Statement of The Honorable Mark W. Everson, Commissioner, Internal Revenue Service

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

March 20, 2007

Introduction

Chairman Lewis, Ranking Member Ramstad, and members of the Subcommittee, thank you for the opportunity to testify today on the 2007 Income Tax Filing Season.  I would also like to update you on the progress we have made in the areas of taxpayer service and enforcement, our FY 2008 budget request, and our latest efforts to improve voluntary compliance and reduce the tax gap.

2007 Filing Season

This filing season presented the potential to be one of the most challenging in recent memory.  The Tax Relief and Health Care Act of 2006 (TRHCA), which passed late last year, included the extension of several significant tax benefits.  Since forms and publications for Tax Year 2006 were printed and distributed prior to enactment, we were required to notify taxpayers on IRS.gov as to how to modify those forms to claim the allowable benefits.  We are also faced with implementing the Telephone Excise Tax Refund Program (TETR).  This was the first filing season that we allowed taxpayer refunds to be split and deposited into separate accounts. And, because the normal April 15^th filing date falls on a Sunday and the following Monday is a legal holiday in the District of Columbia, we had to adjust our programs to provide taxpayers an extra two days to file and pay this year.   

Despite these challenges, I am proud to report that thus far the filing season has gone very well.  By early February, we were able to begin processing tax returns claiming the tax benefits authorized by the enactment of TRHCA in December.  We have also taken a number of steps to make sure that taxpayers understand how to claim the benefits.  For example, we provided instructions on IRS.gov and conducted extensive outreach and media events to publicize these provisions. In addition, we sent a special mailing of Publication 600, which included the state and local sales tax tables and instructions for claiming the sales tax deduction on Schedule A (Form 1040), to 6 million taxpayers who had previously claimed the state and local sales tax deduction.

I will discuss the TETR Program later in my testimony, but let me first give an update on some of the numbers we are looking at approximately one month from the return due date. 

Numbers Thus Far

We expect to process almost 136 million individual tax returns in 2007, and we anticipate a continued growth in the number of those that are e-filed.  In the 2006 filing season, 54 percent of all income tax returns were e-filed.  We fully expect to exceed that number this year.  As of March 10, we have received almost 45.5 million tax returns electronically, an increase of 4.87 percent compared to the same period last year. 

This increase in e-filing is being driven by people preparing their own returns using their personal computers.  The total number of self-prepared returns that are e-filed is up by over 8 percent compared to this time a year ago.  Over 13.3 million returns have been e-filed by people from their personal computers, up from over 12.3 million for the same period a year ago. 

Overall, 75 percent of the 60.9 million returns filed thru March 10th have been e-filed.  Encouraging e-filing is good for both the taxpayer and for the IRS. Taxpayers who use e-file can generally have their tax refund deposited directly into their bank account in two weeks or less.  That is about half the time it takes us to process a paper return.  For the IRS the error reject rate for e-filed returns is significantly lower than that for paper returns.

More people are choosing to have their tax refunds directly deposited into their bank account than ever before.  So far this year, we have directly deposited over 39 million refunds, or 77 percent of all refunds issued this tax filing season.  This is up from 73 percent for the same period in 2006.

People are also visiting our web site, IRS.gov, in record numbers.  We have recorded almost 83.4 million visits to our site this year, up over 9 percent from 76.4 million for the same period a year ago.  The millions of taxpayers that have visited IRS.gov have benefited from many of the services that are available through the web site.  We have made it easier for taxpayers to get answers to many of their tax questions online.  The web site:

• Assists the taxpayer in determining whether he or she qualifies for the Earned Income Tax Credit (EITC);
• Assists the taxpayer in determining whether he or she is subject to the Alternative Minimum Tax (AMT); 
• Allows more than 70 percent of taxpayers the option to file their tax returns at no cost through the Free File program;
• Allows taxpayers who are expecting refunds to track the status via the “Where’s My Refund?” feature; and
• Allows a taxpayer to calculate the amount of their Sales Tax Deduction

As of March 10, we have received almost 60.9 million returns, a very slight increase over the same period as last year.  We have issued 50.5 million refunds so far this year, for a total of $128.7 billion.  The average refund thus far is $2,548, approximately $125 more than last year.  In addition, over 16.8 million taxpayers have tracked their refund on IRS.gov, up 15.19 percent over last year.

As of March 10th, our Taxpayer Assistance Centers (TACs) are reporting a very slight 0.6 percent decline in face- to-face contacts this filing season as compared to last year.  We have also seen a decline in the number of calls answered (-2.54 percent) as well as automated calls (-5.13 percent).  We believe that the decline in visits to our TACs is largely attributable to taxpayers increasing their use of IRS.gov, volunteer services, and other more convenient means of obtaining tax forms, filing their returns or getting their questions answered.   The decline in the number of calls answered can be attributed to a few weather-related temporary call site closures earlier this winter and a slight decrease in overall caller demand.  

Free File

Almost 2.5 million people have utilized Free File as of March 9^th, down 5.5 percent from last year.  This year anyone with adjusted gross income of $52,000 or less is eligible for Free File.  This would include 95 million taxpayers.  The number of Free File returns compared to the prior year has been steadily increasing and we expect to meet or exceed 2006 totals by the end of the filing season.

A key difference in this year’s Free File program is that Alliance members are no longer offering ancillary products, such as refund anticipation loans (RALs) through the Free File program.  IRS data from the last filing season shows that only 0.5 percent of Free File users chose to utilize a RAL.  The Free File Alliance may still offer customers the option of having their state tax return prepared for a fee though some Alliance members are offering to do the state return at no cost as well as the Federal.

In the 2006 filing season an indicator was included for the first time on Free File returns, which allowed the IRS to identify those taxpayers using Free File.  As a result, the Service was able to obtain important information such as customer satisfaction and demographic data that had never before been available.

This information allowed us to verify that there was a high level of customer satisfaction with Free File.  According to a  survey conducted for the IRS, 94 percent said they intend to use Free File again next year; the same number said they found Free File very easy or somewhat easy to use; and 97 percent said they would recommend Free File to others. Convenience, not the free cost, was the most appealing factor of Free File.

VITA/TCE Sites and Other Community Partnerships

The use of tax return preparation alternatives, such as volunteer assistance at Volunteer Income Tax Assistance (VITA) sites and Tax Counseling for the Elderly sites (TCEs), has steadily increased while the numbers of TAC contacts have decreased.  In FY 2006, over 2.2 million returns were prepared by volunteers.  As of March 10th, volunteer return preparation is up 7.6 percent above last year’s level.  Volunteer e-filing is also up slightly, by 0.6 percent over the same period in the last tax filing season.  This is reflective of continuing growth in existing community coalitions and partnerships.

We have also made a concerted attempt to improve outreach to taxpayers, particularly those taxpayers who may be eligible for the EITC.  For example, we sponsored EITC Awareness Day on February 1, in an effort to partner with our community coalitions and partnerships to reach as many EITC-eligible taxpayers as possible and urge them to claim the credit.

Telephone Excise Tax Refunds

In the middle of 2006, the IRS announced plans to refund at least $13 billion in telephone excise taxes to more than 160 million taxpayers.  To do this, the IRS modified every individual and business tax return form, retooled our systems to handle the forecast demand, and launched an extensive communications campaign to increase awareness and encourage people without a filing requirement to request a refund anyway. 

One difficulty in administering this refund was that taxpayers could have experienced significant burden if they had been required to find 41 months of old phone bills in order to obtain the information they needed to compute their refunds.  For this reason, the IRS created a set of standard amounts that individuals can claim in lieu of actual amounts.  For businesses and non-profits – faced with potentially more paperwork than individuals – the IRS developed an estimation method that could require significantly less paperwork than requesting an actual amount.

A review of returns filed so far this year turned up a surprising fact:  nearly 30 percent of returns we have received did not include a telephone excise tax refund request.  Though one of our communications goals was to encourage taxpayers not to overlook the telephone tax refund, it appears many taxpayers are missing out.  In response, to these early numbers, we consulted with tax professionals, citizens groups and tax software companies to determine potential causes for the low take up rate.  The only logical reason we were given was that despite our best efforts, some taxpayers were still not aware of the credit and how to claim it.  We then conducted additional media outreach to increase awareness of the refund and were able to generate broad national media coverage, including CNN, the Associated Press, and USA Today. 

As we monitored the initial returns, we also noticed some problems.  Even though 99.5% of all taxpayers who are requesting the refund are claiming the appropriate standard amount, some tax-return preparers are requesting thousands of dollars of refunds for their clients in instances where clients are entitled to only a tiny fraction of that amount.  This may indicate criminal intent on the part of the return preparer.  In some cases, taxpayers requested a refund in the thousands of dollars, suggesting that the taxpayer paid more for telephone service than they received in income.  While some of the large claims may be the result of misunderstandings – a number of refund requests appear to be for the entire amount of the taxpayer’s phone bill, rather than just the three-percent long-distance tax – others may be deliberate attempts to scam the system.

To address this problem, in late February, IRS special agents executed search warrants seeking evidence from a small number of tax-preparation businesses suspected of preparing returns on behalf of clients requesting large, improper amounts in telephone excise tax refunds.  Special agents temporarily closed these businesses, seizing computers and documents to use in their investigations.  In addition, IRS revenue agents (auditors) and special agents also visited other tax preparers who were suspected of preparing questionable telephone tax refund requests.

On a positive note, the number of returns with seemingly high telephone excise tax refunds dropped significantly this month.  This suggests our enforcement actions, along with increased communications, may be having the desired effect. 

Tax Scams

Each year, we alert taxpayers about the “Dirty Dozen”, 12 of the most blatant tax scams affecting American taxpayers.  This is in part an effort to alert taxpayers so that they may be wary if approached and encouraged to participate in any of the listed schemes.  It also alerts promoters that we are aware of the scam and will be taking steps to prevent them from getting away with it.

This year the “Dirty Dozen” highlights five new scams that IRS auditors and criminal investigators have uncovered.  Topping the list this filing season are fraudulent refunds being claimed in connection with TETR, which I have already discussed.  Other scams making the list include:

• Abusive Roth IRAs: Taxpayers should be wary of advisers who encourage them to shift under-valued property to Roth Individual Retirement Arrangements (IRAs). In one variation, a promoter has the taxpayer move under-valued common stock into a Roth IRA, circumventing the annual maximum contribution limit and allowing otherwise taxable income to go untaxed.
• Phishing:  This is a technique used by identity thieves to acquire personal financial data in order to gain access to the financial accounts of unsuspecting consumers, run up charges on their credit cards or apply for loans in their names. These Internet-based criminals pose as representatives of a financial institution –– or sometimes the IRS itself –– and send out fictitious e-mail correspondence in an attempt to trick consumers into disclosing private information. A typical e-mail notifies a taxpayer of an outstanding refund and urges the taxpayer to click on a hyperlink and visit an official-looking Web site. The Web site then solicits a social security and credit card number. It is important to note the IRS does not use e-mail to initiate contact with taxpayers about issues related to their accounts. If a taxpayer has any doubt whether a contact from the IRS is authentic, the taxpayer should call 1-800-829-1040 to confirm it.
• Disguised Corporate Ownership: Domestic shell corporations and other entities are being formed and operated in certain states for the purpose of disguising the ownership of the business or financial activity.  Once formed, these anonymous entities can be, and are being, used to facilitate underreporting of income, non-filing of tax returns, listed transactions, money laundering, financial crimes and possibly terrorist financing.  The IRS is working with state authorities to identify these entities and to bring their owners into compliance.
• Zero Wages: In this scam, which first appeared in the Dirty Dozen in 2006, a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 showing zero or little income is submitted with a federal tax return. The taxpayer may include a statement rebutting wages and taxes reported by the payer to the IRS. An explanation on the Form 4852 may cite statutory language behind Internal Revenue Code sections 3401 and 3121 or may include some reference to the paying company refusing to issue a corrected Form W-2 for fear of IRS retaliation.
• Return Preparer Fraud: Dishonest return preparers can cause many headaches for taxpayers who fall victim to their schemes. Such preparers make their money by skimming a portion of their clients’ refunds and charging inflated fees for return preparation services. They attract new clients by promising large refunds. Some preparers promote filing fraudulent claims for refunds on items such as fuel tax credits to recover taxes paid in prior years. Taxpayers should choose carefully when hiring a tax preparer. As the old saying goes, “If it sounds too good to be true, it probably is.” Remember that no matter who prepares the return, the taxpayer is ultimately responsible for its accuracy. In recent years, the courts have issued injunctions ordering dozens of individuals to cease preparing returns, and the Department of Justice has filed complaints against dozens of others.  During fiscal year 2006, 109 tax return preparers were convicted of tax crimes and sentenced to an average of 18 months in prison. 
• American Indian Employment Credit: Taxpayers submit returns and claims reducing taxable income by substantial amounts citing an American Indian employment or treaty credit.  Although there is an Indian Employment Credit available for businesses that employ Native Americans or their spouses, there is no provision for its use by employees.  In a somewhat similar scam, unscrupulous promoters have informed Native Americans that they are not subject to federal income taxation.  The promoters solicit individual Indians to file Form W-8 BEN seeking relief from all withholding of federal taxation.  A recent “phishing” variation has promoters using false IRS letterheads to solicit personal financial information that they claim the IRS needs in order to process their "non-tax" status.
• Trust Misuse: For years unscrupulous promoters have urged taxpayers to transfer assets into trusts.  They promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes.  However, these trusts do not deliver the promised tax benefits.  There are currently more than 150 active abusive trust investigations underway and 49 injunctions have been obtained against promoters since 2001.  As with other arrangements, taxpayers should seek the advice of a trusted professional before entering into a trust. 
• Structured Entity Credits:  Promoters of this newly identified scheme are setting up partnerships to own and sell state conservation easement credits, federal rehabilitation credits and other credits.  The purported credits are the only assets owned by the partnership and once the credits are fully used, an investor receives a K-1 indicating the initial investment is a total loss, which is then deducted on the investor’s individual tax return.
• Abuse of Charitable Organizations and Deductions: The IRS continues to observe the use of tax-exempt organizations to improperly shield income or assets from taxation.  This can occur when a taxpayer moves assets or income to a tax-exempt supporting organization or donor-advised fund but maintains control over the assets or income.  Contributions of non-cash assets continue to be an area of abuse, especially with regard to overvaluation of contributed property.  In addition, the IRS is noticing the return of private tuition payments being disguised as charitable contributions to religious organizations.
• Form 843 Tax Abatement: This scam rests on faulty interpretation of the Internal Revenue Code.  It involves the filer requesting abatement of previously assessed tax using Form 843.  Many using this scam have not previously filed tax returns and the tax they are trying to have abated has been assessed by the IRS through the Substitute for Return Program.  The filer uses the Form 843 to list reasons for the request.  Often, one of the reasons is:  “Failed to properly compute and/or calculate IRC Sec 83-Property Transferred in Connection with Performance of Service.”
• Frivolous Arguments: Promoters have been known to make the following outlandish claims:  the Sixteenth Amendment concerning congressional power to lay and collect income taxes was never ratified; wages are not income; filing a return and paying taxes are merely voluntary; and being required to file Form 1040 violates the Fifth Amendment right against self-incrimination or the Fourth Amendment right to privacy.  Taxpayers should not believe these or other similar claims.  These arguments are false and have been thrown out of court.  While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law or else they may subject themselves to increased penalties.  As part of the Tax Relief and Health Care Act of 2006 [Public Law No. 109-432], Congress amended the Code to increase the amount of the penalty for frivolous tax returns from $500 to $5,000 and to impose a penalty of $5,000 on any person who submits a "specified frivolous position."  Last week, we released guidance identifying these and other frivolous claims that, when asserted by a taxpayer on a tax return filed with the Service or submitted in a collection due process request, offer-in-compromise, application for an installment agreement, or application for a Taxpayer Assistance Order, expose the taxpayer to the $5,000 penalty. 

A Commitment to Service and Enforcement

In FY 2006, we continued making improvements in both our service and enforcement programs.  This is not just our assessment, but also that of the IRS Oversight Board in its most recent annual report.  According to the Board, the IRS has made steady progress towards “transforming itself into a modern institution that provides efficient and effective tax administration services to America’s taxpayers.”  

Improving Taxpayer Service

According to a survey commissioned by the Board in 2006, taxpayers increasingly recognize that the IRS provides quality service through a variety of channels, such as its web site, toll-free telephone lines and Taxpayer Assistance Centers (TACs).  This is supported by the metrics that we use to determine the effectiveness of our taxpayer service efforts.  In category after category, we continue to see improvement in the numbers in our telephone services, electronic filing, and IRS.gov access.  This is demonstrated by the following FY 2006 business results:

• Electronic filing by individuals continued to increase.  It rose three percentage points from FY 2005, to 54 percent of all individual returns.
• The level of service for toll-free assistance was 82 percent, about the same level of FY 2005 and up substantially from FY 2001.  The level of customer satisfaction with the toll-free line remains 94 percent.
• The tax-law accuracy of toll-free responses improved to 91 percent and account accuracy increased to over 93 percent.
• Visits to the IRS web site jumped nearly 10 percent in FY 2006 to more than 197 million visits.
• More taxpayers used the online refund status tool “Where's My Refund.”  In FY 2006, there were 24.7 million status checks, up nearly 12 percent from FY 2005.    

At the IRS, we continue to work to improve services. Clearly, we are making progress, and these numbers underscore that point.

Another development in our taxpayer service program is the Taxpayer Assistance Blueprint (TAB).  This collaborative effort of the IRS, the IRS Oversight Board, and the National Taxpayer Advocate began in July, 2005 in response to a Congressional mandate to develop a five year plan that outlines the steps we should take to improve taxpayer services.  We sent Phase 1 of the Blueprint to Congress in April, 2006.  Phase 1 identified and reported the following five strategic service improvement themes for increasing taxpayer, partner, and government value:

• Improve and expand education and awareness activities:  This theme addresses the critical need for making taxpayers and practitioners aware of the most effective and efficient IRS service options and delivery channels for meeting their tax obligations and receiving benefits they are due.
• Optimize the use of partner services:  This theme emphasizes the critical role of third parties in the delivery of taxpayer services, and calls for improving the level of support and direction provided to partners to ensure consistent and accurate administration of the tax law.
• Enhance self-service options to meet taxpayer expectations:  This theme focuses on providing clear, standard, and easily customized automated content to deliver accurate, consistent, and understandable self-assistance service options—particularly for transactional tasks.
• Improve and expand training and support tools to enhance assisted services:  This theme highlights the need for ensuring accurate information across all channels by improving and expanding training, technology infrastructure, and support for employees, partners, and taxpayers.
• Develop short-term performance and long-term outcome goals and metrics:  This theme provides for the development of a comprehensive set of performance goals and metrics to evaluate how effectively the IRS is meeting taxpayer expectations, and how efficiently it is delivering services.

Phase 2 of the Blueprint will be sent to Congress soon.  Throughout this project, extensive research allowed us to refine our understanding of taxpayer and partner needs, preferences, and behaviors and to identify current planning documents, decision processes, and existing commitments affecting IRS service delivery.  Certain recurring findings emerged from the wealth of data analyzed.  These findings, combined with agency-wide considerations and priorities, led to the development of the five-year Strategic Plan for taxpayer service.

The Strategic Plan includes a suite of service improvement initiatives across all delivery channels, a portfolio of performance metrics, and an implementation strategy, which recommends numerous future research studies.  The Strategic Plan outlines a decision-making process for prioritizing service improvement initiatives based on taxpayer, partner, and government value and ensuring continued stakeholder, partner, and employee engagement.  This process is designed to help the IRS to balance quality service with effective enforcement to maximize compliance.  More details on TAB Phase 2 will be available when the report is delivered to Congress.

While the TAB remains a work in progress, the FY 2008 budget request includes the funding necessary to implement some of the telephone service and web site enhancements recommended by the Blueprint.  Enhancing telephone service will contribute to the goal of increasing taxpayer, partner, and government value.  Improving IRS.gov will help us to make the web site the first choice of individual taxpayers and their preparers when they need to contact the IRS for help.

The Blueprint also recommends a suite of multi-year research studies to continue to refine and improve our understanding of optimal service delivery.  In addition to funding for research regarding non-compliance, the FY 2008 budget includes funding for research to understand better the effect of service on compliance.

Expanding Enforcement Efforts

Another reason for the Oversight Board’s positive assessment of our work in FY 2006 is that IRS enforcement efforts have increased in virtually every area.  According to the Board, “As demonstrated by a variety of measures, the IRS’ performance on enforcement has improved considerably, and real progress has been achieved over the past six years.”

One of the most obvious measures is the increase in enforcement revenue, which has risen from $34 billion in FY 2002 to almost $49 billion in FY 2006, an increase of 43 percent.  Since 2003, Federal government receipts have also increased by $600 billion.  In FY 2006, the Federal government collected over $2.4 trillion in total receipts.  This is an historic level, with annual receipts up 12 percent over FY 2005 alone.  From FY 2005 to FY 2006, the U.S. has seen the highest year-to-year revenue growth in 25 years.  This growth is primarily the result of a strong economy supported by sound economic and tax policy.  But, corporate and high-income individual taxpayers are also both areas where we have substantially increased our enforcement presence in recent years. 

In FY 2006, both the levels of individual returns examined and coverage rates have risen substantially.  We conducted nearly 1.3 million examinations of individual tax returns.  This is almost 75 percent more than were conducted in FY 2001, and reflects a steady and sustained increase since that time.  Similarly, the audit coverage rate has risen from 0.58 percent in FY 2001 to more than 0.97 percent in FY 2006.

While the growth in examinations of individual returns is visible in all income categories, it is most visible in examinations of individuals with incomes over $1 million.  The number of examinations in the category rose by almost 78% compared to FY 2004, the first year the IRS began tracking audits of individuals with income over $1 million.  The coverage rate has risen from 5 percent in FY 2004 to 6.3 percent in FY 2006.

Growth in audit totals and coverage rates extend to other taxpayer categories.  Preliminary estimates show that the IRS examined over 52,000 business returns in FY 2006, an increase of nearly 12,000 over FY 2001.  The coverage rate over the same period rose from 0.55 percent to 0.60 percent.  For corporations with assets over $10 million, examinations rose from 8,718 in FY 2001 to 10,578 in FY 2006, an increase in the coverage rate from 15.1 percent to 18.6 percent.  For the largest corporations, those with assets over $250 million, examinations have increased by over 29 percent growing from 3,305 in FY 2001 to 4,276 in FY 2006. 

Finally, examinations of tax exempt organizations have also risen.  In FY 2001 5,342 tax exempt examinations were closed.  This number rose to 7,079 in FY 2006.

President’s FY 2008 Budget Maintains the Balance between Taxpayer Service and Enforcement

The IRS and its employees represent the face of the Federal Government to more American citizens than any other government agency.  The IRS administers America’s tax laws and collects 95 percent of the revenues that fund most government operations and public services. 

The IRS’ taxpayer service programs provide assistance to millions of taxpayers to help them understand and meet their tax obligations.  The IRS’ enforcement programs are aimed at deterring taxpayers inclined to evade their responsibilities while vigorously pursuing those who violate tax laws.  Delivering these programs demands a secure and modernized infrastructure able to fairly, effectively, and efficiently collect taxes while minimizing taxpayer burden.

The IRS FY 2008 President’s Budget request supports its five-year strategic plan and Treasury’s compliance improvement strategy.  These documents underscore the IRS’ commitment to provide quality service to taxpayers while enforcing America’s tax laws in a balanced manner.  The IRS’ strategic plan goals are:

• Improve Taxpayer Service.  Help people understand their tax obligations, making it easier for them to participate in the tax system;
• Enhance Enforcement of the Tax Law.  Ensure taxpayers meet their tax obligations, so that when Americans pay their taxes, they can be confident their neighbors and competitors are also doing the same; and
• Modernize the IRS through its People, Processes and Technology.  Strategically manage resources, associated business processes and technology systems to effectively and efficiently meet service and enforcement strategic goals.

Budget Request

Our total budget request for FY 2008 is for $11.1 billion in appropriated resources and represents a 4.7 percent increase over the recently enacted FY 2007 Joint Resolution (JR) level of $10.6 billion. 

The IRS’ taxpayer service and enforcement activities are funded from three appropriations: Taxpayer Services (TS); Enforcement (ENF); and Operations Support (OS).  The total FY 2008 Budget request for these three operating accounts is $10.8 billion supplemented by the $180 million from user fee revenue, for a total operating level of $10.9 billion, or 5.5 percent increase over the FY 2007 JR level.  As in FY 2006 and FY 2007, the Administration proposes to include IRS enforcement increases as a Budget Enforcement Act program integrity cap adjustment, and I am pleased that the Senate Budget Committee mark for the 2008 resolution includes the full cap adjustment for this activity, recognizing the return on investment from these enforcement investments. 

The Budget also includes $282.1 million for Business Systems Modernization (BSM) and $14.2 million to administer the Health Insurance Tax Credit program, a 32.6 percent and 2.6 percent increase, respectively, over FY 2007 JR level.

Our FY 2008 Budget request provides $409.5 million for new initiatives and $340.0 million for the pay raise and other cost adjustments needed to sustain base operations.  The IRS’ initiatives focus on the most significant needs for FY 2008:

• $20.0 million to enhance taxpayer service through expanded volunteer tax assistance, increased funding for research to determine the most effective means to help taxpayers, and implementing new technology to improve taxpayer service;
• $246.4 million to expand enforcement activities targeted at improving compliance; and
• $143.1 million to improve the IRS’ information technology (IT) infrastructure, including $62.1 million for the BSM program and $81.0 million for security and infrastructure enhancements.

This request also includes several program savings and efficiencies that reflect the IRS’ aggressive efforts to identify and deploy work process and technology improvements that will benefit both taxpayer service and enforcement programs.  Collectively, these cost savings total $120.0 million:

• Taxpayer Service Efficiencies -$23.4 million / -527 FTE:  These savings will result from operational efficiencies achieved through on-going efforts to automate and enhance IRS taxpayer service programs’ workload distribution such as the implementation of automated issuance of Employer Identification Numbers and Correspondence Imaging System.  Additional efficiencies and savings are expected to be achieved through the implementation of optimal service channels identified from the Taxpayer Assistance Blueprint.
• Enforcement Program Efficiencies -$60.2 million / -620 FTE:  These savings will result from productivity and efficiency improvements realized through the implementation of enhanced technology and business processes such as improved case selection tools and techniques.  In addition, the completion of initial training and transition of the FY 2006 new hires back to their front-line enforcement activities will result in additional efficiencies for the examination and collection programs.
• Shared Service Support Efficiencies -$36.4 million / -37 FTE:  These savings will result from several efforts including the optimization and consolidation of space projects, implementation of cost-efficient government-wide contract support, and postage savings achieved through the consolidation, automation, and renegotiation of contract services for correspondence delivery. 

A Strategic Plan to Improve Voluntary Compliance

Enhancing Taxpayer Service

Taxpayer service is especially important to help taxpayers avoid making unintentional errors.  The IRS provides year-round assistance to millions of taxpayers through many sources, including outreach and education programs, tax forms and publications, rulings and regulations, toll-free call centers, the IRS.gov web site, TACs, VITA, and TCE sites.

Assisting taxpayers with their tax questions before they file their returns reduces burdensome post-filing notices and other correspondence from the IRS, and proactively addresses inadvertent noncompliance.

The FY 2008 Budget contains three significant taxpayer-service initiatives.  First, we are requesting $5 million to expand volunteer income tax assistance, a significant component of our effort to support taxpayers eligible to claim the Earned Income Tax Credit.  This taxpayer service initiative will help expand our volunteer return preparation, outreach and education, and asset building services to low-income, elderly, Limited English Proficient (LEP), and disabled taxpayers.

The budget also requests $5 million for additional resources to enhance our understanding of the role of the taxpayer service on compliance. This research will focus on understanding taxpayer burden, opportunities for enhanced service to help reduce errors made on returns, and the impact of service on overall levels of voluntary compliance.

Finally, the budget requests $10 million for four of the initiatives recommended by the Taxpayer Assistance Blueprint (TAB).  As part of the TAB effort, we conducted a comprehensive review of our current portfolio of services to individual taxpayers to determine which services should be provided and improved.  Based on the findings of the Blueprint, the funding for this initiative will implement the following telephone service and web site interaction enhancements:

• Contact Analytics provides an analytical tool for evaluating contact center recordings for the purpose of improving business processes and lowering business costs, as well as improving customer service.
• Estimated Wait Time provides a real-time message that informs taxpayers about their expected wait time in queue, allowing them to make more informed decisions based on the status of their call and thus reducing taxpayer burden and increasing customer satisfaction.
• Expanded Portfolio of Tax Law Decision Support Tools enables taxpayers to conduct key word and natural language queries to get answers to tax law questions through the Frequently Asked Questions database accessed on IRS.gov, thereby steadily increasing customer satisfaction and operational savings.
• Spanish “Where’s My Refund?” adds the ability to check refund status to the Spanish web page on IRS.gov, enabling the Spanish-speaking community to receive the same level of customer service on the web as available to the English web page.

Continued technological advancements offer significant opportunities for the IRS to improve the efficiency and effectiveness of call center services.  Web site enhancements are designed to maximize the value of IRS.gov, making the site taxpayers’ first choice for obtaining the information and services required to comply with their tax obligations.

Improving Compliance Activities

The IRS is continuing to improve efficiency and productivity through process changes, investments in technology, and streamlined business practices.  We will continue to reengineer our examination and collection procedures to reduce cycle time, increase yield, and expand coverage.  As part of our regular examination program, we are expanding the use of cost-efficient audit techniques first pioneered in the National Research Program (NRP).

We are also expanding our efforts to shift to agency-wide strategies, which maximize efficiency by better aligning problems (such as nonfilers and other areas of noncompliance) and their solutions within the organization. The IRS is committed to improving the efficiency of its audit process, measured by audit change rates and other appropriate benchmarks.

There are six specific initiatives proposed in the FY 2008 Budget aimed at improving compliance.  These initiatives provide:

• $73.2 million to improve compliance among small business and self-employed taxpayers in the elements of reporting, filing, and payment compliance.  This funding will be allocated for increasing audits of high-risk tax returns, collecting unpaid taxes from filed and unfiled tax returns, and investigating persons who have evaded taxes for possible criminal referral.  It is estimated that this request will produce $144 million in additional annual enforcement revenue per year, once new hires reach full potential in FY 2010.
• $26.2 million for increasing compliance for large, multinational businesses.  This enforcement initiative will increase examination coverage for large, complex business returns; foreign residents; and smaller corporations with significant international activity.  It addresses risks arising from the rapid increase in globalization, and the related increase in foreign business activity and multi-national transactions where the potential for noncompliance is significant in the reporting of transactions that occur across differing tax jurisdictions.  With this funding, we estimate that coverage for large corporate and flow-through returns will increase from 7.9 to 8.2 percent in FY 2008, and produce over $74 million in additional annual enforcement revenue, once the new hires reach full potential in FY 2010.
• $28 million for expanded document matching in existing sites.  This enforcement initiative will increase coverage within the Automated Underreporter (AUR) program by minimizing revenue loss through increased document matching of individual taxpayer account information.  We believe the additional resources will result in an increase in AUR closures from 2.05 million in FY 2007 to 2.64 million in FY 2010.  We expect $208 million of additional enforcement revenue per year, once the new hires reach full potential in FY 2010.  In addition, the budget requests $23.5 million to establish a new document matching program at our Kansas City campus.  This enforcement initiative will fund a new AUR site within the existing IRS space in Kansas City to address the misreporting of income by individual taxpayers.  Establishing this new AUR site should result in over $183 million in additional enforcement revenue per year once the new hires reach full potential in FY 2010.
• $6.5 million to increase individual filing compliance.  This enforcement initiative will help address voluntary compliance.  The Automated Substitute for Return Refund Hold Program minimizes revenue loss by holding the current-year refunds of taxpayers who are delinquent in filing individual income tax returns and are expected to owe additional taxes.  We estimate that this initiative will result in securing more than 90,000 delinquent returns in FY 2008 and produce $82 million of additional enforcement revenue per year, once the new hires reach full potential in FY 2010. 
• $15 million to increase tax-exempt entity compliance.  This enforcement initiative will deter abuse by entities under the purview of the Tax-Exempt and Governmental Entities Division (TEGE) and misuse of such entities by third parties for tax avoidance or other unintended purposes.  The funding will aid in increasing the number of TEGE compliance contacts by 1,700 (six percent) and employee plan/exempt organization determinations closures by over 9,000 (eight percent) by FY 2010.
• $10 million for increased criminal tax investigations.  This will help us to aggressively attack abusive tax schemes, corporate fraud, nonfilers, and employment tax fraud.  It will also address other tax and financial crimes identified through Bank Secrecy Act related examinations and case development efforts, which include an emphasis on the fraud referral program.  Our robust pursuit of tax violators and the resulting publicity is aimed to foster deterrence and enhance voluntary compliance.
• $41 million for conducting research studies of compliance data for new segments of taxpayers needed to update existing estimates of reporting compliance.  The data collected from these studies will enable the IRS to develop strategies to combat specific areas of non-compliance.

In addition to these initiatives, I would stress the importance of allowing us to continue with the private debt collection program.  The use of private collection agents (PCAs) was authorized by the American Jobs Creation Act of 2004.  As we continue to debate the efficacy of this program, I want to take this opportunity to make a couple of points for purposes of our ongoing discussions.

One issue that has been debated is the relative efficiency of using PCAs versus IRS employees to collect the taxes owed.  The most important question is not whether IRS employees or PCAs can do the job more efficiently, but rather whether PCAs collect money that would otherwise go uncollected.  The IRS lacks the resources to pursue the relatively simple, geographically dispersed cases that are now being assigned to PCAs.  It is not realistic to expect that the Congress is going to give the IRS an unlimited budget for enforcement, and if Congress provided the IRS additional enforcement resources, I believe those resources would be applied best by allocating them to more complex, higher priority cases that are not appropriate for PCAs.

The IRS continues to work with PCAs to ensure that the program is fair to taxpayers and respects taxpayer rights.  We currently estimate that between now and FY 2017, our partnership with PCAs will result in approximately 2.9 million delinquent cases receiving treatment that would otherwise have gone unworked.  This partnership will help reduce the backlog in outstanding tax liabilities, which has grown by 118 percent over the last 12 years.  From September 7, 2006, when cases were first assigned to PCAs, through February 15, 2007 PCAs collected $14.47 million in gross revenue.  We estimate that cases worked by PCAs will generate estimated gross revenue of between $1.4 billion through FY 2017.

Another reason to continue to use this tool is to evaluate whether we in the public sector can learn anything from these PCAs that will enable us to do our jobs better.  Particularly over the last 20 years, government agencies at all levels have adopted many practices and ways of doing business that have been pioneered in the private sector.  One need look no further than the vastly expanded use by the government of the Internet in providing services to the public as an example of a practice that was pioneered in the private sector, but adopted quickly and effectively by the government.  We should not remove PCAs as a tool for addressing the problem before we have an opportunity to evaluate the potential of this initiative to help improve compliance and perhaps even to show the government how to be more effective in its own efforts.

Reducing Opportunities for Evasion

The IRS is already aggressively pursuing enforcement initiatives designed to improve compliance and reduce opportunities for evasion.  As I pointed out earlier, these efforts have produced a steady climb in enforcement revenues since 2001, as well as an increase in both the number of examinations and the coverage rate in virtually every major category. 

In the budget request, the Administration proposes to expand information reporting, improve compliance by businesses, strengthen tax administration, and expand penalties in the following ways:

Expand information reporting – Specific information reporting proposals would:

1)      Require information reporting on payments to corporations;

2)      Require basis reporting on sales of securities;

3)      Expand broker information reporting;

4)      Require information reporting on merchant payment card reimbursements;

5)      Require a certified taxpayer identification number (TIN) from non-employee service providers;

6)      Require increased information reporting for certain government payments for property and services; and

7)      Increase information return penalties.

Improve compliance by businesses – Improving compliance by businesses of all sizes is important.  Specific proposals to improve compliance by businesses would:

1)      Require electronic filing by certain large businesses;

2)      Implement standards clarifying when employee leasing companies can be held liable for their clients’ Federal employment taxes; and

3)      Amend collection due process procedures applicable to employment tax liabilities.

Strengthen tax administration – The IRS has taken a number of steps under existing law to improve compliance. These efforts would be enhanced by specific tax administration proposals that would:

1)      Expand IRS access to information in the National Directory of New Hires database;

2)      Permit the IRS to disclose to prison officials return information about tax violations; and

3)      Make repeated failure to file a tax return a felony.

Expand penalties – Penalties play an important role in discouraging intentional noncompliance.  Specific proposals to expand penalties would:

1)      Expand preparer penalties;

2)      Impose a penalty on failure to comply with electronic filing requirements; and

3)      Create an erroneous refund claim penalty.

The Administration also has four proposals relating to IRS administrative reforms.

The first proposal modifies employee infractions subject to mandatory termination and permits a broader range of available penalties.  It strengthens taxpayer privacy while reducing employee anxiety resulting from unduly harsh discipline or unfounded allegations.

The second proposal allows the IRS to terminate installment agreements when taxpayers fail to make timely tax deposits and file tax returns on current liabilities.

The third proposal eliminates the requirement that the IRS Chief Counsel provide an opinion for any accepted offer-in-compromise of unpaid tax (including interest and penalties) equal to or exceeding $50,000.  This proposal requires that the Secretary of the Treasury establish standards to determine when an opinion is appropriate.

The fourth proposal modifies the way that Financial Management Services (FMS) recovers its transaction fees for processing IRS levies by permitting FMS to add the fee to the liability being recovered, thereby shifting the cost of collection to the delinquent taxpayer.  The offset amount would be included as part of the 15-percent limit on continuous levies against income.

Collectively, these proposals should generate $29.5 billion in revenue over 10 years.  The proposed budget provides $23 million to implement these initiatives.  This will fund the purchase of software and the modifications to IRS information technology systems necessary to implement these legislative proposals.

Enhancing Research

Research enables the IRS to develop strategies to combat specific areas of noncompliance, improve voluntary compliance, and allocate resources more effectively. Historically, our estimates of reporting compliance were based on the Taxpayer Compliance Measurement Program (TCMP), which consisted of line-by-line audits of random samples of returns. This provided us with information on compliance trends and allowed us to update audit selection formulas.  However, this method of data gathering was extremely burdensome on the taxpayers who were forced to participate.  One former IRS Commissioner noted that the TCMP audits were akin to having an autopsy without the benefit of death.  As a result of concerns raised by taxpayers, Congress, and other stakeholders, the last TCMP audits were done for Tax Year (TY) 1988. 

We have conducted several much narrower studies since then, but nothing that would give us a comprehensive perspective on the overall tax gap.  As a result, until the recent NRP data, all of our subsequent estimates of the tax gap were rough projections that basically assumed no change in compliance rates among the major tax gap components; the magnitude of these projections reflected growth in tax receipts in these major categories.

The National Research Program, which we have used to estimate our most recent tax gap updates, provides us a better focus on critical tax compliance issues in a manner that is far less intrusive than previous means of measuring tax compliance.  We used a focused, statistical selection process that resulted in the selection of approximately 46,000 individual returns for TY 2001. This was less than previous compliance studies, even though the population of individual tax returns had grown over time.  Like the compliance studies of the past, the NRP was designed to allow us to estimate the overall extent of reporting compliance among individual income tax filers, and to update our audit selection formulas.  It also introduced several innovations designed to reduce the burden imposed on taxpayers whose returns were selected for the study.

The NRP provided updated estimates for determining the sources of noncompliance.  The IRS also uses the NRP findings to better target examinations and other compliance activities, thus increasing the dollar-per-case yield and reducing “no change” audits of compliant taxpayers.  Innovations in audit techniques to reduce taxpayer burden, pioneered during the 2001 NRP, have been adopted in regular operational audits.

Almost as important as understanding what the NRP research provides is to understand its limitations.  The focus of the first NRP reporting compliance study was on individual income tax returns.  It did not provide estimates for noncompliance with other taxes, such as the corporate income tax or the estate tax.  Our estimates of compliance with taxes other than the individual income tax are still based on projections that assume constant compliance behavior among those major tax gap components since the most recent compliance estimates were compiled (i.e., for TY 1988 or earlier). 

Recurring and timely compliance research is needed to ensure that the IRS can efficiently target resources, effectively provide the best service possible, and respond to new sources of noncompliance as they emerge.  Compliant taxpayers benefit when the IRS uses the most up-to-date research to improve workload selection formulas, as this reduces the burden of unnecessary taxpayer contacts.  

The FY 2008 Budget requests funds for two significant research initiatives.  First, the budget requests $41 million to improve compliance estimates, measures, and detection of noncompliance.  This will fund research studies of compliance data for new segments of taxpayers needed to update existing estimates of reporting compliance.  Unlike in the past, the IRS will conduct an annual study of compliance among 1040 filers based on a smaller sample size than the 2001 NRP study.  This will provide fresh compliance estimates each year, and by combining samples over several years, will provide a regular update to the larger sample size needed to keep our targeting systems and compliance estimates up to date.

The second research program funded by the request is to research the effect of service on taxpayer compliance.  The budget requests $5 million for this project, which will undertake new research on the needs, preferences, and behaviors of taxpayers.  The research will focus on four areas:

• Meeting taxpayer needs by providing the right channel of communication;
• Better understanding taxpayer burden;
• Understanding taxpayer needs through the errors they make; and
• Researching the impact of service on overall levels of voluntary compliance.

Continuing Improvements in Information Technology

Tax administration in the 21^st century requires improved IRS information technology (IT).  We are committed to continuing to make improvements in technology and the FY 2008 Budget reflects that commitment.  The FY 2008 Budget requests $81 million to improve the IRS’ information technology infrastructure.  Sixty million dollars of this amount is requested to upgrade critical IT infrastructure.  This infrastructure initiative will provide funding to upgrade the backlog of IRS equipment that has exceeded its life cycle.  Failure to replace the IT infrastructure will lead to increased maintenance costs and will increase the risk of disrupting business operations.  Planned expenditures in FY 2008 include procuring and replacing desktop computers; automated call distributor hardware; mission critical servers; and Wide Area Network/Local Area Network routers and switches.

The other $21 million will be used to enhance the Computer Security Incident Response Center (CSIRC) and the network infrastructure security.  This infrastructure initiative will provide $13.1 million to fund enhancements to the CSIRC necessary to keep pace with the ever-changing security threat environment through enhanced detection and analysis capability, improved forensics, and the capacity to identify and respond to potential intrusions before they occur.  The remaining $7.9 million will fund enhancements to the IRS’ network infrastructure security.  It will provide the capability to perform continuous monitoring of the security of operational systems using security tools, tactics, techniques, and procedures to perform network security compliance monitoring of all IT assets on the network.

Finally, the FY 2008 Budget requests a total of $282.1 million to continue the development and deployment of the IRS Business Systems Modernization (BSM) program in line with the recommendations identified in the IRS Modernization, Vision, and Strategy.  This funding will allow the IRS to continue progress on modernization projects, such as the Customer Account Data Engine (CADE), Account Management Services (AMS), Modernized e-File (MeF), and Common Services Projects (CSP).

The development of the CADE (Customer Account Data Engine) and AMS (Account Management Services) systems is the heart of the IT modernization of the IRS.  The combination of these two systems working together will enable the IRS to process tax returns and deal with taxpayer issues in a near real-time manner.  In fact, our objective is that the IRS operate similarly to what one expects from one’s bank; account transactions occurring during the business day will be posted and available by the next business day.  In addition, AMS will enable the IRS representatives who work with taxpayers to have access to all the information regarding that taxpayer, including electronic access to tax return data, and electronic copies of correspondence.  Equipped with such comprehensive and up-to-date information, our representatives will be in a much better position to help taxpayers resolve their issues. 

MeF is the future of electronic filing.  It provides a standard data format for all electronic tax returns, which will reduce the cost and time to add and maintain additional tax form types.  MeF is a flexible real-time system that streamlines the processing of e-filed tax returns, resulting in a quicker acknowledgement of the filing to the taxpayer or their representative.  In FY 2007, the IRS will start development and implementation of the 1040 on the MeF platform.

CSP will provide funding for new portals, which are technology platforms that meet many IRS business needs through web-based front-ends, and provide secure access to data, applications, and services.  The portals are mission-critical components of the enterprise infrastructure required to support key business processes and compliance initiatives.

The benefits accruing from the delivery and implementation of BSM projects not only provide value to taxpayers, the business community, and government, but also contribute to operational improvements and efficiencies within the IRS.

Summary

The FY 2008 Budget request includes significant increases for IRS enforcement efforts.  Fully funding that request will help us make progress in greatly improving voluntary compliance.  Based on our analysis covering the most recent 11 years of collection experience, we estimate that every dollar we have spent on enforcement has generated a direct return of an average of four dollars in increased revenue to the Federal Treasury.  This return can be expected to occur when the full productive benefit of the investment is realized.

Our role is not unlike that of a highway patrolman.  He will never be able to ticket every speeder, but he attempts to position himself in areas where he knows that his time is more likely to be spent productively.  He also knows that every time he pulls a speeder over, other motorists see that and slow down as well.

We also believe that dollars spent on taxpayer service have a positive impact on voluntary compliance.  The complexity of complying with the nation’s current tax system is a significant contributor to the tax gap, and even sophisticated taxpayers make honest mistakes on their tax returns.  Accordingly, helping taxpayers understand their obligations under the tax law is a critical part of improving voluntary compliance.  To this end, the IRS remains committed to a balanced program assisting taxpayers in both understanding the tax law and remitting the proper amount of tax.

In addition, the President’s FY 2008 Budget contains a number of legislative proposals that provide additional tools for the IRS to enforce the existing tax law.  Perhaps the most critical of these tools is greater third party reporting.

An analysis of the data from the National Research Program of TY 2001individual income tax returns leads to one very obvious conclusion.  Compliance is much higher in those areas where there is third party reporting.  For example, only 1.2 percent of wages reported on Forms W-2 are underreported.  This compares to a 53.9 percent underreporting rate for income subject to little or no third party reporting.

The FY 2008 Budget request asks Congress to expand information reporting to include additional sources of income and make other statutory changes to improve compliance. These legislative proposals are intended to improve tax compliance with minimum taxpayer burden.  When implemented, it is estimated that these proposals will generate $29.5 billion over ten years. 

I anticipate that some of this year’s Budget proposals will be criticized, perhaps because of concerns about their potential impact on small businesses.  While the information reporting proposals will inevitably impose some burden on compliant taxpayers, they are designed to minimize that burden and to help the IRS better target its audit resources, thereby reducing the number of burdensome audits that result in little or no change to compliant taxpayers’ reported liability.  The challenges that a small business faces are difficult enough without having to compete directly with noncompliant competitors.  We have an obligation to support those compliant small businesses by ensuring that their competitors are also paying their fair share.  This is not only a matter of fairness, but also a way of supporting compliant small businesses in their efforts to remain compliant.

Finally, full funding of the budget request will enable the IRS to improve our research with respect to compliance.  Despite all of our progress, there is still much we do not know about the tax gap.  Although the updated estimates provided by the NRP study are more accurate than our previous estimates, and more accurate than the estimates made at various times by others using more indirect methods, they have many limitations.  These estimates are useful for understanding the general areas and levels of noncompliance and the scope of the problem, but they are far from exact measurements.  With the exception of the individual income tax gap, the estimates do not adjust for noncompliance that goes undetected during examination, and estimates are not even available for certain (minor) components of the tax gap.  Beginning in October 2007, the IRS will begin ongoing annual research activities that will ensure we have the most up to date compliance data possible to measure portions of the tax gap, focus our resources, and improve our audit selection criteria.

I appreciate the opportunity to testify this morning, and I will be happy to respond to any questions that Members of the Committee may have.