[House Hearing, 114 Congress]
[From the U.S. Government Publishing Office]
IRS PUTS SMALL BUSINESSES THROUGH AUDIT WRINGER
=======================================================================
HEARING
before the
COMMITTEE ON SMALL BUSINESS
UNITED STATES
HOUSE OF REPRESENTATIVES
ONE HUNDRED FOURTEENTH CONGRESS
SECOND SESSION
__________
HEARING HELD
SEPTEMBER 14, 2016
__________
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Small Business Committee Document Number 114-072
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
WARREN DAVIDSON, Ohio
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
Kevin Fitzpatrick, Staff Director
Jan Oliver, Chief Counsel
Adam Minehardt, Minority Staff Director
C O N T E N T S
OPENING STATEMENTS
Page
Hon. Steve Chabot................................................ 1
Hon. Alma Adams.................................................. 2
WITNESSES
Ms. Kathy Petronchak, Director of IRS Practice and Procedure,
alliantgroup, LP, Houston, TX.................................. 4
Mr. Warren Hudak, President, Hudak & Company, Lemoyne, PA,
testifying on behalf of the National Association of Enrolled
Agents......................................................... 5
Mr. Don Williamson, Executive Director, Kogod Tax Policy Center,
American University, Washington, DC............................ 7
Ms. Jennifer E. Breen, Partner, Morgan, Lewis & Bockius LLP,
Washington, DC, testifying on behalf of the American Bar
Association Section of Taxation................................ 8
APPENDIX
Prepared Statements:
Ms. Kathy Petronchak, Director of IRS Practice and Procedure,
alliantgroup, LP, Houston, TX.............................. 19
Mr. Warren Hudak, President, Hudak & Company, Lemoyne, PA,
testifying on behalf of the National Association of
Enrolled Agents............................................ 27
Mr. Don Williamson, Executive Director, Kogod Tax Policy
Center, American University, Washington, DC................ 32
Ms. Jennifer E. Breen, Partner, Morgan, Lewis & Bockius LLP,
Washington, DC, testifying on behalf of the American Bar
Association Section of Taxation............................ 38
Questions for the Record:
None.
Answers for the Record:
None.
Additional Material for the Record:
None.
IRS PUTS SMALL BUSINESSES THROUGH AUDIT WRINGER
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WEDNESDAY, SEPTEMBER 14, 2016
House of Representatives,
Committee on Small Business,
Washington, DC.
The Committee met, pursuant to call, at 11:00 a.m., in Room
2360, Rayburn House Office Building. Hon. Steve Chabot
[chairman of the Committee] presiding.
Present: Representatives Chabot, Luetkemeyer, Hanna,
Huelskamp, Gibson, Hardy, Kelly, Davidson, and Adams.
Chairman CHABOT. Good morning. The Committee will come to
order. We thank everyone for being here. Special thanks to our
witnesses who have taken time away from their busy schedules to
be here with us today.
We are here today to follow up on the June hearing held by
our Subcommittee on Economic Growth, Tax, and Capital Access.
In that hearing, we laid out many systemic problems within the
IRS that are harming small businesses, including burdensome
regulations, poor communication, and overly aggressive audits.
Today, we are focusing specifically on IRS audits and how small
businesses are treated, and often mistreated, during that
process.
Members of this Committee regularly hear from constituents
about the IRS, and these constituents are not calling us to
tell us what a great job the IRS is doing generally. They are
calling because they are desperate and frustrated, and they
have good reason to be oftentimes. I know members of this
Committee have heard from constituents who were audited so
aggressively by the IRS that they had to actually close their
doors. Others are engaged in protracted audits that seem like
vague fishing expeditions with no end in sight. Most are
hindered in their ability to actually run their businesses
because endless document demands from the IRS require so much
of their time and resources. In many cases, small businesses
simply cannot afford to hire a professional to deal with the
demands of an audit.
The IRS has an obligation to provide small businesses with
clarity and to treat all taxpayers with fairness and respect.
The agency has failed repeatedly in meeting this obligation to
the people it is supposed to be serving.
I do not need to tell you that a business forced to close
its doors can no longer pay taxes. It also cannot hire
employees and create economic growth in that community. Our
current system is working oftentimes against small businesses
when it should be working for them. The IRS must do better.
Today, we will be examining some of the issues and problems
with the current exam process. We will also be exploring some
possible solutions.
I am looking forward to hearing from all of our witnesses
here today, and I would now like to yield to the ranking
member, Ms. Adams, for her opening statement.
Ms. ADAMS. Thank you, Mr. Chair, for holding this valuable
hearing, which follows up on the Subcommittee on Economic
Growth, Tax, and Capital Access hearing held in June. During
that hearing there was testimony from several witnesses about
the difficulties associated with a tax audit. While tax audits
serve an important purpose in the IRS' role to enforce and
collect taxes, the auditing process can be confusing and
intimidating for small business owners.
As we all know, our tax code is complex, resulting in
simple and innocent mistakes, mistakes that should not be met
with a time-consuming and costly audit. However, audits do
serve an important purpose. They are the primary tool used by
the IRS in its effort to reduce the tax gap, which is caused by
nonfiling, underreporting, and underpayment. In total, the gap
is over $450 billion, even with voluntary compliance at 84
percent. This lost revenue is unacceptably high, but because of
IRS enforcement actions, like audits, an additional $50 billion
is recovered. The recovery of this amount proves just how
important audits can be, but it should not come at the expense
of our Nation's job creators. Rather, the IRS should be tasked
with doing all that they can to improve voluntary compliance
before audits are required.
Working with the taxpayer to correct mistakes is
quintessential to a thriving tax system. Accordingly, the IRS
has made strides to improve its relationship with taxpayers
through increased customer service and outreach. Yet
improvements can always be made.
Today's hearing will give us another opportunity to learn
what enhancements can be performed and modifications made to
auditing techniques to reduce the burden on small business
owners. These recommendations are critical to improving tax
compliance and closing the tax gap. They also serve a very
important purpose in assisting small firms. We often hear
reports of small employers closing their doors due to an audit.
They just could not recover from the process or the expense. In
many cases, the owner's energy is shifted from maintaining or
growing the businesses toward meeting IRS demands to
substantiate records. This problem is compounded by that of the
great financial cost of hiring an outside professional, which
many businesses do when facing an audit. Such burden makes it
essential to understand how the IRS' primary collection tool,
audits, impact a small business who is attempting to comply
with complex rules. While a small employer has a duty to pay
taxes and keep an efficient recordkeeping system, the IRS also
owes a duty to that taxpayer to conduct the audit in a manner
which is clear, ensure the employer understands his rights or
her rights during an audit, and to prevent harming the small
business from aggressive tactics. So I look forward to learning
more about the auditing process and what we can do to help both
the IRS modify and update its practices and small business
taxpayers do a better job by complying and recordkeeping.
So I would like to thank the witnesses today for the time
that they are taking out from their busy schedules to testify.
Thank you very much, Mr. Chair. I yield back.
Chairman CHABOT. Thank you. The gentlelady yields back.
And I would now like to explain our timing rules here. And
before that, Committee members who may have opening statements,
we would ask that they submit them for the record.
We operate under the 5-minute rule. You will each get 5
minutes to testify. We take 5 minutes to ask questions, and
there is a lighting system to assist you. The green light will
be on for 4 minutes and then the yellow light will be on for a
minute to let you know that you have got about a minute to go,
and then the red light will come on. And if you can stop near
that I will appreciate it. We will give you a little time, but
not a whole lot.
And I would now like to introduce our very distinguished
panel here this morning. Our first witness is Kathy Petronchak,
who is director of the IRS Practices and Procedures for
alliantgroup in Houston, Texas. In that capacity, she provides
advisory assistance on a wide range of issues related to IRS
procedures and represents clients before the IRS. Ms.
Petronchak previously had a 29-year career with the IRS in
various positions, most recently serving as commissioner for
the Small Business/Self-Employed Division. We welcome you here
and appreciate your testimony.
Our second witness will be Warren Hudak, president of Hudak
and Company in Lemoyne, Pennsylvania. Hudak and Company is a
small business that provides comprehensive tax services to
other small businesses. Mr. Hudak is an enrolled agent and CPA
and has owned Hudak and Company for the last 20 years. And we
welcome and appreciate your testimony this morning, Mr. Hudak.
Our third witness today is Don Williamson, executive
director of the Kogod Tax Policy Center, Kogod School of
Business at American University. Professor Williamson teaches a
number of subjects related to taxation. He is also a partner in
LaMonaca and Williamson, a small Falls Church, Virginia, firm
that specializes in accounting, auditing, and tax preparation
for small businesses, and we thank you for being here this
morning.
And I would now like to yield to our Ranking Member for the
introduction of our final witness.
Ms. ADAMS. Thank you, Mr. Chair.
It is my pleasure to introduce Ms. Jennifer Breen. Ms.
Breen is a partner at Morgan Lewis where she concentrates on
tax controversy and planning matters with an emphasis on audits
and IRS administrative proceedings. Before joining Morgan
Lewis, she worked at Mattel, Inc., PricewaterhouseCoopers, and
as a lawyer with the IRS Office of Chief Counsel. She received
her juris doctorate from the University of Houston Law Center.
Welcome, Ms. Breen.
Chairman CHABOT. Welcome, Ms. Breen.
And Ms. Petronchak, you are recognized for 5 minutes.
STATEMENTS OF KATHY PETRONCHAK, DIRECTOR OF IRS PRACTICES AND
PROCEDURES, ALLIANTGROUP, LP; WARREN HUDAK, PRESIDENT, HUDAK &
COMPANY; DON WILLIAMSON, EXECUTIVE DIRECTOR, KOGOD TAX POLICY
CENTER, AMERICAN UNIVERSITY; JENNIFER E. BREEN, PARTNER,
MORGAN, LEWIS & BOCKIUS LLP
STATEMENT OF KATHY PETRONCHAK
Ms. PETRONCHAK. Chairman Chabot and Ranking Member Adams,
thank you for inviting me to testify. It is an honor to provide
comments today for your hearing.
I interact with small businesses in my work with
alliantgroup, a tax consulting firm that ensures small and
midsize businesses are able to avail themselves of the tax
benefits provided by Congress. I also spent almost 29 years at
the IRS, and so this gives me a unique perspective into the
examination process. My testimony focuses on challenges that
small businesses face and what the IRS can do to improve the
examination process.
Before I go into specifics, let me just say that much of
the problem we see today is exacerbated by a lack of adequate
funding for the IRS, a trend that needs to change. With respect
to the IRS exam process, we believe there is some inconsistent
treatment of small versus large businesses, as well as
differing procedures being used in audits of these businesses.
It is important to remember that America's small businesses
have needs, interests, and resources that may differ
significantly from those of larger businesses. However, some of
the procedures utilized in large business audits, as outlined
in my testimony, provide added transparency that would bring
greater fairness to the small business examination.
I raised five issues in my testimony. I would like to
briefly focus on two of those issues: specialist assistance and
third-party contacts.
With regard to the first issue of specialist assistance, in
an IRS audit there are instances when specialists are needed.
While this assistance is necessary, the process is often
mysterious and the taxpayer is left in the dark regarding who
is making decisions. Our experience includes situations where a
revenue agent who lacks expertise may rely on a technical
specialist to make the decision in an examination, and due to
staffing levels, the specialist may not have adequate time to
fully assist, so revenue agents have only consultations with
them. In some cases, the taxpayer is not aware that this has
occurred or has not had an opportunity to discuss the
specialist's technical conclusions. My firm has encountered
situations in which the taxpayer did not know this assistance
happened until a FOIA request was made in preparation for
appeals.
Another recent experience creates a greater concern. We
recently encountered a case in which the agent told our client
that he was going to sustain a majority of the tax credit at
issue. However, the agent then told our client he had to have a
technical specialist review his final report. Weeks later, the
agent told us that the specialist had directed him to allow
little of the tax credit. The agent's manager informed us that
he did not have the authority to reverse the specialist's
decision, and when a conference call was requested with these
specialists, we were advised that they would not participate.
This behavior is particularly troublesome if the specialist is
making the ultimate decision. The ideal situation is where the
taxpayer is aware that a specialist is assigned and has access
to that individual.
The second issue I want to address is third-party contacts.
The IRS often reaches out to third parties that are not under
audit, but who may have needed information on the audited
taxpayer. Such contacts are permitted in certain circumstances,
but the IRS must give the taxpayer reasonable notice.
We are seeing increased use of questionable third-party
contacts. In our experience, it appears the IRS is increasingly
using these contacts when they already have the information,
and other times when they have not, as required, first
requested the information from the taxpayer. The IRS seems
reckless in its third-party contacts, disregarding the adverse
impact on the business of the taxpayer as the IRS tells
customers, vendors, former employees, and others that it is
examining the taxpayer.
This trend has been noticed by others doing IRS oversight.
The National Taxpayer Advocate, in its 2015 annual report to
Congress, raises a number of points, including that the IRS is
not always effective in providing notice to taxpayers,
oftentimes only providing them Publication 1, Your Rights as a
Taxpayer, at the beginning of the exam and not at or anywhere
near the date of a third-party contact. The practice of issuing
third-party contacts should be modified to ensure notice and an
opportunity to respond prior to the time a third-party contact
is to actually be initiated.
In closing, I commend the Committee for its work on
oversight and ensuring that small businesses receive fair
treatment and good service from the IRS, and alliantgroup looks
forward to working with the Committee to further improve tax
administration.
Chairman CHABOT. Thank you very much.
Mr. Hudak, you are recognized for 5 minutes.
STATEMENT OF WARREN HUDAK
Mr. HUDAK. Chairman Chabot, Ranking Member Adams, members
of the House Small Business Committee.
Chairman CHABOT. You might want to pull that mic down just
a little bit. There you go. Thanks.
Mr. HUDAK. I was thanking everyone for the invitation
today.
Chairman CHABOT. Sure.
Mr. HUDAK. My firm provides comprehensive tax services,
including tax preparation, planning, and representation before
the IRS. We work with all categories of small business: sole
proprietors, partnerships, and S-corporations. Our
representation services include audits, negotiating installment
agreements, offers-in-compromise, collection due process
hearings, appeals, and penalty abatements.
Today, I share with you my perspectives, and I participate
here on behalf of the National Association of Enrolled Agents.
Over the last 5 years, we have witnessed a significant
shift in the number and quality of IRS audits. This shift has
coincided with a dramatic decrease in funding. We, too, have
seen the quality of audits go down with the funding.
In short, the agency is struggling to rely more on
automated and faceless decisions based less on field audits and
many on just scrubbing of third-party information.
Importantly, IRS examinations range from simple issuance of
an IRS notice asking for clarification of a single item, but
oftentimes that leads to unintended consequences, the runaway
audit that was mentioned earlier. As resources dwindled, we
have seen that increase in techniques. For instance, 1099Ks. We
recently had a client who triggered an audit because their
revenue that they reported did not coincide with the 1099K.
They had an entity change during the course of the year, had
two entities and properly reported all income on both entities.
Once that was presented to the auditor inside a very short
period of time, in 5 minutes, the auditor was satisfied that
all of the income was reported within IRS tolerances. But that
did not stop. It turned into a 6-month audit with requests from
third parties and infringement on the interests of the client
for their ability to have privacy.
There seems to be more and more of a win-win culture for
the IRS. It is not to get at the actual correct tax, but the
maximum tax. In a recent call with the IRS, we had presented a
Rev. Proc. to them to abate a penalty. Before I could even get
the words ``Rev. Proc.'' out, they said, ``we have it'', and
they accomplished the task. When asked why do you not offer
this to other taxpayers when they call in, they said, we do not
want to lead the customer. And that was a problem. Why is the
IRS in these terms not being more helpful? Why are they not
making them aware of the provisions of the code to allow them
to comply with the law in the best interest of the taxpayer?
Why would it be always the best interest of the government
maximizing revenue?
Training does make a difference. Increasingly, we are
finding requests for things outside the scope of the audit, and
we have forced audits into appeals to allow us the latitude of
a fresh, independent look. Many of our clients come to us after
there is a controversy, and what we find is at that point in
time they are under the misguided impression that the IRS is
there to assist them and represent them.
And that leads me to really my closing. The Taxpayer Bill
of Rights is an awesome, awesome law. It would clear up a lot
of the problems we have in the audit. Along with the Pledge of
Allegiance, the ITS agents when they get up in the morning
should recite the Taxpayer Bill of Rights. Nina Olson in the
Taxpayers Office did an awesome job in advocating for that. She
deserves all the credit in the world for accomplishing that.
For small businesses in audits and compliance, we really should
have more safe harbors, like the home office deduction. That
was incredible. It simplified the recordkeeping and, quite
frankly, you are probably collecting close to the right amount
of revenue.
Training in the IRS' future state we are so excited about,
but we want to be cautious. To my earlier comment, with the
IRS's future state, during that taxpayer interaction online, at
some point during that interaction we have to be careful to be
clear that the IRS is not their representative. Thank you.
Chairman CHABOT. Thank you very much.
Mr. Williamson, you are recognized for 5 minutes.
STATEMENT OF DON WILLIAMSON
Mr. WILLIAMSON. Chairman Chabot, Ranking Member Adams, and
members of the Committee, thank you for the opportunity to
testify on the issues small businesses confront when they are
audited by the Internal Revenue Services.
My name is Don Williamson, and I am a professor of taxation
at American University's Kogod School of Business, where for
the past 32 years I have been the director of the school's
Masters in Taxation program, and for the past 27 years have had
my own tax preparation and tax planning practice, LaMonaca and
Williamson, CPAs, in Falls Church, Virginia, which specializes
in representing small businesses and their individual owners
before the Internal Revenue Service.
Mr. Chairman, the majority of small business audits are
conducted by correspondence. While this approach may work when
the taxpayer has failed to report income reported to the
Internal Revenue Service by third parties on Form 1099s,
problems arise when the IRS is seeking verification of or more
detail about the information on the return itself. In these
cases, taxpayers' written responses to notices often sit at the
IRS processing centers for months until assigned to an auditor.
The auditor will often find the taxpayer's response to be
insufficient, setting off a new round of correspondence,
consuming yet several more months.
Furthermore, because small business owners usually rely
upon enrolled agents, CPAs, or attorneys when they are
contacted by the IRS, significant costs arise for even
insignificant inquiries, such that many business owners simply
concede to a proposed adjustment and opt to pay the extra tax.
These problems were most recently illustrated in my own
practice where a client living in Texas was contacted by the
IRS Philadelphia Service Center regarding the income and
expenses claimed on his Schedule C. The letter did not provide
the name of any person at the IRS to contact and simply
requested copies of all the taxpayer's books and records. The
taxpayer, at considerable cost of time and professional fees,
assembled the requested information in large boxes which were
mailed to the address requested. After 4 months, the client
received a one-page letter with the attached page statement
declaring the taxpayer's business was a hobby, resulting in a
substantial proposed assessment of tax, interest, and
penalties. At that point, my client had already incurred
substantial fees in responding to the initial request for
information, and I frankly advised him that taking the matter
to the appeals division would cost even more. Nevertheless, my
client insisted that I file a protest showing that his business
was not a hobby. After several more months and several letters,
while I was able to transfer the case from Philadelphia to the
Appeals Office in Texas where the taxpayer resides, we received
yet another letter asking again for a complete record of all
the taxpayer's travel and entertainment expenses with schedules
reconciling the individual expenses to the totals on the
return, documentation which we had already provided.
Nevertheless, we again began to prepare new schedules, cross-
referencing each receipt to the totals on the return. However,
before we could complete the work, the client received a one-
paragraph letter dropping the case. As a result of this
exercise that lasted for almost a year, the client incurred
professional fees that exceeded the initial adjustment in tax
proposed by the IRS having not contested the matter.
The substantial cost of this case not only to the taxpayer
but indeed to the IRS itself illustrates the limits of
correspondence audits. Because most correspondence audits
initially have one point of contact at the IRS to discuss the
matter, taxpayers and their representatives simply hope they
are providing the correct information. At the very least, the
IRS must better facilitate the internal tracking of
correspondence audits and end the process of courtesy
disconnects when a taxpayer is on hold for more than 45 minutes
when calling the IRS. In addition, the IRS should consider
assigning a case to an arbiter if the taxpayer requests such an
assignment at the time of first contact.
Finally, if the IRS can significantly improve its online
capabilities, and more importantly its security over its online
functions, taxpayers could respond to email communications with
specific IRS personnel.
Thank you for the opportunity to testify today, and I look
forward to working with the Committee on this critical problem
of tax administration.
Chairman CHABOT. Thank you very much.
Ms. Breen, you are recognized for 5 minutes.
STATEMENT OF JENNIFER E. BREEN
Ms. BREEN. Thank you. Thank you for the invitation today to
discuss the IRS's approach to the audits of small business
taxpayers.
My name is Jennifer Breen, and I am the vice chair of the
Administrative Practice Committee of the American Bar
Association Section on Taxation. I am also a partner with the
law firm of Morgan, Lewis and Bockius, where I represent
taxpayers before the Internal Revenue Service in audits and
appeals.
I am here today on behalf of the ABA Tax Section, so my
testimony today should not be construed as representing the
policies of the larger association.
In the IRS' 2015 fiscal year, it closed approximately 1.3
million examinations, of which over 300,000 were examinations
of small business returns. The audits of these small businesses
were conducted by the IRS' SBSE, or Small Business/Self-
Employed Division.
When SBSE determines that a return warrants an audit, it is
sorted for one of two possible types of audit: a correspondence
audit or a field audit. Of the examinations completed in 2015
for small businesses, over half were correspondence audits. A
correspondence audit is one that is conducted exclusively by
mail. The service center or campus will first mail a standard
boilerplate letter to the taxpayer to notify them that they
have been selected for examination and to provide them with a
list of documents that they will need to provide to be
verified. Now, these notices are computer-generated. There is
virtually no customization with respect to the taxpayer, the
taxpayer's business, or the issues that may have been the
reason that it was selected for examination in the first place.
This initial generic request will require the taxpayer to
provide a variety of records to the IRS, such as the work
papers that were used to prepare the return, the taxpayer's
general ledger, bank statements, canceled checks, and deposit
slips. A taxpayer must respond within 30 days. They must mail
the requested documentation to a general address that is listed
on the notice, and should the taxpayer have any questions
regarding the initial letter, they are directed to call a
general number or write to a general address. Once a taxpayer
responds, the correspondence is then placed in a queue and then
will be assigned to a campus examiner. This process can take
months, and sometimes taxpayers are forced to resend the
correspondence that they originally sent as the information
that was mailed cannot be located by the IRS.
Unfortunately, in many examinations, the quality of a
taxpayer's response to the requests that are made by the IRS,
as well as the agent's understanding of the position that has
been taken by the taxpayer, is impacted by the fact that all
the discussions between the two parties are held exclusively
through correspondence.
Now, field audits, on the other hand, are generally
conducted through direct contact with the taxpayer through a
combination of face-to-face meetings, telephone calls, and
written correspondence. Now, at the outset of one of these
audits, the taxpayer will be provided with a request for
documents that the agent has identified for review. Now, while
these requests are often customized, they also contain
boilerplate items that agents are required to seek regardless
of the issues that the agent has identified and regardless of
the type of business that the taxpayer is operating.
Regardless of the type of the examination that a small
business taxpayer receives, establishing good accounting and
recordkeeping will help a taxpayer prepare for an examination
should one arise. Now, if one does, it is important to
thoroughly and timely review all notices and requests for
information that you receive from the service. While the IRS
outlines the examination process on its website and in the
various publications, for taxpayers, this process can be
confusing. Taxpayers are often unsure about what to expect and
how to proceed.
Unlike the large business and international, the LB&I
Division, SB/SE does not have a public examination process
policy statement whereby the division provides an
organizational approach for examinations from first contact
through the final stages of an issue resolution, nor does it
have directives requiring discussions with taxpayers around
certain examination procedures, such as the issuance of
requests for information or documents.
Now, last year, the IRS, including the SB/SE, announced its
Future State Initiative. Through this initiative, SB/SE has
indicated that it is looking for ways to find better and more
efficient manners of doing business. It has identified possible
changes to include the use of digital notifications, possibly
examination at earlier stages shortly after returns are filed,
the use of limited issue examinations based upon specific
aspects of a taxpayer's return, and the ability for taxpayers
and their representatives to exchange information
electronically with an agent during the examination process.
Now, examinations do provide the IRS with an important tool
to identify noncompliance. Efforts such as these that have been
identified should lead to improvements in the process and help
the IRS examine taxpayers more effectively and efficiently.
Thank you for the opportunity to be here today and to
provide the Committee with this information.
Chairman CHABOT. Thank you very much. We appreciate the
testimony of all the members of the panel here. And I recognize
myself for 5 minutes to begin the questioning.
I will start with you, Ms. Petronchak, if I can.
You mentioned that one of your clients did not even know
that a specialist was advising on the audit until a FOIA
request was made. How and why would a taxpayer ever need to
file a FOIA request to receive information related to their own
audit? That sounds pretty outrageous to me.
Ms. PETRONCHAK. That is a good question. Let me try to be
brief in answering it.
Chairman CHABOT. Take as much time as you need.
Ms. PETRONCHAK. A strategy used by some controversy
professionals would be to file a FOIA request to ensure that
they have all the information from a case file, particularly,
you know, if they want to ensure they are adequately
representing their client in an appeal. So that may be a large
issue. Or SB/SE's work papers are not quite as thorough as
those used by the large business division, so they have a lot
of lead sheets. So trying to get all the information and
understanding from a file, exactly who they were talking to and
how they came to conclusions would be very important. And they
would not get the file unless they asked for it.
Chairman CHABOT. Okay. All right. Thank you very much.
Mr. Hudak, I will turn to you at this point. What would you
identify as the single biggest problem with the IRS exam
program as it relates to small businesses, and how would you
address it? If there are two, which one? You can take two if
you like.
Mr. HUDAK. Well, that is a good question. I think third-
party contact is a big ideal. Increasingly, we are seeing
blanket requests to banks, blanket requests to third-parties.
We are also seeing an increased number of improper contact with
taxpayers. When a properly executed power of attorney is
stopping by to drop off something, the taxpayer says, well, you
should give that to my representative. He said, no, that is
okay. You can have it. And the question is what was discussed?
That is a big problem.
But increasingly, the IRS will be using this future state
concept where you get a notice, the taxpayer is encouraged to
create an online account, and they chat or banter back and
forth with the IRS. And if you look at the taxpayer advocates'
foldouts on that process and what it looks like, one comes to
the realization at some point during that, the taxpayer gets
the feeling they are being represented by the IRS and that is
simply not the case. And there is some concern with the IRS's
future state as it pertains to representation.
I think it can be satisfied in a number of ways. I know
NAEA, National Association of Enrolled Agents, has asked to
bring back the ability to execute powers of attorney online. We
did that before. I think the Office of Chief Counsel seems to
think there is a way to do that safely and with confidence.
Chairman CHABOT. Thank you very much.
I guess similar to that, if I could go back into my earlier
career of practicing law, I used to handle all kinds of stuff,
but one thing was in the domestic relations area. In Ohio, we
have divorces and dissolutions. And a dissolution is basically
the parties coming in, they usually come in together, but you
cannot represent as an attorney both parties. You have to be
clear. They have to sign saying, you know, I know he represents
this person and not this person. You have the right to get
another attorney. So I could see it is very significant for
folks to know that the IRS is not necessarily your friend,
maybe you instinctively know that when you are born as an
American, but certainly, when you are dealing with them, you
want to make sure you realize they are not representing you.
Mr. Williamson, I will turn to you at this point. What are
some of the most persistent concerns you have encountered in
your representation of small businesses in the conduct of the
exam process? And I know you already dealt with some of them in
your statement and if you want to expand upon those.
Mr. WILLIAMSON. Thank you. It is basically time. This is
what really frustrates my clients. In the testimony I gave to
you, we were looking at a very simple exchange of information.
Had I been able to speak with someone, even on the telephone, I
am sure I could have settled this scenario I just described to
you in minutes; instead, it took a year. And so that is what
really frustrates clients is time.
Also, in small business audits, the agent will show up,
begin the audit, walk away and you do not see them for 6
months. And then suddenly you have presented to you an
extension of a statute of limitations.
So my clients want to do business and they want to do it
efficiently and as quickly as possible, and they do not need an
IRS audit hanging over their heads for 18 months to 2 years
when something could be settled very quickly.
Chairman CHABOT. My time has almost run out here, but you
mentioned before about the person who was being audited and
contested it and by the time they got to the end of it, all the
expenses they had far exceeded the amount that the IRS said
that they owed, which was wrong. But so you are in a situation
where even when you win, you lose.
Mr. WILLIAMSON. You are absolutely right. I cannot tell you
how often a client will receive a notice for a few hundred
dollars and he contacted me to get a power of attorney to
exchange information. He will pay it.
Chairman CHABOT. Yeah. It should not be like that. It
absolutely should not. And thank you for shedding some light on
that.
My time has expired. The ranking member is recognized for 5
minutes.
Ms. ADAMS. Thank you, Mr. Chair.
Small businesses are the backbone of America. They are the
entrepreneurs and the job creators that are necessary to
stimulate our economy. We know that tax compliance is
burdensome, both from a financial and administrative
perspective. So in order to be adequately prepared in case of
an audit, what is the best practice for a small business when
it comes to tax records? Ms. Breen?
Ms. BREEN. Yes. So as I mentioned a moment ago, I think one
of the keys is good accounting and recordkeeping. But I think
that it is also important to maintain those records in real
time. Tax returns are prepared after the close of the year, and
oftentimes, many months after the close of the taxable year.
And so it is important that as expenses and items of income are
accounted for or recorded, the documentation to support that is
kept in real time. When an audit occurs, it often can occur up
to 2 to 3 years after the expenditure or the item of income was
received. And so, therefore, it becomes even harder for a
taxpayer to pull together those records. So it is important
that those records are maintained in real time and in a way
that a taxpayer can access them quickly should an audit occur.
Ms. ADAMS. Thank you.
Ms. Breen, audits are the primary collection tool for the
IRS in their effort to close the tax gap. So what makes this
the most attractive tool for the IRS, and how successful is it
at recovering unpaid taxes?
Ms. BREEN. Well, I think that it is the most successful
tool because it does bring success. And if we look at the
statistics that the IRS releases each year about the filing
season, last year the IRS reported that in 2015, over 25
billion in total recommended taxes were determined pursuant to
that audit cycle, and of that 25 billion, approximately 4
billion was associated with small businesses.
As part of the IRS LB&I and SBSE future state, the other
operating divisions are announcing other types of treatment
streams, so ways that they could identify noncompliance or seek
to enforce compliance in other ways outside of the traditional
audit. If those are successful, we may see those expand into
the SBSE Small Business Division as well.
Ms. ADAMS. Thank you.
The idea of individualized taxpayer accounts seems to be a
popular notion. How could prioritizing accounts of enrolled
agents, CPAs, and tax attorneys be helpful to small business
clients as it pertains to tax filing and auditing?
Ms. BREEN. Well, the IRS has identified the need to expand
its use of technology as a way to enhance the use in
examinations and the way that it interacts with the taxpayer.
And one of those ways would be to allow taxpayers and their
representatives to exchange information electronically with the
IRS. Now, these types of abilities could improve the
communication between the two parties, and it could help to
minimize some of the delays or missing documentation that
sometimes occurs when you are communicating with the IRS and
something I think that when any of us are communicating with
the IRS we want to try to avoid.
Ms. ADAMS. Okay. Because data security is extremely
important, considering the hack of IRS accounts, can you
address how we can keep these accounts safe, particularly when
these professionals are responsible for assisting small
business clients?
Ms. BREEN. Absolutely. I think that it is indisputable that
cybersecurity and fraud detection are integral to the IRS's
mission of enforcement and service to American taxpayers. The
ABA tax section has consistently supported adequate funding of
the IRS. We believe that improvements are needed that require
substantial investment, and we encourage Congress to provide
that sufficient funding so that the service can implement those
very important initiatives in the use of technology to better
service taxpayers.
Ms. ADAMS. All right. I am going to yield back my time, Mr.
Chair. Thank you.
Chairman CHABOT. Mr. Gibson?
Mr. GIBSON. Thanks, Mr. Chairman. I appreciate the
panelists.
I must say I am somewhat concerned by some of the testimony
to date so I want to follow up, particularly with regard to due
process. It was mentioned in one example we had a case where a
specialist provided insight. The IRS said, well, this is the
determination and there is really nothing that I can do about
it. My question explicitly is where are we now in terms of
current law on due process? And what recommendations would you
have? So to put a finer point on the question, can the
individual, can the small business, for example, call for a
face-to-face meeting with all the parties where they can sit
down with records and actually sort through? Is that within the
Bill of Rights? I mean, is that within the current state of
play that a small business owner can call for such a meeting?
Mr. WILLIAMSON. No. Basically, in my case that I recited to
you, there was no right for me to sit down with someone from
the Internal Revenue Service and go through these documents
until I got to the Appeals Division, and then they did assign
an appeals officer. Until then, in these correspondence audits
it is pretty much back and forth. Now, indeed, after a while in
a correspondence audit there will be someone assigned to the
case at the service center, but good luck trying to reach them.
Ms. PETRONCHAK. Congressman, I would say that in the
Taxpayer Bill of Rights, it talks about the right to be
informed. So maybe it does not go far enough in the Bill of
Rights for the situation I described in my testimony. And I
used ``specialist'' generically. It could be a counsel employee
who is advising the agent. It could be a subject matter expert
in LB&I from an issue practice group. It could be an engineer
or it could be a technical specialist within SBSE. Whoever that
is that is working on the case, it should be more transparent
to the taxpayer and they should be at those face-to-face
meetings.
Recently, I was at a client site. We were having a meeting,
and the SBSE agents were doing great jobs interviewing the
taxpayer about issues, but there was a specialist that had been
involved in the examination, and my understanding is that the
specialist, he could not come to the interview. Now, I think it
would have been helpful for that specialist to be at the
interview to follow up and ask the pertinent questions in
making a final decision on that case.
Mr. GIBSON. So to understand, there is not clarity at this
point as to what the legal definition of ``informed'' means.
That is what I am hearing from the panel at this point.
Ms. PETRONCHAK. I would agree with that. I am not aware of
it.
Mr. HUDAK. I would agree with that. Very much so. I do
believe that the Taxpayer Bill of Rights, though, is a document
that has to be asserted. And if the representative is not
involved and the practitioner is not involved, oftentimes the
Taxpayer Bill of Rights are not being asserted. The IRS is not
offering this. It has to be asserted from the taxpayer or the
representative.
Mr. GIBSON. Thank you. And to follow up on your original
testimony, which I heard very loud and clear, so if you have a
small business owner, they are working really hard hours, they
are just trying to survive and flourish, and they get this
notification of audit, is it clear when they receive that that
they have the right to counsel? In other words, the IRS is not
their advocate in this, is that clear?
Mr. HUDAK. There is an insert. To the extent they
understand the notice in the first place, yes, they are
notified. But they are scared. Their records are usually a mess
because they are behind a grill 12 hours and at the end of the
day they have got to reconcile their tips in their credit card
machine. Oftentimes it just does not happen. It is not that
they do not care. It has nothing to do with that. It has
everything to do with this unique nature of a small business.
And I alluded to the safe harbor with the home office
deduction. We need to do more things like that to relieve these
burdens off of small businesses.
Mr. GIBSON. I had one other question, too. It was
concerning to me with regard to the notification of third
parties. It can be intimidating. It can be friends and
colleagues. Is there some kind of provision now for
notification at the end of this that there has been a closed
case and there have been no discrepancies found?
Ms. PETRONCHAK. Congressman, I would say at the end of a
case, yes. I think Jennifer addressed in her testimony there
are reports at the end. But with regards to the----
Mr. GIBSON. But third parties though were notified?
Ms. PETRONCHAK. The third party does not get that. It only
goes to the taxpayer.
Mr. GIBSON. So the onus is really on the taxpayer to say,
look, I know you got contacted, but I was cleared. You know,
there were no issues. Does the taxpayer get a full listing of
all the third-parties that were contacted?
Ms. PETRONCHAK. They can request a list. I think in the
Taxpayers Advocate's Report she addresses the notification
process and the requirements in the law that periodically a
list should be provided. The IRS has chosen not to provide that
periodic list. So unless a taxpayer requests a list, they do
not get one.
Mr. GIBSON. And I see my time has expired. Thank you, Mr.
Chair.
Chairman CHABOT. Mr. Davidson?
Mr. DAVIDSON. Thank you, Mr. Chairman. Thank you for the
witnesses who could be here today. It is just an honor to talk
with you about concerns small businesses have in interacting
with the IRS.
I spent a lot of time as a small business owner myself, and
would like to continue our track record of not being audited by
the IRS, as I think all small business owners would like to do.
When that does happen, you have all addressed some concerns
about how that process is for the small business owner. And I
am curious if you have been able to discern how the IRS is
measuring the auditors? What are the metrics? Does anyone have
that answer?
Ms. PETRONCHAK. Congressman, it has been a while since I
looked at it, but I think in their performance elements they
are measured on their taxpayer relations, their technical
knowledge of a case, and how they conduct the audit. So it
would be subjective things that a manager reviews and how they
are evaluated.
Mr. WILLIAMSON. Technically, since the 1990s and some of
the scenarios that arose in the 1990s, they made a big deal out
of it is not a race to how much revenue each agent can collect
versus the other agents. It is how quickly you can settle your
cases and how efficient you are, and not how much revenue you
have gained. It is my understanding. I have not been on the
other side of the table myself to know these things.
Ms. BREEN. Historically, there were also metrics about case
closures. So agents were evaluated on the number of cases they
could get closed, and currency was something that was very
important. The IRS with its future state has announced perhaps
it is stepping away from closure as a metric and looking more
to cases that have been opened.
Mr. DAVIDSON. Okay. Thanks for that.
Can anyone answer what the average cost in terms of
dollars, hours, and duration an audit is for a small business?
Mr. WILLIAMSON. Congressman, as I said in my testimony, I
cannot specifically say so many dollars. I will simply say it
is excessive. If we can communicate with the Internal Revenue
Service and show them in my cases here are the books, here are
the records, what questions do you have, let us settle them
today, I do not have to have a case on my desk for a year. Nine
out of 10 of my cases is simply documentation, and I can show
the IRS the documentation if I can have the meeting or have the
telephone call and we can look at things together.
Mr. DAVIDSON. Okay. And now, there are increasingly other
factors linked besides just tax compliance for small
businesses, and of particular note is Obamacare. And in
Congress' appropriations to the IRS, we historically have not
funded the IRS specifically to enforce Obamacare audits, but
the IRS has diverted a significant amount of money to do that.
How has that impacted the audit process for small businesses?
And how does that relate to the IRS' explanations for their
ability to turn these things around in a timely manner?
Mr. WILLIAMSON. Obamacare and the returns that are required
with it in the 8000 series have only been around for a couple
of years, so I do not think you have an audit history where you
can determine how much time is being spent and how the returns
are being selected based upon the forms that the taxpayer is
filing with respect to their payments of medical care
insurance. So we are just not there yet to get a handle on how
onerous the audits will be of issues dealing with Obamacare.
Mr. DAVIDSON. In fiscal year 2015, the IRS spent $462
million of its budget on Obamacare enforcement, so somebody
must be getting enforced.
Mr. WILLIAMSON. Somebody is.
Ms. PETRONCHAK. Congressman, the only thing I can say is
when the laws are passed, usually I found that it was a couple
of years before you started seeing revenue agents addressing
specific issues when the laws were passed; however, there is a
lot of work up front with computer systems or counsel and
guidance that go into it, so I can only guess that maybe that
is where the money went.
But to Mr. Williamson's point, it usually is a few years
before you actually start seeing examination activity related
to that.
Mr. DAVIDSON. Just one last question.
I thought it was interesting to say, hey, you actually have
to go through the process and note a request, you know, a copy
of other parties that have been notified. From the small
business perspective, are there any other things that we might
say, hey, this just ought to be standard practice that you
would advise?
Ms. PETRONCHAK. I will start. Obviously, the third-party
contact process needs to be looked at closely, and I think Ms.
Olson's views on those speak well to that. I do not know if the
Committee can look at it.
The other thing, I would not want to lose fact--on the
fact-finding part. I mean, we have talked about we send in
documents or correspondence; they get lost. But the
interactions and the fact-finding, I think the IRS in looking
at their future state needs to make sure they stay focused on
face-to-face interactions with the taxpayer and does not move
to too much online interaction and expect that to take care of
everything.
Mr. DAVIDSON. Thank you. My time has expired.
Chairman CHABOT. Ms. Petronchak, you mentioned in your
testimony that the IRS is understaffed, underfunded. There is a
theme here, because the common complaint is not directed at
their behavior, necessarily, although there is that. What it
sounds like is they have moved to make their systems
accommodate themselves in a way that reflects their ability to
respond. By that I mean I am listening to this and I am
thinking that they barely can keep up. I mean, if I was them
trying to defend them here I would say give us what we need to
do this and we can make sure that the special people are there
and we can answer our phone in less than 45 minutes you said,
Mr. Williamson, and that we did not get computer-generated
things or letters in the mail that were essentially a list of
everything, send us everything you have and maybe we will get
back to you.
So I would like, just to be fair in this because we do not
have anybody from the IRS here, I would like to ask what you
think about that conjecture, if it is wrong, and do you think
that--how much of this do you think is driven by resources as
opposed to other things that we have talked about?
Mr. WILLIAMSON. Let me just chime in. I want to emphasize,
and I think most of the panelists will agree with me on this,
the professionalism of the individual agents we do business
with is very high and I commend them for that. I think what
they have tried to do is in trying to be more efficient, they
become less efficient. And my case was an example of that. Had
we just had some communication one-on-one, I think we could
have settled my case really in minutes rather than a year.
Chairman CHABOT. What would they say about that, though?
Mr. WILLIAMSON. I do not know what they would say about it.
Chairman CHABOT. It has got to be aggravating for them to
get a box of paper in the mail and have to read it all.
Mr. WILLIAMSON. You will have to ask them. I agree
wholeheartedly, sir. No question about it. The hours it took us
to put this together to me would be much easier for us just to
sit down with somebody.
Ms. BREEN. I think the IRS has made statements over and
over again that it has a commitment to looking for ways to
handle audits more efficiently and effectively. And at the same
time, the IRS has been publicly stating that it is doing less
with less. That is why the ABA tax section does support
adequate funding.
On the other hand, you have got small businesses who are
also trying to do more with less in many instances. With the
IRS's new future state, I think as a practitioner, I would hope
that the initiatives that they are coming up with and putting
together would create an opportunity for clearer and more
effective communication between taxpayers and the IRS and more
focused and efficient audits. I think in that way, both
America's small businesses and the IRS can go do the jobs that
they want to go do.
Chairman CHABOT. It sounds like they are building walls,
though, as well. Responding to somebody, writing to someone in
a paragraph and asking for essentially maybe hundreds or
thousands of pages, it is easy to do on one end, but it is
impossible to respond to on the other.
Ms. BREEN. Absolutely. And many instances where the letters
that are sent to taxpayers that contain that perhaps brief or
cryptic information or request is computer-generated. So no
human being is actually looking at that letter or looking at
that return once it is first selected and saying, hey, let us
look at X, Y, and Z, and let us ask these very specific
questions to the taxpayer.
Chairman CHABOT. So you think it has been dumbed down to
the point where it is easier to ask a big question that
requires a lot of work than ask a simple question that requires
homework?
Ms. BREEN. I think because the computer is issuing these
letters in the beginning, it is giving you a boilerplate list.
Taxpayers have no idea what it is they are supposed to give.
They do the best they can. They send it in and hope that
someone looks at it.
Chairman CHABOT. What do you think? You were there 29, 28
years?
Ms. PETRONCHAK. Yeah, I was.
Chairman CHABOT. You must have made a lot of enemies in
that time.
Ms. PETRONCHAK. Yeah, I am sure. You know, most people like
revenue agents. I think they said most of them are
professional.
You know, there are cultural problems at the IRS. It is not
all funding. Yes, funding would help. They could do things,
maybe they need training. Third-party contacts is a cultural
issue. They could do something with training, revising their
procedures for that to fix it.
I talked about the use of specialists. Yes, more
specialists would help them if they really want to have a
specialist on a case devote their resources, but maybe they
work fewer cases if they do not have a specialist and it
requires that type of resource, instead of opening it up and
not being fair to taxpayers during that exam.
Mr. HUDAK. We have heard a lot of comments from NAEA's
members about disappearing auditors going away on detail, going
away on training, disappearing for 6 months. Increasingly, they
are working from home, telecommuting. The question is, with the
security, I understand they are doing to keep costs down, but
at the end of the day, you know, they are carrying taxpayer
information home with them and there is a concern there. But I
think it is all being driven by the same budget issue that we
have been discussing today.
Chairman CHABOT. Well, thank you for that. I appreciate it.
I want to thank everybody for being here today. We have
heard a number of problems. Some might describe it as an
epidemic to small business; the exam process that is. These
issues need to be addressed, and I hope that today's hearing is
a good first step in our ensuring that that happens.
I want to thank you all again for being here. I appreciate
the effort of our distinguished panel in bringing these issues
to light. Sunshine is essential for change. All too frequently,
taxpayers are hesitant to take the IRS to task publicly for
fear their situation may actually get worse. I cannot blame
them for that. So these problems persist. Creating an
environment where we can identify, discuss, and take these
issues head-on is a key goal of this Committee. And I
especially want to thank our witnesses again for working to
achieve that goal.
If there are no comments, ma'am, would you like to have a
closing statement?
Ms. ADAMS. Just to thank you all very much. It has been
very insightful. And I would appreciate the opportunity to hear
from you.
Chairman CHABOT. Thank you. This Committee hearing is
adjourned.
[Whereupon, at 12:04 p.m., the Committee was adjourned.]
A P P E N D I X
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Chabot, Ranking Member Velazquez and Members of
the Committee, thank you for the opportunity to testify on the
issues small businesses confront when they are audited by the
Internal Revenue Service.
My name is Don Williamson and I am a professor of taxation
at American University's Kogod School of Business where for the
past thirty-two years I have been the Director of the School's
Masters in Taxation degree program. The MST program at American
University offers graduate courses in federal taxation to
accountants and small business owners who wish to expand their
knowledge of our nation's tax laws. Our course offerings
include not only traditional classes in subject areas such as
the taxation of corporations and partnerships, international
taxation and tax policy but also more specialized areas of the
tax law such as IRS practice and procedure that address the
issues of this hearing regarding the IRS examination of small
business tax returns.
In addition to my academic work, for the past 27 years I
have had my own tax preparation and tax planning practice,
LaMonaca & Williamson, CPAs, in Falls Church, Virginia which
specializes in the tax issues facing small businesses and their
individual owners. LaMonaca & Williamson prepares hundreds of
tax returns of small businesses as well as representing such
taxpayers daily before the IRS examination, appeals and
collection divisions, thereby making me uniquely qualified to
speak with you today.
I. Complexity of the Law Contributes to Time Consuming,
Unproductive Return Examination
Over the course of my tenure as an academic and tax
practitioner I have seen with dismay the Internal Revenue Code
grow in complexity, becoming intrusive and pervasive in its
reach and incomprehensible to all but those who devote their
careers to its study.
This complexity arises, in part, from the now annual
amendments to the Internal Revenue Code that have a profound,
even paralyzing, effect on small businesses that impedes their
efficient operation and obstructs their ability to grow and
create jobs. In fact, since 2001, there have been approximately
5,000 amendments to various sections of the Internal Revenue
Code--about one per day on average. Consequently, not only
small business persons, but even their tax advisers are
overwhelmed by the complexity resulting in steady increases in
fees advisers charge to their small business clients.
The National Taxpayer Advocate estimates that each year
small businesses spend approximately 2.5 billion hours
preparing tax returns or otherwise responding to IRS inquiries
about the preparation of their returns, the equivalent of 1.25
million full-time jobs. In meeting these requirements 70% of
small businesses employ tax professionals to prepare their
returns and represent their interests before the IRS at a cost
of more than $16 billion for the services of attorneys,
accountants and other professionals.
In addition to waste time and resources, there is the
practical reality that it is impossible today to be
knowledgeable in the entirety of our tax law. Professionals
must specialize in areas (e.g., corporations, partnership,
employee benefits, etc.). As a result, small businesses find
that they must employ a team of tax advisers to prepare their
returns and ultimately represent their interests if the returns
are audited. Our own Kogod study of more than 40,000 self-
employed small business owners, which we conducted earlier this
year together with our research on the sharing economy, found
that more than 44% of our respondents paid more than $200 for
assistance in preparing their annual taxes. While generating a
lucrative ``cottage industry'' for tax professionals, small
businesses--who comprise more than 99% of all businesses--
suffer from burdensome tax compliance requirements that require
professionals advice and divert time and resources away from
activities encourages business growth and create jobs.
In fact, a survey conducted by the National Federation of
Independent Business found that CPAs, attorneys, enrolled
agents and other tax specialists not only prepared, at least in
part, over 90% of all tax returns filed by small businesses but
were also retained to represent small businesses when they were
selected for IRS audit. When small business owners believe they
are unable to file their own tax returns, represent their own
interests before the IRS or simply contact the IRS by telephone
without being subject to a ``courtesy disconnect'' after
remaining on hold for 30 minutes, resentment towards the
``system'' arises, creating a cynicism and disrespect toward
our tax law that will only foster non-compliance and ultimately
fraud.
II. Why Target Small Businesses for IRS Examination?
As part of the tussle over tax rates and appropriate
deductions that create an overly complex statute, tax
collection and enforcement accomplished by IRS audits of tax
returns remain a necessary and appropriate tool needed to
enforce our tax laws. But in deciding what taxpayers to select
for audit, the IRS needs to recognize that on an hourly basis
of IRS auditor time, the agency collects far more revenue from
large corporations with higher taxable incomes than from small
and medium size businesses with lower incomes. But,
nevertheless, the highest number of audits for 2014 of
individual tax returns with business income was in the lowest
range of business returns, i.e. $200,000 to $400,000, amounting
to 50% of all audits of upper income individual returns.
Indeed, the chances of a Schedule C being audited are almost
twice as great as a small corporation being audited. This
evidence seemingly indicates that small proprietorships are in
the audit crosshairs.
One reason the IRS appears to disproportionately target
small business taxpayers is the view that small businesses
receive most of their income in cash, which can be particularly
difficult to identify and easily misreported. The IRS has done
multiple studies on the tax gap, i.e., the difference in the
amount of taxes imposed and the amount of taxes paid every
year, and concluded that where information reporting or tax
withholding is not imposed, there is a 63% net misreporting
rate of income. As a result, the IRS uses audits of small
businesses and their owners to find unreported income. But,
both the IRS and taxpayers agree such exercises are time-
consuming and imperfect with the IRS collecting just $7.3
billion from audits last year--its lowest in 13 years.
Most audits are not random, i.e. the IRS has a secret
algorithm for determining how likely each taxpayers is to have
unreported income. Employing this calculus, the IRS has
concluded that small businesses are less likely to be paying
their fair share of taxes relative to much larger enterprises,
a surprising conclusion in light of frequent press reports of
multi-national corporations allocating billions of dollars of
profits to no or low tax jurisdictions to avoid U.S. income
taxation.
In short, use of IRS resources disproportionately targeting
small businesses, regardless of the degree of misreported
income by a few, is both an inefficient use of IRS resources
and unfair to the vast majority of small businesses that
properly report all their income while generating more growth
and creating more jobs than any other sector of our economy.
III. Unwinding the Wringer
The excessive time and expense of auditing small businesses
is, in part, due to the difficulty the IRS has in conducting
examinations of tax returns when specific personnel are not
assigned to a taxpayer's case. While audits are often conducted
by correspondence, they can also be performed by IRS personnel
who go to the taxpayer's business or ask the taxpayer to come
to the local IRS office. The majority of small business audits
are conducted by correspondence. If the issue involves
adjustments based on third-party income reporting documents,
e.g. Form 1099s, where the taxpayer failed to report income,
the matter can be promptly settled by the taxpayer paying the
tax on the omitted income plus paying interest on the
deficiency. Penalties are often not imposed.
However, problems begin when there is a disagreement over
the proposed adjustment or the IRS is seeking verification of
the information on the return. In these cases, taxpayer
responses to written notices often sit at IRS processing
centers for weeks or even months until assigned to an auditor.
Once a taxpayer's response is actually reviewed by an IRS
auditor, it is often the case that the auditor will often find
the taxpayer's response to be insufficient setting off a new
round of correspondence consuming several more weeks or months.
Rather than this exchange of letters that inevitably must be
made by certified mail to ensure receipt by the IRS, a meeting,
or even simply a telephone call, with someone at the IRS
assigned to the case could often settle the matter in a few
minutes.
Furthermore, because small business owners rely upon
enrolled agents, CPAs or attorneys when they are contacted by
the IRS, significant costs arise for even insignificant
inquiries. In fact, many small business owners simply conclude
that the cost of their time and professional fees is not worth
the effort to dispute the proposed adjustment and opt simply to
pay the extra tax--rather than continue to fight.
Because most correspondence audits have is no point of
contact at the IRS to discuss the matter, taxpayers and their
representatives simply hope they are providing the correct
information. At the very least the IRS must better facilitate
the tracking of correspondence audits so taxpayers may receive
more prompt service. In addition, IRS should consider assigning
cases to an auditor or perhaps a group of auditors if the
taxpayer requests such an assignment at the time of first
contact. Perhaps, if the IRS can significantly improve its
online capacity, and, more importantly, its security over its
online functions, taxpayers could respond to e-mail
communications with specific IRS personnel.
IV. Inefficient Conduct of Audits--A Case Study
Ironically, small businesses which are more likely to be
audited are less likely to have the resources to respond to
inquiries and assemble evidence to support or explain their tax
returns. In addition, individual taxpayers continue to have an
almost illogical fear associated with being selected for an
audit resulting in a strained relationship between taxpayers
and an agency simply seeking to verify the information reported
on a tax return. Finally, the impersonal approach by the IRS in
correspondence audits, apparently due to the lack of personnel
to conduct the examinations, makes for a frustrating and
inefficient exercise.
These problems were illustrated most recently, in my own
practice, where a small business client living in Texas was
contacted by the IRS Philadelphia service center to explain the
income and expenses claimed on his Schedule C. The letter did
not provide the name of any person at the IRS to contract to
discuss the audit and simply requested copies of all the
taxpayer's books and records. With no way to understand what
specific items on the return were under examination, the
taxpayer, at considerably cost of time and professional fees,
assembled the requested information in three large boxes which
were mailed to the address requested.
After four months, the client received a one page letter
with an attached one page statement of explanation declaring
the taxpayer's business was a ``hobby'' and therefore the net
operating loss claimed on the return was disallowed resulting
in a substantial proposed assessment of taxes, interest and
penalty. At that point, my client had already incurred fees of
several thousand dollars in responding to the request for
information; and I frankly advised him that taking the matter
to the Appeals Division would cost even more. Nevertheless, my
client insisted that I file a protest showing that his business
was not a hobby.
After several more months and several letters where I was
able to have the Appeals Office in Texas rather than
Philadelphia hear the case, we received another letter asking
again for a complete copy of all the taxpayer's travel and
entertainment expenses with schedules reconciling the
individual expenses incurred to the totals on the return,
documentation which we had already provided. I called the
Appeals Officer assigned to the case and explained that we had
already supplied the examination division with this
information. The Appeals Officer insisted we supply the
information in even greater detail than we had the first time.
Therefore, we again began to prepare new schedules cross-
referencing each receipt to the totals on the returns. However,
before we could complete the work, the client received a one
paragraph letter dropping the case. As a result of this
exercise that lasted for almost a year, the client incurred
professional fees that exceeded the initial adjustment in tax
proposed by the IRS had he not contested the matter.
The substantial cost of this case, not only to the taxpayer
but also the IRS itself, illustrates the limits of
correspondence audits. Had an IRS employee in Philadelphia been
assigned to this case, the matter would have been resolved in a
few weeks rather than a year. So often audits of small
businesses and individuals are resolved by simply having
documentation to support the items claimed on the return. In
this case the taxpayer had the documentation and I am confident
the entire matter would have been closed with one face-to-face
meeting.
IV. Conclusion
The burden of compliance costs, including the often
unnecessary examination of small business tax returns, arises
not only because of the complexity of the tax law but also
because of basic inefficiencies in the selection of returns for
audit and the conduct of the examinations themselves. Because
of these inefficiencies, small businesses have had to turn over
responsibilities for the audit of their returns to tax
professionals whose fees have made it necessary for taxpayers
to concede possibly incorrect IRS adjustments. By revisiting
its approach to the conduct of correspondence audits, the IRS
can make such examinations more efficient thereby raising
additional revenue for the government and lessen the burden on
the tax paying community that is the fastest growing sector of
our economy.
* * *
Thank you for the opportunity to testify today and the
Kogod Tax Policy Center looks forward to working with the
Committee on this critical problem of tax administration.
STATEMENT OF JENNIFER E. BREEN
ON BEHALF OF THE
AMERICAN BAR ASSOCIATION SECTION OF TAXATION
BEFORE THE
COMMITTEE ON SMALL BUSINESS
OF THE
UNITED STATES HOUSE OF REPRESENTATIVES
FOR THE HEARING ON
IRS AUDITS OF SMALL BUSINESSES
SEPTEMBER 14, 2016
Good morning, my name is Jennifer Breen, and I am honored
to be here today. I have been a tax practitioner for over
fifteen years and have spent time as an attorney for the
Internal Revenue Service (the ``IRS''), in-house as a member of
a corporate tax department, and as an outside advisor to
taxpayers. I am currently a tax partner with the law firm of
Morgan, Lewis & Bockius, LLP, in Washington, D.C., where my
practice includes representing taxpayers involved in
examinations before the IRS.
I appear before you today in my capacity as Vice Chair for
the Administrative Practice Committee of the American Bar
Association Section of Taxation. This statement is presented on
behalf of the Section of Taxation. It has not been approved by
the House of Delegates or the Board of Governors of the
American Bar Association. Accordingly, it should not be
construed as representing the policy of the Association.
The Section on Taxation appreciates the opportunity to
appear before you today to discuss examinations of small
business taxpayers by the IRS, and it is honored to serve as a
resource to the Committee on this topic.
American Bar Association Section of Taxation
The Section of Taxation is comprised of more than 17,000
members. Our members include attorneys who work in law firms,
corporations and other businesses entities, government, non-
profit organizations, academia, accounting firms, and other
multidisciplinary organizations.
Our members provide advice on virtually every substantive
and procedural area of the tax law, and interact regularly with
the IRS and other government agencies and offices responsible
for administering and enforcing such laws. Many of our members,
including myself, have served in positions at the IRS, the
Department of the Treasury, the Tax Division of the Department
of Justice, and the Congressional tax writing committees.
Examinations of Small Business Taxpayers: A Background
The IRS's Small Business/Self-Employed Division (``SB/SE'')
is one of four IRS operating divisions. It has responsibility
for approximately 57 million taxpayers, including 41 million
self-employed individuals and 9 million small corporations
(those having $10 million or less in assets) \1\. SB/SE's
enforcement responsibilities include examining individual and
business tax returns to detect misreporting \2\. Examinations,
or ``audits'' as they are often called, consist of a review of
a taxpayer's books, records, and other data to ascertain the
correctness of any return or to make a return where one was not
made by the taxpayer. Examinations are authorized by Internal
Revenue Code section 7602, which gives the Secretary of the
Department of the Treasury, the IRS's parent agency, authority
to conduct such examinations.
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\1\ The IRM states the mission of SB/SE is ``to help small business
and self-employed taxpayers understand and meet their tax obligations,
while applying the tax law with integrity and fairness to all.'' IRM
1.1.16.1.1.
\2\ SB/SE also has enforcement responsibility for estate, gift,
fiduciary, excise and most employment tax returns.
In the IRS's 2015 fiscal year \3\, the IRS closed
approximately 1.3 million examinations.\4\ Of those
examinations, over 300,000 were examinations of small business
returns, with the majority of those returns reflecting a total
income of under $1,000,000, and over 200,000 of these returns
reflecting income of under $200,000.\5\ These audits resulted
in over $4 billion of the $25 billion in total recommended
additional taxes across all IRS examinations during the 2015
fiscal year.\6\
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\3\ The IRS operates on a fiscal year running from October 1
through September 30.
\4\ Statistics from the IRS 2015 fiscal year, Internal Revenue
Service Data Book, 2015, Publication 55B, March 2016. For purposes of
the numbers contained herein as they pertain to small business returns,
the following categories of returns were included: 1) individual income
tax returns reporting Schedule C business activity with positive income
of $1,000,000 or less and small corporations with total assets of under
$10,000,000. These numbers do not include partnership returns, as the
data presented by the IRS to date does not distinguish between large
and small business partnerships for the IRS's 2015 fiscal year.
\5\ Id.
\6\ Id.
Examinations provide the IRS with an important tool to
identify noncompliance in reporting tax obligations and help to
enhance voluntary reporting compliance. In so doing,
examinations help to reduce the ``tax gap,''which is defined as
the amount of tax liability that is not paid voluntarily and
timely. Earlier this year, the IRS estimated that the gross tax
gap for the 2008-2010 time period (the most current estimates
available) was $458 billion and that $52 billion would
eventually be collected, resulting in a net tax gap of $406
billion.\7\
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\7\ Tax Gap Estimates for Tax Years 2008-2010, Internal Revenue
Service, April 2016.
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The Examination Process
I. Selection for Examination \8\
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\8\ This testimony focuses on the general processes utilized by the
SB/SE operating division of the IRS, as it is the division responsible
for conducting examinations of small business taxpayers. Other
operating divisions, such as the Large Business & International
(``LB&I'') division, may utilize different or additional processes not
addressed herein.
After a return is filed, SB/SE uses a variety of methods to
identify whether a return should be identified for potential
examination. These methods include the use of a computer
scoring program (called the ``Discriminant Index Function'' or
``DIF'' \9\) and other methods, such as internal and external
referrals, the use of data matching (where the information
reported to the IRS from third parties is matched against the
information reported by the taxpayer), and random
identification. Many of the methods used by the IRS use some
form of automation to determine which returns should be
selected, and most, but not all, involve some form of manual
review to further evaluate which returns have audit potential.
These selection methods create a pool of returns that the IRS
has identified for possible audit.
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\9\ DIF, as referenced in the IRS's procedures manual, the Internal
Revenue Manual (``IRM''), is a mathematical technique used to score
income tax returns for examination potential. These formulas were
developed based upon National Research Program data. Each return
measured under DIF receives a DIF score by assigning weights to certain
basic return characteristics. Generally, returns with the highest DIF
scores are screened for examination potential. The DIF formulas are
confidential in nature and for official use only. See IRM 4.1.3.2.
Revenue Agents and other IRS employees then conduct a
review of the pooled returns in a procedure known as
``classification''.\10\ During the classification procedure, an
employee determines whether a return warrants an audit through
a review of the information reported on the return.\11\ During
this stage, the taxpayer is not notified of the potential for
selection, and if the employee classifying the return finds no
issues, the IRS will take no further action on the return at
that time. The returns that are identified during this process
as warranting further review then become available to assign
for examination. The IRS reviews more returns than are selected
for audit to ensure that it has enough returns that are
available for examination when staff become available to be
assigned to an examination.\12\ Due to limited resources, the
IRS will only examine a limited number of the returns filed,
making the classifier's role critical to ensure resources are
used effectively.
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\10\ See IRM 4.1.5, Classification and Case Building, for more
detailed information regarding the classification process.
\11\ The criteria that classifiers use to decide what issues should
be sent for audit are generally set forth in IRM 4.1.5 and IRM 4.19.11.
\12\ GAO, IRS Return Selection: Certain Internal Controls for
Audits in the Small Business and Self-Employed Division Should be
Strengthened, GAO-16-103: Published December 16, 2015 (Publically
Released January 13, 2016).
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II. The Examination
During the classification process outlined above, returns
selected for potential examination are also sorted for one of
two types of possible audit, a ``Correspondence Audit'' or a
``Field Audit,'' based upon guidelines set forth by the IRS.
Both of these examinations are discussed in detail below. Of
the over 300,000 examinations completed for small businesses in
2015, approximately 160,000, or over half, were conducted as a
correspondence audit and the remainder were conducted as a
field audit.\13\
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\13\ Statistics from the IRS 2015 fiscal year, Internal Revenue
Service Data Book, 2015, Publication 55B, March 2016.
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A. Correspondence Audits
Correspondence audits, also called ``Campus Examinations,''
are the most basic type of audit and are conducted exclusively
by mail. These examinations are conducted through one of four
``campus'' locations, commonly referred to as ``service
centers,'' that are located in Brookhaven, New York;
Cincinnati, Ohio; Memphis, Tennessee; and Ogden, Utah.
Once a return has been selected for a correspondence audit,
an IRS analyst will review the return to ensure it adheres to
the selection rules embedded in the automated processes, and
then the return is assigned to a campus through automated
processes. Generally, this means there is no further review by
a manager or oversight group to determine whether to assign,
hold, or screen out returns.\14\
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\14\ GAO, IRS Return Selection: Certain Internal Controls for
Audits in the Small Business and Self-Employed Division Should be
Strengthened, GAO-16-103: Published December 16, 2015. Publically
Released January 13, 2016.
Once assigned to a campus, examinations are initiated by a
standard boilerplate letter, the ``initial contact letter,''
which is mailed to the taxpayer to notify them that they have
been selected for examination, provide them with a list of
items to be verified, and with a copy of IRS's Publication
3498-A, The Examination Process (Audits by Mail). As these
notices are computer generated, there is virtually no
customization with respect to the taxpayer, the taxpayer's
business activities, or the possible issues that have triggered
the examination. Rather, the initial request is generic in
nature and requires the taxpayer to provide a variety of
records to the IRS.\15\ A taxpayer must respond within 30 days
by mailing copies of the requested documentation to a general
address for the campus conducting the examination. Should a
taxpayer have any questions regarding this initial letter, they
are directed to call a general number or write to the campus's
general address, as the case not yet been assigned to a
specific campus examiner at this point in the process.
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\15\ Generally, the first request seeks general records including
the following: chart of accounts; Year-end workpapers which reconcile
the taxpayer's books to the tax return; adjusted closing trail balance;
year-end adjusting journal entries and closing entries, the general
ledger; bank statements, duplicate deposit slips and canceled checks
for all bank accounts; and copies of financial statements.
Once a taxpayer responds, the correspondence is placed in a
queue to be assigned to a campus examiner, who will notify the
taxpayer that the response was received. This process can take
months, often due to the number of cases in the queue.
Sometimes, a taxpayer is forced to resend the correspondence as
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the original information mailed cannot be located by the IRS.
In some instances, after submitting the requested
information, taxpayers will receive notification that nothing
more is needed and that their examination is being closed with
no changes. However, in many instances, the examiner will
contact the taxpayer with further issues or requests due to the
records provided or a dispute over a matter of law.
Unfortunately, in many examinations, the qualify of the
taxpayer's response to the requests made by the IRS, as well as
the agent's understanding of the position taken by the
taxpayer, is impacted by the fact that all discussions between
the two parties are undertaken through correspondence and
limited telephonic communication (if any), rather than face-to-
face conversations.
If a taxpayer fails to respond at any point in the process,
the IRS will send a second notice. If it receives no reply at
that time, the IRS will then issue a statutory notice of
deficiency, also known as a ``90-day letter.'' At the end of 90
days, the IRS will assess the tax, and any penalties and
interest associated therewith and send a Notice and Demand for
payment, unless the taxpayer petitions the Tax Court for a
redetermination of the asserted deficiency.
As a whole, the IRS conducted the majority of its 2015
audits, 72.6 percent, via correspondence. As noted above, with
respect to small businesses, over half of these audits were
done via correspondence. For some types of small business
taxpayers, this percentage is even higher. For example, of the
nearly 170,000 small business taxpayers reporting gross
receipts of under $100,000 that underwent an audit in 2015,
more than 65% underwent a correspondence audit.
B. Field Audits \16\
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\16\ This testimony focuses on the general processes utilized by
the SB/SE operating division of the IRS, as it is the division
responsible for conducting examination of small business taxpayers.
Other operating divisions, such as LB&I, utilize different or
additional processes not addressed here.
Field audits are generally conducted through direct contact
with the taxpayer or the taxpayer's representative through a
combination of face-to-face meetings, telephone calls, and
written correspondence. SB/SE conducts these types of
examinations through field offices located in seven regional
areas across the United States. When classifying a return to
determine whether to identify it for a potential field audit,
the employee considers whether the issue would likely require
an on-site inspection of a taxpayer's books, records, or
assets, whether extensive time is anticipated to complete an
audit, and whether the issues appear complex. In such
instances, IRS guidance recommends that a field audit should be
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considered over one conducted via correspondence.
For cases that are referred to the field for examination,
the inventory provided to each office is generally reviewed by
a group manager, who has the discretion to assign, hold, or
screen out returns for audit based upon resource constraints or
priority of the workload.\17\ The group manager then assigns
each case to an agent who will conduct the examination. Once
assigned, the agent will notify the taxpayer that its return
has been selected for examination and will provide it with a
list of documents the agent has identified for review through
an Information Document Request (``IDR''). While these lists
are often customized with documents the agent has identified as
required based upon his or her preliminary review of the
return, this request also contains boilerplate items agents are
required to seek regardless of the issue or issues the agent
has identified for examination or the nature of the taxpayer's
business.\18\ The letter will suggest a date and time for the
first meeting with the taxpayer or the taxpayer's
representative, at which the taxpayer is expected to produce
the records requests for the agent's review.
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\17\ GAO, IRS Return Selection: Certain Internal Controls for
Audits in the Small Business and Self-Employed Division Should be
Strengthened, GAO-16-103: Published December 16, 2015. Publically
Released January 13, 2016.
\18\ Similar to the boilerplate requests made in a correspondence
audit, the first request in a field audit generally seeks general
records including the following: chart of accounts; year-end workpapers
which reconcile the taxpayer's books to the tax return; adjusted
closing trail balance; year-end adjusting journal entries and closing
entries, the general ledger; bank statements, duplicate deposit slips
and canceled checks for all bank accounts; and copies of financial
statements. In addition, this request also usually seeks all related
returns. For example, if the taxpayer under audit is a partner in a
partnership, the initial request will seek copies of the partnership's
returns, or if the taxpayer under audit is a partnership, the initial
request will seek copies of all of the partner's returns as well.
At the outset of the examination, and generally at the
first meeting with the taxpayer, the agent will also spend time
asking the taxpayer a series of questions. Some of these
questions will have been customized through the agent's
development of the case. However, often these questions are
boilerplate and are required by SB/SE guidelines for procedures
and techniques that should be used in every examination,
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regardless of the issues or type of taxpayer involved.
After the agent has reviewed the initial information and
met with the taxpayer, in some instances, taxpayers will
receive notification from the examiner that nothing more is
needed and that their examination is being closed with no
changes. However, in many instances, the examiner will contact
the taxpayer with further issues he or she has identified or
for additional documents to be requested through subsequent
IDRs.
C. Completion of an Audit
Both correspondence and field audits can be concluded in
one of three ways: as a ``No Change,'' as ``Agreed,'' or as
``Unagreed.''
A No Change resolution means that during the examination
the taxpayer was able to substantiate that all of the items
being reviewed on the return were correctly reported and the
examination results in no changes. While the IRS did not
tabulate data reflecting the total percentage of No Change
examinations that occurred in 2015, it did report statistics as
broken down by specific types of taxpayers. In nearly every
instance of small business taxpayer examinations, No Changes
occurred more frequently in cases for which a correspondence
audit was conducted. Additionally, for some groups of small
business taxpayers, the likelihood of completing a
correspondence examination that resulted in no changes was
high. For example, of the 13,684 business returns with total
positive income of under $200,000 and total gross receipts of
over $200,000 that were selected for examination, 2,135 were
subjected to a correspondence audit and over half of the
examinations resulted in no change.\19\
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\19\ Statistics from the IRS 2015 fiscal year, Internal Revenue
Service Data Book, 2015, Publication 55B, March 2016.
An examination that has concluded as Agreed means the IRS
has proposed changes and the taxpayer understands and agrees
with the changes. If a taxpayer agrees with the audit findings,
the taxpayer will be asked to sign the examination report or a
similar form, depending on the type of audit conducted. If
money is owed, the taxpayer will be required to make a payment
or seek to utilize one of the payment options offered by the
IRS, if one is available.\20\ Of the over 300,000 small
business cases closed in 2015, roughly 4% closed in agreement.
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\20\ See Publication 594, The IRS Collection Process, for more
information regarding these options.
Finally, cases that are closed as Unagreed are those where
the IRS has proposed changes with which the taxpayer has
disagreed. If the taxpayer does not agree with the findings, a
conference with a manager may be requested for further review,
the taxpayer may seek review by the IRS Office of Appeals or
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may seek to use of the IRS's Appeals Mediation Programs.
Conclusion
In 2015, the IRS examined a total of approximately 1.4
million tax returns, and a large part of these returns were
associated with small businesses across the United States.
Although the experience of an examination by the IRS can
require time and attention and cause uncertainty for the
taxpayer, examinations are an important tool for the IRS to
identify noncompliance in reporting tax obligations, help to
reduce the tax gap, and enhance voluntary reporting compliance.
The IRS outlines the examination process on its website and
in Publication 556, Examination of Returns, Appeal Rights, and
Claims for Refund, for taxpayers who have never experienced an
examination. The examination process nevertheless can be
confusing and time consuming. Consequently, taxpayers often are
unsure about what to expect and how to proceed. Unlike the
Large Business and International (``LB&I'') Division, SB/SE
does not have a public ``Examination Process'' statement
whereby the Division provides an organizations approach for
examinations from the first contact through the final stages of
issue resolutions, nor does not have directives requiring
discussions with taxpayers around certain examination
procedures, such as the issuance of IDRs.
Regardless of the type of examination a small business
taxpayer experiences, establishing good accounting and
recordkeeping will help a taxpayer prepare for an examination,
should one arise, and help to put the taxpayer in a position to
effectively and efficiently respond to any issues raised by the
examiner. Good record keeping is not enough, however. It is
also important to be cooperative and responsive to all IRS
notices and requests for information.
Last year, the IRS, including SB/SE, announced its ``Future
State Initiative.'' \21\ Through this initiative, SB/SE has
indicated that it is looking for ways to find better and more
efficient ways of doing business, including using technology to
transform the examination process. It has identified possible
changes to include the use of digital notifications of possible
examination at early stages shortly after filing, the use of
limited-issue examinations based upon specific aspects of a
taxpayer's return, and the ability for taxpayers and their
representatives to exchange necessary information
electronically with an agent during an examination. Efforts
such as these should lead to improvements in the examination
process and help the IRS examine taxpayers more effectively and
efficiently.
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\21\ ``Future State Initiative'' Internal Revenue Service, February
22, 2016. https://www.irs.gov/uac/newsroom/future-state-initiative
(September 11, 2016).
Thank you for affording me the opportunity to be here today
to provide the Committee with this information. I look forward
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to your questions.
[all]