
practitioner to make a clean break from their paper process.
    Employers and financial institutions would file withholding 
information returns electronically, providing electronic copies 
to taxpayers and their designated representatives. Financial 
institutions may integrate tax account information with other 
customer financial information into an electronic financial 
portfolio, allowing online account inquiry, customized 
financial advice, tax filing and payment reminders, and 
electronic tax payments.
    The IRS would act as an integrator of this network of tax 
administration service providers. Its own electronic tax 
administration processes and systems would be designed to 
facilitate the smooth interaction of its internal functions 
with the specialized functions of its third-party partners and 
taxpayers while protecting the security and confidentiality of 
taxpayer information.
    As has happened with the Free File Alliance, in this 
environment the existing tax administration service providers 
would likely create new and innovative offerings, and new 
providers would undoubtedly enter the market with fresh ideas 
and new business models. Taxpayers will be the ultimate 
beneficiaries.
    Thank you, Mr. Chairman, for the opportunity to provide 
ETAAC's views on electronic filing.
    [The prepared statement of Mr. Belden follows:]
  Statement of Kevin Belden, Chairman, Electronic Tax Administration 
               Advisory Committee, Averill Park, New York
    Mr. Chairman, Members of the Subcommittee and distinguished guests, 
my name is Kevin Belden and I'm honored to serve again this year as 
Chairman of the Internal Revenue Service's Electronic Tax 
Administration Advisory Committee (ETAAC). Thank you, on behalf of the 
Committee, for the opportunity to share our views on the progress and 
future direction of electronic filing. ETAAC was established to provide 
continued input to the development and implementation of the IRS 
strategy for electronic tax administration. Members of ETAAC represent 
a diverse cross-section of IRS partners, customers and stakeholders, 
whose interests and insights are critical to the overall attainment of 
electronic filing goals.
The Progress of Electronic Filing
    We're approaching the midpoint between enactment of the 
Restructuring and Reform Act of 1998--which set goals for electronic 
tax administration--and the year 2007 when those goals were targeted to 
be achieved. The goals Congress has set for electronic filing have been 
powerful motivators for focusing IRS resources on electronic filing 
initiatives. However, while the IRS has made considerable progress, at 
the current rate of adoption electronic filing rates will fall short of 
the goals. Initial IRS efforts focused on expanding the availability of 
electronic filing, particularly for individuals. While those were 
necessary first steps, we've since learned that offering electronic 
filing options doesn't, by itself, lead to their use. The vast majority 
of individual tax filers are able to file electronically, but just 
fewer than 35% (46.3 million) of all individual returns were 
electronically filed this past year.
    Business electronic filing initiatives to date have been limited, 
but well received. Business returns are generally more complex than 
individual returns, as are the filing, authentication and signature 
processes. Work is underway, as part of a comprehensive strategy, to 
develop and market additional opportunities for business e-filing that 
add value for businesses while improving IRS internal operations.
    Taxpayers and government tax agencies are not the only players in 
the tax administration life cycle. Third party tax practitioners and 
tax software developers are key links in the value chain. Tax 
practitioners file 60% of all individual returns and at least 85% of 
all business returns using tax software acquired from commercial 
developers. Many of the returns prepared and filed by taxpayers 
themselves are prepared using private sector tax software. The key 
challenge to increasing electronic filing is to stimulate demand by 
taxpayers and tax preparers. That, in turn, is dependent on increasing 
the value of electronic filing for taxpayers and the IRS' third party 
partners in tax administration.
    To improve the growth rate of electronic filing, the IRS will need 
to overcome increasingly challenging barriers to adoption. Research 
indicates that those barriers include a continued preference by 
taxpayers for paper filing, lack of awareness of e-filing and how to do 
it and concern about privacy, security and the role of third parties in 
the process. Some of these barriers can be addressed through education 
about the advantages of electronic filing--faster refunds, electronic 
receipts that offer proof of filing, convenience, accuracy and reduced 
likelihood of receiving a notice from the IRS. But the benefits offered 
today by electronic filing are not compelling for all taxpayer and 
practitioner segments. More needs to be done to increase the value of 
electronic filing for these segments. It needs to become part of a 
routine way of doing business.
Free File Alliance--An Innovative Approach to No-Cost Online Filing
    There are approximately 52 million individual tax returns filed 
each year by taxpayers who prepare and file their own tax returns. At 
least 30 million of these returns are prepared on a computer, but then 
printed and mailed to the IRS. The new Free File Alliance initiative 
primarily targets this group of taxpayers. The Free File Alliance 
eliminates cost as an obstacle for a potential target segment of at 
least 60% of individual taxpayers. This innovative approach allows each 
of the players in the tax administration value chain to focus on what 
they do best. The IRS will receive more electronic returns, while 
avoiding the cost of developing its own online filing product. The IRS 
can then focus its efforts on modernizing its backend systems and 
electronic filing platforms to provide greater value and increased 
electronic services. The initiative preserves and strengthens 
government/industry cooperative relations which have led, in large 
part, to the electronic filing gains achieved to date. Taxpayers have a 
choice of service providers, each offering unique value in a virtual 
marketplace.
    However, the Free File Alliance initiative alone will not solve the 
problem of attaining the 80% electronic filing target by 2007. Cost is 
only one of the inhibitors to electronic filing. Demonstrating the 
value of electronic filing will continue to be a challenge. Many in the 
target segment are comfortable with manual preparation and may be 
resistant to change. Free File Alliance products will need to prove 
their value by saving time, adding convenience, improving accuracy and 
contributing to expedited refunds. To do so, the product offerings in 
future years will need to incorporate free State online filing.
    Lack of access to a computer and the Internet will likely be a 
roadblock for many in this group. The IRS will need to identify and 
encourage public access to computers and the Internet in such places as 
IRS and other government offices, community colleges, public schools, 
libraries and post offices. Additionally, tax preparation companies may 
realize significant client development benefits from providing free 
Internet access in their offices.
A Foundation for Future Growth
    Many of the essential elements for rapidly expanding electronic 
filing participation are falling into place. The IRS is modernizing its 
core tax administration systems to make them more capable, flexible and 
responsive. New electronic service delivery channels are being 
implemented, including secure Web ``portals'' for access to internal 
information resources, services and taxpayer account information by IRS 
employees and trusted external customers, including taxpayers' 
authorized representatives.
    The IRS is beginning to offer electronic services, like the ability 
to register as a trusted external customer and for a new business to 
obtain an Employer Identification Number (EIN) online. These e-services 
are highly anticipated and will be much appreciated by the professional 
tax community. The IRS is also implementing the first of a series of 
modernized electronic filing platforms, beginning with the Employment 
Tax e-Filing System earlier this month, to be followed by Corporation 
Income Tax (1120 and related forms) e-Filing in January 2004. These 
modern new electronic filing platforms will be based on industry-
accepted standards for data sharing and communication, making them 
cost-effective for the IRS and attractive to software developers and 
tax practitioners.
    ETAAC encourages the IRS to continue the current efforts and to 
expand them rapidly to include a broader range of e-services and to 
encompass modernization of the 1040 e-filing platform, as well as other 
business tax return types. While these new e-services and modernized e-
filing platforms require an upfront investment of resources, ETAAC 
firmly believes that the costs will be more than offset by the 
benefits, including significantly increased electronic filing by those 
practitioners who still file computer-prepared individual income tax 
returns on paper (30 million such ``V-code'' returns were filed by 
practitioners last year) and a substantial increase in the percentage 
of e-filed business tax returns.
A Future Vision of ``End to End'' Electronic Tax Administration
    As has happened in the private sector, the growth of the Internet 
and the development of new ``networked'' supply chain business models 
have prompted a change in the way we think about tax administration. 
The new view--which you might think of as ``end to end electronic tax 
administration''--acknowledges that third parties in the tax business 
are also the IRS' partners in serving a common customer--the taxpayer.
    In the private sector, new end to end business models--driven by 
innovative thinking and enabled by new technologies--are emerging in 
industries with characteristics similar to the tax administration 
environment. Those characteristics include a diverse customer base, 
complex and highly-specialized functions, seasonal peaks and valleys 
and a high level of dependency on value-adding intermediaries. Highly-
competitive businesses have responded to new market challenges and 
opportunities by shifting their view from streamlining internal 
processes and systems to integrating internal and external service 
providers in a seamless, end to end service delivery value network. 
That view takes into account business partner capabilities and needs, 
creating a flexible, dynamic environment that allows each partner to 
perfect its own specialized processes, reduce costs, enhance value and 
respond quickly to customer needs.
    For the IRS to achieve the electronic tax administration goals of 
RRA 98, it needs to promote an end to end vision of tax administration 
with these characteristics:
    Taxpayers would have multiple choices in terms of how they interact 
with the IRS (e.g., directly or through an authorized representative; 
electronically, by phone or by mail) and what value-added services they 
choose to use (e.g., online preparation and filing services from a 
variety of competing vendors). In this vision, taxpayers would not only 
be e-filers, but e-customers. They could decide among a variety of 
options how they would like to view their own IRS account information, 
perhaps choosing traditional paper correspondence, maybe through a 
secure session at irs.gov, or potentially as part of an electronic 
financial portfolio offered securely by a private sector financial 
institution. Taxpayers would be able to retain their books and records 
electronically, a particular benefit to large corporations.
    Tax Software Developers would continue to be active participants 
with the IRS in defining new services that would be beneficial to 
mutual customers. The IRS would define changes requiring software 
investments in ways that minimize costs and maximize value for the tax 
software companies. The IRS would also provide electronic services and 
secure account access in ways that would integrate securely with 
private sector software. For example, the tax software used by a 
practitioner would automatically validate taxpayer identification 
information in near real time and securely pre-populate account 
information, such as Estimated Tax payments, reducing costs for the 
practitioner and increasing accuracy for the taxpayer and the IRS. Tax 
software companies, in turn, would be prompted by competitive market 
pressures to enhance other features of their software, such as 
providing direct links into IRS tax research knowledge bases.
    Online Filing Providers similarly would have access to electronic 
services that they could incorporate into their tax preparation and e-
filing offerings. Their services would be easily accessed and 
understood by taxpayers. The new Free File Alliance is an excellent 
example of how this type of business model could benefit the IRS, its 
partners and its customers.
    Tax Practitioners, in the end to end vision of tax administration, 
would choose from a variety of third party software products offering 
highly interactive e-services, made possible through online 
communication with the IRS' systems. A full range of e-services would 
be available, allowing practitioners to make a clean break from their 
paper processes. Those services would include the ability to e-file all 
form types, research taxpayer account information online or through a 
direct software interface, correspond electronically with the IRS, 
easily obtain electronic taxpayer signatures and maintain all records 
electronically. Information returns would be filed electronically by 
employers and financial institutions (2D bar coding of information 
returns would be a helpful interim enhancement), and made available 
timely to taxpayers, practitioners and tax agencies.
    Other Government Agencies, such as SSA, FMS and State tax agencies, 
would exchange information electronically with the IRS to improve 
compliance, taxpayer service and processing accuracy. Federal and State 
filing obligations would be addressed in a single transaction.
    Employers and Financial Institutions would file withholding and 
information returns electronically, providing electronic copies to 
taxpayers and their designated representatives. Financial institutions 
may integrate tax account information with other customer financial 
information into an electronic financial portfolio, allowing online 
account inquiry, customized financial advice, tax filing and payment 
reminders and electronic tax payments. As an incentive to customers, 
financial institutions and other third parties may offer free online 
tax preparation and filing, provided by a specialized online filing 
provider.
Achieving the Future Vision
    The IRS would act as an integrator of this network of tax 
administration service providers. Its own electronic tax administration 
processes and systems would be designed to facilitate the smooth 
interaction of its internal functions with the specialized functions of 
its third party partners and taxpayers. The focus of its electronic tax 
administration initiatives would be to increase value and reduce costs 
for all the participants in the tax administration service network, 
while protecting the security and confidentiality of taxpayer 
information.
    Those initiatives would enhance timely processing of returns and 
refunds and speedy resolution of issues, standardize interface and data 
transfer protocols, provide simple and comprehensive views of taxpayer 
account information and facilitate the ability of third parties to 
dynamically tailor services to the needs of individual customers. Key 
enablers of this future vision, led by the IRS, would be the creation 
of ``natural integration points,'' such as an electronic means for 
designating, tracking, updating and authenticating authorized 
representatives, definition of open standards such as XML for data 
exchange and development of simple but effective data encryption and 
electronic signature mechanisms.
    In this environment, existing tax administration service providers 
would likely innovate with new and creative electronic service 
offerings and new providers would undoubtedly enter the market with 
fresh ideas and new business models. Taxpayers will be the ultimate 
beneficiaries.
    That concludes my remarks to the Oversight Subcommittee. Thank you 
for the opportunity to comment on the future direction of electronic 
filing.

                                 

    Chairman HOUGHTON. Thank you very much, Mr. Belden. Now Mr. 
Cavanagh, who is the manager of the Free File Alliance in 
Alexandria. Please submit your testimony.

STATEMENT OF MICHAEL F. CAVANAGH, MANAGER, FREE FILE ALLIANCE, 
                      ALEXANDRIA, VIRGINIA

    Mr. CAVANAGH. Good afternoon, Mr. Chairman, Mr. Pomeroy. My 
name is Michael Cavanagh, and I serve as the industry manager 
of Free File Alliance.
    Chairman HOUGHTON. Could you put the microphone a little 
closer to you?
    Mr. CAVANAGH. Is that better?
    Chairman HOUGHTON. Yes. Much better.
    Mr. CAVANAGH. Okay. Pardon me. I am accompanied by Stephen 
Ryan, General Counsel to the Alliance, and a partner in the 
Manatt law firm.
    The Free File Alliance was launched last month on January 
16, at a press conference conducted by the Acting Treasury 
Secretary, the Office of Management and Budget Director, and 
Acting IRS Commissioner Wenzel. Currently, 17 industry 
companies offer free services to taxpayers.
    We can now report, as you heard from the IRS, that as of 
last week almost 650,000 free returns already had been 
processed, transmitted and accepted by the IRS. Further, we 
know that 20 percent of the total traffic of visitors to the 
IRS site is going to the Free File page, and that the total 
number of hits at the site is very significant. The total 
number of individuals who will return to file their taxes 
through the program before April 15 remains to be seen, but we 
fully anticipate that the figure will represent a very large 
addition to the 650,000 returns that have already been filed.
    We believe that this is a truly unique public-private 
partnership that offers American taxpayers significant 
benefits. It is a far better public policy approach than the 
idea that has been suggested in some quarters that the 
government should spend tens of millions of dollars to enter 
the tax preparation marketplace, thus stifling competition and 
dampening the innovation that has been so notable in the 
products and services emanating from this industry over the 
past several decades. Despite some calls for government 
intervention in the marketplace, we have not heard anyone 
suggest that government software could possibly display the 
quality, diversity and continuous innovation so readily visible 
in the competitive marketplace.
    Mr. Chairman, this initiative obviously provides tens of 
millions of Americans with the option of preparing and filing 
their taxes electronically online for free. Clearly we cannot 
say yet how many taxpayers will take advantage of this offer.
    We look forward to answering your specific questions about 
the Alliance and its operations.
    [The prepared statement of Mr. Cavanagh follows:]
    Statement of Michael F. Cavanagh, Manager, Free File Alliance, 
                          Alexandria, Virginia
    Good afternoon, Mr. Chairman, and distinguished Members of the 
Subcommittee. My name is Michael F. Cavanagh and I serve as the 
industry Manager of the Free File Alliance LLC. I am accompanied by 
Stephen Ryan, General Counsel to the Alliance and a partner in the 
Manatt law firm.
    The Free File Alliance was launched last month, on January 16, at a 
press conference conducted by the Acting Treasury Secretary, the OMB 
Director and the Acting IRS Commissioner. Currently, seventeen industry 
companies offer free services to taxpayers, each serving at least 10% 
of American taxpayers, and many considerably more.
    We can now report to you that the initial response to the Free File 
initiative has been very, very strong. As of last week, almost 650,000 
free returns already had been processed, transmitted, and accepted by 
the IRS. Further, we know that 20% of the total traffic of visitors to 
the IRS site is going to the Free File page, and that the total number 
of hits at the site is very significant. The total number of 
individuals who will return to file their taxes through the program 
before April 15 remains to be seen, but we fully expect that the figure 
will represent a very large addition to the number of returns already 
filed.
    We believe that this is a truly unique public-private partnership 
that offers American taxpayers significant benefits. It is a far better 
public policy approach than the idea suggested in some quarters that 
the government should spend tens of millions of dollars to enter the 
tax preparation marketplace, thus stifling competition and dampening 
the innovation that has been so notable in the products and services 
emanating from this industry over the past several decades. Despite 
some calls for government intervention in the marketplace, we have not 
heard anyone suggest that government software could possibly display 
the quality, diversity or continuous-innovation so readily visible in 
the competitive marketplace.
    Mr. Chairman, this initiative obviously provides tens of millions 
of Americans with the option of preparing and filing their taxes 
electronically online for free. Clearly, we now can say that many 
taxpayers are taking advantage of this offer.
    Bringing the program to fruition has taken an intense amount of 
work over the past year. First, I would like to acknowledge support 
that we have received from a number of Members of Congress.
    We would also like to thank the Bush Administration, and within the 
Administration, the Department of Treasury, the Internal Revenue 
Service, and even the Department of Justice (which provided clearance 
and review). On a personal level, we would like to thank former IRS 
Commissioner Charles Rossotti and IRS Director of Electronic Tax 
Administration Terry Lutes. Since November, Acting IRS Commissioner Bob 
Wenzel has taken up the leadership of the program. At the Treasury 
Department, Christopher Smith, Counselor to the Secretary, and George 
Wolfe, Deputy General Counsel, played a critical role in achieving the 
Agreement.
    For industry, there is an important philanthropic basis to the 
services donated under this program, but there is also a practical side 
to the Agreement. It permits stability in the marketplace of providing 
tax preparation services and, again, fundamentally the continuation of 
a successful competitive marketplace without government competition.
    The Alliance companies are offering readily available commercial 
products, the same as are being offered with paid preparation. The 
members of the Free File Alliance look forward to working with this 
Subcommittee and others in the Congress to ensure that this program 
serves the American taxpayer to the maximum extent possible.
    We look forward to answering your specific questions about the 
Alliance and its operations.

                                 

    Chairman HOUGHTON. Thank you very much. I am just going to 
ask one question, and then I will turn it over to you. I guess 
one of the things that comes to mind is what is going to happen 
if the Alliance members fail to meet their side of the bargain 
to allow 60 percent of the taxpayers to file online 
electronically?
    Mr. CAVANAGH. Mr. Chairman, one of the questions as this 
entire project was being discussed over the course of the last 
year was would, in fact, there be participants among the 
private sector who would partner with the government, and would 
they, in fact represent 60 percent of total tax-paying public, 
would those offers total that. There was some question.
    We had the question answered as we moved into this filing 
season. There is well over 60 percent that has been provided 
with free service should they choose to use the Free File 
option. The agreement calls for, if there were ever to be a dip 
below 60 percent, that the government would go to the private 
sector and say that the private sector is not living up to its 
side of the bargain in maintaining the 60 percent. At that 
time, the industry would make an effort to within a period of 
some months, within 6 months, regain the 60-percent threshold.
    Again, that has not turned out to be an issue as we see 
things operating today, but there would be that process that 
has been outlined in the operating agreement.
    Chairman HOUGHTON. Okay. Thanks. How about you, Mr. Belden? 
Do you have any comments?
    Mr. BELDEN. No, nothing to add to what Mr. Cavanagh had to 
say on that point, sir.
    Chairman HOUGHTON. Good. Fine. Mr. Pomeroy.
    Mr. POMEROY. Thank you, Mr. Chairman.
    As I understand it, the IRS has--first of all, let me 
commend you, Mr. Cavanagh, and the members of your association. 
It is exciting for us to see this kind of public-private 
partnership, and the response looks pretty promising so far 
this tax season.
    As I understand it, there are not particular standards 
relative to participating companies? What is the core deal that 
has to be offered?
    Mr. CAVANAGH. Oh, yes, there are specific standards. Each 
of the participants has to agree to the details in the 
operating agreement, and some of those were outlined by the 
Commissioner. They must obtain security and privacy seals. They 
must, of course, go through a testing with the IRS, and they 
must agree to live by a variety of elements of the operating 
agreement. We have supplied to the Chairman the operating 
agreement. So, there is a whole framework of requirements that 
each of these companies has agreed to comply with in order to 
participate in this Alliance.
    Mr. POMEROY. What about the--obviously, with the brave new 
world of the Internet, there has been a lot of business models 
that have rolled out that have not been so successful. We are 
looking, and there is a hope here that there will be a business 
opportunity for, on the one hand, free filing; on the other 
hand, there is a business relationship that can be established 
which will make it pay for the private partner participants.
    Is there any review by the IRS of what services are offered 
that represent the business plan for how this works with the 
company?
    Mr. CAVANAGH. Well, the principle has been that during this 
long discussion we began with former IRS Commissioner Rossotti 
back January a year ago, and the concept evolved into what this 
would be. One of the real concerns was that industry players 
might suggest that they would offer dumbed-down versions to the 
American public of software and whatever. The commitment was 
that there must be commercial services that are offered to the 
public would be the ones that would be part of the Free File 
Alliance.
    Now, within that--within those commercial products, there 
in many instances are various add-ons. You were talking about 
one before. There are a whole range of different things that 
the public can get, and there never was any sense that in the 
Alliance process that there should be any element of service 
being taken away. The core tax product must be free, and there 
must be absolutely no quid pro quo.
    Mr. POMEROY. What worries me is basically we are--a basic 
fee for filing might be easier and more of a straight-up method 
to have this paid for than unbundled services that are--that 
involve a variety of costs and maybe--purchased by people that 
aren't quite sure whether they need them or not. That is the 
source of my concern.
    Again, I have heard no complaints of untoward market 
activity. I am just trying to look at this going forward. So, I 
certainly, again, salute your Members. I don't mean to impugn 
anything inappropriate on their behalf.
    Do you think there should be some dialog with the IRS or 
some review by the--in terms of where these products fall? 
Obviously as an association you can't really do it. It would 
seem to be antitrust activity if you did. Is there an area 
where this Committee ought to have some concern?
    Mr. CAVANAGH. Well, Congressman, you were referring to one 
particular set of products, which the Commissioner and the ETA 
Director made the point that indeed that product is primarily 
offered and primarily used by millions of Americans not in the 
online arena, but in other arenas. Certainly any product like 
that is, of course, appropriate for your oversight. It doesn't 
have anything to do with the Free File Alliance.
    Mr. POMEROY. What are people buying, the 600,000 that have 
filed this year; do you know?
    Mr. CAVANAGH. Pardon me?
    Mr. POMEROY. I see that my time is expired. I will just 
close with what--have you surveyed your members, and what are 
taxpayers purchasing by way of add-on services of the 600,000?
    Mr. CAVANAGH. No, we are not surveying them on that 
question.
    Mr. POMEROY. Perhaps after the tax year we could. It would 
be very interesting to see what kind of commercial activity is 
taking place.
    Mr. CAVANAGH. Yes, Mr. Congressman, yes. Thank you.
    Chairman HOUGHTON. There are only two of us here, if you 
want to continue asking the questions.
    Mr. POMEROY. I think I pretty well got through it. I am 
interested in when the Commissioner said there is no express or 
implicit endorsement of products, the fact that there is a 
public-private partnership and you can access these vendors 
through the IRS Web site leaves me a little concerned that 
there may be an implicit statement by the IRS that these are 
appropriate products, and yet there does not seem to be an 
active review of whether the products are indeed appropriate. 
So, maybe we can install that going forward.
    Mr. CAVANAGH. Congressman, but I would just note these 
companies are not vendors to the Federal Government. This is 
the www.irs.gov Web site. These companies are not contracting 
with the--through the IRS to do anything. So, vendors--that is 
not the relationship they have.
    Mr. POMEROY. If I refer someone to someone else, I want to 
make sure that what they are selling is legit, and I think the 
same is true about the United States.
    Mr. CAVANAGH. Sure.
    Mr. POMEROY. If we refer we want to feel good about the 
product sold. By the way, I believe absolutely there are 
appropriate business opportunities for companies providing a 
service for products that taxpayers need. So, I don't impugn 
this. This isn't something--a marketplace that I think is 
judged guilty before proven innocent. I think it is a fine 
opportunity. I just want to know what activity is taking place 
in this marketplace. Thank you very much.
    Chairman HOUGHTON. I think that is about all. The only 
other question I might have is about the EITC and those people 
who were involved in that, how do you reach them?
    Mr. CAVANAGH. Well, Mr. Chairman, they are provided--there 
are a number of offers that would cover them and would cover 
the--those schedules, and so that is certainly included in the 
program. Absolutely.
    Chairman HOUGHTON. All right.
    Mr. CAVANAGH. Even as I think--as I saw here today the IRS 
was actually showing some the screens that the IRS has 
developed for information for EITC. So, that is absolutely an 
area that is--that is available as part of this Free File 
Alliance, Mr. Chairman.
    Chairman HOUGHTON. Okay. Well, thank you very much. I am 
sorry this has been sort of a truncated type of thing, but we 
are victims of the flow of votes. So, thank you very much 
gentlemen for being with us. Now, Ms. Olson, if you could step 
up here, and we will see what we can do.
    Ms. Olson, what I thought we would do is if you could give 
your testimony, and that would fit into our timeframe, then we 
will break, and then we will come back for questions afterward. 
Is that all right with you?
    Ms. OLSON. That sounds wonderful, sir.
    Chairman HOUGHTON. All right. Let me give you a chance to 
pour yourself a little water. Thank you very much for being so 
patient here.
    Ms. OLSON. Oh sure.
    Chairman HOUGHTON. Thanks again, gentlemen, for being part 
of this program. All right. Ms. Olson, who is the NTA of the 
Internal Revenue Service. Ms. Olson, we are delighted to have 
you here again.

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

    Ms. OLSON. Thank you. Okay. Mr. Chairman and Members of the 
Committee, thank you for inviting me to appear before you today 
to discuss my 2002 annual report to Congress. I appreciate your 
and the Committee's interest in the Taxpayer Advocate Service 
(TAS) and your work on tax simplification and taxpayer rights. 
I also wish to acknowledge here the efforts and talents of the 
many TAS employees who contributed to this report.
    Last year I came before you to discuss some of our 
legislative recommendations for tax simplification, most 
notably the uniform definition of a qualifying child and the 
alternative minimum tax. This year we focus on the difficulty 
facing the IRS to fairly administer an enormous tax system 
while respecting taxpayer rights and providing customer 
service. The size and scope of the U.S. tax system makes 
achieving this balance a challenge.
    Our theme this year is taxpayer rights. Taxpayer rights 
includes the taxpayer's right to expect to be treated promptly 
and courteously and to be provided accurate information, the 
right to receive adequate notice of any disagreement the IRS 
has with the taxpayer and the reasons for that disagreement, 
and the right to an adequate opportunity to dispute the IRS 
position before the taxpayer is required to pay any additional 
tax. These rights must be available to the taxpayer without 
causing the taxpayer undue burden in obtaining them. We are, 
after all, asking taxpayers to voluntarily pay over their taxes 
to us. We should not make it difficult for them to do so.
    I believe that the next serious challenge to tax 
administration in the 21st century will not revolve around the 
balance between enforcement and taxpayer rights or customer 
service. Rather it will involve the balance between taxpayer 
rights, including customer service, and the drive toward 
efficiencies as a consequence of the sheer size and complexity 
of the U.S. tax system.
    Over and over in the report's Most Serious Problems 
section, we highlight the difficult choices the IRS must make 
in its struggle to provide taxpayers with the services they are 
requesting. Take offer in compromise, for example. We 
understand the basis for the Service's decision to centralize 
the processing of offers; however, we believe that centralizing 
offers does not mean that offers should be rejected without 
contact or discussion with the taxpayer. It may be with a phone 
call that some apparently unacceptable offers might turn into 
valid ones. There might be some vital information or some 
special circumstance left off the form, or with one follow-up 
phone call the taxpayer might be willing to enter into an 
installment agreement. Thus the taxpayer might not get the 
offer he or she wants, but he will get closure of some sort and 
a fresh start toward compliance. Yet direct phone contact with 
the taxpayers is the exception, not the norm, in centralized 
sites.
    This emphasis on efficient processing of offers can lead to 
rework of the case by Appeals or the Taxpayer Advocate Service 
or, more importantly, to a lost opportunity to collect the tax. 
The IRS simply does not know what happens to offers after they 
are rejected. We do not know if we collect another dime on 
those rejected offers. Moreover, the program's own quality 
measures indicate that much can be done to improve the IRS's 
computation of the taxpayer's ability to pay or the correct 
offer amount.
    In addition to the right to communicate with the IRS, the 
taxpayer has the right to be advised clearly and specifically 
about any proposed changes on his or her income tax return. For 
example, under math error authority, the IRS sends a notice to 
the taxpayer telling him that it has changed the tax due on the 
taxpayer's return. Unless the taxpayer timely requests an 
abatement of tax, the taxpayer cannot petition the U.S. Tax 
Court, which is the only forum in which a taxpayer can litigate 
a tax before it is assessed and becomes collectible. When 
Congress expanded math error authority in 1976, it clearly told 
the IRS to send taxpayers detailed, itemized, line-by-line 
explanations of the error so that taxpayers could timely 
respond with an abatement request. Yet math error notices today 
do not set out the adjustments line by line, and a sample of 
tax cases indicates that taxpayers do not know what is being 
adjusted and cannot reach someone in the IRS to explain the 
adjustment of the item, so they miss the opportunity to request 
abatement.
    In 2001, Congress expanded math error authority, effective 
in 2004, to the use of the Federal Case Registry of Child 
Support Orders. This 2001 expansion applies math error 
authority to a question that is inherently factual and not 
ascertainable from the face of the tax return. It is our 
recommendation that Congress repeal the expansion of math error 
authority it enacted in 2001 and limit expansion of math error 
to quantitative, not qualitative, items.
    In addition to math error authority, we have identified 
several key legislative recommendations in our reports, 
including the tax treatment of attorneys' fees in nonphysical 
personal injury cases and a system of registering, testing and 
certifying Federal income tax return preparers who are not 
already attorneys, certified public accountants or enrolled 
agents.
    We are also proposing that a husband and wife who jointly 
own an unincorporated business and who file a joint Federal 
income tax return be permitted to elect out of the partnership 
provisions of the Code and instead file a joint sole 
proprietorship or farm schedule and report each spouse's share 
of self-employment income.
    We submit a proposal relating to the taxation of children's 
income, also known as the kiddie tax. This proposal goes to tax 
simplification and the reduction of taxpayer burden. As you 
know, if children under 14 have more than $1,500 in unearned 
income, their tax must be computed at the parent's top marginal 
rate. Further, the parent can elect to include the child's 
unearned income on his or her return. Because these options 
lead to different tax results, a parent must calculate three 
returns in order to determine what is the best tax outcome. 
This process must be repeated for each additional child. Add to 
this the possibility of triggering a child's alternative 
minimum tax, and the difficulty of obtaining tax information 
from an estranged spouse, and you have a needlessly complex 
provision.
    We propose that the calculation of tax on children's income 
be severed from the parents' tax computation or tax rate. The 
concern that taxpayers might shift income-producing assets to 
children and thereby take advantage of lower tax rates can be 
addressed by establishing an appropriate tax rate on the 
children's income.
    In the interest of simplification, we also propose that 
Congress establish a set standard deduction for dependents 
rather than the current floating deduction amount.
    Our last proposal addresses the operation of the Office of 
Taxpayer Advocate. We are recommending six revisions to our 
authorizing statute. All of these revisions derive from the 
fundamental premise reaffirmed in 1998 that the Office of the 
Taxpayer Advocate must be independent, and yet function within 
the IRS.
    We first propose that the NTA be authorized to appoint a 
counsel who shall report directly to the Advocate and advise 
her on matters pertaining to taxpayer rights.
    Chairman HOUGHTON. Ms. Olson, can I just interrupt a 
minute? I am going to have to go and vote, and if you wouldn't 
mind, we will vote fast, and then come right back. So, you can 
finish your testimony, and we will have the questions.
    Ms. OLSON. Thank you.
    Chairman HOUGHTON. Thank you for your forbearance.
    Mr. PORTMAN. [Presiding.] Ms. Olson, a second welcome to 
the Subcommittee. I am glad to be with you. We have been tag-
teaming this afternoon, as you know. I understand you had 
managed to get through some, but not all, of your oral 
testimony. If you would be so kind to continue that, Chairman 
Houghton and other Members should be returning shortly.
    Ms. OLSON. All right. Let me find my place.
    Our last proposal addresses the operation of the Office of 
the Taxpayer Advocate. We are recommending six revisions to our 
authorizing statute. All of these recommendations derive from 
the fundamental premise reaffirmed in 1998 that the Office of 
the Taxpayer Advocate must be independent, and yet function 
within the IRS.
    We first propose that the NTA be authorized to appoint a 
counsel to the NTA who shall report directly to the Advocate 
and advise her on matters pertaining to taxpayer rights, tax 
administration and the Office of the Taxpayer Advocate.
    Currently the NTA receives advice from a special counsel 
who reports directly to the Chief Counsel of the IRS. Given the 
unique role of the NTA to take positions that may be different 
from the official position of the IRS, there are times when 
this reporting structure creates a serious conflict of interest 
and limits the Advocate's access to independent legal advice.
    We believe it is important to maintain the counsel to the 
Advocate's current ability to participate in the day-to-day 
development of guidance and regulation. We also believe it is 
important that the TAS continue to receive its legal advice on 
substantive tax law matters in specific cases from the IRS 
counsel. However, and finally, we believe that the conflict of 
interest on taxpayer rights and tax administration would 
warrant independent advice from a counsel that directly reports 
to the NTA.
    We also propose that the Taxpayer Advocate Directive, which 
is currently delegated to the Advocate by the Commissioner, and 
which authorizes her to act on behalf of groups of taxpayers or 
taxpayers at large, be codified to ensure that it cannot be 
revoked.
    We also propose that the definition of ``significant 
hardship,'' which grants taxpayers access to TAS, be expanded 
to explicitly include impairment of taxpayer rights as a 
grounds for issuance of a Taxpayer Assistance Order or Taxpayer 
Advocate Directive.
    Finally, we make some recommendations about the ability of 
and discretion of the Taxpayer Advocate Service to hold 
taxpayer communications confidential both from the IRS and in 
Federal courts.
    I would like to conclude by acknowledging again the support 
your Committee has shown for my office and indeed the entire 
IRS. I know that the key subjects of this year's report, 
taxpayer rights and making the system simpler and more 
accessible so it is easier for taxpayers to comply with their 
tax obligations, are of special interest to this Committee. I 
hope our report has been of some assistance to your oversight 
duties.
    Thank you for this opportunity. I also request permission 
at this time to submit a written statement for the record.
    [The prepared statement of Ms. Olson follows:]
   Statement of Nina E. Olson, National Taxpayer Advocate, Internal 
                            Revenue Service
    Mr. Chairman and Members of the Committee, thank you for inviting 
me to appear before you today to discuss my 2002 Annual Report to 
Congress. I appreciate your and the Committee's interest in the 
Taxpayer Advocate Service and your work on tax simplification and 
taxpayer rights. I also wish to acknowledge the efforts and talents of 
the many Taxpayer Advocate Service employees who contributed to this 
Report.
    Last year I came before you to discuss some of our legislative 
recommendations, most notably the uniform definition of a qualifying 
child and the alternative minimum tax. Our focus was on tax 
simplification. This year, we focus on the difficulty facing the IRS to 
fairly administer an enormous tax system. Combined with the complexity 
of the tax law--well, one can easily declare this task impossible. And 
yet, 98,000 employees each day show up to work, willing to take on this 
thankless job and do the best they can at it. Their efforts are 
obviously the reason why the Federal tax system runs as well as it 
does, despite all the challenges it faces.
    The theme of this year's report is taxpayer rights. We do not use 
this term narrowly. Although clearly the concepts of sufficient notice 
and due process are integral to taxpayer rights, in this year's report 
we focused on a broader definition--one that looks at the essential 
contract between the government, as represented by its tax 
administration agency, and the taxpayer.
    The U.S. tax system is, in fact, a voluntary tax system. Although 
people may joke about this, we rely on taxpayers to voluntarily file 
their tax returns and report the correct income and deductions and 
credits and tax. We ask employers to voluntarily submit the earnings 
and withholdings of their employees, and we ask the self-employed to 
voluntarily report revenue and expenses. And we ask everyone to 
voluntarily pay their correct share of the tax burden. Certainly, in 
some instances the IRS must take additional steps to secure this 
information or payment, but the compliance and enforcement functions of 
the IRS are only two of many aspects of tax administration.
    The recognition and protection of a taxpayer's rights is a 
necessary and quite possibly paramount element of a voluntary tax 
system. By taxpayer rights, I mean the taxpayer's right to expect to be 
treated promptly and courteously and to be provided accurate 
information; the right to receive adequate notice of any disagreement 
the tax agency has with the taxpayer's return or position and the 
grounds for that disagreement; and the right to an adequate opportunity 
to dispute the tax agency's position before the taxpayer is required to 
pay any additional tax. These rights must be available to the taxpayer 
without causing the taxpayer undue burden in obtaining them. We are, 
after all, asking taxpayers to voluntarily pay over their taxes to us. 
We should not make it difficult for them to do so.
    I believe that the next serious challenge to tax administration in 
the 21st century will NOT revolve around the balance between 
enforcement and taxpayer rights or customer service. Rather, it will 
involve the balance between taxpayer rights, including customer 
service, and the drive toward efficiencies as a consequence of the 
sheer size and complexity of the U.S. tax system.
    Right now, the IRS is trying to identify when taxpayers should be 
spoken with in person, when they can receive recorded answers to 
questions, when they can be asked to leave a message and receive a 
return call. It is trying to determine what should be the core services 
delivered at ``Taxpayer Assistance Centers,'' formerly called ``walk-in 
sites.'' It is also trying to streamline processing of certain offers 
in compromise, correspondence audits of underreporter amounts and the 
earned income tax credit, and even the collection of certain tax debts 
through the use of private collection agencies.
    Taxpayers and practitioners, on the other hand, complain of not 
being able to reach the IRS by phone--they cannot find the appropriate 
person to speak with or identify the management chain of command, or 
they leave messages that are not returned. They miss the geographic 
footprint of the IRS and they are unable to identify an IRS employee's 
job duties merely from that person's job title. Thus, we identify the 
top problem of taxpayers (and IRS employees, I might add) as that of 
merely navigating the IRS.
    Over and over, in the Report's Top 20 problems section, we 
highlight the difficult choices the IRS must make in its struggle to 
provide taxpayers with the services they are requesting. Take offer in 
compromise, for example. This is a program in which the Office of the 
Taxpayer Advocate has been very active. We agree with the IRS that 
having Revenue Officers work the vast majority of offers, which present 
very simple situations, would be an inefficient use of very valuable 
resources. The expertise of Revenue Officers should be reserved for 
those offers that present difficult questions of valuation or other 
specific circumstances. We also understand the basis for the Service's 
decision to centralize the processing of offers, and my office and I 
are working with the IRS to improve that aspect of the program.
    However, we believe that centralizing offers does not mean that 
offers should be processed without contact or discussion with the 
taxpayer. We understand that approximately 14 percent of submitted 
offers are returned to the taxpayer because the taxpayer's own 
financial calculation shows that he or she can fully pay the tax and 
does not need a compromise. Yet it may be, with a phone call, that some 
of these offers might turn into a valid offer--there might be some 
vital information or some special circumstance left off the form. Or, 
with one follow-up phone call, the taxpayer might be willing to enter 
into an installment agreement. Thus the taxpayer might not get the 
offer he or she wanted, but he will get closure of some sort, and a 
fresh start toward compliance. Yet direct phone contact with the 
taxpayer is the exception, not the norm, in centralized sites.
    This emphasis on ``efficient'' processing of offers can lead to re-
work of the case by Appeals or the Taxpayer Advocate Service, or, more 
importantly, to a lost opportunity to collect tax. The IRS simply does 
not know what happens to offers after they are rejected. We do not know 
if we collect another dime on those taxpayer accounts. Moreover, the 
program's own quality measures indicate that much can be done to 
improve the IRS's computation of the taxpayer's ability to pay, or the 
correct offer amount.
    In our report we identify what we believe is a serious taxpayer 
rights issue--the IRS's increasing use of a notice called a 
``combination letter,'' which combines into one letter the notice of 
the Service's proposed decision as well as notice of the taxpayer's 
appeal rights. This ``combination letter'' pops up in the context of 
both offers in compromise and the earned income tax credit. For most 
other situations where a taxpayer is offered administrative appeal 
rights, including audits, the taxpayer receives two separate letters--
one setting forth the proposed change and offering an opportunity to 
present more information, and the other outlining the IRS's decision 
and explaining appeal rights. In the EITC ``combo'' letter, however, 
the IRS invites the taxpayer to send in additional information if he or 
she disagrees with the IRS's proposed position. At the same time, the 
taxpayer is advised that he has a right to appeal, which is explained 
in an enclosed publication. Yet, that enclosed publication refers the 
taxpayer back to the letter for information on how to request an 
administrative appeal.
    We simply do not believe that the ``combo letter'' format 
adequately advises the taxpayer of his or her right to an 
administrative appeal. It is poor customer service, leads to rework as 
audit reconsiderations and refund claims, and imposes an undue burden 
on taxpayers--all in the name of efficiency and minimizing resources.
    In addition to the taxpayer's right to be advised, clearly and 
specifically, about his or her administrative appeal rights, we believe 
the taxpayer has the right to be advised, clearly and specifically, 
about any proposed changes on his or her income tax return. As you 
know, the IRS has the authority under section 6213 to summarily assess 
mathematical and clerical errors that a taxpayer might make on his or 
her return. These errors include errors in addition, switching the 
digits on a Social Security number, or transcribing the wrong number 
from one form to another. If the taxpayer does not agree with the IRS 
about the adjustment, then the taxpayer must write the IRS within 60 
days and ask it to abate the tax. If the taxpayer misses the 60 days, 
the IRS begins collection, and the taxpayer must make a refund claim. 
The taxpayer loses the ability to request an administrative appeal or 
the ability to go to the United States Tax Court, which is the only 
forum in which a taxpayer can litigate a tax before it is assessed and 
becomes collectible.
    When Congress expanded the summary assessment authority in 1976 to 
clerical as well as math errors, it clearly directed the IRS to send 
taxpayers detailed, itemized, line-by-line explanations of the math or 
clerical error, so that taxpayers could timely respond with an 
appropriate abatement request. Yet math error notices today do not set 
out the adjustments line-by-line, and a sample of Taxpayer Advocate 
Service cases indicates that taxpayers do not know what is being 
adjusted and cannot reach someone in the IRS to explain the adjustment 
to them, so they miss their opportunity to request abatement.
    Today, in the interests of efficiency and driven by concerns about 
EITC compliance, Congress has expanded math error authority to include 
matching information against external databases, despite Congress's 
original concern that the authority should only be used where the error 
and inconsistency is apparent from the face of the return. In most of 
these expanded provisions, the correct answer is quantitative and not 
based on facts and circumstances, and the external database is highly 
reliable. However, in 2001, Congress expanded math error authority, 
effective in 2004, to the use of the Federal Case Registry of Child 
Support Orders. I have grave reservations about the currency and 
adequacy of the FCR's data, but these concerns will be expressed in a 
report to be issued by the Treasury Department, in consultation with my 
office. My point today is that this 2001 expansion applies math error 
authority to a question that is inherently factual--whether a child 
lived with a taxpayer for more than half the year. I do not believe 
this information can accurately be determined from the face of the 
return, nor from any existing database. It relies on the specific facts 
and circumstances of a taxpayer's situation, it is a qualitative--not 
quantitative--analysis, and as such is not the proper subject of a 
summary assessment, one that can result in the taxpayer losing the 
opportunity to petition the Tax Court.
    Thus it is our recommendation that Congress repeal the expansion of 
math error authority it enacted in 2001 and impose certain requirements 
for any proposed expansion of math error authority--namely, that it 
apply only in those situations where inconsistencies can be determined 
from the face of the return, where items or schedules are omitted from 
the return, and where numerical or quantitative items are reported on 
the return and can be verified by a government entity that issues or 
calculates those items. We believe this approach to summary math error 
authority, coupled with clear and understandable explanations of math 
error adjustments, recognizes the IRS's need to process information 
expeditiously without violating a taxpayer's right to deficiency 
procedures in disputes of a factual nature.
    In addition to math error authority, we have identified several key 
legislative recommendations in our report, including the tax treatment 
of attorney fees in nonphysical personal injury cases, which results in 
significantly different tax treatment of Federal taxpayers depending on 
the underlying State law. We also propose a system of registering, 
testing, and certifying Federal income tax return preparers who are not 
already attorneys, CPAs, or enrolled agents. Our proposal is 
comprehensive and, we believe, does not require the expenditure of 
significant resources once the registration system is established.
    We submit a proposal relating to the taxation of children's 
income--also known as the ``kiddie tax.'' This proposal goes to tax 
simplification and the reduction of taxpayer burden. As you know, if 
children under 14 have more than $1,500 in unearned income, their tax 
must be computed at the parent's top marginal tax rate. Further, the 
parent can elect to include the child's unearned income on his or her 
return. Because these options lead to different tax results, a parent 
must calculate three returns in order to determine what is the best tax 
outcome. This process must be repeated for each additional child. Add 
to this the possibility of triggering a child's alternative minimum tax 
liability, or the difficulty of obtaining tax information from an 
estranged spouse, and you have a needlessly complex provision.
    We propose that the calculation of tax on children's income be 
severed from the parent's tax computation or tax rate. The concern that 
taxpayers might shift income-producing assets to children and thereby 
take advantage of lower tax rates can be addressed by establishing an 
appropriate tax rate on the children's income. In a related matter, we 
note that the dependent's standard deduction is the only deduction that 
is not a set, flat amount. A dependent's standard deduction can be any 
number between $750 and the single standard deduction amount. In the 
interests of simplification, we propose that Congress establish a set 
standard deduction for dependents.
    As another simplification measure, we have suggested that a husband 
and wife who jointly own an unincorporated business and who file a 
joint Federal income tax return be permitted to elect out of the 
partnership provisions of the Code and instead file a ``joint'' sole 
proprietorship or farm schedule and report each spouse's share of self-
employment income. Under today's law, a husband and wife jointly owning 
and operating an unincorporated business--say a dairy farm or small 
shop or even pet-sitting businesses--should file a partnership return. 
In practice, most couples merely report the business' income as a sole 
proprietorship, with only one member of the couple receiving credit for 
Social Security and Medicare purposes. This can lead to disastrous 
consequences if the uncovered spouse becomes disabled or dies. Because 
97 percent of all sole proprietorship and farm schedules show income 
below the Social Security wage cap and because we propose to make this 
provision elective in any event, no couple would experience a tax 
increase yet many would clearly benefit from Social Security and 
Medicare eligibility. This proposal clarifies and simplifies the status 
of husband and wife co-owned businesses and ensures appropriate Social 
Security and Medicare coverage for the working couple.
    One of our proposals was actually enacted and later repealed, but 
we think it is a good idea so we are proposing it again. Today, under 
section 3402(i)(1), taxpayers can increase their withholding from 
paychecks by a specified amount. They cannot, however, decrease their 
withholding by specified amounts. The only way to decrease withholding 
is by claiming additional withholding allowances, which requires a 
complex set of calculations on various schedules or worksheets. We 
propose that taxpayers be able to decrease the amount of their 
withholding by discrete amounts, just as they can increase their 
withholding. This approach reflects the way taxpayers actually think 
about their withholding and, in many instances, eliminates the burden 
of having to fill out schedules and forms.
    Our last proposal addresses the operation of the Office of the 
Taxpayer Advocate. We are recommending six revisions to our authorizing 
statute, five of which I will discuss today. Our proposal for amicus 
brief authority I will leave to another time. All of these 
recommendations derive from the fundamental premise, reaffirmed in 
1998, that the Office of the Taxpayer Advocate must be independent and 
yet function within the IRS. These recommendations attempt to 
strengthen that independence while preserving the Advocate's internal 
placement. These proposals also attempt to strengthen the Advocate's 
ability to protect taxpayer rights.
    We first propose that the National Taxpayer Advocate be authorized 
to appoint a Counsel to the National Taxpayer Advocate, who shall 
report directly to the Advocate and advise her on matters pertaining to 
taxpayer rights, tax administration, and the Office of the Taxpayer 
Advocate. Currently, the Advocate receives advice from a special 
counsel, who reports directly to the Chief Counsel of the IRS. Given 
the unique role of the National Taxpayer Advocate to take a position 
that may be different from the official position of the IRS, there are 
times when this reporting structure creates a serious conflict of 
interest and limits the Advocate's access to legal advice. We believe 
it is important to maintain the Counsel to the Advocate's current 
ability to participate in the day-to-day development of guidance and 
regulations. We also believe that it is important that the Taxpayer 
Advocate Service continue to receive its legal advice on substantive 
tax law matters in specific taxpayer cases from the Office of Chief 
Counsel. Thus, this proposal provides the Office of the Taxpayer 
Advocate with dedicated legal counsel on matters specifically related 
to its statutory mission, namely taxpayer rights in the context of tax 
administration.
    The other proposals flow from the recognition of our statutory 
mission. We propose that the Taxpayer Advocate Directive, currently 
delegated to the National Taxpayer Advocate, be codified to ensure that 
it cannot be revoked. The Taxpayer Advocate Directive grants the 
National Taxpayer Advocate the authority to direct the IRS to act or 
not act with respect to any program or action--actual or proposed--that 
may create a significant hardship for a group of taxpayers or for all 
taxpayers. We also propose that the definition of significant 
hardship--which grants taxpayers access to the Taxpayer Advocate 
Service--be expanded to explicitly include ``impairment of taxpayer 
rights'' as a grounds for issuance of a Taxpayer Assistance Order or a 
Taxpayer Advocate Directive.
    Finally, we recommend that the provision relating to the discretion 
of the Local Taxpayer Advocate to not disclose to the rest of the IRS 
any information obtained from the taxpayer directly be amended to make 
clear that this discretion applies notwithstanding any other provision 
of the Code. This discretion applies except in clear instances of 
criminal acts or civil fraud. Our proposal clarifies the source of 
authority for the approach we have adopted. We also recommend that the 
confidentiality provisions of the Administrative Dispute Resolution Act 
with respect to compelling a ``neutral'' to testify be incorporated 
into IRC section 7803(c)(4). These provisions would require a judge to 
weigh whether the need for a Taxpayer Advocate Service employee's 
testimony outweighs the chilling effect such testimony might have on 
future taxpayers seeking our assistance. We believe this neutral, third 
party determination will provide some assurance to taxpayers that their 
conversations with the Taxpayer Advocate Service, absent some serious 
violation or need, will not be disclosed to the IRS or even in open 
court, unless necessary to resolve the taxpayer's problem.
    I would like to conclude by acknowledging again the support your 
Committee has shown for the work of my office, and indeed the entire 
IRS. I know that the key subjects of this year's report--taxpayer 
rights and making the tax system simpler and more accessible so it is 
easier for taxpayers to comply--are of special interest to this 
Committee. I hope our report has been of some assistance to your 
oversight duties. Thank you for this opportunity to come before you to 
discuss these important matters.

                                 

    Chairman HOUGHTON. [Presiding.] Absolutely. Thank you very 
much. You have done a wonderful job. We are honored to have you 
here. The fact that you have this job is really because of Mr. 
Portman and the structural work which he had done. So, I am 
indebted to him as always.
    Anyway, at the end you talked about the confidentiality 
issue. Do you think that really is working, the ability to 
communicate to your office by taxpayers?
    Ms. OLSON. We have not yet fully implemented the 
confidentiality provisions. We are beginning to, as our new 
database system goes online, which enables us to keep 
information confidential from the rest of the IRS. In talking 
to practitioners and taxpayers in some of our focus groups--we 
went out to six different focus groups during the last year--we 
found that regardless of income level or language facility, it 
mattered to taxpayers that they had someone independent inside 
the IRS to speak to and that they could tell us things. Most 
people think these things have to do with fraud or something 
like that, but they mainly have to do with personal matters. 
Taxpayers could tell us things that related to their problems, 
they could talk with us, and it wouldn't necessarily need to go 
to the IRS. It was irrelevant in a way to the underlying tax 
law, but they wanted to have an ear in the IRS that they could 
speak to.
    So, I think that that provision is very important. Our 
employees understand the importance of it.
    We have tried to work with the IRS to convince them that we 
will be implementing this and not using it as a way to hide 
important information from the IRS, but rather to bring 
taxpayers into compliance and have them feel comfortable coming 
to us on touchy issues and coming into compliance with the 
Internal Revenue laws. I think confidentiality is vital to 
that.
    Chairman HOUGHTON. All right. Well, I am always in awe of 
lawyers, but I wonder why you are adding a counsel to your 
staff at this particular time.
    Ms. OLSON. We have had several issues in which my office 
has taken a different position from the direction in which the 
IRS has chosen to go. As you know, I do have the ability 
through the annual report to Congress and other means to take 
positions that are different from the Commissioner. I cannot 
override the Commissioner's decision, but I can be on the 
record about my position. It places the counsel that I 
currently have--who reports to Chief Counsel, who advises the 
Commissioner and would advise the Commissioner on his 
position--in sort of an untenable conflict position.
    I would like to have sound advice if I am going to take a 
position. I don't want to be taking a position that is out of 
ignorance rather than sound principle or law.
    Chairman HOUGHTON. Right. Well, just one final question for 
you, then I will ask Mr. Portman to question. Of all the 
recommendations you have made, what is the most important?
    Ms. OLSON. Oh, dear. That is very difficult to answer 
because they are all so different. In terms of taxpayer rights, 
I think the math error authority recommendation is the most 
important. In terms of tax simplification, I think it is 
actually a toss-up between the children's income proposal and 
the husband and wife co-owned business proposal. I think both 
of them present simplification issues. Probably the children's 
income affects many more taxpayers than the husband and wife 
proposal.
    Chairman HOUGHTON. Okay. Well, thank you very much.
    Mr. Portman.
    Mr. PORTMAN. Thank you, Mr. Chairman. Although you are 
inaccurate in saying that Ms. Olson got her job because of our 
work, you probably made her mad at me by saying that, because 
she has been in the middle of some very, very tough issues, but 
she has done well, and she has managed to do what we had hoped 
would happen in the legislation that went through this 
Subcommittee, which is to have a truly independent Taxpayer 
Advocate and someone who could give us an unvarnished view on 
not just Tax Code simplification, which you did well in your 
report last year, but also on tax law administration, which you 
have focused on more this year. That is extremely important to 
this Subcommittee and to our Committee because it gives us the 
ability to legislate with better information.
    I want to focus on two things, if I could, quickly. One is 
the offer in compromise issue. You said that is the number 2 
issue for you. There has been a lot of attention focused on 
that recently. I know the oversight board met late January and 
discussed this issue at some length, and some practitioner 
groups have raised concerns with the offer program. On the 
other hand, I saw that Dale Hart was recently quoted in the 
Wall Street Journal, who is the Deputy Commissioner of the 
small business area and self-employed, saying he thought the 
offer and compromise program had turned the corner.
    So, I am hearing sort of different perspectives on it. We 
added under the IRS Restructuring and Reform Act of 1998 (P.L. 
105-206) another criteria. You could always do it if there is a 
question about liability or collectability, and we added this 
relatively broadly defined notion of effective tax 
administration. Has that created some of the problems, and 
where do you think the offer and compromise program is at this 
point?
    Ms. OLSON. Well, first let me address why we put it as 
number 2, because if you look at it in the context of all the 
business that the IRS does, we only get 130,000 offers a year, 
and that is a pittance in terms of all the other work that we 
do. We put it as number 2 because it has been around for so 
long. In fact, 1868 is the first time it showed up in the U.S. 
Code, the authority for the revenue officer to compromise tax 
debts. We have felt that at least since 1992, the IRS hasn't 
gotten it right, so we thought maybe by giving a lot of 
attention to it and going carefully through what we thought 
were problems with the program, we could lay out some of the 
adjustments that needed to be made.
    Since we started, maybe since 2001, we have had an analyst 
dedicated entirely to that program, and much to the Small 
Business and Self Employed Division's great credit, they have 
worked closely with us, and I think it is a successful 
partnership.
    I agree with Deputy Commissioner Hart that the program has 
turned the corner. I think that I can live with centralization, 
but there are things that we need to do to make the centralized 
sites more responsive to taxpayers. It does take some 
adjustment, but if we continue to work along some of the lines 
that we have identified in the report, we will finally get 
there.
    Now, effective tax administration--there were three 
grounds--economic hardship, equity and public policy. I think 
the IRS has understood economic hardship pretty well, but I 
think on the grounds of equity and public policy, we have had 
some difficulty in trying to decide what those words mean. What 
we came up with, what Treasury announced through its recent 
regulation that was issued this past summer was, on those two 
categories, equity and public policy, we want taxpayers, if 
there is some reason other than financial inability to pay, or 
you don't think you actually owe the tax, to come in to us and 
tell us why it is that you should be cut a break as opposed to 
all the other taxpayers in the world who pay their taxes. What 
is so different about your facts and circumstances?
    We would take a look at those factors, rather than giving a 
list to which somebody could say, well, you are not on the 
list, so we are not going to listen to you. We would see what 
came in. People had to answer that first question, though: What 
is so special about you? Can you look at your neighbor and say 
to them with a straight face, I am going to get a break, but 
you have to pay?
    Mr. PORTMAN. It almost becomes a fact and circumstances 
test, which again, in the legislation, economic hardship is 
easier, it is closer actually to doubt as to collectability, 
which is already in the criteria. It is true that equity 
probably comes down to a facts and circumstances, more 
subjective test. You are saying you have flexibility to do 
that. You feel like you are turning the corner.
    Just for those who are listening and might not understand 
what we are talking about, this is when a taxpayer does not 
have to pay the full amount, the full liability owed. The 
process of negotiating with the IRS gives them an opportunity 
to settle for less than the full amount, which is a very 
important way to clear the decks and to help a lot of taxpayers 
who do have some specific circumstances that make it difficult 
to pay.
    I don't have another question, but I will say just briefly, 
Mr. Chairman, we appreciate what you do for our taxpayers; also 
what you do for us. Keep giving us those simplification ideas. 
Mr. Houghton has a bill on simplification that is very 
important. I have one, too. We take your ideas seriously, as 
you see in our legislation, and this notion of how to tax 
children, which is a huge simplification, is an example of what 
you need to keep giving us and working with us. So, thank you 
for your work.
    Ms. OLSON. Thank you very much.
    Chairman HOUGHTON. Thanks very much.
    Ms. Tubbs Jones.
    Ms. TUBBS JONES. I want to pick this Committee. I could be 
Chairman soon, right, if I just hang around. I will keep on 
moving over here. I am okay. Thanks. Hi, Ms. Olson. How are 
you?
    Ms. OLSON. I am fine, thank you.
    Ms. TUBBS JONES. I am trying to get up on this. I don't 
serve on this Subcommittee, but I am glad to be here. I was 
just looking at some questions I was going to ask you, and I 
lost my place. If you will just give me 1 second. Why don't you 
for one moment talk about something, anything you would like to 
talk about no one has asked you. Have you already been given 
that authority?
    Ms. OLSON. Actually I thought one of the things I would 
like to talk about is our first problem, which is navigating 
the IRS. I wanted to tell a story. When the report came out, we 
issued a voice message to all IRS employees and told them that 
they could look at the report. I got back a lot of e-mails from 
IRS employees from all over the United States, and one e-mail 
that I got back was from a woman who said, I used to be--I was 
a revenue agent in the examination division before the 
reorganization, and people could always find me because if they 
knew that they were being audited, even if they didn't know my 
job title, they could look up ``exam'' in the phone book and 
find me. Today I am called small business self-employment 
technical analyst, branch 2, and how can someone find me?
    I read that e-mail, and I just sort of slapped my forehead; 
naming conventions. We have made it so difficult for people to 
communicate with us through all of this reorganization by just 
simply removing common-sense names.
    Ms. TUBBS JONES. What is your position with regard to the 
Free File, if I may ask?
    Ms. OLSON. I think that free filing is an important 
service. I think that the products we have up there are 
excellent. I have expressed my concern during the development 
of the products and the consortium negotiations about the 
additional products that were present in the software. I do 
have a strong feeling that we should not be making available 
those products through a government Web site. I am concerned 
that the disclaimers are not adequate, in fact, to warn 
taxpayers, particularly when you look at the taxpayer 
population that is targeted for these products. If you look at 
their financial literacy levels, their ability to understand 
contracts, over and over and over again you see that these 
disclaimers may not be understood.
    Ms. TUBBS JONES. That is an area that I was working on 
before I came to this Committee. I was on Financial Services, 
and the whole issue of predatory lending, and rent to own, and 
payday loans and all of those opportunities where people--you 
get to the people who are most vulnerable. I am not saying that 
there should not be the opportunity, I understand that subprime 
lending provides opportunities for those who may not be able to 
go in the prime market, but clearly I think there has to be 
some way that we can do a few more disclaimers or better notice 
in the area.
    Let me see what else I would like to ask you. Talk to me 
for a moment if you have not already about the taxation of 
attorney fee awards, if you would.
    Ms. OLSON. Well, what we discovered in looking at the case 
law, and this came up through our most litigated issues 
section, we found that there was a split in the circuits about 
the taxation of attorneys' fees in what is called nonphysical 
personal injury suits: race discrimination, sex discrimination, 
sexual harassment, age discrimination; and that in some 
circuits, depending on the underlying State law, the fees may 
be deductible above the line or below line. They trigger 
radically different tax results, including the triggering of 
the alternative minimum tax. In our report, we gave an example 
of a woman who ended up being a successful plaintiff and paying 
more in taxes and attorneys' fees than she won in the award. 
So, she came out in a negative amount. She would have been 
better off not prevailing.
    So, we proposed several alternatives. The one that we liked 
was putting everything what we call above the line so that you 
don't trigger alternative minimum tax, basically netting out 
the attorneys' fees and making that uniform across the Nation 
and not dependent on underlying State law.
    Ms. TUBBS JONES. Ms. Olson, I just ran out of time. I am 
looking forward to have the opportunity to get to know you 
better and working with you, and hopefully providing some 
additional information to the constituents, my constituents in 
the 11th Congressional District of Ohio. I thank you very much 
for your testimony, though I missed some of it.
    Chairman HOUGHTON. Thanks, Ms. Tubbs Jones.
    Mr. Pomeroy.t
    Mr. POMEROY. Thank you, Mr. Chairman.
    Ms. Olson, I suppose right up next to the Commissioner we 
put the Taxpayer Advocate as one of the most important if not 
the most important position in the IRS. It was established with 
bipartisan support. We commend you for your efforts on behalf 
of taxpayers. This service is their service, and we want to 
make certain that it is fair and equitable in its delivery of 
services to the American public.
    Several things I want to talk to you about, but time is 
short. Let me begin by products. It would seem to me as though 
there is a substantial contribution by the private partners in 
this private-public partnership delivering free e-filing. 
Obviously they are interested in participating with the hope of 
some business opportunity. Does that right off the bat strike 
you as inappropriate or so far so good depending on what they 
are selling?
    Ms. OLSON. Right. I think that is an appropriate 
arrangement, I do.
    Mr. POMEROY. So, you think there needs to be within the 
service some due diligence as to appropriateness of services 
rendered?
    Ms. OLSON. I would like us to develop standards and really 
address this issue, yes, I would.
    Mr. POMEROY. It seems to me incongruous and unacceptable to 
have a very thorough due diligence in terms of whether they 
have got the security in place, whether they have the technical 
competence to get it all figured right--undoubtedly give each 
of the partners a very thorough review relative to the 
technical components of their ability to deliver e-filing. Then 
to let them offer caveat emptor whatever they may hope to try 
to sell, that just doesn't cut it.
    We ought to be able to find some happy medium in terms of 
appropriate review, again not making the service a regulator as 
well as a tax collector, but making sure that those things sold 
by its private sector partners pass the smell test to market 
suitability. Is that how you would see it?
    Ms. OLSON. I would agree with that, and I would also say 
that there needs to be appropriate disclaimers directed to the 
reading level and the literacy level of the target audience. We 
have targeted the Free File to low-income taxpayers.
    Mr. POMEROY. Does the Advisory Committee look at this sort 
of thing?
    Ms. OLSON. The ETAAC?
    Mr. POMEROY. Yeah.
    Ms. OLSON. I know that they have considered this issue. 
That would be an appropriate place, I would think, to start to 
develop some recommendations.
    Mr. POMEROY. I will direct that inquiry to them. Thank you 
for that.
    We received from your counterpart in Fargo, North Dakota, a 
really fabulous idea that we want to advance, and that is 
relative to filing a husband/wife return on a farm, presently, 
as I understand it, it has to be either in partnership, which 
involves some taxpayer complexity, or basically between the two 
of them they have to allocate all of the income to one, 
usually, of course, the male.
    Ms. OLSON. Legally they are supposed to file a partnership 
return.
    Mr. POMEROY. Within this partnership return is the revenue 
attributed to one spouse or the other, or how does that work?
    Ms. OLSON. In a partnership return they can attribute it to 
the extent that they agree. It is completely open. What we find 
in practice is that most husband and wife co-owned businesses 
that aren't incorporated tend to put all the income in one 
person's name and report it on a sole proprietorship schedule 
or in the farming business, on a Schedule F. So, what ends up 
happening is that the other spouse doesn't have any income 
reported to them, and the consequence of that is the spouse 
doesn't get any Social Security or Medicare credits.
    Mr. POMEROY. Precisely. So, what appears to be, while the 
easy route in terms of filing the tax return in a given year, 
becomes a pattern, and the income is attributed just to one 
spouse.
    Ms. OLSON. Correct.
    Mr. POMEROY. Down the road that might mean the other 
spouse, should this marriage end by divorce or death, does not 
have the 10 quarters required for purposes of qualifying for 
Social Security; is that right?
    Ms. OLSON. That is correct.
    Mr. POMEROY. The recommendation from the Fargo Taxpayer 
Advocate is that this needs to be attended to in ways that 
family farmers can avail themselves of simpler tax filings, but 
still allocate the income; is that correct?
    Ms. OLSON. Right. We recommended that you could use a 
Schedule C, for sole proprietorships, or the Schedule F, for 
farms and report all the income on one form, but just add two 
lines to the form where you could allocate between the husband 
and wife at the very bottom of the form what percentage of the 
net profit or loss is each person's.
    Mr. POMEROY. The Chairman and I each represent farm 
families, and this is an idea we think is very interesting. We 
will be looking to see whether or not we want to advance a 
joint bipartisan legislative proposal directly as a result of 
your Fargo, North Dakota, Taxpayer Advocate. I am very proud of 
the job----
    Ms. OLSON. I am very proud of that person, too.
    Mr. POMEROY. Thank you very much.
    Chairman HOUGHTON. Thank you. Well, I just have one other 
question. You obviously have got a very important job now 
between Mr. Rossotti going in and--going out and Mr. Everson 
coming in and Mr. Wenzel leaving, lots on your shoulders.
    Let me ask you a question. How many people read your 
report?
    Ms. OLSON. Well, I know----
    Chairman HOUGHTON. Or even open it?
    Ms. OLSON. Well, let me just say that I know that 
Commissioner-designate Everson has read it; not all of it, but 
I know that he has read parts of it. It is surprising how many 
people read it if you judge by my e-mail and my voice messages 
and my mail. We would like more people to read it because we 
believe that particularly this year we have shown a spotlight 
on the way that the IRS works, and it should actually make 
taxpayers feel very good as they read through the top 20 
problems--and they see how we identify a problem and the IRS 
responds--how much the IRS really is doing about the problems 
that it faces.
    So, much of what is troubling to the IRS is just a result 
of the complexity of the tax system both in terms of the law 
and the processing, the Administration, and they are doing an 
enormous amount. The report really shows that, and citizens 
should feel good about it.
    Chairman HOUGHTON. One of my hot buttons has always been 
the issue of complexity of the Code, and we sit here and we 
pass legislation, we think it is for the good of the country, 
and yet it horribly complicates the Code. So, I think it might 
be helpful in further meetings that we have that you can sort 
of keep us up to date with a scorecard on what we have done, 
because it is a two-way street here.
    I have one final question. You have this fine report, and 
there is a conclusion, section 1 of page 4. What would you like 
the conclusion to say next year?
    Ms. OLSON. I will have to look at what the conclusion says 
this year.
    I think I would like to see the IRS having made substantial 
progress in the five areas that I outlined in the preface 
underlying taxpayer rights; the concept of access to 
information, to the IRS, to the Taxpayer Advocate Service, to 
representation from low-income taxpayer clinic programs, which 
just came under my jurisdiction, and free tax preparation. We 
are along the way. I really want to see some progress that we 
can report on, and particularly on that number 1 issue, 
navigating the IRS. It is in the social contract between the 
IRS, the tax administration system, and its taxpayers. We have 
to become accessible to them, or else why should they ever pay 
their taxes if they can't reach us to talk about their 
problems? I want more progress on that. That is really why we 
made it number 1.
    I would like to conclude that we had made progress. There 
are steps to go, but we have made progress.
    Chairman HOUGHTON. All right. Well, thank you. You are a 
credit to all of us, and thanks so much for your testimony. 
Good luck to you.
    Ms. OLSON. Thank you, sir.
    [Whereupon, at 4:50 p.m., the hearing was adjourned.]
    [Submission for the record follows:]
   Statement of Grover Norquist, President, Americans for Tax Reform
    On July 31, 2002, the Bush Administration announced a Public-
Private Partnership with the high technology industry to increase the 
availability of free online tax preparation and e-filing services to 
American taxpayers. On October 31, 2002, then-Commissioner of Internal 
Revenue, Charles Rossotti, signed this historic agreement in 
Washington. This innovative initiative is a constructive and thoughtful 
resolution of a long-standing public policy problem.
    But it's only the first step. What happened in Washington needs to 
be replicated in every State capital in the union. Here's why.
    On multiple occasions over the past five years the Internal Revenue 
Service has proposed that it should provide electronic tax preparation 
and filing services to taxpayers. One year ago, the Office of 
Management and Budget revived the idea and pressed to move ahead. 
Fortunately, Congress has repeatedly objected to these attempts to have 
the Nation's tax collector take on the additional role of also acting 
as citizen's tax preparer.
    While such an obvious conflict of interest has at times been 
advanced by some as representing a new ``service to the citizen,'' it 
would in reality have been a significant and intrusive expansion of the 
role of government, and a major setback for the American principle of 
voluntary compliance in our tax system.
    Worst of all, it would have served as a disguised revenue 
enhancement strategy--bracket creep through mission creep.
    But while Congress rebuffed these attempts to expand the role of 
government at the Federal level, there were no similar checks and 
balances at the State level, and as a result over the last several 
years some 26 State revenue collection agencies instituted the very 
programs the Federal Government has so wisely shunned, and in the 
process the States collectively expended literally billions of taxpayer 
dollars to pay for the design, development and operation of these 
government-run online tax preparation systems.
    Their national tax collectors union, the Federation of Tax 
Administrators (FTA), reported last year that all of these State online 
tax systems combined generated 800,000 tax returns in the last tax 
season. That's just 1% of State income tax returns, all at a staggering 
administrative cost. (With this kind of waste, it's little wonder that 
our State governments are now going broke.) So why do they press ahead 
with this effort? Indeed, why did they try in the first place?
    We know that at least some State revenue agencies designed their 
online tax preparation systems with the intent of using them to 
increase revenue receipts from taxpayers, and actually financed the 
substantial cost of the systems from those projected new revenues. The 
Virginia Department of Revenue, for example, has boasted of their 
plans, in reports addressed to their Governor, bragging that their new 
$125M ``iFile'' online tax preparation system would be financed from 
``increased tax revenues attributed to the successful implementation,'' 
and that the system would assist the tax agency in ``selecting audits 
and . . . performing focused, effective, and timely account 
collections.''
    Just last week, the New Jersey Star-Ledger, The Los Angeles Times 
and other newspapers across the Nation reported that State tax agencies 
across the Nation are using the modern tools of electronic data 
retrieval and examination to do exactly what the Virginia Department of 
Revenue described. The Executive Director of the national Federation of 
Tax Administrators (FTA), Harley Duncan, is quoted promoting the value 
of using ``data mining'' to deeply penetrate electronic taxpayer 
records, and how State revenue agencies are now using their modern 
computerized tools to dig through citizen data files of personal 
financial information.
    ``It amounts to combing through files that can tell you something 
about taxpayers,'' the FTA's Duncan explained. He went on to justify 
these new practices by his members in State tax agencies across the 
Nation, saying that ``data mining isn't enough, in and of itself, to 
bring States through this particular (budget) crisis, but if you're . . 
. looking for $25 million to augment a program, and you can pick it up 
by better mining your tax base, that's significant.''
    This kind of intrusive surveillance, and surreptitious 
investigation of taxpayer records and personal financial information, 
is deeply disturbing, and is but the latest in the long, sorry history 
of abuses of taxpayers by government revenue collection agencies. 
However, this is not unexpected; indeed, it is just one of the dangers 
that has long been predicted from the conflict of interest created when 
tax collectors are put into the role of tax preparers.
    The reality is that when a citizen prepares their taxes online in a 
State revenue agency computer system, every keystroke, correction, 
change and draft created in the course of preparing that tax return is 
automatically recorded and stored in the tax agency's data files. That 
is the basic nature of server-based online transactional technology. 
And when government unwisely decides to provide personal financial 
services to citizens, such as tax preparation, the dangers of this 
technology are suddenly very real.
    In defending its desire to build these systems and begin preparing 
citizen's tax returns for them online, the State of California revenue 
bureaucrats actually had the temerity to tell the public that ``(We) 
will always be beholden to the taxpayers and have the taxpayers' best 
interest at heart.''
    That is not reassuring, nor is it credible.
    Back in a more sensible past, government tax agencies only received 
a citizen's final, completed return. And tax agencies only lawfully got 
their hands on a citizen's preliminary tax information and other 
personal financial data through official investigations, and by court 
order in civil and criminal proceedings. But not anymore.
    If a citizen is foolish enough to prepare their tax return on a 
State revenue agency's online system, they are playing with fire, and, 
unwittingly, with potential self-incrimination. If our citizens use the 
online tax preparation systems provided and operated by State revenue 
agencies, they are effectively serving themselves up to be flagged for 
examination, investigation and audits.
    The high risk of this threat to our citizenry is a prime example of 
why the Bush Administration well deserves the bipartisan support it has 
received for instituting its Public-Private Partnership solution, where 
those in need can get free online tax services, but from the private 
sector, instead of the government. Under this national solution, the 
IRS will still only receive a citizen's final, completed tax return. 
And that's the way it should be in the voluntary compliance system we 
have in the United States.
    It has been our consistent view at Americans for Tax Reform that 
changes in tax policy should be dealt with openly and with full public 
disclosure and debate. Bureaucratic ambitions for stealth tax 
increases--enabling government to grow and expand its mission without 
oversight or checks and balances--should never be permitted by 
policymakers under any circumstances. It is, in reality, a betrayal of 
the public trust.
    Notwithstanding the vociferous advocacy of these programs by the 
Federation of Tax Administrators, as the preferred electronic weapon of 
choice for its nationwide membership of professional tax collectors, 
the fact is that the per-return cost of these government systems is 
astronomical, and, in the end, is serving only to provide employment 
security for tax bureaucrats. These initiatives are not ``electronic 
government'' or ``citizen service''; they are electronic fraud and 
amount to nothing more than citizen deception.
    It is little wonder, then, that this same national tax collectors 
union has tried mightily to protect its vested self-interests by going 
around to newspapers all over the United States attacking the Federal 
Free File Alliance initiative. However, the Bush Administration 
solution is so cost-effective and even-handed that it puts the lie to 
any justification for governments wasting public funds on creating 
their own online tax systems.
    Some States know better than to pay heed to their tax bureaucrats' 
self-interested ambitions, and are instead looking for better answers 
that maintain the integrity of their relationship with their citizens. 
After the Federal Free File Alliance Agreement was signed on October 31 
last year, the States of New York, Massachusetts and Michigan had 
already replicated the Federal initiative and launched their own Free 
File Alliances by the following January.
    But those States that do not choose this sensible approach are 
headed down a road to nowhere. This same folly of building government 
online tax systems has been attempted elsewhere, and with results 
similar to those we've seen in the U.S.--taxpayers shun them.
    For example, in the United Kingdom, hundreds of millions of pounds 
have been incinerated on these same government online tax systems, but 
which collected only 75,000 tax returns last tax year (less than 1% of 
total returns, with much of the online filing done by panicked 
procrastinators) in a ``service'' that was riddled with errors, 
breakdowns and breaches of privacy and security. Polls released just 
this week in the United Kingdom have shown that 93% of Britons say they 
refuse to even consider using the government online tax system, citing 
risks relating to security, reliability and accuracy among other 
concerns. A similar system deployed by the Australian government has 
been used by only 3% of the taxpayers there.
    The decision by the Bush Administration to ultimately reject this 
path is not only enlightened, but, most importantly, puts the best 
interest of the citizen ahead of that of the bureaucrat. The American 
taxpayer simply cannot afford the public waste of government investing 
hundreds of millions of dollars for bureaucratic featherbedding, 
duplicating the electronic tax systems already invented, developed and 
deployed by the private sector e-commerce industry, with services 
already available at low-cost and no-cost to taxpayers today. Whether 
tax bureaucrats would build or buy such systems and services is 
irrelevant. Either way, it would waste precious tax dollars on 
expansion of government into a mission that is a gross conflict of 
interest, and the taxpayer would end up paying the freight, coming and 
going.
    The new Public-Private Partnership announced by the Administration 
is a precedent-setting innovation that chooses the consumer benefits of 
market competition instead of anti-competitive government expansion, 
and ensures protection of taxpayer privacy and taxpayer rights over the 
threat of government intrusion and conflict of interest.
    The Administration's voluntary agreement with industry costs the 
public treasury virtually nothing, and encourages continued private 
sector investment, competition and innovation, while encouraging the 
private sector to provide free services to those who truly need them. 
Congress has already legislatively endorsed the Administration's policy 
direction. Now the national solution to this issue should be emulated 
by all of the Nation's governors and State legislatures.
    Asking taxpayers to trust the tax collector is ludicrous. Making 
them pay for such folly is unacceptable.

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