    [House Hearing, 114 Congress]
    [From the U.S. Government Publishing Office]

     AUDITS AND ATTITUDES: IS THE IRS HELPING OR HURTING SMALL BUSINESSES?

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

                                    HEARING

                                   before the

            SUBCOMMITTEE ON ECONOMIC GROWTH, TAX AND CAPITAL ACCESS

                                     OF THE

                          COMMITTEE ON SMALL BUSINESS
                                 UNITED STATES
                            HOUSE OF REPRESENTATIVES

                        ONE HUNDRED FOURTEENTH CONGRESS

                                 SECOND SESSION

                                   __________

                                  HEARING HELD
                                 JUNE 22, 2016

                                   __________

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                Small Business Committee Document Number 114-065
                  Available via the GPO Website: www.fdsys.gov

                                       ______

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                       HOUSE COMMITTEE ON SMALL BUSINESS

                          STEVE CHABOT, Ohio, Chairman
                                STEVE KING, Iowa
                          BLAINE LUETKEMEYER, Missouri
                            RICHARD HANNA, New York
                             TIM HUELSKAMP, Kansas
                             CHRIS GIBSON, New York
                              DAVE BRAT, Virginia
                 AUMUA AMATA COLEMAN RADEWAGEN, American Samoa
                            STEVE KNIGHT, California
                            CARLOS CURBELO, Florida
                             CRESENT HARDY, Nevada
                   NYDIA VELAZQUEZ, New York, Ranking Member
                             YVETTE CLARK, New York
                              JUDY CHU, California
                            JANICE HAHN, California
                         DONALD PAYNE, JR., New Jersey
                              GRACE MENG, New York
                           BRENDA LAWRENCE, Michigan
                           ALMA ADAMS, North Carolina
                          SETH MOULTON, Massachusetts
                               MARK TAKAI, Hawaii

                       Kevin Fitzpatrick, Staff Director
                           Jan Oliver, Chief Counsel
                      Michael Day, Minority Staff Director

                                C O N T E N T S

                               OPENING STATEMENTS

                                                                       Page
    Hon. Tim Huelskamp...............................................     1
    Hon. Judy Chu....................................................     1

                                   WITNESSES

    Mr. Pete Sepp, President, National Taxpayers Union, Washington,
      DC.............................................................     3
    Mr. Lee Davenport, Member, Electronic Tax Administration Advisory
      Committee (ETAAC), Washington, DC..............................     4
    Mr. Roger Harris, President & COO, Padgett Business Services,
      Athens, GA.....................................................     6
    Ms. Emily Peterson-Cassin, Project Coordinator, Bright Lines,
      Washington, DC, testifying on behalf of Public Citizen.........     8

                                    APPENDIX

    Prepared Statements:
        Mr. Pete Sepp, President, National Taxpayers Union,
          Washington, DC.............................................    18
        Mr. Lee Davenport, Member, Electronic Tax Administration
          Advisory Committee (ETAAC), Washington, DC.................    38
        Mr. Roger Harris, President & COO, Padgett Business Services,
          Athens, GA.................................................    41
        Ms. Emily Peterson-Cassin, Project Coordinator, Bright Lines,
          Washington, DC, testifying on behalf of Public Citizen.....    47
    Questions for the Record:
        None.
    Answers for the Record:
        None.
    Additional Material for the Record:
        None.

     AUDITS AND ATTITUDES: IS THE IRS HELPING OR HURTING SMALL BUSINESSES?

                                  ----------

                            WEDNESDAY, JUNE 22, 2016

                      House of Representatives,
                   Committee on Small Business,
                       Subcommittee on Economic Growth,
                                        Tax and Capital Access,
                                                        Washington, DC.
        The Subcommittee met, pursuant to call, at 10:00 a.m., in
    Room 2360, Rayburn House Office Building, Hon. Tim Huelskamp
    [chairman of the Subcommittee] presiding.
        Present: Representatives Huelskamp, Chabot, Radewagen, and
    Chu.
        Chairman HUELSKAMP. Good morning. Thank you all for being
    with us today. I call this hearing to order.
        Whether we want to or not, each and every one of us has a
    relationship with the IRS. Benjamin Franklin famously said,
    ``In this world, nothing can be said to be certain except death
    and taxes.''
        In the administration of the tax code, the IRS has dual
    roles, collection and enforcement. Small businesses have a
    right to be treated fairly on both counts. Unfortunately, that
    is not always the case. Many can appreciate that the IRS is a
    tough job to do; however, the best outcomes will result from
    the IRS and taxpayers working together to improve voluntary
    compliance and efficiently allocate resources.
        The Small Business Committee has heard from a number of
    small businesses that have been harmed in one way or another by
    the IRS. In at least two cases, aggressive audits have resulted
    in these companies actually closing their doors.
        Today's hearing will focus on some of the ways the IRS can
    proactively work with small business taxpayers to improve
    communication and compliance, as well as on some things the IRS
    needs to do differently.
        I would like to thank our witnesses for coming today. I
    look forward to your testimony.
        I now yield to the ranking member for her opening remarks.
        Ms. CHU. Thank you, Mr. Chairman.
        One of the focuses of this Subcommittee is to ensure that
    small businesses are given the tools to comply with regulations
    without increasing their costs. This is particularly true when
    it comes to taxes and interacting with the Internal Revenue
    Service.
        In the past, when small businesses have testified before
    the Committee, they have told us that complexity and
    uncertainty create difficulty when filing tax returns. Many
    business owners worry that one simple mistake can lead to a
    costly and timely audit, and at a time when many businesses are
    striving to expand and hire additional employees, every hour
    and dollar counts.
        As a result of IRS procedures and administrative
    challenges, small firms must devote greater resources towards
    accounts and lawyers to properly report income and pay taxes.
    Over a quarter of small businesses in the 2015 National Small
    Business Association's Taxation Survey stated that they spent
    over $10,000 on tax compliance, and another 8 percent stated
    that they employ an outside tax expert to handle tax issues.
        Unlike larger, multinational corporations, the time spent
    by small businesses in complying with tax laws is much more
    costly, impacting business expansion, job growth, economic
    prosperity, and growth of small businesses. They should not
    also have to face intense scrutiny from the IRS through
    business audits and inadequate IRS compliance with the
    Regulatory Flexibility Act. Nevertheless, small firms cite
    filing hardships, aggressive auditing, and collection
    procedures as confusing as to how a new regulation will affect
    their business.
        Seeing as our nation's fiscal constraints are an ongoing
    priority, I understand that closing the $450 billion tax gap is
    critical to our long-term prosperity, but so are small
    businesses. Any effort to increase tax compliance must be done
    in a way that is responsible, fair, and not disproportionately
    burdensome to small firms.
        Today's hearing will give us a better grasp of the scope
    and collection techniques regarding small business audits. This
    hearing also allows us to examine what is being done to
    minimize IRS regulatory procedural burdens for small entities.
    I believe that this information is even more important right
    now as the agency seeks to be more efficient due to financial
    realities. The fact of the matter remains that the IRS cannot
    review and modify the procedures impacting small businesses if
    Congress continues to cut their budget every year. These
    actions have weakened the IRS's ability to enforce the nation's
    tax laws while also providing sufficient customer service for
    our small businesses. With the proper tools, America's small
    firms can sustain the economic growth currently underway by
    investing in their operations without fear of an audit and
    confusing regulations.
        With that, I would like to thank the witnesses for being
    here today. I yield back.
        Chairman HUELSKAMP. Thank you for that opening statement.
        A quick summary again on timing. First, if Committee
    members have an opening statement prepared, I ask that it be
    submitted for the record.
        I would like to take a moment to explain the timing lights
    for you. You will each have 5 minutes to deliver your
    testimony. The light will start at green. When you have 1
    minute remaining, the light will turn yellow. Finally, at the
    end of 5 minutes it will turn red. I ask that you kindly adhere
    to that time limit.
        Our first witness this morning is Mr. Pete Sepp, president
    of the National Taxpayers Union here in Washington, D.C. Mr.
    Sepp first started with the NTU in 1988. Currently, he
    supervises their government affairs, public relations, and
    development activities. Mr. Sepp has testified before Congress
    on a wide range of tax-related issues and has also been a guest
    on several nationally broadcast radio and television programs.
        Mr. Sepp, you have 5 minutes, and you may begin.

     STATEMENTS OF PETE SEPP, PRESIDENT, NATIONAL TAXPAYERS UNION;
     LEE DAVENPORT, MEMBER, ELECTRONIC TAX ADMINISTRATION ADVISORY
     COMMITTEE; ROGER HARRIS, PRESIDENT AND COO, PADGETT BUSINESS
     SERVICES; EMILY PETERSON-CASSIN, PROJECT COORDINATOR, BRIGHT
                                 LINES

                         STATEMENT OF PETE SEPP

        Mr. SEPP. Mr. Chairman, Madam Ranking Member, I am honored
    to be here to discuss a central feature of our tax system, the
    examination process. Back in 1988, my organization, National
    Taxpayers Union, led a transpartisan coalition, which included
    American Civil Liberties Union and National Council of La Raza,
    business organizations, taxpayer groups, all on behalf of a
    taxpayer bill of rights. There have been subsequent coalitions,
    subsequent pieces of legislation, but one interesting facet of
    this process has been a lack of focus on improving
    examinations. They tended to focus instead on making reforms to
    the collection process. There is a wide range of problems that
    have been identified in the small business community that still
    need to be addressed, particularly pertaining to examinations.
        I call them ``fear factors.'' One major fear factor has to
    do with the complexity of the tax system itself and the
    uncertainty that brings. The Ranking Member of the Full
    Committee, Congresswoman Velazquez, said this very eloquently
    in 2013. I quote, ``Many business owners worry that one simple
    mistake can lead to a costly and timely audit and at a time
    when many businesses are striving to expand, every dollar and
    hour counts.'' Quite true.
        I also think we have to worry about intimidation tactics
    used against small businesses. We are witnessing right now a
    counter and paradoxical trend of speed up audits where
    businesses are getting audit notices and being asked to respond
    almost immediately to whether they want to even appeal. They do
    not even have time to consider the central issues of the audit
    itself. On the other hand, there are ``slow-down'' audits where
    the procedure drags on and on. Interest keeps accruing through
    no fault of the taxpayer and abatement of that interest is a
    very difficult matter to resolve indeed.
        We also have the question of opportunity costs. When you
    look at very small businesses, under $100,000 in receipts, they
    tend to have a tax liability after examination, an additional
    tax of less than $10,000. They could easily rack up that much
    in legal and audit representation costs. Many if not most of
    them decide, in my opinion, not to fight it. That is why the
    audit appeal rate is so low. It hovers between 5 and 7 percent
    annually.
        When they have these problems, the remedies in court remain
    pitifully small. The cap on attorney fees that they can recover
    if they prevail in court nowhere near matches the amount that
    they actually need to spend to prove their position.
        There are other problems on the horizon. We are part of a
    coalition called the Coalition for Effective and Efficient Tax
    Administration involving more than a dozen associations
    representing thousands of businesses. We are identifying
    problems in the large business and international division with
    issuing designated summonses and designating cases for
    litigation, tactics which are normally supposed to be reserved
    for a very small number of uncooperative taxpayers or broad
    ranging, and they are being applied in consistently greater
    fashion and with more force, and the threat is being wielded to
    compel taxpayers into accepting the IRS's position. That is
    going to be a major problem for smaller businesses down the
    road. Taxpayer experts and litigation representatives, like
    Daniel Pilla, who has been before Congress in the past, has
    said he fully expects those kinds of tactics to migrate into
    the small business area and the self-employed area sooner or
    later.
        There is the issue that is being discussed in Committee
    markup for the Financial Services and General Government Bill.
    One of your colleagues, Congressman Katko, is offering an
    amendment to block the IRS from hiring private outside counsel
    to participate deeply in the examination process. Essentially,
    farming out audits.
        Now, this is currently applying to large business, the IRS
    hiring thousand-dollar-an-hour attorneys. You could easily see
    $300, $400 an hour attorneys working on small business
    liabilities. It happens because the IRS may consider the hazard
    of litigation in an appeal situation. They do not have to
    consider the cost of that litigation versus the tax due. So we
    have a volatile situation here.
        We need to enact reforms ranging from S. 2809 by Senator
    Portman, which would address some of the CEETA Coalition's
    concerns, and the Small Business Taxpayer Bill of Rights, H.R.
    1828, to reviewing the taxpayer advocates' most serious
    problems affecting small businesses, and coming together in a
    bipartisan fashion to address the factors of lack of trust,
    lack of certainty, and lack of remedies for small businesses in
    the audit process. We did it in 1988 and 1998. We can do it
    again. Thank you.
        Chairman HUELSKAMP. Thank you, Mr. Sepp. We appreciate your
    testimony.
        Our next witness is Mr. Lee Davenport, member of the
    Electronic Tax Administration Advisory Committee here in
    Washington, D.C. Mr. Davenport is in his third year as a member
    of the Advisory Committee, which serves as a public forum to
    discuss electronic tax administration issues. He is principal
    of Davenport Consulting, which provides business consulting and
    private financing services. He was also the architect of
    Myfreetaxes.com, which assists those who earn less than $62,000
    per year to file their state and federal taxes for free.
        Mr. Davenport, thank you for being here today. You may
    begin.

                       STATEMENT OF LEE DAVENPORT

        Mr. DAVENPORT. Thank you. Chairman, I thank you for holding
    today's hearing on how the IRS could help small businesses.
    Twenty-eight million small businesses in America are a
    cornerstone to our economy. Small businesses account for over
    half of all U.S. sales and 55 percent of all jobs, and they pay
    significant amounts of income, employment, and excise taxes
    into the U.S. Treasury.
        Helping small businesses easily file and pay their taxes is
    a critical mission of the IRS Electronic Tax Administration
    Advisory Committee, ETAAC. ETAAC was formed by law in 1998 to
    make strategic recommendations to Congress on how to improve
    tax administration and better serve taxpayers, including small
    business taxpayers through electronic means. In short, we are
    objective, digital, strategy consultants to the IRS.
        The Committee believes that modernizing the IRS taxpayer
    service communication platform is an urgent and strategic
    priority for the IRS. In the 2015 tax season, the IRS was in
    its fourth consecutive year of budget reductions and IRS
    service levels plummeted. IRS answered only 38 percent of its
    calls from taxpayers. IRS has been unable to modernize its tax
    service platform to move away from traditional paper and phone
    interactions. A current phone and paper taxpayer service
    platform is also not the preferred choice of the IRS or the
    many taxpayers who expect secure online services.
        Along with this issue is a lack of transparency with the
    IRS. For most taxpayers, the information the IRS has about them
    is a complete mystery. It is not easy for taxpayers to access
    and understand their tax information on file with the IRS,
    their previous tax-related interactions, or their tax
    compliance obligations.
        For small business taxpayers, this issue is even more
    critical because small businesses are more likely to complete
    multiple year-round transactions with the IRS. In many cases,
    when there is a compliance issue, small business taxpayers find
    out through a surprising IRS notice after they file, or even
    more stressful, an audit that can take months or years to
    resolve. For all types of taxpayers, accessing and using their
    information to proactively comply is almost entirely out of the
    question in our current system.
        The Committee believes that a key solution to these
    problems is a more digitally-enabled, modernized IRS that
    better equips taxpayers with information on how they can
    proactively comply, rather than solely focusing on detecting
    and enforcing compliance.
        In the past 3 years, ETAAC has provided recommendations
    based on a simple vision of how the IRS could serve taxpayers.
    The vision allows taxpayers to fully understand their tax
    obligations, to have transparent access to their tax
    information status with the IRS, and effectively and securely
    interact with their tax administrator on the way they want to
    be served, in the way they want to be served.
        The end state is a tax system that is less burdensome. It
    is a tax system that relies less on reactive measures, such as
    audits, and more on preventative and educational measures for
    taxpayers to remain proactively compliant. There are two
    challenges the IRS faces in achieving this vision.
        First, the current tax system is designed to be reactive.
    It does not leverage tax information to help taxpayers meet
    their obligations.
        Second, the IRS cannot quickly develop and implement its
    digital roadmap, including online accounts to address the needs
    of preferences of taxpayers. Our last two reports to Congress
    explain this dilemma and provide recommendations to overcome
    these challenges. In our 2015 report to Congress, we
    recommended that the IRS accelerate its digital taxpayer
    service strategy; that is, develop and implement secure online
    accounts for all business and individual taxpayers. We know
    that businesses are much more likely to use a tax professional
    for tax filing compliance needs. Online accounts for these tax
    professionals should be a priority. ETAAC advocates for the IRS
    to commit to quickly developing online accounts for business
    taxpayers and the tax professionals who serve them, and we
    encourage the Committee to do the same.
        In our most recent 2016 report, which actually comes out
    today, ETAAC addresses the lookback tax system that centers on
    post-filing programs that detect current noncompliance. We
    challenge Congress and the IRS to move to a system that
    verifies taxpayer identities and tax return information before
    accepting the return.
        A system that uses information statements, such as forms
    1099 and W-2 to verify taxpayer tax return information is
    essential to fighting fraud and reducing the taxpayer burden.
    The IRS should support taxpayers in filing accurate returns,
    giving them full electronic access to their tax account
    information at the time of filing. This proactive system would
    verify accuracy upfront and reduce audits, particularly those
    on small businesses.
        ETAAC is pleased with the IRS's first steps in its digital
    service plans. IRS released an initial draft of the Future
    State Initiative in January of this year that specifically
    incorporated ETAAC recommendations from the past 3 years. The
    initiative specifically contemplates small business taxpayers
    and their needs. ETAAC endorses this digital service component
    of the Future State plans, and we clearly identified the urgent
    need for small businesses. The IRS needs to accelerate online
    accounts for businesses and tax professionals.
        On behalf of the entire ETAAC, I thank you for inviting us
    to testify on this important topic.
        Chairman HUELSKAMP. Thank you, Mr. Davenport. We appreciate
    your testimony and your service on the Advisory Committee.
        Our third witness this morning is Mr. Roger Harris,
    President and COO of Padgett Business Services in Athens,
    Georgia. Mr. Harris has served twice as Chairman of the
    Internal Revenue Advisory Council, and has previously testified
    before this Committee, as well as before the Senate Small
    Business Committee. He has been named one of Accounting Today's
    Top 100 People. Mr. Harris, you have 5 minutes.

                       STATEMENT OF ROGER HARRIS

        Mr. HARRIS. Thank you, Mr. Chairman, and Ranking Member
    Chu. It is a pleasure to be here today.
        To give you a little background, Padgett Business Services
    provides accounting, tax, and payroll services to small
    businesses. We are currently celebrating our 50th year and have
    over 200 offices throughout the United States.
        We define a small business as someone with less than 20
    employees. Now, a lot of people consider that to be a ``mom-
    and-pop'' type business, but I would remind those people that
    almost 90 percent of people who have employees would fit that
    definition, so it is a very powerful part of our economy.
        Our history and our relationship with our clients gives us
    a good perspective to comment on the interactions that small
    businesses have with the IRS and, in our case, their
    representative. Specifically as it relates to audits, no
    taxpayer, be it an individual or small business, ever wants to
    receive a notice that they are being audited. But in a
    voluntary tax system like we have, there is an element of
    enforcement that must be present. So, if you are successful and
    stay in business long enough, there is a good possibility you
    are going to interact with the IRS in some form of audit or
    some sort of correspondence.
        Currently, the IRS really executes two different types of
    audits on small business. The one that seems to be most
    prevalent and continues to increase over the years is the
    correspondence audit. Now, the idea behind a correspondence
    audit is that some computer or some person somewhere in the
    bureaucracy selects what appears to be some simpler issues and
    the small business owner is notified by mail, as the name
    indicates, and they are to respond to that notice about the
    specific issues in question. In theory, this is a very good
    system and I think it is partly the reason that we are seeing
    more and more of these is for the better use of IRS resources.
    It eliminates face to face, which is intended, again, I think,
    to minimize the cost and burden that a small business owner or
    their representative might face.
        Unfortunately, it does not work always as intended. First
    and foremost, sometimes the tax code is a little more
    complicated than it might seem, and what looks like a simple
    issue that can be very easily dealt with through correspondence
    really has more complicated pieces in it than may be on the
    surface. Sometimes that lack of face-to-face is a disadvantage,
    not an advantage, because the small business owner or their
    representative may feels like they are just talking to the
    bureaucracy and they do not really know where their information
    is and what is being done with it, and if there is something
    that needs to be questioned explained, there is not a real
    convenient process to do that.
        The thing that we probably hear the most as a criticism of
    correspondence audit through our company and our experiences,
    is that there is an inconsistency in the quality of this
    unknown person responding from the IRS. In many instances it is
    almost as if they do not know the issue as well as the
    representative or the taxpayer does. Eventually, you really do
    need to move to a face-to-face environment to get the issue
    resolved. So, in many instances, what starts as a
    correspondence audit can only be resolved if it moves to some
    sort of face-to-face contact.
        We understand that correspondence audits are probably going
    to continue to be the preferred method of auditing small
    businesses, but if that is the case, I think there are three
    areas that the IRS needs to focus on and address.
        First of all, they need to do a better job of selecting the
    issues that work in this type of environment, so if it is going
    to be done through correspondence, it is an issue that can be
    resolved through corespondence. Secondly, they need to have
    more consistency and better training of their employees. And
    finally, I think something that is very important is they need
    to develop a tracking system. It is interesting to us that
    FedEx or UPS can track packages all the way through the
    delivery process, but the IRS cannot allow a taxpayer or a
    representative to track the status of their information in
    their audit. There needs to be better tracking of the
    information as it is submitted and as it is going through the
    process.
        The audits that I think we all associate with the IRS are
    field audits where people come out and spend time either at the
    small business owner's place of business or the
    representative's place of business. The good news for that is
    you tend to get a more trained and better qualified IRS
    representative. The bad news is those audits can last days,
    weeks, months, and sometimes years, and the cost of those are
    almost exclusively the burden of the small business owner.
    Again, they are necessary evils because they can be very costly
    and very expensive.
        I agree almost completely with some of the comments of Mr.
    Davenport as we move forward with online accounts. The IRS is
    setting up individual accounts, which I commend them for.
    However, there is a vast need for business accounts and
    practitioner accounts. Currently, about 70 percent of small
    business owners have some sort of relationship with a
    practitioner, and, therefore, you need to give access to
    accounts to the people who would be most likely to use them.
    Unless you operate as a Schedule C, if you are a partnership or
    a corporation, there are no accounts right now, but I think we
    need those accounts as well.
        Finally, even on the individual accounts, which I think are
    a step in the right direction, and I certainly understand the
    challenges of identity theft that the service is facing, but
    right now the service says that the way to authenticate those
    accounts today, by their own admission, are only successful 30
    percent of the time. If we are going to have individual
    accounts, they need to be something that the average person can
    actually access when needed.
        So with that, I see my time is up, again, thank you for
    allowing me to being here, and I look forward to your
    questions.
        Chairman HUELSKAMP. Thank you, Mr. Harris, we appreciate
    your testimony.
        I now yield to our Ranking Member for the introduction of
    the final witness.
        Ms. CHU. It is my pleasure to introduce Ms. Emily Peterson-
    Cassin. Ms. Cassin is the Coordinator of Public Citizen's
    Bright Lines Project. The Bright Lines Project was founded in
    2008 and worked to change the big test that currently defines
    political activity for nonprofits. Before joining Public
    Citizen, she worked as an attorney in ERISA litigation and in
    indigent representation. She received her juris doctorate from
    Georgetown University Law School.
        Welcome, Ms. Peterson-Cassin.
        Chairman HUELSKAMP. I thank the Ranking Member for that
    introduction.
        Ms. Peterson-Cassin, you may begin.

                   STATEMENT OF EMILY PETERSON-CASSIN

        Ms. PETERSON-CASSIN. Thank you. Mr. Chairman, Madam Ranking
    Member, thank you for the opportunity to testify today.
        My name is Emily Peterson-Cassin. I am the Bright Lines
    Project coordinator at Public Citizen Congress Watch. Public
    Citizen is a national, nonprofit, public interest organization,
    with more than 400,000 members and supporters.
        For 45 years, we have successfully advocated for stronger
    health safety, consumer protection, and other rules, as well as
    for a robust regulatory system that curtails corporate
    wrongdoing and advances the public interest. My own work at
    Public Citizen is to coordinate the Bright Lines Project, an
    expert team of attorneys and nonprofit partners working for an
    improved definition of political activity for all nonprofits.
        I do not need to tell this Committee how important small
    business is to our economy and our society. Congress can, and
    should, protect small business by ensuring a clear, predictable
    framework of tax rules and regulations. Rules that are easy to
    follow and enforce allow small businesses to thrive, while
    minimizing opportunities to abuse the tax system.
        The IRS should be doing more to ensure that small
    businesses can easily comply with the regulations already in
    existence, and work to improve its ability to provide accurate
    and timely guidance. The Bright Lines project focuses on
    nonprofits, advocating for a definition of political activity
    that increases civic participation and creates objective
    standards for the IRS to follow when enforcing the law. Clear
    rules are just as important for a small business. Indeed,
    nonprofits can be likened to small businesses with a social
    mission. At the same time, it is important to recognize the
    benefits to small business and our society of having a safe and
    healthy workforce made possible by sensible government
    regulation.
        Regulation is also essential for opening up new markets for
    small businesses and helps incentivize innovation in safer and
    cleaner technologies. Regulations make our country stronger,
    safer, cleaner, healthier, and more fair to small business.
        The regulatory system must not operate to give large
    corporations an unfair advantage by delaying important
    regulations or muddying the rulemaking process. Making the
    rulemaking process too complicated for commonsense regulations
    harms small businesses rather than helps them. The analysis
    required under SBREFA, for example, can delay the already
    laborious rulemaking process for months. A recent GAO report,
    which investigated the slow process of rulemaking at OSHA,
    found that it takes 8 extra months of work for OSHA to prepare
    for the SBREFA panel. In addition, small business analysis
    should be narrowly targeted to benefit small business.
        Though the advisory panel component of SBREFA legislation
    often results in unnecessary delays to needed regulations,
    other aspects of the law do help small businesses comply with
    regulations and could be expended to be even more helpful.
    Supporting and expanding the Small Business Ombudsman and
    Compliance Assistance programs is a sensible way to give
    direct, tangible help to small business.
        The information the IRS provides to business taxpayers is
    essential to increasing compliance and decreasing hassle for
    small business. However, funding cuts to the IRS in the past
    few years has made that assistance more difficult to provide.
    Since fiscal year 2010, the IRS's funding has been drastically
    cut again and again. Consequences of those cuts have led to
    reductions in staff available to assist taxpayers and in the
    training available to that staff. An IRS staff that is
    adequately knowledgeable and available to small business
    taxpayers makes filing taxes easier and prevents compliance
    problems from compounding. Yet, over and over, the IRS is
    unfairly attacked and prevented from fulfilling its mission.
    Therefore, it is essential that the IRS is fully funded.
        It is in our nation's interest that small businesses are
    able to grow and thrive in a society that protects health and
    safety and ensures that the market operates fairly to
    businesses of all sizes. Small changes to SBREFA, fully funding
    the IRS, and ensuring a predictable rulemaking process will
    ensure that the playing field is level for small business.
        Again, it is an honor to come before you today, and I look
    forward to your questions.
        Chairman HUELSKAMP. Thank you, Ms. Peterson-Cassin. I
    appreciate your testimony. We will begin with questions.
        I would first like to direct a question to Mr. Harris. I
    appreciate your experience as a practitioner. Looking at this
    and after a correspondence audit, what do we really know how
    the IRS determines who is going to be audited? The New York
    Times article contends they have a secret algorithm. What is
    your experience or your best guess in what is occurring over
    there?
        Mr. HARRIS. They have what they call a DIF score. Tax
    returns are scored and compared to some norms of other returns
    and their prior returns, which, I guess, is the most common
    way. They also at times target specific issues where they see
    problems either in a tax part of a law or taxpayer behavior.
    Sometimes they are just random. They do some audits that are
    for research purposes, and those are done randomly and are done
    in great depth and detail. Quite honestly, sometimes you just
    do not know why you are selected. You see some returns that you
    think, wow, I do not know why that one is not getting an audit
    and one that looks fairly simple gets one, so, I think there
    are a lot of different reasons. I am not sure anybody knows
    them all.
        Chairman HUELSKAMP. Another question for Mr. Sepp about the
    auditors. How are they currently held accountable when they
    make errors that might cause a catastrophic result for
    taxpayers and/or small businesses?
        Mr. SEPP. There are some methods by which taxpayers can see
    redress if the IRS either loses documentation or if, perhaps, a
    math error on an examiner's part is discovered. That was
    something brought up to me in an interview I conducted with a
    tax professional. Interestingly, the IRS issues millions of
    math correction error notices on its own. Sometimes the IRS's
    own staff make mistakes in the calculation of a tax. The
    problem is, beyond going to appeals, and assuming the taxpayer
    even understands his or her appeal rights, getting into tax
    court or district court is a very expensive proposition. One of
    the elements of H.R. 1828, the Small Business Taxpayer Bill of
    Rights, would begin a pilot program for alternative dispute
    resolution in small business tax cases. That was an idea that
    had been developed by an IRS Reform Commission some 30 years
    ago, or 20 years ago I should say, and it is a good idea now. I
    think we should move forward with it.
        Chairman HUELSKAMP. With a tax appeal rate of 5 to 7
    percent, is this because businesses are a function of being
    scared as well as not knowing, or not worth the price of entry?
    There is a lot of discussion about large corporations that will
    draw audits for years. For a small business with 20 folks or
    less a couple days is a major crippling factor on their
    business if they are shut down or have to spend all their time
    with an auditor on an appeal.
        Mr. SEPP. Yes, absolutely. Some professionals have reported
    to me, just the basic misunderstanding, that when taxpayers
    receive the so-called 30-day letter with an RAR, the report of
    the examiner, as to the issues and the position of the IRS,
    they think it is a bill. They think they have to pay it.
        Chairman HUELSKAMP. Who would they call?
        Mr. SEPP. It is very difficult sometimes. That is a problem
    the Taxpayer Advocate has pointed out, that there needs to be a
    single point-of-contact with a phone number that a citizen
    under examination can get in touch with. The IRS has
    interpreted that mandate in a very fluid fashion, and that is
    not very helpful.
        Chairman HUELSKAMP. Mr. Davenport, what is your sense of
    volume of audit activity? Could that be diminished, and more
    targeted, and more efficient? You filed recommendations for the
    council you are on. Can you describe that a little bit more,
    how we could actually make it more efficient and better
    allocate the resources? Thoughts on that?
        Mr. DAVENPORT. I do not know if I can speak to the volume
    of the audits and their current status. I think that they would
    be increased. You would have more efficiency in the system if
    you allowed the small businesses to transparently see
    information that is on file. If the IRS presented to you an
    electronic account or a format, that they could say this is
    what we have for you. These are the kinds of things we are
    going to be talking about.
        As was previously mentioned, they could track the audit
    process, the paperwork through the entire cycle of the audit.
    Their interactions are, as I mentioned, largely unaccountable
    for, so you can change hands of the audit process several
    times. You can speak with people on one issue or event in the
    IRS and then speak with another person in another department.
    They do not have a way to be able to speak knowledgeably about
    all the information held in one place at one time, and I think
    it would improve dramatically.
        Chairman HUELSKAMP. They have, certainly, some type of
    internal processes, but are taxpayers not privy to those? Or if
    they ask who is looking at it next or who looked at it, where
    it is, what do they tell a small business man or woman that is
    appealing? Where is the appeal? Will they even answer that
    question?
        Mr. DAVENPORT. I think it would require several lengthy
    responses back and forth. I think putting all the information
    we have into the same place and having an important and dynamic
    conversation about the information that we have at the same
    time would be fair and transparent for both the filer and the
    service.
        Chairman HUELSKAMP. Well, thank you. I appreciate that.
        Next, I would like to recognize the ranking member for her
    5 minutes of questions.
        Ms. CHU. Thank you, Mr. Chair.
        Ms. Peterson-Cassin, the Regulatory Flexibility Act, or
    RegFlex, was passed by Congress and mandates that Federal
    agencies consider the potential economic impact of Federal
    regulations on small entities. In fact, it was this Committee
    that created the RegFlex Act over 25 years ago. How can the
    lack of RegFlex compliance from the IRS impact the ability of
    small businesses to adjust according to a new regulation?
        Ms. PETERSON-CASSIN. Well, clarity and predictability are
    essential to a good regulatory system to any regulation that
    comes out. It makes compliance easier and it makes enforcement
    easier. Small businesses want to comply with regulations, and
    when they do not know when the regulations are coming out, what
    the regulations will be, whether the regulations are going to
    affect them, it is impossible to comply. Furthermore,
    compliance problems, once they start, have a tendency to
    compound, which leads to a lot of the problems with difficult
    audits that we have been discussing previously.
        Ms. CHU. Well, this Regulatory Flexibility Act, RegFlex,
    and the Small Business Regulatory Enforcement Fairness Act,
    were designed with small business compliance in mind. What are
    the most advantageous aspects of these laws and could these
    tools be extended to further assist small firms?
        Ms. PETERSON-CASSIN. Absolutely. The best thing these laws
    do is to provide direct tangible assistance to small
    businesses, including creating small business ombudsmen. Most
    agencies already have one, including Treasury. Those ombudsmen
    are there to answer questions, provide guides, and help small
    businesses comply with existing procedures. But the program
    should be expanded to include more outreach, make sure that
    small businesses know that those resources are available and
    can be found easily. There should also be best practices
    guidelines on how to do that outreach. More compliance
    assistance and making that assistance meaningful will have
    enormous benefits, and remove burdens also to small businesses.
        Ms. CHU. Absolutely. Now I would like to ask you about the
    significant budget cuts at the IRS. The IRS has had significant
    budget cuts and it has resulted in limited resources. Is it
    realistic to think that the IRS can appropriately and
    efficiently perform all the duties it has been tasked to do
    while also reviewing the modified problem areas, like the price
    of audit on taxpayer accounts? How can increasing the IRS
    budget, and therefore increasing personnel, address many of the
    problems we are hearing about today?
        Ms. PETERSON-CASSIN. An answer to your first question,
    unfortunately, I do not think it is realistic at all to expect
    the IRS to carry out its vast mission of enforcing the tax code
    with the cuts that have been in place. Since 2010, as Mr.
    Davenport mentioned, the IRS has lost about 17,000 full-time
    employees, including 5,000 from enforcement. As we have been
    hearing, audits are an imperfect tool. Increasing compliance
    assistance and guidance, before the problems compound, makes
    those audits easier, and increasing the training available to
    staff through adequate funding would decrease the problems that
    those audits cause as well.
        Ms. CHU. How about increasing personnel and increasing the
    budget? What could that do to address these problems that we
    are hearing about?
        Ms. PETERSON-CASSIN. That is exactly right. I mean, the
    most obvious thing that the IRS can do to increase its
    compliance is answer their phones. As Mr. Davenport mentioned,
    he cited the statistic that the IRS has a 38 percent service
    level on their phones. That is obviously unacceptable. When
    they do get more funding, as they did, they got a little bit of
    funding in 2015 to address that problem, the service level goes
    up. In fact, when that extra funding came up, they were able to
    hire 1,000 temporary workers and increase the phone level
    service to about 70 percent. Now, that is not even talking
    about the first thing I do when I have a problem or I have a
    question, which is go to the internet. The IRS needs that extra
    funding in order to create easy-to-find compliance guides so
    that small businesses do not have to wonder what they are
    supposed to be doing. They should be able to find those answers
    right away. More funding will make sure that happens.
        Ms. CHU. Thank you. I yield back.
        Chairman HUELSKAMP. Thank you. Next, I would like to
    recognize Mrs. Radewagen for her 5 minutes of questions.
        Mrs. RADEWAGEN. Thank you, Mr. Chairman. I, too, would like
    to welcome the panel. Thank you for appearing today.
        Mr. Davenport, you talk about a system that verifies
    taxpayer identities and tax return information before the IRS
    accepts a return. How would this work in practice?
        Mr. DAVENPORT. In my mind there are a few things that would
    have to change. There are some regulations in place now to
    bring in information returns in earlier, much earlier.
    Information now from the 1099s and the W-2 passes through
    Social Security and then gets to the IRS sometime around the
    summer or late summer. If information was to arrive earlier and
    it would be usable by the IRS, searchable and cross-matched, we
    could better identify information that was included on those
    information statements, like W-2s and 1099s, and use it to
    verify, authenticate the individual.
        I think there is some movement in the spending bill this
    year, the IRS will start issuing refundable credits on February
    17th this year. This has some negative impacts for the system,
    but if you move back the date the refunds come out and you move
    up the date information comes in, you have a better chance of
    matching that information, and then knowing who the individual
    is and if they are getting the right number.
        This is not to stop me stealing his information at a coffee
    shop; this is to stop the 500,000 returns and refunds that are
    issued improperly to people who do not exist. They are phantom
    corporations that have filed for millions of people.
        Mrs. RADEWAGEN. Given the IRS cybersecurity challenges, as
    well as those of taxpayer identity theft and refund fraud, how
    do we ensure that the taxpayer online portals you recommend are
    secure?
        Mr. DAVENPORT. Security is an evolving thing. Even 3, 4
    years ago, we thought security questions were lightyears ahead
    of where we are. Now you can find that stuff on Ancestry.com
    and this is a pretty common thing that we think the status of
    evolving authentication, for me knowing who an individual is,
    the computer must be smarter than we are and those are powered
    by people and people have to make the decisions, and
    cybersecurity is a big deal. Right? So if we can improve that,
    if we can know who they are and if we can master information,
    we will have a better chance of making those payments
    correctly.
        The thing is now I can choose to interact with the IRS on
    the schedule I want. I can come in and out of the system at any
    point. I can file and not file next year and no one will know
    the better. We will know later, years later, but if we were to
    create an online system that I could match my information the
    employer sent me. I am a small business owner, if I got 1099s
    in the mail, as did the IRS, and if I could actually see what
    was there, what they had, what I had, in a prefiling season I
    could know my compliance was going to be right and I was going
    to file the right return. I could submit my return through an
    online account. They would send me a note, we received your
    return today. Thank you very much. We are going to drop your
    refund in your account today. Is that okay? Well, if it was not
    me or that was not my return I would say no and we would stop
    immediately.
        I think there are some security concerns around how to do
    it, but does it need to be done? It absolutely has to be done.
        Mrs. RADEWAGEN. Okay. I am running out of time here.
        I wanted to ask Mr. Sepp, the current audit process seems
    to be a bit of a mess based on a number of issues you
    identified: lack of centralized management, lack of
    transparency, flawed IDR process, et cetera. But it appears
    that many of these issues could be resolved administratively
    within IRS. What recommendations would you make to the agency
    to make the process work as intended?
        Mr. SEPP. Some of these recommendations are being made by
    the Coalition for Effective and Efficient Tax Administration,
    but I think they apply not only to the large business and
    international division but small business and self-employed.
    There needs to be more centralized case management and points
    of contact. There needs to be much more consultation between
    the auditors and the audited about deadlines for information
    document requests, about timelines for completion of the audit,
    and about issues identified in the audit. I would echo the
    testimony of those here who say we need better training of IRS
    staff to focus more intently on the issues and to refrain from
    tactics such as designated summons or threatening to designate
    cases for litigation or hiring outside firms. Those kinds of
    issues, again, are eventually going to migrate into the small
    business community in some form or another. We need to address
    those now.
        Mrs. RADEWAGEN. Thank you, Mr. Chairman. I yield back.
        Chairman HUELSKAMP. I have a feeling we may have some
    members streaming in from other committees, and I have a couple
    of additional questions and the members will have another round
    of questions.
        Mr. Sepp, you did mention the option of farming out audits,
    which is a new concept to me. I understand the current system
    where we actually do in most States, if not all, participate in
    assisting the IRS in tax administration. But the current
    system, farming out audits to hire private companies are
    perhaps conflicts of interest? Describe why that should be
    allowed or your opinion on the IRS doing that. Apparently, it
    is doing it on a number of cases.
        Mr. SEPP. Well, certainly, National Taxpayers Union has in
    the past supported allowing the private sector to deliver
    services more efficiently and effective than government, but
    you have to draw a line. This is an inherently governmental
    function involving sensitive information and very sensitive
    issues. When a business is involved, of course, anything that
    gets made public can affect the reputation of the business, its
    ability to attract capital and the like.
        This issue was first raised when the Internal Revenue
    Service retained Quinn Emanuel in an investigation, an audit of
    a very large firm, and this has led to concerns on the Senate
    Finance Committee side of all kinds of things. We have privacy
    issues, we have whether this is worth the expense. We also have
    the issue of whether this is something that reinforces the
    intimidation factor when you have attorneys at over $1,000 per
    hour participating in the examinations. We are not talking
    about appearing as expert witnesses about issues that the
    examiners within the IRS might need help with, but rather,
    deposing witnesses. That could be very troubling.
        Chairman HUELSKAMP. Is this a new route for the IRS? Or
    have they been doing this for a long time?
        Mr. SEPP. No. It is very recent. Very recent. We are
    essentially ahead of the curve here in our ability to curtail
    this practice before it becomes commonplace. As I mentioned,
    one of your colleagues, Congressman Katko, is already offering
    an amendment regarding this. Senator Portman's legislation has
    a somewhat different approach to curtailing the practice, but
    we need to get on this as quickly as possible.
        Chairman HUELSKAMP. It seems very shocking to me and I was
    actually in a different type of regulatory setting of
    environmental regulations with the idea we would bring in a
    competing firm to help enforce or decide what permits their
    competitive firm gets and it is just beyond unbelievable the
    IRS would do this as well.
        Ms. Peterson-Cassin, you said you had experience in the
    nonprofit world as well, and there have been a lot of
    discussions in the last few years in trying to figure out who
    gets targeted for audits or selection of special scrutiny,
    which has come under a lot of discussion lately. Can you
    provide an insight? Should the IRS be using special words they
    target, or how do they pick these out in the nonprofit world
    for this tax-exempt status, which of course raised plenty of
    concerns, I think, by many folks. Can you describe what they
    should have done, what you think they did?
        Ms. PETERSON-CASSIN. Absolutely. What happened in that case
    is that the laws governing what political activity is for
    nonprofits are so vague that they are not only hard for
    nonprofits of all stripes to comply with, but they are also
    very, very difficult to enforce. This is exactly the discussion
    we have been having. Compliance and enforcement are two sides
    of the same coin.
        So I liken it to a speed limit sign that says do not go too
    fast. When the rule is that vague, there are going to be plenty
    of people who do go too fast for whatever reason. Then there
    are going to be even more people, in fact, the most common
    thing we hear from nonprofits is they just do not engage. They
    restrict themselves from things that they could be doing, could
    be participating in, could be furthering their mission, and
    they say we are too afraid. We are too afraid and we are not
    going to do it. The Bright Lines project exists to make that
    clear so that everyone can be on the same page.
        Chairman HUELSKAMP. In my conversations with the
    Commissioner, there are things that he told me they could do
    that no one in their right mind in the nonprofit world would
    even try to do because they know they are going to be hit on
    the wrist or even worse. How do you know what you know? How do
    you find out? Now we are in the middle of just trying to figure
    out what exactly they were doing in Cincinnati, which is the
    subject of other hearings of other committees, so I appreciate
    that insight.
        Ms. Chu, did you have any additional questions?
        Ms. CHU. Yes. Mr. Davenport, I was intrigued by the
    recommendations of the Electronic Tax Administration Advisory
    Committee. Electronic signatures is just such a basic common
    sense idea and would allow small business owners to save time
    and money when filing their taxes electronically. How could
    such a simple administrative change create efficiency for small
    businesses and the IRS?
        Mr. DAVENPORT. You hit on a multiyear problem and I think
    this has come out of ERSAC before as well, but it is the way
    the form line 40-ES, the employment form for small businesses,
    it is a form that is filed quarterly and their employment taxes
    paid. It is administratively much easier to go to the form,
    print the form itself, sign it, and then scan it back than it
    is to create an electronic account to do this. It is a simple
    fix, but, you know, if we talk about the 80 percent goal to get
    electronic filing above 80 percent, which is going to charter
    ETAAC in 1998, we are close in most categories: individual
    filings, 87 percent of individual taxpayers; businesses are
    below 80 percent, just below 80 percent, because the 94X
    series, which there are 20-something million of these forms
    that come in every year, only about 37 percent of them come in
    electronically. It is something that the IRS has formed a
    working group on, they did that when I was in my first year in
    ETAAC. They formed a working group in e-services. They will
    make recommendations, and they expect to implement those
    recommendations in fiscal year 2018. And so you can see the arc
    for change is not as agile as you would expect in the private
    sector, but I do think that we are going to see some changes in
    that soon because it is honestly just an easier thing to do
    than not to do.
        Ms. CHU. What makes implementing these changes so difficult
    for the IRS? Why is it taking so long? Also, are there any
    downfalls to allowing electronic signature, such as fraud or ID
    theft?
        Mr. DAVENPORT. I think one of the things they are dealing
    with is that an individual must authenticate for a business, on
    behalf of a business, and as a Schedule C filer. There are
    millions of Schedule C filers, it is no problem for me to
    authenticate myself with my own social, but to do so on behalf
    of a business, you have to share your own personal identity on
    behalf of a business as a business owner, and sometimes as
    businesses grow, that information then has to pass to internal
    accounting services or external folks.
        Again, it may just be an administrative thing that can
    change, that we can fix the system and make it easier, but I
    think they have to think about authentication as a whole
    strategy. That is just kind of wound up in it. I would probably
    defer to Mr. Harris, he may have strategies.
        Mr. HARRIS. No, I think your comments are true. We need to
    move to more electronic filing capabilities, and I think the
    service, if I was going to be critical, it is the old saying,
    ``The enemy of good is perfect.'' At some point we need to
    begin to allow businesses--there is always a reason not to do
    something. We need to start trying to find a reason to do
    something.
        Ms. CHU. Mr. Harris, collecting tax debt is possible
    through flexible collection tools and can be an efficient way
    of helping these individuals, yet these tools are rarely
    utilized by the IRS and instead tax liens, levies, and seizures
    are used. What makes liens and levies, which are much harsher
    points of collection, the preferred method for IRS agents?
        Mr. HARRIS. I really have no idea why it would be the
    preferred method because it is the most cumbersome method. It
    creates the most difficulties. I guess if you have exhausted
    every other tool. As you said, there are plenty of
    opportunities through any collection process through the use of
    installment agreements or offers in compromise or just paying
    the tab, it should be in all cases the place of last resort. If
    it moves up anywhere beyond that, then something in the system
    has not gone as intended because, again, that should be the
    last thing anyone gets to because that has the most severe
    impact of all on a small business owner.
        Ms. CHU. I yield back since I think votes have been called.
        Chairman HUELSKAMP. Are there votes this early? I did not
    know that, so I appreciate that. We got sidelined with another
    Committee, so I would like to thank all of you witnesses for
    participating today. You have raised a number of issues and
    potential solutions--I like hearing solutions--that require
    some serious attention at the IRS. It seems we have a lot more
    work to do in this area but this hearing is a good start.
        I know the Full Committee and this Subcommittee will follow
    up with the IRS and other stakeholders on the issues raised
    today. You have not heard the last from us. It is important
    that these issues and other related concerns are identified,
    addressed, and corrected.
        I ask unanimous consent that members have 5 legislative
    days to submit statements and supporting materials for the
    record. Without objection, so ordered.
        This hearing is now adjourned.
        [Whereupon, at 11:28 a.m., the Subcommittee was adjourned.]

                                A P P E N D I X

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                            Prepared remarked from the

              IRS Electronic Tax Administration Advisory Committee

        Chairman, thank you for holding today's hearing on how the
    IRS can help small businesses. The 28 million small businesses
    in America are a cornerstone to our economy. According to the
    Small Business Administration and the IRS, small businesses
    account for over half of all US sales and 55% of all jobs. They
    pay significant amounts of income, employment, and excise taxes
    to the US Treasury.

        Helping small businesses easily file and pay their taxes is
    a critical mission of the IRS Electronic Tax Administration
    Advisory Committee, or ETAAC. ETAAC was formed by law in 1998
    to make strategic recommendations to Congress on how to improve
    tax administration and better serve taxpayers--including small
    business taxpayers--through electronic means. In short, we are
    objective digital strategy consultants to the IRS. Recently,
    the committee has sharpened its focus on how the IRS could make
    the tax system less reactive and intrusive by providing
    taxpayers with digital access to their tax information and a
    better understanding of their compliance requirements.

        The committee believes that modernizing the IRS taxpayer
    service platform is an urgent, strategic priority for the IRS.
    In the 2015 tax season, the IRS was in its fourth consecutive
    year of budget reductions, and IRS service levels plummeted.
    The IRS answered only 38% of its calls from taxpayers. The IRS
    has been unable to modernize its taxpayer-service platform to
    move away from traditional paper and phone interactions. The
    current phone and paper taxpayer-service platform is also not
    the preferred choice of the IRS or the many taxpayers who
    expect secure online services.
        Aligned with this issue is a lack of transparency with the
    IRS. For most taxpayers, the information the IRS has about them
    is a mystery. It's not easy for taxpayers to access and
    understand their tax information on file with the IRS, their
    previous tax-related interactions or their tax compliance
    obligations. For small-business taxpayers, this issue is even
    more critical, because small businesses are more likely to
    complete multiple year-round transactions with the IRS. In many
    cases, when there is a compliance issue, small-business
    taxpayers find out with a surprising IRS notice after they
    file, or--even more stressful--an audit that can take months or
    years to resolve. For all types of taxpayers, accessing and
    using their tax information to proactively comply is almost
    entirely out of the question in the current system.

        The committee believes that a key solution these problems
    is a more digitally enabled, modernized IRS that better equips
    taxpayers with information on how they can proactively comply,
    rather than solely focusing on detecting and enforcing
    compliance.

        In the past three years, ETAAC has provided recommendations
    based on a single vision of how the IRS should serve taxpayers.
    This vision allows taxpayers to:

               Fully understand their tax obligations,

               Have transparent access to their tax
            information and status with the IRS, and

               Effectively and securely interact with their
            tax administrator in the way that they want to be
            served

        The end state is a tax system that is less burdensome. It
    is a tax system that relies less on reactive measures, such as
    audits, and more on preventative and educational measures for
    taxpayers to remain proactively compliant.

               First, the current tax system is designed to
            be reactive, and does not leverage tax information to
            help taxpayers meet their tax obligations, and

               Second, the IRS cannot quickly develop and
            implement its digital roadmap, including online
            accounts, to address the needs and preferences of
            taxpayers.

        Our last two reports to Congress explain this dilemma and
    provide recommendations to overcome these challenges.

        In ETAAC's 2015 report to Congress, we recommended that the
    IRS accelerate its digital taxpayer-service strategy--that is,
    develop secure online accounts for all business and individual
    taxpayers. Taxpayers should have secure digital access to their
    tax information, and they should be equipped with comprehensive
    tools to interact effectively with the IRS online.

        In the report, we directly addressed key problems in the
    IRS strategy that affect small businesses, and we advocated for
    an expedited release of online accounts and tools for
    businesses--still not a stated IRS priority.

        Additionally, we know that businesses are much more likely
    to use a tax professional for tax filing and compliance needs.
    Online accounts for these tax professionals should be a
    priority. In the current IRS digital plan, online accounts for
    business taxpayers and their tax professionals arrive much
    later. ETAAC advocates for the IRS to commit to quickly
    developing online accounts for business taxpayers and the tax
    professionals who serve them, and we encourage this committee
    to do the same.

        In our most recent 2016 report, ETAAC addresses the ``look-
    back'' tax system that centers on post-filing programs that
    detect and correct noncompliance. We challenge Congress and the
    IRS to move to a system that verifies taxpayer identities and
    tax return information before accepting a return.

        A system that uses information statements, such as Forms
    1099 and W-2, to verify taxpayers and their tax return
    information is essential to fighting fraud and reducing
    taxpayer burden. The IRS should support taxpayers in filing
    accurate returns by giving them full electronic access to their
    tax account information at the time of filing. This proactive
    system would verify accuracy upfront and reduce audits,
    particularly those on small-business taxpayers.

        ETAAC has been pleased with the IRS' first steps in its
    digital service plans. The IRS released an initial draft of its
    Future State Initiative in January of this year. The initiative
    specifically contemplates small-business taxpayers and their
    needs. However, the delivery date of these digital capabilities
    is unknown.

        Many of the ETAAC's recommendations from the past three
    years are incorporated into the IRS Future State Initiative's
    digital plans. ETAAC endorse4s the digital-service components
    of the IRS' Future State plan, and we have advocated to
    Congress that the IRS should accelerate these plans. Our
    recommendations clearly identify the urgent needs of small
    businesses. The IRS needs to accelerate online accounts for
    businesses and tax professionals.

        On behalf of the entire ETAAC, thank you for inviting us to
    testify on this important topic.

        For more information on ETAAC's recommendations to the IRS,
    and those impacting small businesses, please see the
    committee's recent reports at https://www.irs.gov/uac/
    electronic-tax-administration-advisory-committee-etaac-annual-
    reports.

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        Good morning, I am Roger Harris, President and Chief
    Operating Officer of Padgett Business Services. I have been a
    tax practitioner for over 40 years and have served on the
    Internal Revenue Service Advisory Council for four years and
    was its Chair for two of those years. I believe this experience
    gives me a balanced approach to small business taxation--I have
    had the opportunity to see what works and what doesn't work in
    the real world.

        For nearly fifty years, Padgett Business Services has been
    providing accounting, income tax planning and preparation,
    payroll and payroll tax services to thousands of small business
    owners through our network of over 200 offices across the
    United States. Our clients generally have 20 or fewer employees
    and are what some people would consider ``mom & pop''
    businesses; however, based on recent studies almost 90% of all
    firms that have employees operate in our target market.

        Internal Revenue Service Audits of Small Businesses

        Padgett's business model brings us in contact with our
    clients throughout the year, not just during filing season. We
    assist our clients in establishing good accounting,
    recordkeeping and tax processing. This ongoing communication
    allows us to understand these small business owners well beyond
    just knowing their numbers. Our strong belief is the best way
    to survive an audit is to do everything within your means to
    never have one. Enforcement being a prerequisite for our tax
    system to work, there is a real possibility for all small
    business owners to one-day experience the pleasure of an IRS
    audit. Because of that possibility the second best way to get
    through the process is to have a clear, traceable record of
    financial transactions and of course to keep and organize
    receipts and invoices. A disciplined approach throughout the
    year generally results in less trouble with the tax man--local,
    state and federal.

        In those occasions where audits do arise, either for
    established clients or individuals new to the small business
    world, it's important to have a broad overview of the process.

        In general, there are two kinds of audits: Correspondence
    and Field. According to IRS data for 2014, the IRS conducted
    just over 291,000 Field Audits and over 950,000 Correspondence
    Audits. Both of these numbers have dropped considerably since
    their peak in 2010 of 391,000 and 1.173 million, respectively.
    Because Correspondence Audits tend to focus on more moderate
    income tax returns, and more basic issues that should not
    require a face to face meeting, mom-and-pop small businesses
    are much more likely to experience these than actually sitting
    across from an IRS auditor.

        Correspondence Audits, known within the IRS as Campus
    examinations, are the most basic type of audit and are
    conducted--as the name implies--by mail. They are usually
    triggered by software that compares returns against common
    trends and selects those that might be considered outliers.

        Field Audits typically occur when the IRS suspects major
    violations or they are part of an IRS research program. IRS
    auditors may ask that taxpayers come to their offices, but they
    typically visit the place of business at least once during the
    process.

        The vast majority of small business audits are
    Correspondence Audits. While they are intended to cover only
    simple issues, because of the IRS's focus on efficiency, they
    can be frightening to small business taxpayers, as well as
    being time consuming and expensive. In some circumstances when
    things go wrong, they can be devastating to a business.

        For a Correspondence Audit, the IRS will mail small
    business taxpayers either a Letter 566 or a CP 2000 notice. 566
    letters advise taxpayers that their returns have been selected
    for examination and will list documents such as receipts needed
    to verify positions on returns. The CP 2000 notice will contain
    adjustments based on third-party documents associated with the
    return. A taxpayer typically must respond within 30 days.

        If taxpayers agree with a notice, they simply sign the
    letter and return it with a check made out to the US Treasury;
    the problem arise usually when there is a dispute.

        When responses from taxpayers arrive at the Examination
    center, they sit in a queue at the IRS processing center for
    weeks or even months depending on the backlog--causing great
    anxiety on the part of taxpayers. Eventually, files are
    assigned to auditors. If all goes well, taxpayers will receive
    letters thanking them for their responses and telling them
    nothing more is needed. Sometimes, for whatever reasons,
    taxpayers do not receive these acknowledgements, forcing them
    or their representatives to hunt down their case files or to
    keep resending them.

        As expected a good number of these responses are denied by
    auditors due either to the quality of the records or because of
    a dispute over a matter of law. While many people believe tax
    law is black and white the reality is most areas are gray. This
    graying requires the law to be applied to the facts and
    circumstances that exist and are specific to that small
    business. Sometimes it is difficult to understand all of the
    facts and circumstances when the discussion is by
    correspondence.

        Unfortunately, it is not uncommon for a small business
    taxpayer to fail to respond to the original correspondence from
    the IRS in a timely manner. If taxpayers do not respond, the
    IRS issues a second notice, and if there still is no response,
    it will issue statutory notices of deficiency, known as a ``90-
    day letter.'' At the end of that time, the IRS ``assesses'' the
    tax, including penalties and interest. Assessment establishes
    that taxpayers legally owe the amounts in question and then the
    cases are move over to collections.

        The problems associated with the audit process for small
    businesses can range from the mundane to the Kafkaesque. First,
    even the simplest correspondence audits consume time and focus
    for business owners to find, gather and mail the requested
    records to the auditor. The IRS often states ``but, it is up to
    taxpayers to keep proper records.'' This is correct but it
    doesn't make it any less burdensome. Even for the most
    organized among us, it takes time to locate and organize the
    correct documents. In addition to time requirements, the small
    business owner is usually under a great deal of stress. For
    many taxpayers this is their first dealing with the IRS in this
    way. Their minds wander to the horror stories they have all
    heard and they wonder how bad will this be and can I do this
    without help?

        Second, over 70 percent of small business owners rely on
    enrolled agents, CPAs or attorneys when they are contacted by
    the IRS. Because of this, even mundane correspondence audits
    can have significant cost, even for small disputes the cost of
    representation can easily exceed the taxes in question. Many
    business owners do the math and decide to just pay the extra
    tax instead of fighting it. For those instances when small
    businesses respond to correspondence audit notices and auditors
    reject their records or legal position, outside practitioner
    costs can quickly add up to thousands of dollars. Longer more
    complex field audits can be even more cost prohibitive for
    taxpayers.

        Another problem area for taxpayers that cost both time and
    money is when responses are seemingly lost or delayed in the
    system. The deadlines come and go and taxpayers believe that
    they have responded. The nature of the Correspondence Audit
    process is that it is almost wholly automated. If the computer
    at the examination campus does not know taxpayers have
    responded it continues to send out notices, deadlines will
    continue to not be met, as the IRS claim marches inevitably
    into assessment and collection. The IRS seems to have gotten
    better over the years at tracking cases but approximately a
    million cases go through Campus Examination centers each year.
    Cases can either be lost, not processed correctly, or they are
    not submitted in a timely manner. It is important to keep in
    mind that there is no one point of contact taxpayers or their
    representatives can call at the center to track down a
    particular case. This lack of a responsible human being within
    the bureaucracy is often the most frustrating aspect of the
    Correspondence Audit.

        A similar problem, except on the taxpayer side, is the non-
    receipt of notices because taxpayers have moved, or for
    whatever reason are not receiving them. Taxpayers are
    blissfully ignorant. And on top of that the computer processing
    correspondence audits is blissfully ignorant as well, belching
    out notice after notice until cases end up in collections.
    Taxpayers can first learn they have a problem when their
    business checking accounts are frozen or another collection
    action has been taken. Once again unwinding these cases can be
    particularly time consuming and expensive.

        Finally, our franchise owners have experienced inconsistent
    quality in personnel. It is readily apparent that older more
    experienced auditors have the benefits of more training, a
    deeper understanding of the law, and more real life experience
    to guide them. Younger personnel only have a basic
    understanding of the law or do not have the experience that
    only time can provide. This lack of experience can cause
    delays, or even worse an incorrect determination. There has
    been a long term practice of allowing more complicated
    Correspondence Audits to be transferred to a local area office
    at the request of taxpayers. It has become very difficult to
    have these transfers approved. Similarly, requests to speak to
    managers and referrals to appeals can be ignored. The IRS is
    clearly experiencing a shortage of personnel and suffering from
    a lack of training.

        The small business taxpayer is also at the mercy of the
    knowledge and experience of their tax preparer or
    representative. Additionally, a less qualified tax preparer may
    be the very reason the small business owner finds themselves in
    the mess they find themselves in.

        At the end of the day no matter if it's the small business
    taxpayer, the tax practitioner, or the individual from the IRS,
    the cost of an extended process will be paid by the small
    business owner.

        So, what can the IRS improve even within the constraints of
    fewer resources? We believe they better facilitate the tracking
    of cases. If Federal Express can manage millions of packages
    all over the world, it seems that the IRS could come up with
    some sort of bar code or other tracking system that would allow
    both the IRS and the taxpayers to track correspondence
    responding to notices and the status of their cases. Most
    importantly, the IRS may need to be willing to assign cases
    earlier to an auditor or a team of auditors if the taxpayer
    believes such a request is in their best interest. And finally,
    leading to my next discussion, the IRS needs to drive a large
    part of the Correspondent Audit communications to the interest.

        IRS Future State Vision for Small Businesses and
    Practitioners

        The IRS vision for Future State could provide significant
    relief to many of the problems associated with Correspondence
    Audits. A taxpayer receiving one of these notices could simply
    activate an individual account through IRS.GOV, view their
    status online, scan the requested documents and email them to
    the examination campus, and respond to any follow ups. All of
    these communications would be done through a secure email
    system that would track all communications. If taxpayers are
    required to make payments, they can do so through their
    accounts or enter into installment agreements all online. We
    believe strongly that Future State accounts could provide their
    greatest return on investment in managing Correspondence
    Audits.

        Unfortunately, like most things there is good news and bad
    news. First, IRS plans to roll out online applications for
    individual taxpayers over the next year or so. Similar accounts
    for practitioners, however, will not be available for at least
    a year or two beyond that. It is important to keep in mind that
    over 70 percent of small businesses choose to have an enrolled
    agent, CPA or lawyer deal with notices from the IRS. This means
    that most small businesses will effectively be stuck in the
    current snail-mail process.

        Another considerable problem has to do with authentication.
    In order to access these accounts, taxpayers must provide
    information associated with their tax returns, their account
    numbers for a loan or credit cards, and cell phone numbers
    associated with their name and social security number.
    Unfortunately, for taxpayers who have not filed a tax return,
    or do not have loans or credit cards, or have cell phones
    provide by work or a family member, they will be effectively
    locked out of their own accounts. The IRS estimates that only
    30 percent of taxpayers will be able to authenticate themselves
    and use their accounts. Currently, unlike a typical financial
    institution, there is no 800 line planned that taxpayers could
    use to authenticate themselves over the phone.

        Additionally, the agency has no real plans for providing
    business level accounts. Luckily, most sole proprietors or LLCs
    filing a schedule C will be able to use the individual
    accounts. More complex small businesses organized as C
    corporations or partnerships will not have access to these
    accounts.

        Generally, because of the real threat of online hackers,
    the IRS is creating a very high authentication barrier to
    access online accounts. The reality is, however, that most
    taxpayers will rarely, if ever, need access to their accounts.
    They will try once, with 70 percent of the time failing to gain
    access, and then picking up the phone or using the U.S. Mail as
    their primary method of contract. While practitioners and
    businesses, both of whom have many more interactions with the
    agency, will do whatever it takes to go through the
    authentication juggernaut in order to access the accounts.

        Additionally, in the case of practitioners, they are well
    known to the IRS, having registered for a PTIN and a Central
    Authorization File number. Further, if necessary, the IRS could
    require a one time in-person authentication similar to the
    FAA's PreCheck system.

        In short, as the IRS moves forward with online accounts, it
    must include access by practitioners--enrolled agents, CPAs,
    and attorneys--and businesses in order for the strategy to be
    successful. The agency needs to find practical methods to
    authenticate Circular 230 practitioners and to authorize them
    to solve their clients' problems. Any solution that omits
    practitioners fails to recognize many taxpayers benefit from
    representation because they (a) do not want to represent
    themselves, (b) recognize they are not proficient enough to
    represent themselves, or (c) are afraid to engage with IRS
    enforcement staff. Forcing a portal to face taxpayers only will
    place taxpayers with practitioners at a disadvantage, as a
    result, practitioners will continue to be parked on phone
    lines, and it will significantly impede taxpayers' rights to be
    represented before the agency.

        We urge the Internal Revenue Service to consider four
    important policies:

              1. Develop robust individual and practitioner online
            accounts at he same time.

              2. Allow Circular 230 practitioners to execute and
            file authorizations electronically and immediately
            represent those clients.

              3. Allow the use of electronic signatures for all
            power of attorney and disclosure authorization forms.

              4. More expeditiously to provide access to business
            accounts.

        Thank you for this opportunity to testify today and Padgett
    Business Services looks forward to working with the Committee
    on this crucial area of tax administration.

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