Statement of Mark A. Ernst, President and Chief Executive Officer,
H&R Block, Kansas City, Missouri

Testimony Before the Subcommittee on Oversight
of the House Committee on Ways and Means

Hearing on the 2001 Tax Return Filing Season

April 3, 2001

Mr. Chairman and Members of the Subcommittee:

I'm Mark Ernst, President and Chief Executive Officer of H&R Block. We appreciate the opportunity to discuss the 2001 tax filing season. With me is Robert Weinberger, our Vice President for Government Relations.

About H&R Block. H&R Block, founded in 1955 and headquartered in Kansas City, is America's largest tax return preparation company. Over 175,000 individuals take our tax training courses annually. With more than 9,000 U.S. offices, we handled over 16 million individual returns in 2000, which is one in seven received by the IRS and about 37,000 per Congressional district. We are leaders in electronic filing, originating over half the practitioner e-filed returns that the IRS receives. We publish Kiplinger TaxCut® tax preparation software, which has over 1.6 million users, and we author the annual "H&R Block Income Tax Guide." Internationally, we prepare tax returns at over 1,200 offices in Canada, Australia, and the United Kingdom.

In the past several years, we have reshaped the company to offer our clients--many of whom view a stop at H&R Block as an annual financial check-up--more than tax services. We also offer financial planning, mortgages, and savings and investment products. And to expand our business services, we have built a national accounting practice anchored by RSM McGladrey.

Filing Season News. We're offering a number of innovations this year to make online tax preparation and e-filing more appealing. In addition to our online program for do-it-yourself tax filers, we offer "Electronic Refund Advances" that allow online e-filers to get a loan in the amount of their refund in as little as 24 hours. Our "Professional Review" allows taxpayers who use our do-it-yourself program to have an experienced H&R Block tax professional review, sign, and guarantee their return. "Ask a Tax Advisor" enables any taxpayer to connect with a Block tax professional by phone, e-mail, or online chat for immediate answers to specific tax questions. And our new "Professional Tax Service" allows customers to enter their tax information in our online tax organizer and then send it to an H&R Block tax professional, who will prepare, sign, and guarantee the taxpayer's federal and state return.

We're also aiding clients with "Express IRAs" to convert refunds in a tax-advantaged way into retirement savings. And this year, in cooperation with the U.S. Department of Health and Human Services, we advised clients of their potential eligibility for free or low-cost state children's health insurance programs (SCHIP) and how to get more information. We've been told that calls to the "Insure Kids Now" 800-number in January-February tripled over last year.

We continue to emphasize the multiple benefits of e-filing while reducing cost as a possible barrier. This year, we did not charge additional fees for e-filing in 80% of our offices, we participated in the IRS's PIN, DI, and Web hyperlink programs, we distributed 500 IRS public service announcements promoting e-filing to local TV stations with whom we place our ads, and we offered additional services to online and software clients that created value-added incentives to e-file--and that suggest a future in which combinations of new technology and traditional service will enable customers to be served when, where, and how they choose.

Filing Season Results. Although the main 2001 tax filing season does not end for 13 exciting days, we have enough information to report that it has generally been successful. Our own experience in working with the Service has been very positive. The e-file system has worked very well this year across five service centers. We experienced very little IRS down-time as compared to previous years.

Our return preparation as of February 28 is up 2.4%, and e-filing is up 7.8%, as nearly 90% of our returns are e-filed. E-filing through our Kiplinger TaxCut® software and Web-based tax preparation is up about 60% over last year.

Filing Season Problems. Given the range of disruptions that might occur, we count ourselves lucky when things go so well. That said, we believe more can be done to make the next filing season even better. No system that processes 1.2 billion tax and information returns, issues 97 million refunds, answers over 100 million assistance calls, and collects almost $2 trillion annually--much of it in a 105-day filing season--will ever be error-free. Let me identify three glitches in an otherwise good season--in shorthand LES, DI, and PIN:

n LES/W-2 Requirements: Under new IRS rules, tax preparers need a client's W-2 form before electronically filing his taxes. Some firms, however, improperly use pay stubs or leave and earnings statements (LES) to prepare substitute W-2s. Their clients file earlier and get refunds sooner, which is a competitive advantage over firms that comply with the rules. We alerted the IRS to the potential for this problem prior to tax season. We hoped that swift enforcement would address it.

Delays, however, blunted any impact until after February 16, following the early peak of the filing season, costing many honest firms tax business and income. One of our company-owned districts near a military base in North Carolina, for example, saw business plummet by nearly 50% during what should have been our busiest time of the season. If the IRS expects firms to follow the rules, it must enforce the law against those who do not. The IRS was ill-prepared to deal with violators, despite advance warnings, and when it acted it did too little, too late. More needs to be done for next year.

n Debt Indicator (DI): This is the second year of a test of a Debt Indicator in which, at the taxpayer's instruction, IRS and the Financial Management Service electronically signal the representatives of taxpayers who use bank products (like refund anticipation loans) if offsetting obligations (delinquent federal or state taxes, student loans, or child support payments) will reduce refunds. The information helps taxpayers and enables lenders to avoid making loans for which they will not be repaid which, in turn, enables them to pass reduced costs through to clients in the form of lower fees charged.

Last year, the program worked fairly well although there were some problems. In anticipation of the DI, the provider of bank products for H&R Block led the industry in lowering fees. For taxpayers, the private sector and the IRS, it should have been a "win-win" with e-filing up, bank fees down, and compliance improved. But IRS didn't get the DI working properly until well into the tax season.

This year, again, there were problems. Social Security numbers ending in 00 to 32 were not included in IRS offset screens until February 1. Returns reported as having no offset had offsets taken when refunds were processed. The result was unhappy taxpayers and significant losses for participating firms.

When it works well, the DI program benefits taxpayers, tax preparers, lenders, and the IRS. Unfortunately, when errors occur, all suffer. We believe the program is worth continuing and look forward to working with the IRS to ensure better execution.

One use of a DI--supporting RAL transactions--may decline as the IRS fulfills its strategic plan to speed refunds to all e-filers within 48-72 hours. We welcome faster refunds as a solid plus for taxpayers, a strong incentive to e-filing, and a showpiece of IRS's computer modernization program. But if the IRS wants to win taxpayer confidence in electronic notifications and two-way e-transactions--both e-filing and e-responses--it must make its responses reliable so taxpayers are not confused.

n PINs. Practitioners welcomed the IRS allowing taxpayers to use a self-selected personal identification numbers (PIN) in place of paper form 8453 that is otherwise required to be sent by mail with a signature to authenticate an e-filed return. To obtain a PIN, the taxpayer must provide his correct name, SSN, date of birth (now required only for on-line filers), AGI, and total tax from last year's return.

This year, thousands of PIN applications submitted with correct "shared secrets" information were rejected, costing tax professionals time and income as they worked to correct the rejects, and angering many customers who anticipated easier filing and faster refunds. Some preparers abandoned the program as it became easier to use the paper 8453 form instead of having to deal with a PIN reject and asking the client to return to file an 8453.

Under the online e-filing program, for self-prepared returns using software or online applications, the reject rate this year has been about 20% compared to our normal e-file rejection rate for TaxCut® and online customers of about 12-13%. Almost all of the difference is attributable to PIN rejects.

One problem is that IRS records are sometimes wrong. As a result, a taxpayer may enter the correct AGI and total tax but the IRS system says it's wrong. IRS also has potential errors in its records of citizenship, marriages, decedents, and name, SSN, and DOB as received from the Social Security Administration.

The IRS believes the majority of PIN rejects are caused by customer error. But whether the problem is with the practitioner, the taxpayer, or the IRS, one fact remains: If you e-file using a PIN, your return is more likely to be rejected. We hope to work with the IRS to solve this problem so that filers won't abandon PINs and e-filing in frustration next year.

If PINs, intended to make e-filing easier, make it harder, more complex, more expensive, and less satisfying, the entire e-filing program will be endangered. We look forward to helping the IRS find error-free, non-paper, simple signature authenticators that work to encourage, not discourage, e-filing.

In highlighting these points, we don't want to detract from the larger conclusion that the filing season is going well and IRS's overall record is good. We hope to work with the IRS to mend these problems next year.

IRS Reform. In the last year, the IRS's four new divisions "stood up," a landmark in continuing reform, and the IRS Oversight Board began its work. Commissioner Rossotti has continued impressive initiatives to improve the agency's performance, modernize technology, and improve customer service. We think he's doing a great job.

Electronic Filing Shortfall. The IRS has increased its e-filing promotion to achieve Congress' twin goals of e-filing all computer-prepared returns by 2002 and e-filing 80% of all tax and information returns by 2007. But the early numbers this year are slightly below IRS projections and the projections are that the targets will not be met unless more Americans overcome apprehensions and more practitioners enlist.

Our suggested priorities, many already a part of the IRS strategy, remain: (1) a continuing focus on private-sector cooperation, through the Electronic Tax Administration Advisory Committee, through industry's Council on Electronic Revenue Communication Advancement (CERCA), and especially with accounting firms who will soon be able to e-file all forms and attachments; (2) expanding IRS's already-strong marketing and promotion; (3) universal PINs to enable paperless filing--if the information needed to validate the PIN does not itself become a hurdle and if IRS rejects are not so numerous as to make the PIN counterproductive; (4) streamlining the application process to make it easier for tax practitioners to become Electronic Return Originators (EROs) and easing suspension rules for EROs--high ERO application standards and stringent suspension rules are barriers that deter participation in the program; and (5) continued reform of old rules for the e-filing program.

E-Filing Jump Start. Despite our optimism and support, we may face the uncomfortable reality that for many Americans, the incentives to e-file--beyond a faster refund--are simply not compelling. Before reaching that conclusion, we believe both the IRS and tax professionals can try harder to persuade taxpayers of the benefits of e-filing. And Congress can help.

We recommend a three year refundable tax credit of $10-25 to encourage e-filing and to provide the dramatic pull needed to convert more American taxpayers and enable the IRS to meet your goals for 2002 and 2007.

The IRS Restructuring and Reform Act of 1998 allows IRS to pay "appropriate incentives," and the Clinton Administration last year proposed a $10 tax credit for those who e-filed in 2002-6. We prefer incentives that go to taxpayers, not to e-file originators or transmitters.

Complexity. In three of the last five years, we sent the Ways & Means Committee, the Senate Finance Committee, the Treasury, and the IRS ten modest suggestions for Tax Code simplification, several of which have now been enacted. We look forward to working with you on your efforts to simplify the tax law, especially as it affects average American families.

Check Box. This year, the IRS allows taxpayers to check a box to allow their tax preparer to be contacted by the IRS for additional information. The idea is good but it only authorizes contact with tax preparers, not tax preparation companies. We recommend modifying the program to allow us to help clients with in-office personnel rather than bring back the actual tax preparer since we have both seasonal and year-round tax preparers.

IRS Liaison. This year, the IRS installed an accounts manager system for its largest external customers to serve as our ombudsman in solving various problems. The program has worked well and it deserves high marks. We found other IRS staff responsive and diligent, especially in the area of electronic tax administration.

Most IRS interaction with practitioner groups comes through formal advisory committees or public liaison meetings. Outreach and information sharing have increased. Status reports and briefings are excellent.

As a large customer, we also work directly with senior IRS officials to manage an ongoing agenda. We are often an early-warning system for the IRS, spotting problems before they generally appear. We hope to expand our contacts to improve cooperation, reduce bumps in the next filing season, and participate in the IRS's planning process. The problems that inevitably occur each filing season, especially as new programs are implemented, can be reduced if private-sector partners have a greater opportunity to discuss ideas in the planning stage to identify issues and share perspectives.

FY 2002 Budget. While the President will not submit his detailed IRS budget until April 9, early reports indicate that the Administration will not support the full $10.26 billion recommended by the IRS Oversight Board. Plans to hire 4,000 new employees would be trimmed by 1,400 and a $1 billion fund for two years of technology modernization would be cut to $400 million.

We strongly support the agency receiving the funds it needs to do its job, especially in modernizing outdated technology, so that the risk of any system breakdown is reduced. IRS reform and restructuring requires dependable financial support to enable the agency to fulfill its strategic plans for better customer service, faster return processing, more effective law enforcement, and modernized technology.

Conclusion. Mr. Chairman, there are many other areas I could comment on, and I will be happy to respond to your questions. We look forward to working with the Subcommittee to ensure that for most Americans the tax filing experience is, if not enjoyable, at least tolerable. We are working to ensure that lessons from this tax season will help us all achieve smoother filing next year, with refunds issued promptly, and with the IRS continuing on the path of reform.