Statement of Claudia Hill, Chair, Government Relations Committee,
National Association of Enrolled Agents, Cupertino, California

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

I am honored Mr. Chairman to present this testimony on behalf of the National Association of Enrolled Agents (NAEA). There are approximately 35,000 Enrolled Agents, more than 10,000 of whom are members of our organization. Enrolled Agents represent over 5 million taxpayers and small businesses at all administrative levels of the IRS, including tax preparation. In order to be enrolled before the Department of Treasury, a practitioner must pass a detailed exam covering the administrative procedures and practical tax laws affecting real people and small businesses, or have significant experience working at the IRS. In addition to demonstrating ongoing competency each year through continuing education requirements, our members must undergo a thorough background check and abide by a strong code of conduct. Our members are proud to be the federal tax code specialists.

The Subcommittee has asked us to comment on the state of the filing season, and we are happy to report that from the perspective of frontline practitioners the state of the filing season is generally good. The IRS seems to be providing a basic level of service to more taxpayers with generally fewer resources at the same time that they manage annual tax code changes. They seem to be making progress with their strategic initiatives such as 80 percent electronic filing and business organization restructuring, while technology modernization has yet to materialize in terms of deliverables to taxpayers or frontline IRS employees. On the other hand, as there are in any undertakings as complex as filing season, there are some problems.

Before I touch on a number of specific problems our members have discovered with the current filing season, I would like to discuss a number of issues that affect the job IRS is doing with the filing season and with taxpayers service and compliance in general.

Over the last decade, the IRS has been asked to do more with fewer resources. While the overall budget for the agency has grown in recent years, by many measurements it has declined.

First of all, the number of full time employees available to handle the workload for more taxpayers and more transactions has gone down over the last 10 years. 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 is yet to be delivered, the IRS is generally doing a more professional job of handling case management issues and general tax questions from taxpayers. For example, our members continue to experience helpful and knowledgeable IRS employees. Generally, we have seen a strong positive change in attitude with employees at the agency.

Unfortunately, we also have witnessed a corresponding decline in service at the audit and collection functions. Experienced IRS employees in these areas are being reassigned to "cover the phones" and help with tax returns during filing season.

While at first glance, audits and collections activities do not seem to fit into the definition of "service," resources available in these areas often assure the timely resolution of costly disputes for middle- income and small business taxpayers. An enrolled agent from North Carolina recently wrote to us telling of an incident where the single remaining auditor in Durham has been reassigned temporarily to customer service and will not be able to complete any ongoing audits until after April 16^th. Without adequate resources, audits, which should take hours, spread out to days and even weeks. Meanwhile taxpayers are left with the uncertainty of knowing where they stand with the IRS. Other relief measures such as offers in compromise and innocent spouse claims are delayed to the point that many taxpayers are harmed needlessly.

It is our belief that adequate resources for the IRS make a difference in the public’s 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. Honest taxpayers need to know that there are consequences for non-compliance. When audit and collection efforts are reduced as greatly as they have been in recent years, it sends an ambiguous message about our voluntary tax system. Keep in mind, more citizens interact with the IRS than any other agency of the federal government. Their budget should reflect this reality.

This is the first filing season since the IRS finished its business reorganization. The purpose behind this complex and expensive undertaking is to organize the IRS around its customers so that they can better respond to the needs and track non-compliance of particular taxpayer groups. 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 incredible number of taxpayers and professionals visiting and using this site attests to the needs it has met.

· The Small Business/Self Employed Web site is a marvel of accessibility and usefulness. We hope to see it expanded and that other divisions will embrace this concept of providing information out where taxpayers and tax practitioners can access it easily.

· More forms are capable of being e-filed than ever before. We expect 99% of all forms to be capable of being e-filed by next filing season. Changes in the number of occurrences in which a form may be e-filed have also had a positive impact on the ability of taxpayers to e-file.

· Two hundred NAEA members are currently working with the IRS on a secure messaging system pilot program. It has taken longer than we expected for a variety of reasons, among them security concerns and the meshing of various computer systems and software, but this has been a project to which NAEA has been committed for a long time. It is meeting certain needs effectively for the practitioner community and we are gratified with the progress made thus far.

· The Communications and Public Liaison effort at IRS has been greatly enhanced. We are seeing the leveraging of the information systems of practitioner groups, the small business community and other business organizations to inform and advise the public on a broad range of issues. This is smart thinking and we applaud those who have run counter to the old IRS culture of "no comment."

· Partnerships between IRS and professional societies and trade associations are making it possible for us to develop solutions to long-standing issues in a timely and cost-effective manner.

While the business modernization seems to be taking its first tentative steps toward delivering value to taxpayers, it is clear that its full promise will not be delivered until the IRS and its contractors complete the information systems modernization. Our understanding is that a great deal of the initial planning and designing stages for the first projects are almost completed, and that IRS and its private sector partners are about to beginning building key elements of the project. Unfortunately, we have yet to see benefits delivered in the field.

The ability of the agency to collect more accurate data more efficiently and then to be able to better manage taxpayer data is key to the future of the IRS. Taxpayers will see their refunds faster. Practitioners and individual taxpayer will be able to resolve more problems with one or two calls instead of dozens. Additionally, the new system will allow taxpayers and practitioners more options for solving problems like 800 lines and on-line access and management of accounts. The IRS will be able to spot non-compliance faster making it cheaper for both taxpayers and the IRS to resolve these problems. Currently, it takes the IRS over 18 months to reconcile tax returns with information from 3^rd parties such as W-2 and 1099 information. Modern systems and business practices should shorten this cycle considerably.

Our message to Congress is stay the course in these investments and make sure the IRS and its partners begin delivering benefits to taxpayers on schedule.

Every year, we survey our members on problems with the filing season. Separate from this effort, we 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 two years, the overwhelming response in both cases has been the same – the individual alternative minimum tax. We believe the message is clear: Complexity is the number one tax filing season problem.

Why is the AMT the "Tax Headache of the Year?" Our members tell us of increasing numbers of their clients who were blindsided this year by falling into this insidious alternative tax system. Here are a few examples:

One of our enrolled agents in Youngstown, Ohio wrote to us to say how deeply troubled she was to see an elderly client "clobbered by the AMT." The taxpayer was caring for his wife with Alzheimer’s, and had to withdraw extra pension money to pay medical bills. The AMT calculation required him to add-back into AMT a portion of his otherwise deductible medical bills and his state income and property taxes. This caused the AMT to exceed the regular tax. He didn’t think it was a good alternative!

In my state of California, I find that many middle-income taxpayers fall unwittingly into the AMT because of the high cost of property taxes on their homes and equally high state income taxes. When these taxpayers also happen to be employees who incur ordinary and necessary business expenses and whose employers either do not reimburse expenses or use "not accountable plans," they are injured even more, since those miscellaneous deductions are also added back to the AMT base. None of these items, normally allowable deductions, are permitted against AMT.

Our members are reporting that more and more farm families are being hit with the AMT. Congress saw a need to provide farmers a special income averaging method a few years ago. Unfortunately, when that method lowers the regular tax below AMT, the taxpayer loses the benefits, and must pay the higher AMT.

U S taxpayers living outside our country are provided in the law a means to avoid double taxation through the use of foreign tax credits (FTC). Once again, AMT undermines the intent of fairness Congress intended with the credit system, by allowing the FTC to offset no more than 90% of the AMT while the regular tax can be completely offset. The taxpayer is injured once again.

Although Congress may be considering an extension allowing use of non-refundable child and education related credits against AMT, general business credits still cannot be used against the AMT. In example, for taxpayers that are affected, the benefits of the low-income housing credit are not allowed against the AMT – a Code provision that is essential for providing affordable houses in high-cost states.

With increasing emphasis on equity-based compensation, the use of employee stock options as part of a worker’s compensation package has become mainstream. Nearly 30 percent of those surveyed as part of the 35^th Index of Investor Optimism reported that they or their spouse had received options at some point in their career. Of this group, 43 percent said options were part of their 2000 compensation and comprised approximately 11 percent of their total income last year. However, during this past year a hidden danger of employee stock options became apparent. When an employee exercises their right to acquire incentive stock options at a price below the fair market value of the shares on the date of exercise, the "virtual income" (difference in values) is included in the AMT base but not in the regular tax base. The date of exercise value sets the preference—regardless of what eventually happens with the value of the shares if they are not disposed of in the same calendar year as exercise. If the employee chooses to hold the stock for the one year period prescribed in the law to obtain capital gains treatment of the income, they may find themselves expected to pay taxes on income they never really receive.

There have been many accounts in the media recently of taxpayers that have been injured by this "preference" because of dramatic volatility in the stock market this past year. We have heard from taxpayers and their advisors with egregious examples of phantom income far exceeding any economic benefit the taxpayers will ever receive, being taxed due to the provisions of the Alternative Minimum Tax (specifically IRC 55 and 56 and Regs. Sections 1.421 and 1.422). A taxpayer from San Luis Obispo, CA wrote,

"Ideally, "ISOs works for both employer and employee. It gives the employee an incentive to stay with the company and it gives the company ways to reward the employee without increasing salary costs…I exercised the stock options not realizing that the price of the stock on the day I exercise will be used to figure out my income WHETHER I ACTUALLY SELL THE STOCK OR NOT. Now that the value of our stock has been depressed over 60%, I am being taxed on income that was never realized and have what is call a PHANTOM INCOME. This made my effective tax rate to be 290%!"

This certainly was not what Congress intended. We hear of people mortgaging or selling their homes to pay their year 2000 AMT. Others are so distraught they fear filing their 2000 tax returns because they cannot pay the liability. This certainly was not what Congress intended.

Over three years ago, the National Commission on Restructuring the IRS found a direct connection between the complexity of the Internal Revenue Code and the difficulty of tax law administration and taxpayer frustration. The AMT tops our list of complex provisions, but our members cited two more that definitely cause problems each filing season and need your intervention to resolve.

As frontline practitioners, we believe Congress could provide significant relief and make the job of the IRS easier by making immediate changes in three areas. First, Congress needs to repeal the alternative minimum tax for individuals. Second, phase-outs and phase-ins need to be standardized. And finally, it needs to simplify the rules for qualifying for the Earned Income Credit.

There are over twenty commonly encountered aspects of individual returns that require phase-out calculations. To mention a few: limits for deductible IRA contributions, limitations on the use of education credits, child credits, elderly credits, personal exemptions, itemized deductions, passive activity losses and credits. When taxpayers are told Congress has provided incentives or rate reductions for their benefit, and realize when they actually file their returns that they don’t "qualify" for the benefits, they feel deceived.

Each year the IRS lists the top errors in filed returns. Earned Income Credit issues make up almost half their list. Our members concur, and express dismay at the number of taxpayers that come to them asking for their assistance in "working the system" to obtain benefits to which they are not entitled. Our members don’t participate in such activities. They are held to strict codes of professional conduct, from our own organization and from the IRS. This is not the case for the vast number of paid-preparers in this country.

These three changes would provide significant relief to taxpayers, as well as allow the IRS to free up resources within the agency for other purposes. In addition to improving tax administration, reducing taxpayer burden by simplifying the tax laws will lower taxpayer frustration and improve voluntary compliance.

Finally, we urge you to consider registration of all commercial tax preparers. This would level the playing field so that return preparers who submit paper returns are held to the same high standards as Electronic Return Originators and as Circular 230 practitioners - Enrolled Agents, CPAs and attorneys.

In an effort to make electronic filing "paperless" IRS offered a program that would eliminate the need for taxpayers to send in a signature document through the use of an electronic signature Personal Identification Numbers (PIN). The program is not truly "paperless" since the practitioners that offer this service must retain a signature document and copies of the W-2 forms. However, numerous problems have been experienced this filing season with the PIN. Although most of the issues could be categorized as related to the start-up of the program, many of our members have pointed out that the current requirements for using taxpayer PINs are complicated enough that it is often easier to have taxpayers sign the form 8453 instead. Additionally, some practitioners report that as many as 10 percent of their e-filed returns have been rejected this year because of PIN problems.

A new addition to the individual tax forms this year is the "check the box" limited authorization for paid preparers. We believe this addition will be beneficial for taxpayers and the IRS as their telephone assistors become better informed as to the types of inquiries it is to permit. An important step in streamlining the ability to resolve issues with the largest account management intensive organization in the country, the IRS. This leads into the final point I would like to raise today. Despite the recent reorganization efforts and technology improvements, and sometime because of them, the IRS continues to have severe problems with basic account management. Simple problems with client returns often entails hours or days of senseless struggle to get the right information to right person at the agency. Faxed information is never received. Phone calls go unanswered. Valuable time is spent on hold waiting to talk to a person at the agency, who then has difficulties resolving problems quickly for lack of training and basic technology tools. The IRS is doing better, but it is a long way from resolving this basic problem first identified by the National Commission on Restructuring the IRS. Congress needs to stay the course with adequate resources for technological enhancements and strong oversight.

I appreciate the Committee giving the National Association of Enrolled Agents the opportunity to talking about the 2001 filing season today. Commissioner Rossotti has a tough job and the organization is generally doing the best it can with the limited resources it has.

Thank you.