Internal Revenue Service:

Hon. Charles O. Rossotti, Commissioner

Nina E. Olson, National Taxpayer Advocate

U.S. Department of the Treasury, Hon. David C. Williams, Inspector General for Tax Administration

U.S. General Accounting Office, James R. White, Director, Tax Issues, accompanied by Randolph C. Hite, Director, Information Technology Systems Issues, and Robert F. Dacey, Director, Information Security Issues

H&R Block, Mark A. Ernst

National Association of Enrolled Agents, Claudia Hill

SUBMISSION FOR THE RECORD

American Institute of Certified Public Accounts

2001 TAX RETURN FILING SEASON

Tuesday, April 3, 2001

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

The Subcommittee met, pursuant to notice, at 2:08 p.m., in room 1100 Longworth House Office Building, Hon. Amo Houghton (Chairman of the Subcommittee) presiding.

[The advisory announcing the hearing follows:]

Chairman HOUGHTON. Ladies and gentlemen, thank you very much for being here. The hearing will now come to order. It is good to see you, Commissioner. Thanks very much for your presence here. You may have one of the most difficult jobs in the city. I believe, though, that you have run the agency admirably, and I know the service is not where you want it to be yet, but you have made great strides and I am sure you have high hopes.

Let me say just a few words about customer service. Customer service means many things, among them are courtesy, efficiency, and, most importantly, fairness. The relationship between the IRS and the ordinary citizen, because of the nature of the function, sometimes can be potentially difficult, but if each time the taxpayers reach out to the IRS or the IRS reaches out to them and they are treated with these three objectives in mind, the IRS will be able to increase its trust in the eyes of the American public. So we will discuss many topics today and ask many questions, but the underlying theme will remain the same: courtesy, efficiency and fairness.

One more thought. No one can understate the importance of security. Taxpayers must feel that the information on their tax returns is safe. This information must be secure from both internal browsing and external break-ins. And I know, Commissioner, that you have made security a focal point. So I thank you for coming today. And the rest of the witnesses, I thank you also and I look forward to your ideas. I am pleased to yield to our ranking democrat, my friend, Mr. Coyne.

[The opening statement of Chairman Houghton follows:]

Mr. COYNE. Thank you, Mr. Chairman. I, too, would like to welcome Commissioner Rossotti. With less than two weeks before Monday, April 16th, it is timely that this Oversight Committee of Ways and Means review how the 2001 tax return filing season is progressing. Reports are that all systems are up and running and that this filing season may be one of the best ever. The commissioner is doing an excellent job in reorganizing and modernizing the IRS and should be commended for the work that he has completed already.

The tax return filing season is a huge and complicated operation. Taxpayers will file over 130 million tax returns this year, including 42 million e-filed returns. IRS employees will issue nearly 97 million tax refund checks, answer over 60 million telephone calls from taxpayers, and serve nearly 6 million taxpayers at IRS walk-in sights. Inevitably, some problems will occur, hopefully with the expert oversight and advice of those testifying before us here today, these situations can be quickly addressed. I am pleased that for the first time this Subcommittee will have the opportunity to hear from the new IRS Taxpayer Advocate, and from the Treasury Inspector General for Tax Administration. Thank you, Mr. Chairman.

[The opening statement of Mr. Coyne follows:]

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

Mr. ROSSOTTI. Is that better? Last year when I came before you, I said we had a clear direction for the IRS and had taken some important steps to improve the IRS. Now, for the first time, I can tell you that we have a real plan, a strategic plan that lays out how we will build on that foundation we have laid to make the IRS everything the American public has a right to expect it to be.

On January 30, 2001, the IRS Oversight Board approved the IRS strategic plan. It follows closely the letter and spirit of the Restructuring Act and reflects the new and modernized IRS. The strategic plan shows how the IRS can dramatically improve service to taxpayers, ensure fairness and compliance with our tax laws, and moreover, meet all of these goals while continuing to shrink in size relative to the economy. The biggest challenge presented by this plan is that we have to continue to administer the world's largest and most complex tax system, while simultaneously reengineering and improving how the agency works at its most basic level.

In other words, we must operate effectively and modernize at the same time. Our entire plan is based on this dual approach: strategies to improve performance over the next two years, while modernizing the agency in the longer term. In connection with our mission and goals, we have developed 10 strategies and for each of these, for 2001 and 2002, have defined specific priorities and responsibilities for carrying them out. For example, in the 2001 filing season, we are demonstrating how we can build on our positive trends in both meeting taxpayer needs, one of our strategies, and broadening the use of electronic interactions, one of our other key strategies.

On the electronic front, so far this filing season, our online filing for home computers is up about 37 percent compared to last year. It has already reached a total volume of about 5 million in that category, which is what we had last year. In total, we expect to receive about 40 million returns electronically this year. There are some specific reasons for this. For example, in this filing season we have added 23 forms and schedules that can be filed electronically. Next year, in 2002, there will be 38 more, which will bring, essentially, all forms and all schedules into the electronic filing program.

I am also pleased to report that our website has received about 1.3 billion hits this fiscal year. In addition to the page hits, we have had about 103 million downloads. These are mostly forms the people get. That's almost twice as many--in fact, it is twice as many as last year--and as I like to say that is a lot of trips to the post office that people do not have to make.

We have also recently announced a new feature where taxpayers who need an extension to file of course, all taxpayers are entitled to an automatic extension till August 15^th can now do that with a simple phone call, no paper, and they also get a confirmation. Another thing that we are piloting that has a lot of exciting potential for the small-business community and for practitioners, is our Internet-based system for businesses to file and pay Federal payroll taxes online. This is called EFTPS online. It allows taxpayers to enroll once in the system and then to securely make Federal tax payments, and also check their payment history over the Internet. Using this system, they will also be able to schedule future payments through the Internet, and cancel payments if necessary.

Let me also stress that during the past year we completed a comprehensive set of changes and upgrades to strengthen our security for the electronic filed returns. With respect to taxpayers who needed assistance from us during the filing season, we have made steady progress in providing telephone service, which is our single most important channel. Busy signals use to be a major problem. A few years ago there were 400 million busy signals, which is more than there are people in the United States. Busy signals have been reduced to a minimal level on the order of four percent. At least people can now get through on the line. With respect to total calls answered, we have had answered, so far this filing season, about 51 million calls through March 23rd, which is about a 14 percent total increase.

With respect to taxpayers who actually want to talk to a live customer service representative, so far this filing season, about 66 percent of taxpayers have gotten through, compared to about 62 percent last year at this time. These are all upward trends. On the other hand, certainly this level of service is not up to the long-term goal, which is comparable to perhaps 90 percent in the private sector. We still have a ways to go.

Moving to our longer-term modernization program, I think we have made progress on our three key change initiatives for modernization. In response to RRA 98, the new customer focused organization structure is in place now and largely implemented. There is a top management team, as well as a field organization in place for each of the four operating divisions and our functional units. We have also approved a set of balanced measures to measure the performance of this new organization, and most of these measures will be in place, fully deployed, through most of the organization by the end of this fiscal year.

These kinds of changes are very important in enabling us to tailor our services to taxpayer needs, as well as to focus our compliance programs where they will do the most good. For example, we recently rolled out a specialized part of our website for the small-business, self-employed community. In addition, for the large-business community, we have initiated two issue resolution programs that are reducing the amount of time it takes for large businesses to resolve tax issues with us.

The third piece of modernization has to do with business systems modernization, our technology program. This program officially kicked off almost exactly 21 months ago, and we believe that we have made solid progress, although we have to acknowledge, this is an extremely difficult program. But in three key areas we have made progress. One is developing an agencywide vision and architecture, the second is building our program management capacity, and the third is delivering on some specific initial projects.

With respect to the overall architecture, which is the road map of the future for modernizing our systems, we approved the enterprise architecture document earlier this year. Our management capability, which include such things as use of our lifecycle management methodology, has improved, although it still needs maturing.

With respect to our first two projects, we will be delivering our first two projects shortly after the filing season in the next couple of months. One is a project which will enable us to build on the progress on phone service and improve it further, and the other is some better tools for our examiners that will be examining corporate income tax returns.

Mr. Chairman, in spite of the progress that I have noted, it is clear that we are still not reaching the level in quality of service, that we think taxpayers deserve, nor, in fact, are we collecting all the taxes that are due efficiently. We have a lot to do.

I can cite some of the things that still need improvement. I mentioned the phone service. It has significantly improved, but it is still not on the level of what taxpayers receive in the private sector. Because of our antiquated computer systems, even when taxpayers do get through to us, we sometimes cannot provide them with updated information on their accounts, which in turn, results in frustration from both the taxpayer and the IRS employees who want to help them.

As a matter of fact, if I looked across all of our business processes, most of them operate too slowly or inaccurately or inefficiently. Many of our notices, which we send 100 million to taxpayers, are still confusing, and it is not just because of the writing. It is because we do not always have the right data to put on those notices.

We are on the path of achieving the goal of 80 percent electronic filing by 2007, which is a part of RRA. However, it is going to be difficult to continue at a pace rapid enough to reach this goal. Finally, with respect to our financial statements, we are very pleased we received, for the first time, a clean opinion on all of our financial statements from GAO. But, they also noted that we continue to have significant material weaknesses in our financial management, and many of those weaknesses cannot be corrected except through business systems modernization.

On the compliance side, we are also very concerned about the continued drop in audit and collection activity. I think the risks of these declines are not simply the dollar value of the taxes which are left uncollected. The greatest risk to me is that the average taxpayer, who honestly pays taxes, could lose confidence if the IRS fails to act effectively and efficiently to collect what is due from those who may not pay what they owe.

I think the effect of the decrease in examination coverage is especially important with respect to fairness. Because it is relatively easy for the IRS to verify most of the income of average, lower or a middle income taxpayers, but it is much harder, and often requires an examination, to verify the income of higher income and certainly corporate taxpayers. I think I testified earlier that the drop in this coverage was caused by several factors, one of which is the long-term decline in staffing. Other factors include the need to assign compliance staff to customer service duties during the filing season, as well as some added responsibilities imposed by RRA.

Finally, let me just note, with respect to the modernization program, and I am speaking of business systems modernization, that we are at a critical juncture. We are really starting to get into serious implementation of this program, which will require more funds. I am pleased to say that the modernization blueprint, which was outlined by the President in the budget blueprint earlier this year, did note they were going to include $397 million in investments for the ITIA fund to modernize IRS's computer systems.

In conclusion, Mr. Chairman, I think we are on the right track, but that track is long and it is going to take a lot of sustained effort to get all the way around to where our strategic plan says we need to be. With then continued support of your Committee and the other committees of Congress, we are confident, however, that we can achieve what we set out to do in our plan and make the IRS what it needs to be for the American people. Thank you.

[The prepared statement of Commissioner Rossotti follows:]

Chairman HOUGHTON. All right. Thanks very much. Before we go to the questions, I would like to introduce our newest member, Earl Pomeroy, who is a very distinguished man for many reasons, one of which is he is my neighbor down the hall here. Anyway, Earl, and also Karen Thurman, who was on this Committee two Congresses ago, not last Congress, and now again. Thanks very much, Karen, for being here.

I would just like to ask a question and then I will turn it over to Mr. Coyne, and we will go back and forth here. You have talked about this electronic filing and I think it was you that put out this goal of 80 percent filing electronically by the year 2007; is that right or was that before you?

Mr. ROSSOTTI. Well, it was included in the Restructuring Act. I think the origin of it might have been the Presidential commission that studied the IRS, but in any case, it was included in the Restructuring Act as a goal.

Chairman HOUGHTON. Tell us a little bit about that. Is that going to be a stretch? How does it look? What are the incentives? Just give us a feel for it.

Mr. ROSSOTTI. It is definitely going to be a stretch in terms of timing. We actually have to average 20 percent-a-year growth between now and 2007 approximately to get there. We did hit 20 percent this year. We may be slightly under 20 percent this coming year. I think the important thing, and I think some or the other folks who are going to testify later will say this, is that it will not happen automatically. It will not happen just because it is currently going up at 20 percent. We have to take some aggressive steps and we are.

I mentioned in my testimony, one of the key things was the ability to file all forms and returns electroncially. Right now, you cannot file all returns because there are certain schedules and forms that are not accepted. That particularly affects practitioners, because 55 percent of the returns are prepared by practitioners and many of them tell us they do not want to file some of their returns electronically and some of them on paper. That is one obstacle we are trying to remove.

Another issue was that electronic filing was not entirely paperless. You had to file a separate form with your signature document. We came up with a strategy this year that eliminated that requirement. You could supply us with a self-selected identification number and two pieces of information from your prior-year return. That has had some startup issues, especially with some of the practitioners, but nevertheless we think it will work with some fine-tuning and that will eliminate that issue.

Another issue has to do with practitioners having sufficient incentive just to change the way they do business. In our modernization program, one of the things we are going to be doing in an early implementation, we expect by 2002, is to provide some additional services to some practitioners who work with us electronically. This will include not just filing the returns, but being able to communicate with us, for example, to get transcripts of tax returns and eventually to settle their accounts. This will essentially provide a broader reason for people to do business electronically with us.

Then, finally, there is the marketing and promotional activities, like any product. You have to promote it and we are continuing to do that. We have a lot of things that we have to do. I have only mentioned a few of them. It will not happen automatically.

On the other hand, the trends in favor of us are just cultural. The newer generation of people, like my two children, they are around 30 years old and I do not know that they have ever bought a postage stamp. I think they do everything by e-mail and computers. They are the kind of generation that is going to automatically generate an interest in things electronic.

Chairman HOUGHTON. Thanks very much. Mr. Coyne?

Mr. COYNE. Thank you, Mr. Chairman. Commissioner, welcome and thank you for your testimony. Is there a difference between the level of funding for 2000 between what the chairman of the oversight board would like and what the IRS has submitted to the administration?

Mr. ROSSOTTI. Well, I am afraid the administration has not submitted its budget yet, so I do not think I can really go into what the President's budget is going to be until it is submitted.

Mr. COYNE. But as far as your request to the administration for funding from the IRS, is there a difference between yours and what Mr. Levitan would like?

Mr. ROSSOTTI. Well, Mr. Coyne, I think we ought to wait a little until we see the President's budget. I think Mr. Levitan, in their public meeting, had made some comments about what they perceive to be the differences between their view on certain items and what they believe the administration was going to have. I think I would be best advised to wait until the President's budget is submitted before commenting on the budget, other than mentioning that they did say in the blueprint they would include $397 million for the modernization fund.

Mr. COYNE. It has been reported that over the last several years audit and collection levels at the service has declined. Could you point out to us here today what the major areas of noncompliance have been?

Mr. ROSSOTTI. Well, of course, one of the things is we have not had for a long time, a very good up-to-date, accurate assessment of how the compliance levels have trended. We are relying on some old estimates. I think, as we noted in our strategic plan, there are really problem areas of noncompliance across the spectrum. There is going to be, in fact, a hearing at the Senate Finance Committee this week on one area, which are the sort of organized tax avoidance schemes, such as these abusive trusts and devices such as that, which are sold to taxpayers, alleging that they can avoid taxes, and we think--we do not know what the numbers are, but there could be many billions of dollars of taxes that are not paid on that kind of scheme.

There are significant problems that we have in collecting employment taxes. We are behind in some areas because of the inventories that have a build up of collections. We have, as you know, in some cases, refunds that get through that should not get through, both based on the earned-income tax credit as well as other refunds. At the other extreme in the corporate area, we have had some major initiatives recently in the last year to deal with abusive corporate tax shelters, which are a different kind of tax shelter. They are kind of technical devices. So if you really look across the board, there are wide ranges of areas of noncompliance, and we are trying to be very focused with the limited resources we have on each of those.

Mr. COYNE. Later on today, the Treasury's Inspector General, Mr. Williams, is going to testify, and I quote from his testimony, that "over a four-day period during this current filing season, their auditors made 368 random test calls to the IRS's toll-free number, and were unable to gain access 37 percent of the time. When successful in getting through, however, the IRS incorrectly responded to 47 percent of the questions. The topics for the test calls were obtained as the most frequently requested requests of callers." Could you address that?

Mr. ROSSOTTI. Well, as I said in my testimony, we certainly believe we made progress in both the quantity, access and quality of calls. But we are far from satisfied with where we are. By looking at the entire filing season rather than just four days, we know what the access is. If someone wants to talk to a person and tries to get through, right now, for the season as a whole, the access is about 66 percent. In other words, about two-thirds of the time, which is not too different from what they found.

In terms of quality, we have a very complete system that tracks in a statistical way actual calls that are made by taxpayers that we have up in Philadelphia, as a matter-of-fact, not in Pittsburgh, but it happens to be in Philadelphia, a site that actually randomly samples all calls that are made and listens into them, because we can do that electronically, and through a statistical means actually rates the accuracy of the calls.

I can give you the statistics for the whole filing season. On tax law calls, the accurate response rate was 74.5 percent for the filing season so far. On accounts calls, which are people calling about their account, it was 86 percent. Neither of those is an acceptable level, although, especially in the accounts, we have improved drastically or at least significantly over what it was last year. I think in terms of where we are going with this, we want to try to get to a commercial level of access, which would be more in the 90 percent range, and certainly, a significant improvement.

In terms of both of those, there are two key things that we are doing besides just better management and better training. One of them is the technology program; in fact, a near-term technology program will provide us additional capacity to answer calls and some additional ability to route calls more precisely. We are also completely reorganizing our whole telephone operation, in the sense that we have about 25 different call sites where there are people who answer calls.

In the older structure, we tried to answer pretty much all the different kinds of calls, which, if you think about it, is an enormous range across the tax laws as well as accounts. What we are doing is working on a plan which we call center optimization, which looks across the whole network, across the whole country, and tries to figure out where we can specialize both the sites and the people in the sites, so that they will become more knowledgeable about the specific kinds of questions they need to answer and then direct the calls to the right kinds of people.

We are convinced that this is the only way we will get completely up to the level of accuracy we need to, because it is just too difficult to answer the entire range of calls in so many different places. This is an example of something where we are doing short-term things, as we are doing this filing season, but we are also making some fundamental changes to really reorganize the way the whole thing works in order to get both access and quality up to the levels that we want.

Mr. COYNE. Thank you.

Chairman HOUGHTON. Mr. Portman?

Mr. PORTMAN. Thank you, Mr. Chairman, and thank you, Commissioner, for being with us again. I think this Subcommittee is very cognizant of your challenge to both reengineer the IRS, while maintaining the taxpayer service as necessary to operate a very complicated system and a very complicated tax code.

If I could focus on a couple areas, one is with regard to electronic filing, I am concerned that you are saying it would be very difficult to meet the goal, but you think the goal is very important for both taxpayer service and also for the IRS itself, to be able to operate efficiently and more accurately. It seems to me, looking at your data, that you have done a pretty good job with regard to folks who file their own returns. In fact, we have about a 37 percent increase on home computers, for instance, this year, which is impressive, only about 10 percent, though, among practitioners.

We are going to hear from some practitioners later and I want to pose some questions to them if I can come back. I have to step out for awhile for another meeting. I hope to be back. What can you do to improve that rate among the practitioners? As you know, more than half the returns are filed by practitioners. You mentioned we can put all forms and all schedules on, rather than the forms we currently have online, but specifically with regard to practitioners, what are your ideas for the next few years?

Mr. ROSSOTTI. Well, I think there are really three things we are trying to do concretely. One of them is to be able to file all the 1040 forms online because they do not want to do some of them on paper and some of them electronically. The first time I ever met with a practitioner on this subject when I came into office, that was one of the first things I heard. It has taken us some time, but by 2002 we will be there.

The second thing is getting rid of the papers, the signature document. We came up with a scheme this year. There is some maturity, some perfection we need to do on that, and we will be working with the practitioners this year to gain their experience and improve it next year.

The third thing is to broaden their ability to interact with us electronically, beyond just filing returns, into dealing with us on other subjects. I think I mentioned that briefly in an answer to the Chairman's question. In our modernization program, our e-services project is aimed squarely at that point. It is directly aimed at enabling us to have, in a secure way, the ability to communicate with practitioners. If we can succeed in our schedules, we will be rolling out the first part of that capacity in 2002, and perhaps, the remainder in 2003.

Within the next two years, I think we will have dramatically increased the attractiveness of our offerings to practitioners.

Mr. PORTMAN. Commissioner, can I interrupt you just for a second? I have got a couple of questions I would like to get at and my orange light is going to come on in just a second. If you can get back to me in writing, that would be great with regard to any other point on practitioners, specifically with regard to the PIN numbers. There has been some information that has recently come to our attention, Federal Computer Week just said there is a lot of complaints about the new system, enabling taxpayers to select their own PIN. We think there is about a 20 percent error rate that you have acknowledged with regard to PIN numbers, and we understand that there are a lot of taxpayers who have been required to file their signatures the old-fashioned way, by mail, in addition to filing returns electronically.

I know you have tried several PIN systems in recent years. They all seem to have some inherent problems and complexities. If you could sort of cut through some of the red tape for us on that and give us what the best systems might be over the next couple of years, that would be very helpful to me and I think to the Subcommittee.

[The following was subsequently received:]

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

[The following was subsequently received:]

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

[The following was subsequently received:]

The final question I have for you is with regard to the oversight board. How is it working? I met with the oversight board. I know you have spent a lot of time with them, which I appreciate greatly. Chairman Levitan testified yesterday before the Oversight Committee. I wonder if you would give us a brief overview of the oversight board?

Mr. ROSSOTTI. My sense is that the oversight board has taken its responsibilities very seriously, very much in the spirit of the Restructuring Act, and has put in a great deal of serious time learning about the IRS. They were appointed in September. They organized at the first meeting. They have had three full-scale meetings, each about two days, the most recent one about two weeks ago which included a public meeting, and then they have three subcommittees that have been organized that have focused on key areas.

I think at this point they are up and running in a full-scale way. They focused a lot of their attention on the strategic plan in the budget, and as I mentioned in my testimony, in January they actually approved the strategic plan. I think that was an appropriate focus for them and something they contribute a lot of value to. Now they have been focusing on the budget to support the strategic plan, and they have issued a report on that. I think they are going to issue some more reports, including the testimony. The Chairman testified yesterday and I believe he is going to testify Thursday.

My sense is this board is doing what the Congress intended it to do, which is to get into an in-depth understanding of the IRS's problems. They certainly have been candid about identifying our problems if you heard the testimony yesterday, but they have also been very constructive about laying out what they think needs to be done. Just speaking personally, I have been involved with a number of boards, both being on them and presenting to them and so forth, in different contexts, but I think this is one of the most substantive kinds of meetings that I have ever been engaged with.

I mean, they have been very substantive, very intense. You were there at one of them for a period. They are fully capable because of their backgrounds, to really know what questions to ask in-depth about almost any subject about the IRS. And they have not hesitated to do that. They have also met with all the outside stakeholder groups and with GAO. The Comptroller General came over to meet with them. I believe if you wanted to have one body that has devoted the time and has the expertise to understand what is going on about the IRS, you have that in the IRS Oversight Board.

Mr. PORTMAN. Thank you, Mr. Chairman.

Chairman HOUGHTON. Well, I will bet you are very proud of that; rather than asking where is it, it is how is it doing.

Mr. PORTMAN. More fun to ask that.

Chairman HOUGHTON. I would like to ask Mr. Pomeroy if he has a question.

Mr. POMEROY. I do, Mr. Chairman, and thank you. I would just begin by saying Commissioner Rossotti has come to North Dakota, and I never would have thought there was anyone who could make people stand and cheer the IRS, but by golly he did. It was a wonderful presentation. That kind of segues into the point that I want to make. There is a lot of debate around tax policy. There always will be. Unfortunately, sometimes I think frustration at the structure of the tax code, or disappointment about the impact of the Federal Government's revenue demands on taxpayers, is ultimately channeled into frustration on the service and the outstanding professionals that run the Internal Revenue Service.

I so appreciate your background, Commissioner, coming from such demonstrated levels of success in the private sector at senior levels of management, to look at the system during this critical period of time and evaluation. My question is whether or not the resources are there, allowing you to get the tasks we, under statute, demand that you perform, done and done well? Obviously, the numbers cited by Ranking Member Congressman Coyne are disturbing, and would be a reflection of whether--raise significant questions in terms of whether the resources have been there as needed.

I guess, to put a point on my question, it is my understanding that the service has sought a $9.7 billion increase for the upcoming fiscal year. That amount itself has generated controversy with the oversight board believing that more was appropriate, I understand. Any idea how you are going to fare in the upcoming President's budget?

Mr. ROSSOTTI. Again, as I said to Mr. Coyne, I think I am best advised not to be commenting on the President's budget until it is released. I do not think I should do that. I will say, just to back up one step, that in 2001, which is the fiscal year we are in now, Congress passed a budget that after a lot of debate and a lot of work that was, from my point of view, a budget that enabled us to make significantly more progress then we had for a number of years in the two key areas.

One is, as I just mentioned, we have to operate. We have to have some staff. We have to have trained people. This is the first year we are actually out hiring some people to replace people that left and to make some modest increases and also to move our modernization. That is good and we want to try to continue that in 2002. Without getting into details, because it has not been announced yet, I think the 2002 budget that will be released, will allow us to continue to make progress in both of these areas. I think there will always be room for debate about how fast we make progress and how much we have, but I think we will be able to make progress in 2002, as well as we have been in 2001.

Mr. POMEROY. Good. I would hope that the request from the IRS is met in the President's budget, and I will be looking specifically at whether the funding matches the $9.7 billion request. As I look at that, I will note that this advisory board that has taken its responsibilities, as you mentioned, very substantively, and have no stake other than sound administration of the service itself, I believe you were $500 million low in that request. So we will have some benchmarks to evaluate whether or not the resources are there.

Regardless of how you feel about the tax code or tax policy, you represent an agency that has to get its work done. And if it does not, literately discredits the entire Federal Government in a way that is more fundamental than what most agencies would. Thank goodness for your distinguished leadership, and I mean it, at doing the best possible under the circumstances, but you need resources and I hope that they are there for you. Thank you. I yield back, Mr. Chairman.

Chairman HOUGHTON. Thanks very much. Mr. Weller?

Mr. WELLER. Thank you, Mr. Chairman and Mr. Commissioner. Good to see you again. I look forward to working with you. I know when I came in, and I apologize for running late, but my friend and colleague, Rob Portman, was discussing with you the progress on electronic filing, something that reduces a lot of paperwork and we all hope moves forward in simplifying the tax filing process for taxpayers in this new economy.

One of the concerns that has been raised to me by some who are in the business of helping prepare tax filing, as well as individual taxpayers, I know Mr. Portman referred to the PIN issue, but others have said that also the social security number becomes a problem, as well. I was wondering, do you have any idea what percent of electronic filings, where there is a complication, results from a number that does not match up?

[The following was subsequently received:]

Mr. ROSSOTTI. I can get you that number. I do not have it off the top of my head. Let me just point out that verifying social security numbers is not something that is unique to electronically filed returns. It is exactly the same, whether they are filed on paper or electronic. The only difference is that it is quicker to identify the problem electronically, which actually helps people, because we identify that rather than sending them a piece of paper in the mail telling them their social security number is wrong.

The reason we do that is really is part of the compliance program. I think the Congress, the IG and GAO and everyone has recognized that this is an important thing to do, to verify all the social security numbers for people who claim dependents or EITC qualifying child, those sorts of things. This is something that is really not related to electronic filing as much as it is making sure the returns are accurately filed. I can get you the numbers. I will get back to you with the specific numbers about how many returns have social security number--

Mr. WELLER. Because I have been hearing numbers of up to 10 percent of those electronic filings being rejected because of social security numbers. Now, whether those numbers are accurate, I wanted to hear from you.

Mr. ROSSOTTI. We will get you those numbers. My only point is the same issue applies whether taxpayers file electronically or on paper and it is just quicker to identify them electronically.

Mr. WELLER. Have your people ever sat down with the Social Security Administration and tried to figure out a way to ease that process? Because I realize it occurs probably when people marry, a woman may take her husband's name and a change in status, what kind of conversation do you have with Social Security?

Mr. ROSSOTTI. We actually do that on a regular basis. I was just talking about it with some people this morning and the kind of issues that come up are small issues. One example that I heard, for example, is that some people were getting names rejected because the social security number--in earlier periods they had not allowed hyphens in certain people's names and then they went and cleaned up the names to put the hyphens in. That was a good thing for them to do, but it did not match what people put on their returns in some cases. There are all these little issues, but in total they add up. We are working with the Social Security Administration to figure out ways to make it as easy as possible for people to make the corrections, and also make sure our files match.

Mr. WELLER. I would appreciate it if you could share with the Subcommittee, just to follow up on this question, where you are in the progress, what the status of your conversation/cooperation with the Social Security Administration would be. They are not far from you and to try to solve that problem, just to simplify the process of filing taxes.

[The following was subsequently received:]

Let me shift over to a kind of a different subject, and that is you come out of the business sector. You are a successful businessman. What is your philosophy about government agencies competing with private businesses in supplying services and products?

Mr. ROSSOTTI. Well, I think that, by and large, it is not a wise thing for the Government agencies to get into business and compete with the private sector. We have enough to do just with what our mission is.

There are some gray areas. There were some issues about exactly how far we should go in order to promote electronic filing, offering additional services, and we have made a determination. As a matter of fact, it was included in the Restructuring Act guidance that we should work with the private sector and foster competition rather than get into that business. For example, we have no intention of getting into the tax software business that distributes software.

Mr. WELLER. That was the question I wanted to follow up. So you have on plans to provide specific software to taxpayers that would than obtain that through the private sources.

Mr. ROSSOTTI. Yes, that is correct.

Mr. WELLER. You do not want to compete it?

Mr. ROSSOTTI. That is correct. As a matter of fact, we had a discussion on that subject with the House Appropriations Committee, the last October hearing, and there is some report language in our appropriation bill that asks us to provide a report to the Committee, which we will, but as I testified at that point, we do not plan and we do not think it would be wise for us to get into that. But we are trying to figure out ways that we could encourage the competition as was specifically required in RRA to drive the costs down as much as we can for the taxpayer, but that would be within the realm of the private sector, not by the IRS getting into the business.

Mr. WELLER. Thank you, Commissioner. I look forward to working with you, and look forward to hearing your report. Thank you very much.

Chairman HOUGHTON. Thanks, Mr. Weller. Mrs. Thurman?

Mrs. THURMAN. Thank you, Mr. Chairman.

Commissioner Rossetti, I am glad to be back on this Committee. Certainly, we have been through a couple of good taxpayer rights bills over the last couple of years together. So it is nice to be back here again.

I have a couple of questions that I would like to talk about. Over the last couple of weeks, we have been, obviously, doing some tax bills, and there has been a lot of concern about the earned income tax credit and being fraudulent. I know we have put a lot of work into doing this.

I noticed it was kind of a secondary in your prepared remarks to us as compared to a story that actually was in the Wall Street Journal yesterday talking about businesses and tax shelters. So can you kind of bring me up to date where we are on the earned income tax credit and what you are seeing in the other filings that seem to go kind of unnoticed on occasion?

Mr. ROSSOTTI. Well, I think, as I said in my opening statement and in our strategic plan, there are compliance problems across the entire spectrum. There really are, and they affect all types of returns and all types of taxpayers.

With respect to the earned income credit, that remains a problem. We issued a report last year that tried to quantify that. We have a little better quantification on that than we do in some other areas, and we did find that there were about, after everything was said and done--and this was for the filing season '98, so it is kind of old data before we had done some new initiatives, but at that time, there was about $7.5 billion of erroneous claims out of $30 billion.

I stress that we use the term "erroneous claims" or "over-claims" because we do not really know in all cases what causes these claims. Some of them may very well be deliberate. Some of them could be simply the fact that there is a complex set of calculations in the EITC. So we do not know exactly what causes them, but we do know what the amount of them was, and that is a significant amount of money. We do have a special appropriation from Congress to work on it.

We have one new feature that we have implemented this year to try to deal with it which is called the dependent database, which was authorized by law and gives us data from the States on who the custodial parents are, and we can use that to match with taxpayers claiming the EITC.

We are working on that, but as you noted in your question, it certainly is not the only area of non-compliance. Ranging from these abusive trusts to the corporate tax shelters to the employment taxes, no matter where you go, you find it. Obviously, the majority of taxpayers in every one of these groups is very compliant and very honest, but there are those who try to take advantage of it, and we try to do what we can.

Mrs. THURMAN. I do appreciate that answer because it always comes back to us like somebody is doing something that they are not supposed to be doing on either one of those questions on any one of those sides.

The second thing that I would like to ask you is--actually, there are two, before I run out of time. One was there was a notice in the FNA Today that was talking about the IRS electronic newsletter that was dated April 1st dealing with taxpayers and preparers are actually misrepresenting instructions used in a notice 703. This has to do with Social Security benefits, and I just was kind of going to ask, can you give us some idea of the extent of this problem, how many taxpayers are making this mistake, and more importantly, something that we might be able to help on is do you think it would be fair for us to be forcing these folks to pay penalties and interest due to the lack of a clarity of a notice that IRS actually sent out.

[The following was subsequently received:]

Secondly, different subject, but just in case we run out of time, when I was on this Committee before, there was a piece of legislation that was passed specifically to deal with the complexities of the IRS Code. I think what we finally came up with was that after the bill was passed out of the Committee, it would go to the Joint Tax Committee, and then in consultation with you all, that it was to try to help us streamline this and make this the least complicated form that we could come out with.

I would like to kind of get an update on where we are in that area as well.

Mr. ROSSOTTI. Let me answer that question first.

Yes, you are correct. That is exactly what was passed, and we have been following that.

The way it works is that when there is a specific proposal for a Tax Code change--and I think there is a threshold of how significant it is--the Joint Committee staff gets together with us through our legislative affairs office and we send them an analysis. We have been doing this now, I guess, for at least 2 years.

Mrs. THURMAN. You just send them an estimate, but do you have conversation about ways of writing this, so that it achieves the same in, but makes it less complicated?

Mr. ROSSOTTI. Well, that is not exactly what we are required to do.

We provide them a specific statement as to what additional complexity, what changes, or what the impact is going to be. It is kind of like an impact statement.

For example, it says such and such a change that it is going to require changing these forms. There are going to be so many more line items or so many less line items, and here is how many taxpayers are going to be affected, and that sort of thing. We provide that to the Joint Committee staff and then they provide that to the Ways and Means Committee and the Finance Committee for inclusion in the Committee reports. We have been doing this since that provision went into effect.

Mrs. THURMAN. I guess the follow-up question on that, then, was has our Tax Codes gotten less complicated because of that.

Mr. ROSSOTTI. I am afraid I could not say that. I do not think it has gotten less complicated.

I think that there was one occasion, I do know, in which there was a proposal to change the way capital gains were treated. In fact, I remember calling Chairman Archer on this particular point myself and saying this is really going to cause a significant problem. I think the Chairman figured out a way to save that so it would not have that particular impact. So, at least at a certain level, it has had some beneficial impact, but, of course, there have been no really big tax bills enacted since that provision was implemented either.

Mrs. THURMAN. Well, they have come out of this Committee. The other issue was on the 703.

Mr. ROSSOTTI. I am afraid I am going to have to get back to you on that first question because I do not have the answer. I will have to get back to you on it. I just do not have the answer in my head.

Mrs. THURMAN. I would love to hear from you because it does deal with the Social Security benefit taxable income, and if we are in a situation where we have given now some bad information or makes it complicated, then I would really like to be able to look at this penalty issue.

Mr. ROSSOTTI. We will get back to you. I just do not have the information readily available.

Chairman HOUGHTON. Thank you, Mrs. Thurman. Mr. Coyne?

Mr. COYNE. Commissioner, as part of the reforms 2 years ago, there was what was called the 10 Deadly Sins provision that was in there, and one of them had to do with the willful failure to file any return after the due date for filing returns and extensions for employees. Are you familiar with that?

Mr. ROSSOTTI. Yes, I am.

Mr. COYNE. Have you had to enforce that at all?

Mr. ROSSOTTI. Yes, sir. As a matter of fact, last year we provided a complete report to the Congress. So I can give you an update on all of the provisions, all of the sections, not only that one section of 1203(b). I think that we have a great deal of experience trying to administer that provision.

Mr. COYNE. So you have submitted that as part of a report?

Mr. ROSSOTTI. We submitted it last year, and I have got an update that I can give you this year, if you like, on the whole section.

Mr. COYNE. Okay, that would be good.

Mr. ROSSOTTI. It gives all the statistics on how many investigations there have been and how many people have been dismissed for violations of various subsections.

Mr. COYNE. Thank you. Thank you.

Chairman HOUGHTON. Mr. Commissioner, thanks very much. We are delighted that you have been here with us.

Now I would like to call the second witness, Nina Olson, National Taxpayer Advocate Service. She is an old hand, having been in this office for a little over a month.

So, Ms. Olson, you will never be more objective than you are now. So we would love to hear your testimony.

Ms. OLSON. Thank you, sir.

I am pleased to appear before you today to address the 2000 filing season. As you know, this is my first appearance before you as the National Taxpayer Advocate. I come to this position with over 25 years of front-line experience in tax practice and procedure, and yet, during my first 30 days on the job, I have learned an enormous amount about how the IRS works.

I already knew from my private practice that IRS employees are dedicated public servants. They are a valuable resource for anyone trying to identify and resolve taxpayer problems. I would like to acknowledge with gratitude my predecessor, W. Val Overson, the first National Taxpayer Advocate, and the Deputy National Taxpayer Advocate, Henry O. Lamar.

I know that the National Taxpayer Advocate's independence and authority are a matter of interest to this Subcommittee. So I will address this issue first.

The Commissioner of Internal Revenue delegated certain authorities to the National Taxpayer Advocate on January 17th, 2001. Some TAS employees may prefer more authority than will be re-delegated to them. I have made it clear to my employees that I will not hesitate to seek additional authorities if we need them. However, I am keenly aware that if we become a shadow IRS, we may lose our effectiveness as an advocate for systemic change.

Some doubt our independence. I have no such doubt. I believe it is appropriate for the Taxpayer Advocate Service to be located within the IRS. TAS is not TIGTA or the GAO. The National Taxpayer Advocate is not a watch dog. She is an advocate before, during, and after the filing season.

For at least the last two filing seasons, IRS compliance personnel were detailed to the customer assistant sites or telephone lines in order to assist more taxpayers. Whenever operational personnel are detailed out of their original areas, response times in those areas lengthen. If the delay is more than 30 days over normal processing time, the matter will meet Taxpayer Advocate criteria.

We are concerned that the number of cases arising from delays of more than 30 days may prevent us from assisting taxpayers we are uniquely designed to help, mainly those suffering from some form of financial hardship or irreparable harm.

No review of the filing season would be complete without mentioning the earned income credit. The statute and procedures developed to reduce error and fraud in this program must also protect the rights of taxpayers. If we subjected middle-class and more affluent taxpayers to the kind of intrusive inquiries we routinely subject a taxpayer to in an EIC audit, the entire EIC audit program would be shut down in response to taxpayer complaints.

Last month, I observed the operation of the dependent database. Once the database is refined, it should significantly lessen the number of eligible taxpayers examined, have a chilling effect on those taxpayers contemplating fraud, and provide an opportunity to better educate those taxpayers who are being examined.

The Taxpayer Advocate Service recognizes the importance of electronic tax administration to the integrity of the tax system. However, we are concerned that taxpayers who face language or literacy barriers, or who do not have ready access to computers, will be left behind in the push for electronic filing.

We are mindful of Congress' direction that the IRS not interfere with the free operation of the market. We also do not believe that the IRS should enter the business of tax return preparation.

As I outline in my written comments, I believe there is a middle ground, but before we reach it, we must answer this question. To what extent should the tax system protect a vulnerable population in the tax preparation arena? This is not a decision the IRS can undertake without further guidance from Congress.

Every filing season results in a host of document-matching procedures and taxpayer notices. Taxpayers and practitioners alike are confused by the various forms these communications may take. We sympathize with the taxpayer's frustration in determining his or her rights related to IRS notices, including the right to appeal.

We have addressed these issues in our administrative and legislative recommendations and will continue to be active in this area.

The Taxpayer Advocate Service's dual mission of problem resolution and systemic advocacy involves a delicate balancing act with almost irreconcilable tension, but this tension can be a source of creativity for all. By being independent, but remaining inside the IRS structure, the National Taxpayer Advocate has access to all IRS employees. This places an obligation on TAS employees to persuade and negotiate, but that is the job of an effective advocate.

Mr. Chairman, I thank you for this opportunity to come before this Subcommittee, and I welcome your questions.

[The prepared statement of Ms. Olson follows:]

Chairman HOUGHTON. Well, thanks very much. I appreciate it. Mr. Coyne, would you like to ask a question?

Mr. COYNE. Thank you, Mr. Chairman.

The Taxpayer Advocate's office in the past has had the problem with the innocent spouse provision, and I was just wondering if you could update us at this point on what the status of the large numbers of those instances are.

Ms. OLSON. We pulled an inventory on March 23rd of our cases. Nationwide, Taxpayer Advocate cases were approximately 2,000, out of about 50,000 cases, or one out of 25 or 4 percent of our caseload. I honestly do not know yet whether that seems a large number or small number.

What I found very interesting is that of those 2,000 cases, 95 percent of them related to the criteria that we use to accept a case resulting from unreasonable delays, more than 30 days; something unresolved by the time it was promised; or systemic failure. The cases were not related to the criteria that we use for the immediate and irreparable harm, the significant hardship type criteria. Those counted for only 10 percent of the cases.

We found that the average processing of those cases was over 180 days, and, interestingly, we found that very few of the cases dealt with tax years after the restructuring act. Almost 20 percent of them dealt with 1980s cases, where the underlying tax liability was in the 1980s, and 60 percent of them dealt with the years 1990 through 1997.

We found some interesting information that we are using to think about recommendations for the innocent spouse program. Currently, all innocent spouse cases by the operation unit are being reviewed, every single one of them. And the Service did that, obviously, to ensure that with a new statute there was some continuity and consistency in the decision. But we do need to ask, should we be doing this, because that review adds 2 or 3 months.

We also found that there was a long delay, often 2 months, when a case was actually closed, and the decision had been made. Two or 3 months were related to an accounting function of trying to separate out the accounts from the innocent spouse and the non-electing spouse, and we couldn't close the case finally until we had done that actual accounting separation.

Let's see if there is anything else. We found that in our particular cases, for many of the cases that were categorized innocent spouse, there was no 8857 form, the request for innocent spouse relief, that had yet been filed. Somebody had just called us saying we are an innocent spouse. So the paperwork hadn't even begun, and yet they are on our system as an innocent spouse case.

We also found that a large number of cases were categorized as innocent spouse, and they were injured spouse, and we had not made that determination.

Finally, we found that some cases were categorized as an innocent spouse case that are really more an erroneous type offset.

So that has led me to believe that in just our own data we need to go in and look at how we are categorizing these cases and then to really see what is going on in the national program about innocent spouse.

Mr. COYNE. On another subject, on the earned income tax credit, in your testimony you point out, and I quote, "It is interesting to note that of 576,000 1990 Form 1040 returns claiming EITC with math errors, 44 percent of those returns showing computational errors were commercially prepared. In addition, commercially prepared returns accounted for 55 percent of the math error adjustments in which the EITC was partially or fully disallowed." And I think that goes to your earlier comment in your testimony where you point out about the necessity to be as fair with EIC filers as you would be with moderate- and low-income filers in other circumstances. Thank you.

Chairman HOUGHTON. Thanks very much. Mrs. Thurman?

Mrs. THURMAN. Thank you, Mr. Chairman.

First of all, Ms. Olson, I just want to tell you that if I don't say this, my office will absolutely have a fit. So let me just say on behalf of my congressional staffers who work very hard in trying to also solve people's problems, they have been very impressed with the Taxpayers' Advocates. They have been very forthcoming. I have actually had the opportunity to sit with one just recently on a case that my office has been involved in on an estate tax issue, and they have been knowledgeable and yet trying to--you know, this is--what you do is not easy. It is not an easy job when you are trying to make it work and sometimes that just doesn't happen. And you can see it in them, and I appreciate their concern.

Ms. OLSON. Thank you. I will pass that on to them.

Mrs. THURMAN. In saying all of that, and as kind of the question that I asked the Commissioner, and certainly because of being one that would be right down there in the front line with some of these folks, I really do look forward to any recommendations, as you have put out and as was put out recently in your report, things that we can do to make it easy. I guess I thought we had gone a little bit further a couple of years ago when we thought that when this Committee did a tax bill that there would be a lot more conversation, not just how many taxpayers or--you know, I really would like to hear the complexity because it certainly sounds to me--and with your background and working with low-income families that the complexity is as much of a problem as any real fraud and abuse that seems to be spouted every so often when we try to get into a tax fight up here.

Ms. OLSON. I think that we are looking at our annual report, and we have engaged in discussions with your staff as to how we can turn this into a tool for you all. We are hoping that this year we will provide examples in our legislative recommendations so that you can see what has brought us to make this recommendation. For certain recommendations, we hope to do an analysis of the information system impact, just simply saying this will save money, this will save time and effort, this will be an easy thing to do.

We will be looking at privacy considerations because I think that that is something that we don't spend enough time about, and we may have some insight on that from the field, maybe even just the appearance of privacy. There may be something that is perfectly legal, but it sends shivers up taxpayers' spines. So I think we have really heard from you your expectations of this document.

I will say that we are--and I have utilized my liberty, my honeymoon period as the new Advocate to come in and suggest that we revisit some of our legislative recommendations over the last 3 years. And you may find the Taxpayer Advocate Service being so independent that they are reversing some of their own legislative recommendations.

Mrs. THURMAN. Well, and I think one of the other services that has been provided for people that don't know this is just the ability for them to come into our Web sites and be able to go out to you all or even to IRS to find out some answers and questions has been an enormous help for us to send people, you know, and then they eventually probably end up back talking to us.

Ms. OLSON. Right.

Mrs. THURMAN. But at least it is available to them, and I know that the Taxpayers' Advocate group from Jacksonville were in a couple of months ago, I guess even prior to your appointment. But they have really given us some help in that way, too.

I really think that you can offer us, instead of us even slamming people that you are trying to help, that we really figure out what we have done to cause a problem out there, so I appreciate the work that you all do. Thank you.

Ms. OLSON. Thank you.

Chairman HOUGHTON. Thanks, Mrs. Thurman.

Ms. Olson, I think I only have one further question. We are going to be hearing from taxpayer preparer groups and their continued need for tax simplification. If there is one area you think needs to be simplified in this brief tenure you have had here, what would you think it would be?

Ms. OLSON. I think there are two specific areas where we see problems that also taxpayer practitioner groups do. One obviously is the areas that impact all taxpayers, dependency exemptions, filing status, and then if you go into the low-income population, the earned income credit. And they do seem to be linked, and we do seem to spend an inordinate amount of time wrestling with these very basic issues that touch almost every single taxpayer. What status do you claim? Are you single, married filing jointly, head of household?

I think that there is a lot out there. We have certainly made some recommendations about how you can unify the various definitions, conform the definitions, and keep different provisions for where there are true policy reasons for keeping those definitions. And I think that we can make those changes. Certainly my report, the annual report, will reflect some very specific recommendations on those issues.

The second one is penalty and interest reform, and my advocates, we have been polling the field asking for examples from the front-line employees of where they see cases where they feel that the taxpayer should be given relief in the interest situation, where the tax debt has accrued interest. And we just can't get there under the current statute.

And we have certainly been looking at penalty reform over the years and have made a recommendation about that. And so we hope that over the course of the year we will be able to give you some very concrete examples of things that might help in crafting legislative fixes for these issues. And as you see in our report, penalties and interest is the top most litigated issue in our list of ten most litigated issues. It is not the underlying tax that they are going to court about.

Chairman HOUGHTON. Well, thanks very much.

Ms. OLSON. Thank you.

Chairman HOUGHTON. We appreciate this.

Mrs. THURMAN. Mr. Chairman?

Chairman HOUGHTON. Yes, go ahead, Mrs. Thurman.

Mrs. THURMAN. I have to ask you this because I just--the great staff that I have over here said you need to ask her about this.

Ms. OLSON. Okay.

Mrs. THURMAN. And it actually deals with a Second Circuit Court of Appeals ruling, and it is called the mail box rule. Evidently, there is a misconnect, just so you will know, between some of the--our Florida office and out of here. So if you would let your Florida office know about this, I could get a constituent very happy. Thank you.

Chairman HOUGHTON. Okay. Thanks very much.

Ms. OLSON. I am familiar with that, yes.

Chairman HOUGHTON. Okay. Well, thanks very much, Ms. Olson. We are delighted to have you here.

Chairman HOUGHTON. Okay. Now we have our next panel: The Honorable David Williams, Inspector General, Treasury Inspector General for Tax Administration, Department of Treasury; and James R. White, Director of Tax Policy and Administration Issues of the General Accounting Office.

Well, gentlemen, thanks very much for being with us. Mr. Williams, would you like to testify?

Mr. WILLIAMS. Thank you, sir. Mr. Chairman and members of the Subcommittee, I appreciate the opportunity to appear here today to discuss the 2001 tax filing season and the IRS' continuing efforts to improve taxpayer service.

The IRS is experiencing success in processing tax returns and issuing refunds. The IRS also continues to provide substantive information to taxpayers on its Web site. This filing season alone, the Web site received over 986 million accesses. While these are bright spots to recognize, the IRS is faced with the challenge of processing a greater number of returns around April 15th, since many taxpayers have chosen to file later than expected.

Electronic returns, while significantly up, have not reached the anticipated level. Challenges also continue to exist regarding the performance of and the plans to enhance customer service. The IRS acknowledges the need for customer service improvements. Our audit results also show the need for improvement.

Over a 4-day period during this filing season, our auditors made 368 random test calls to IRS toll-free numbers and were unable to gain access 37 percent of the time. When successful in getting through, the IRS incorrectly responded to 47 percent of the questions. The topics of the test calls were obtained from the IRS' list of frequently asked questions. We also encountered a similar situation when we visited 47 taxpayer assistance centers in 11 States. The IRS did not provide auditors with the correct answers 49 percent of the time. In the majority of our contacts, we were served within 15 minutes and were treated courteously. However, in over 10 percent of the contacts, the IRS did not provide an adequate professional response.

Dramatic improvements in customer service are heavily dependent on the success of the IRS systems modernization initiatives. Among the benefits taxpayers are expected to receive from systems modernization initiatives are: better and quicker access to tax help; readily available, accurate, and current account information; more electronic filing capabilities; more refund in days instead of weeks; and expanded self-service options over the telephone and the Internet.

To accomplish modernization, the IRS contracted with a consortium of experienced information technology companies led by a major integrator. This contract, known as the PRIME, is a multi-billion-dollar contract over a 15-year period. Since it began 2 years ago, about $400 million has been spent on systems modernization. And while the basic architecture and program management processes have been established to guide the modernization, thus far most of the ongoing systems projects are taking longer and costing more than originally estimated. As a result, benefits to taxpayers have yet to be realized.

The customer communications project is intended to be the first major systems modernization accomplishment. This project is designed to route taxpayer calls to a customer service representative who is best qualified to answer the taxpayer's question anywhere in the United States and will also provide expanded self-service telephone and Internet services. Although progress has been made on the project, deliverables originally scheduled for 2001 have been scaled back significantly, including the ability to route calls to the best qualified person. Also, implementation dates for the deliverables have steadily slipped and cost overruns have occurred. As a result, the expectation of answering an additional 9.6 million calls during the 2001 filing season will not be realized, nor will the telephone assistors be freed up for other work.

This situation in part is due to the decision to move the project's development stage before completing critical foundational products, such as the risk management plan and security testing schedules, initial software design failures, and virtually no allowance for unplanned events. The project has special significance since it is the first systems modernization deliverable for taxpayers' benefits. In this and other instances, the PRIME and the IRS have overestimated their ability to deliver products on schedule and within cost estimates.

I would be pleased to respond to questions that you have at the appropriate time.

[The prepared statement of Mr. Williams follows:]

Chairman HOUGHTON. Thanks very much. Mr. White?

Mr. WHITE. Mr. Chairman and members of the Subcommittee--

Chairman HOUGHTON. Do you want to put the microphone on? Thank you.

Mr. WHITE. Mr. Chairman and members of the Subcommittee, we are pleased to be here today. As requested, our testimony deals with three related subjects: IRS' performance during the 2001 tax filing season, the status of IRS' business systems modernization effort, and the security of IRS' electronic filing system. It is fitting to discuss these topics together. The only contact most Americans have with IRS comes during the filing season. If the promise of IRS' modernization is to be realized, that is, if taxpayers are to receive better service in future filing seasons, then IRS must succeed at modernizing its information systems and ensuring the security of tax data.

With respect to this year's filing season performance, as shown by Figure 1 and also on page 11 of my statement, IRS had received roughly 50 million tax returns by March 16th. The white bars are total returns, starting in 1997. Our preliminary analysis of data available to date shows several positive aspects to the filing season as well as some concerns.

First, IRS' reorganization into four operating divisions has been virtually invisible to taxpayers. Neither positive nor negative effects on service are evident--not surprising, given the newness of the divisions.

Second, IRS has processed tax returns and issued refunds without significant problems and has seen a continued increase in the percentage of returns filed electronically, as shown by the gray bar in Figure 1. The rate of growth in the number of electronically filed returns is important because Congress set a goal that IRS receive 80 percent of all returns electronically by 2007. IRS has projected growth in electronically filed returns of about 20 percent this year; however, the actual increase to date has been only about half that. IRS had tried to make electronic filing more convenient this year by allowing more filers to sign their returns with a PIN number. While used by millions of taxpayers, the PIN program has encountered some problems, however. Many taxpayers have had their returns rejected, for example.

Third, as shown in Figure 2 on page 19 of my statement, IRS has done a better job of answering the telephone this year compared to last. Figure 2 shows level of service or the percentage of calls that are answered. Because IRS rerouted a substantial number of calls this year to improve service, we adjusted the 2001 base to allow for valid comparison to 2000. The comparison to 1998, however, is less certain. In any case, however, there are concerns about assistor productivity, including concerns about the amount of time taken by assistors between calls. Even with the improved service this year, further improvement in telephone assistance is needed if IRS is to achieve its goal of providing top-quality service.

Fourth, the quality of tax law assistance of walk-in sites remains poor, as TIGTA reports. IRS has changed the way it has organized and staffed to provide walk-in assistance and is planning to make changes to improve service during the 2002 filing season.

Turning now to business systems modernization, we have long held that IRS needs to establish fundamental modernization management controls before it begins to build and implement modernized systems. IRS has made important progress in developing and implementing these capabilities, but it still is not where it needs to be. In Figure 3, also on page 31 of my statement, the bottom four horizontal timelines represent four key ongoing systems acquisition projects. The stars on those lines show where detailed design and development began on those projects. The fact that IRS has moved past those stars without all the needed management controls implemented means the risk associated with those projects is now considerably greater. At these later stages in a project's life cycle--that is, after detailed design and development has begun--any systems rework is much more expensive and time-consuming. Given that IRS needs additional money for modernization and is seeking congressional approval of these funding needs, this is an opportune time to ensure that IRS addresses these risks. And just today, the Commissioner told us he is taking steps to pull back on some projects in order to focus on these concerns.

Finally, with respect to the security of IRS' electronic filing systems and electronically transmitted taxpayer data, our review last year showed that IRS had ineffective controls to ensure security. We demonstrated that individuals both inside and outside of IRS could gain unauthorized access to IRS' electronic filing systems and view, modify, copy, or delete taxpayer data. According to IRS officials, IRS moved promptly to correct the access and control weaknesses we identified before this filing season. It developed plans to improve security over its electronic filing systems and internal networks and said that it had substantially implemented those plans.

Mr. Chairman, this concludes my statement. We would be happy to answer any questions.

[The prepared statement of Mr. White follows:]

Chairman HOUGHTON. Thanks very much. Well, Mr. Williams, based on what you said, do you think the 2001 filing season was successful?

Mr. WILLIAMS. I am sorry, Mr. Chairman?

Chairman HOUGHTON. Based on the information you have given me, do you think the 2001 filing season was successful?

Mr. WILLIAMS. Yes, generally I think it has been a successful filing season. The numbers are up. I think IRS has met the goals. The 1040s are being processed in a timely fashion, so far as we know.

We have some concerns with regard to enforcement and customer service, but the filing season itself we felt good about the IRS' performance.

Chairman HOUGHTON. Okay. The accuracy of the tax law questions when TIGTA called the IRS telephone assistance line was less than 50 percent. And these questions came from the IRS list of frequently asked questions. What are we going to do to solve this problem?

Mr. WILLIAMS. The modernization that is moving in our direction we feel very good about. We think that it is very difficult to train low-paid and seasonal workers to answer complex tax law questions. The modernization will bring to them automated tools that will both allow the account to be accessible in a way that has accurate and current information, and it will provide the answers to the kinds of questions that are posed by taxpayers. So we feel that that is certainly part of the solution.

The IRS is moving, although we are not very comfortable with the pace, with regard to simplifying notices and working on forms to simplify those as well. There are taxpayer education programs and programs for preparers that we think will be very helpful, too. And then the IRS needs to continue advising you of efforts to simplify the taxpayer burden with regard to legislation. You asked IRS to begin that, and they have given you the first few products. We need to aggressively continue letting you know where IRS just can't get the job done in terms of explaining to the customers.

Chairman HOUGHTON. All right. Thank you. Now, very briefly, Mr. White, you talked about the security issue. Has the GAO been able to test the new security measures?

Mr. WHITE. Mr. Chairman, let me bring up Mr. Dacey. He is the Director of Information Security Issues at GAO.

Mr. DACEY. Mr. Chairman, no, we have not. We plan to do that as our normal follow-up process.

Chairman HOUGHTON. When will that be?

Mr. DACEY. That will be some time this late summer or fall.

Chairman HOUGHTON. All right. And when you do that, will you report to the Committee? Will you report to the Commissioner? What will you do with that information?

Mr. DACEY. When we finish that, we will go through our normal process of reporting that out in our reports.

Chairman HOUGHTON. Well, I would be interested--I don't know if the rest of the panel would--in getting that information. If you could pass it along to us, it would be appreciated. Mr. Coyne, would you like to ask questions?

Mr. COYNE. Thank you, Mr. Chairman.

Mr. Williams, I wonder if you could outline for us what portions of your funding, the IG's funding, and staffing are allocated to the following compartments: systemic problems at the IRS as one category; complaints about high-level IRS employee actions; and, number three, fraud and abuse in the tax system itself. Are you able to break down what your commitments are to those?

Mr. WILLIAMS. Yes, sir, I am. We have about 1,000 people, and our funding, of course, is largely in support of those efforts.

With regard to attacking the systemic problems and the root causes for issues that come forward and trying to make recommendations for those, we have about 375 of our FTE dedicated to that. They produce about 160 reports a year.

With regard to our fraud efforts, of the 1,000 we have about 475 of our FTE dedicated toward attacking fraud and abuse. They conduct about 4,000 investigations a year.

With regard to complaints and allegations that we have regarding our GS-15s and SES'ers and Presidential appointment level personnel, we have about 8 percent of our resources on that, and we manage about 540 complaints annually. That has been the history of our short existence in the first 2 years.

Mr. COYNE. So the last one you put in percentage terms instead of employee terms? Eight percent, did you say?

Mr. WILLIAMS. Yes, sir.

Mr. COYNE. Eight percent of the personnel?

Mr. WILLIAMS. Yes. Our investigators--8 percent. Our investigators manage that, and within their case inventory are a mixture of general kinds of investigations and high-level investigations.

Mr. COYNE. All right. Thank you.

Chairman HOUGHTON. Mrs. Thurman?

Mrs. THURMAN. Thank you, Mr. Chairman. I have a couple of questions.

In your testimony, Mr. White--I had to figure out who was writing this--you talk about the folks that are actually giving this information, either the telephone--and the problems that have caused. Can you give me who this person might be, what kind of background, what kind of training, what kind of training goes into this person? Because I noticed here it said that in some cases they couldn't even get the 6 weeks' training that was necessary. I need to know a little bit about who this person is that may be answering these questions.

Mr. WHITE. Yes, there are different kinds of assistance there. The IRS has about 10,000 telephone assistors, and then I think the type of assistance you are referring to there is the walk-in assistance. A lot of those people are moved over from other spots in IRS, and they are now taxpayer resolution representatives.

Mrs. THURMAN. So they have some background in the law, they have--

Mr. WHITE. They have some background, but IRS has also recognized that there are training needs associated with these people. They need a fairly broad-based knowledge of IRS and IRS processes in order to deal effectively with taxpayer problems. And so far what we have found is in standing up these new positions and filling these new positions, while they have been trying to meet training needs, there still are unmet training needs there.

Mrs. THURMAN. So maybe one of the recommendations is to make sure before we put them out, they are on the front line or answering phones or whatever, that they should be given some kind of training before we let that happen? Because the next follow-up question I have, especially based on some of the issues that we have heard from other folks, either the Taxpayer's Advocate and/or the Commissioner, I mean, if I am a taxpayer and I call these lines or I go in for this assistance, I mean, I am assuming that the information that I am getting back is correct. And I make a determination based on that information on how I might file. And if my filing is not correct or the information I was given was incorrect, and I don't meet--and all of a sudden I get audited or there is a penalty or whatever, I mean, how do we correct that part for the taxpayer who actually may end up getting the wrong information and they end up having to pay the penalties?

Mr. WHITE. Part of the correction there is the responsibility of middle-level managers at IRS, and in order to better manage that program, they need, first of all, information, about what performance actually is, and then they need to do the kinds of studies to be able to link IRS' training efforts, for example, to the quality of answers. Are assistors getting the right kind of training so that they can give better answers? And that requires an in-depth evaluation of the performance data to make those kinds of linkages. It is not easy to do, but that is the responsibility of middle-level management.

Mrs. THURMAN. But are you seeing that happening now?

Mr. WHITE. We see continued needs for that kind of evaluation. With respect to telephone assistance, for example, we are issuing a report to this Subcommittee later this week where we recommend that the Commissioner ensure that exactly those kinds of performance evaluations are done.

Mrs. THURMAN. I just had a situation in my office where somebody was given some information of not to pay by a tax preparer. I don't know where they got this information if they didn't have this final piece of paper that tells them what the valuation of their property was. So for 4 years, they didn't pay anything. All of a sudden now they are sitting here with, you know, $100,000 worth of penalties and didn't even include, you know, what their estate tax would have been. And these folks are making $14,000 a year. Needless to say, they are in a real bind.

But it just strikes me that if we are giving wrong information and--I mean, you know, where do we go to make this work? I don't know. And how do we make sure that the taxpayer is not getting the penalty for an answer that was given incorrectly?

Mr. WHITE. It is a good question. Again, I think part of the response there is that better information systems are needed at IRS. They need to be able to track those kinds of cases. They need to have the data on how many cases are taking that long to resolve. And then with that kind of data, they can do the sort of analysis to try to figure out what the causes are, and with that information then presumably managers could take informed action to fix the problems.

Mrs. THURMAN. So then based on what, I guess, some of us on this side have asked about with this next budget coming up, is there a number, I mean, based on what has been submitted and--I mean, have you all looked at what the cost of doing this would be? And when we make a recommendation to, you know, the appropriators to make sure that this is covered, is there a magical number out there that makes this work?

Mr. WHITE. I don't think there is a magical number for the sort of evaluation of performance that we are talking about. There clearly is a cost to doing those kinds of evaluations. So it is a management--

Mrs. THURMAN. And then the training.

Mr. WHITE. Yes. There is a cost there as well, and ultimately it is a management judgment that has to be made by higher-level management at IRS about how much of this is worth doing.

Mrs. THURMAN. I will be interested to see the budget to see if it reflects some of the issues that you have raised here today as far as training and personnel and what we are doing. So I hope we will have an opportunity to look at that when it comes in.

Chairman HOUGHTON. Thanks very much. Gentlemen, we appreciate your being here with us. I would like to call the next panel: Mark Ernst, president and chief executive officer of H&R Block, who comes from Kansas City; and Claudia Hill, Chair of the Government Relations Committee, the National Association of Enrolled Agents, from Cupertino, California.

Mr. Ernst, delighted to have you here with us. Would you like to testify?

Mr. ERNST. Thank you, Mr. Chairman, members of the Subcommittee, and thanks for inviting us.

As you know, Mr. Chairman, H&R Block prepares about one in seven individual income tax returns--over 16 million, which works out to about 37,000 per congressional district. We serve clients at 9,000 offices in the United States, and we publish Kiplinger TaxCut software as well as offer online tax preparation and electronic filing.

We are reshaping the company to also offer clients financial planning, mortgages, savings and investment products, so they can combine tax compliance with an annual financial checkup. And to expand our business services, we have built a national accounting practice anchored by RSM McGladrey.

My comments this afternoon can be boiled down to four points:

First, the filing season has gone very well, but not without some problems. We want to highlight three and hope to work with the IRS to fix them.

Second, because we are likely to fall short of the 2007 electronic filing goal set by Congress in 1998, we urge elevated efforts by the IRS and tax professionals, and we recommend a more dramatic incentive to taxpayers in the form of a 3-year refundable credit to accelerate electronic filing.

Third, IRS reform is progressing well, and we are impressed by Commissioner Rossotti's success. To maintain that momentum, we hope that Congress will follow the recommendation of the IRS Oversight Board to ensure adequate funding.

And, fourth, IRS can operate more effectively if it enlists more help from its external stakeholders.

First, on the filing season, although the season does not end for another 13 exciting days, we have enough information to report that it has been successful. Our experience in working with the IRS has been very positive. The e-file system has worked well across all service centers, and we have experienced very little down time.

As of March 15th, our return preparation is up approximately 2 percent and electronic filing is up about 8 percent. Over 87 percent of our returns are electronically filed. Electronic filing through our TaxCut software and Web-based tax preparation is up 58 percent over last year.

But every season has glitches. Three from this year are particularly noteworthy.

First, the IRS needs to aggressively enforce its new rules requiring tax practitioners to use a client's W-2 in order to e-file.

Enforcement delays this year gave unfair competitive advantages to firms that improperly used pay stubs or leave-and-earnings statements to prepare substitute W-2s.

Despite warnings that this might occur, the IRS response was too little and too late. More needs to be done next year so compliant taxpayers and practitioners won't be hurt.

Second, the IRS needs to improve the debt indicator.

When the debt indicator works, taxpayers learn whether any delinquent State or Federal taxes, student loans, or child support payments will be offset against their refunds. The program helps taxpayers by making them aware of problems they need to resolve. It helps tax preparers and lenders by clarifying risk, which helps lower the cost of refund anticipation loans. And it helps the IRS by increasing electronic filing and improving compliance.

But when errors occur, as they did this year when all Social Security numbers were not included in IRS offset screens until February 1st, all suffer. The firms participating in this year's DI test incurred significant losses, which eventually get passed through as higher fees or discourage electronic filing.

We look forward to working with the IRS to make the DI program run more effectively when it is renewed, as we hope it will be, in 2002.

The third glitch involves difficulties using PINs in place of paper signature documents to authenticate electronic filing.

The PIN program needs to be redesigned because the reject rate caused by taxpayer-provided information that doesn't match data in IRS computers is unacceptably high. The reject rate this year for self-prepared returns, using software or online applications, has been 20 percent compared to a normal reject rate of 12 to 13 percent. Almost all the difference is related to PIN rejects.

Whether this occurs because taxpayers or tax practitioners enter the wrong data or because the IRS has wrong data in its computers, the program is in trouble if e-filers using a PIN have a greater likelihood that their returns will be rejected.

Second, on electronic filing generally, we need to face the fact that 3 years after Congress set twin goals of electronically filing all computer-prepared returns by 2002 and electronically filing 80 percent of all tax and information returns by 2007, projections are that America will not meet these targets.

The IRS and practitioners must redouble our efforts to convert paper filers. We need more promotion and marketing, more cooperation from CPA firms, a more workable PIN program, and friendlier standards to encourage more professionals to enlist as authorized e-filers.

But because the present arsenal of incentives may not be adequate, we recommend a more dramatic jump-start, which is the enactment of a $10 to $15 refundable tax credit for a limited period of time for taxpayers who choose electronic filing.

Third, on the budget for 2002, we are concerned about reports that the administration may not endorse the IRS Oversight Board's recommended budget, especially the personnel and technology initiatives.

We believe the IRS should have the funds it needs to do its job. Too much is at stake to shortchange computer updates or risk breakdowns, especially when Congress is about to add new provisions to the tax code.

And, finally, on working with the IRS, we continue to find a welcome spirit of partnership. The new national accounts manager system works well. We get excellent help in solving problems, and IRS staff, especially in the Electronic Tax Administration area, are responsive and diligent.

Mr. Chairman, we look forward to working with the Subcommittee to ensure that for most Americans the tax-filing experience is, if not enjoyable, at least tolerable. We appreciate the chance to be here today and welcome your questions.

[The prepared statement of Mr. Ernst follows:]

Chairman HOUGHTON. Thanks very much. Ms. Hill?

Ms. HILL. Mr. Chairman, members, my name is Claudia Hill--

Chairman HOUGHTON. Would you put the microphone on?

Ms. HILL. Okay. Thank you. Mr. Chairman, members, and staff, my name is Claudia Hill, and I am an enrolled agent from Cupertino, California, in private practice. I work primarily with individuals, small business, and I am an electronic filer--some. Some.

On behalf of my more than 10,000 enrolled agent colleagues in the National Association of Enrolled Agents, I would like to express my appreciation for our ability to present testimony at this hearing today and to express my appreciation for your interest in hearing what the taxpayers have to say about dealing with the filing season.

I have several comments. The first one has to do with the IRS budget. Over the last decade, the IRS has been asked to do more with fewer resources. While the overall budget has grown in recent years, by many measurements it has declined. At the same time, Congress has demanded and the Commissioner has delivered a greater emphasis on taxpayer service. While much of the technology infrastructure for a modern accounts management system has yet to be delivered, our members report that IRS is generally doing a more professional job of handling case management issues and general tax questions from taxpayers.

Unfortunately, we have also witnessed a corresponding decline in service at the audit and collection levels. Experienced IRS employees in these areas have been reassigned to cover the phones and help with tax returns during filing season. It is our belief that adequate resources for the IRS make a difference in the public satisfaction with the IRS specifically and the Federal Government in general. We also believe it is essential that IRS be given adequate resources to maintain an enforcement presence.

Taxpayers need to know that there is a consequence to non-compliance. When audit collection efforts are reduced as greatly as they have been in recent years, it sends an ambiguous message about our voluntary tax system. Some people start thinking the system really is voluntary. As a front-line practitioner, we then must deal with taxpayers who want to play audit roulette or engage in illegal tax schemes.

As to modernization, this is the first filing season since the IRS completed its business restructuring in an effort to organize around its customers. NAEA members are beginning to see some positive returns. Access to information has been dramatically enhanced with the continued improvement of the IRS Web site. The new small business self-employed Web site is a marvel of accessibility and usability. The new criminal investigations site gives practitioners a resource to point to when we find taxpayers who don't believe the IRS is using compliance resources to fight abusive trust and employment tax avoidance schemes. More forms are capable of being filed electronically than ever before, and access to forms and information on the Web is available through public libraries, through home computers. It has been a great, a very good improvement.

The communications and public liaison efforts of the IRS have been greatly enhanced to inform and advise the public on a broad range of issues, and partnerships between the IRS and the public on a broad range of association needs, taxpayer needs are developing and longstanding issues are being resolved in a timely and cost-effective manner.

The ability of the agency to collect more accurate data more efficiently and then to be able to use that better data will help taxpayers deal with the Service and practitioners deal with the taxpayers and the IRS. We look forward to the day when we can resolve problems online, when we can use information that we have gathered electronically and communicate with the IRS electronically. Our message to Congress is to stay the course with these investments in technology and insistence with customer service, make sure the IRS and its partners deliver benefits to taxpayers and practitioners on schedule.

Every year we survey our members on the problems of the filing season, and the number one response we get from our members is tax law complexity. We then ask our members to choose the most complex item in the Internal Revenue Code. We have dubbed their selection "the tax headache of the year." For the second time in 2 years, the overwhelming response has been the individual alternative minimum tax. It is affecting more of our population, including senior citizens, farm families, middle-income taxpayers, U.S. taxpayers living and working overseas, employees expected to bear the majority of their own employment-related expenses, and workers with incentive stock options.

Now, how can one type area of the tax code affect such a wide variety of taxpayers? Because in the last 15 years, the regular tax system has been changed, rearranged, and indexed, without attention to the AMT system running silently beneath it. Unfortunately, as the economy has changed, more taxpayers have found themselves pulled into an AMT trap. Quick examples of people that are affected this year, which you may have seen in some of the media:

A senior citizen who had to take money out of a pension plan to pay for medical expenses to care for his wife with Alzheimer's. He found himself in AMT because the AMT does not allow a complete deduction for medical expenses as the regular tax system does, nor does it allow the deduction for his property taxes or his State income taxes.

We saw taxpayer farmers affected. A few years ago, Congress saw the need to help balance out their income when they have volatile income from year to year by offering what is called a 3-year special income averaging. Unfortunately, there was no provision when income averaging using that method dipped below the AMT to allow the benefit. The taxpayer pays the AMT.

U.S. citizens residing outside our country who are encouraged to file in the U.S. and use the credits for foreign taxes paid are allowed to offset 100 percent of their regular tax but not all of their alternative minimum tax. In essence, they are double taxed.

Chairman HOUGHTON. Ms. Hill, could I just interrupt just a minute? Your time has expired, so if you could wind up your testimony as fast as possible, I would appreciate it. Thank you.

Ms. HILL. Okay. We have seen numerous issues on this. I will just name two other complexity issues and then be available for questions.

More complexity having to do with phase-outs and the earned income credit. There are over 20 commonly encountered aspects of individual returns that require phase-outs. These add complexity and they give a perception of unfairness with the law. When it comes to the EIC, the fraud in this program is an embarrassment to practitioners, the public, to Congress, and the IRS.

We believe that this might be addressed by dealing with whether or not there should be regulation of all commercial preparers, at least registration of them, as is done with the electronic return originator program.

That concludes my testimony, and I would be happy to answer any questions.

[The prepared statement of Ms. Hill follows:]

Chairman HOUGHTON. Thank you very much, Ms. Hill.

I would like to ask a brief question of Mr. Ernst, so thank you very much for being here. We have talked a lot about security. We talked about it with the Commissioner. We talked about it amongst ourselves. And we know that the e-filed returns are a tough area to keep secure. How do you keep those returns secure in your office?

Mr. ERNST. Well, we use a number of different methods to submit returns, both on the Internet and through our software products at retail and through our offices. In our office network, we have differing levels of restricted access and security controls for individuals who work for us. All returns go through a private network to a central location that is secure that we maintain. We do extensive testing of security at that facility as it aggregates returns from around the country from our various offices. Annually, we test our online electronic filing system for what we call "hacker attacks" or by attempting to break into the system ourselves in advance of the filing season and then on a random basis during the filing season to ensure that people cannot access our electronic filing system before or at the point we submit returns to the IRS filing centers.

In addition to that, we maintain client records in a central data warehouse for ongoing storage purposes, and from that we have extensive controls around who within our organization can even access those records. And we keep it separate from our e-file system so that people can't get through our e-file system into those records.

So we have built a fairly elaborate security system around the return data, both at the point of access initially when we acquire the data and when it is transmitted to our central repository before submission to the IRS.

Chairman HOUGHTON. Thanks very much. Mr. Coyne?

Mr. COYNE. Thank you, Mr. Chairman.

Ms. Hill, as you know, too often people who file for the EIC have their returns completed by practitioners that are paid filers. It is a very high percentage, I believe 44 percent. And also too often these filers, when there is a mistake, it is pointed out that it is fraud and abuse on behalf of the filer, the taxpayer that causes these mistakes and is not attributable in many instances to the fact that such an overwhelming number are filed by practitioners.

Is it your testimony--I think I heard you say that one way to correct that is to make practitioners register?

Ms. HILL. Well, first of all, a few years ago Congress did respond to the issue of preparers by having a special penalty for preparers of the EIC returns for due diligence. I believe the issue with electronic filing--not electronic filing but earned income credit has to do with the complexity of the provisions. There is a built-in incentive in the way that it is currently structured to falsify one's filing status. We have numbers of letters from our members who say that people come into their office and expect them to play a game where two people who may be married to each other, at least parents of children, each want to file as head of household and reap maximum benefits to the earned income credit, when if they were filing as married, they would not get the same dollar amount or possibly not even be entitled to it. So there is a built-in incentive in the way it is structured to encourage people to falsify their status.

Now, when someone comes into an office and tells a preparer here is their position, preparers that are regulated, CPAs and attorneys and enrolled agents, have a due diligence standard both to the IRS and to their professions that they cannot prepare those returns. And our members complain that they are injured by the number of other paid preparers who are willing to do this, because the people leave the office and have it done somewhere else.

Mr. COYNE. So do you think that there is a way to help out here by requiring registration beyond what already is required?

Ms. HILL. I believe that if there was a registration similar to what is used with the electronic return originators, IRS would have a much quicker access in instances where they find lack of diligence with preparers. They would be able to encourage education where currently I most States--there are only two States that even encourage education of paid preparers.

Mr. COYNE. Thank you.

Chairman HOUGHTON. Mrs. Thurman?

Mrs. THURMAN. Ms. Hill, just maybe to follow up on Mr. Coyne's question, because you make it sound like a lot of the earned income tax credit people that are trying to get these benefits are out here trying to game the system. What do you think is the real percentage of people trying to do that?

Ms. HILL. I believe there are errors both directions, really. I believe there are a lot of honest mistakes with misinterpretations. A major misinterpretation that was available in January of this year when the preparers were trying to understand was called the high income and the household decision as to whether or not--who could take the child as a dependent and claim the EIC.

I am not convinced that that was adequately resolved. So we may have returns in the system this year that expect it to not be available, but they were.

Mrs. THURMAN. Mr. Ernst, what is your feeling about this issue?

Mr. ERNST. Well, I agree. This is a very complicated area of the law, and, in fact, much of what the IRS now requires in terms of due diligence has been modeled after the work that we originated in trying to address this issue at the front lines of our own system working with clients.

Number one, many households in America do not fit the neat requirements that the tax law tries to describe. You know, household formation and deformation occurs with fluidity in America in a number of these situations. And so the issue often is not one of people trying to game the system per se, although that certainly occurs. Often it is about honest differences in households that don't fit neatly inside of the definitions that practitioners are asked to help our clients comply with.

Mrs. THURMAN. So would you say, then, on the other side of this, since we don't hear as much about this, the complexity of some of the tax shelter issues, some of the things that were brought up in the Wall Street Journal and some of the other issues, is it the same kind of situation?

Mr. ERNST. I certainly don't think it is a situation where there is a loophole that practitioners are out helping taxpayers exploit, which is I think what you allude to. I think it is more of a situation of who qualifies as the primary support for a child, which is a key element in determining who gets to claim that child, and, therefore, who qualifies for the EITC can change because different family situations and differences of opinion of who is providing what kind of support are often dumped on our desks, and we are asked to sort that out and figure out who qualifies for what kind of credits.

Mrs. THURMAN. So there is kind of a difference going on on the other side.

First of all, let me suggest to you that I thank you for doing what you have done with the Department of Health and Human Services on the SCHIP program. I think that is a wonderful thing that you have done there. We need--Ms. Hill, you might want to let your folks know about that, because I think it really was a really good way to get across to low-income folks that need this program that that is available to them.

Ms. Hill, I thought your testimony particularly on the AMT and your--you know, you kind of gave us an outline of several different people and how they interacted with the AMT. If we were not able to do anything about the AMT, which is looking less and less this year in some of these tax bills, some of the areas that you described--the medical issue and some of those--if there were something we could do, because certainly these stories are just really very compelling. Could you give us, besides the one that you mentioned on the health care, the gentleman that took money out, where some others areas with AMT are where you can see some extreme problems that we are facing that we might be able to help in maybe a separate kind of bill? And, Mr. Ernst, if you would like to jump in there, too, I would appreciate it, because I think these examples are extremely--just kind of pull at your heart when you read this as compared to what is going on right now in total repeal.

Ms. HILL. A lot of the media coverage right now has to do with incentive stock options. The taxpayers who did not understand equity-based compensation, who thought that this was the best thing in the world, and all of a sudden they find out later that the amount of value on the day they exercised stock got to be included in their alternative minimum taxable income, even though the stock may have little or no value currently. I don't think the law ever intended this. The concept of the alternative minimum tax, back when it was restructured in 1986, had to look at the economic income, and the concept is it realized or recognized. And when you never realize it, should it ever be recognized gets to be the issue on this.

I don't know that there is something that can quickly be done to resolve that. I think to affect the largest number of people--and I certainly wouldn't want to eliminate equity-based compensation and incentive stock options from the system. But I think you can affect the largest number of people by looking at the benefits of eliminating those Schedule A itemized deduction type preferences.

For example, medical expenses, people don't do them to create a tax shelter. Having children and not being able to take the exemption for your children against alternative minimum tax, children are not a tax shelter.

So small steps, eliminating the children--putting the children back into the exemption base for AMTI, allowing the non-refundable credits to be used, that provision sunsets at the end of this year. If something isn't done, all the talk of families who are benefiting from the child credit, the dependent care credit, will get no benefit at all. They will see their taxes increase.

Mr. ERNST. You know, we would be happy to offer you a number of those types of situations that we think could have the greatest impact at the least amount of cost.

Mrs. THURMAN. Mr. Chairman, I noticed in their testimony--and it is one of the things that I am very concerned about, and maybe Ms. Hill said it--the credibility that we have, and when you take something, what you have been promised or what you believe is out there to be promised, and then to run up against this, we have a problem in what we are saying to folks at home. And I think that is a real concern for some of us, and especially in some of these situations that I think have been described today. So we thank you for bringing those to our attention.

Ms. HILL. Thank you.

Chairman HOUGHTON. Well, thanks. Yes, AMT started out as a beauty queen, and now it has ended up as a monster. Obviously, this whole wave is coming in, and we have got to be careful.

Any ideas, any thoughts you have on this, because we are going to be wrestling with this, whether it is this year or this month or maybe next year, and we have got to have the best advice you possibly can give.

Ms. HILL. It is insidious. It mutated.

Chairman HOUGHTON. Yes.

Ms. HILL. That is what happened.

Chairman HOUGHTON. Absolutely. Well, thank you very, very much. We certainly appreciate it.

[Whereupon, at 4:05 p.m., the hearing was adjourned.]
[Submission for the record follows:]

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