Proposed legislation to restructure and reform the Internal Revenue Service.

On January 29, 1998, Tax Executives Institute testified before the Senate Committee on Finance on proposed legislation to restructure and reform the Internal Revenue Service. The Institute's testimony, which was presented by TEI President Paul Cherecwich, Jr. of the Salt Lake City Chapter, focusses primarily on H.R. 2676, a bill that overwhelmingly passed the House of Representatives in November 1997. TEI's earlier submissions on this topic appeared in the November, December 1996, July-August 1997, and September-October 1997 issues of The Tax Executive.

Good morning. I am Paul Cherecwich, Jr., Vice President-Taxes and Tax Counsel for Thiokol Corporation in Ogden, Utah. I appear before you today as the president of Tax Executives Institute, the largest group of in-house tax professionals in North America. The Institute is pleased to submit these comments on proposals to restructure and reform the Internal Revenue Service -- H.R. 2676, which has been styled The IRS Restructuring and Reform Act of and its Senate counterpart, S. 1096. The legislation, which passed the House of Representatives last November with overwhelming bipartisan support, is based on the work of the National Commission on Restructuring the Internal Revenue Service (of which Senator Kerrey was co-chair and on which Senator Grassley served). In the Institute's view, the legislation holds great promise for improving the management and oversight of the IRS and for significantly enhancing taxpayer rights while giving the agency the tools necessary to fulfill its congressionally approved mandate.

I. Background

Tax Executives Institute is the professional association of corporate tax executives. Our 5,000 members are accountants, attorneys, and other business professionals who work for the largest 2,700 companies in North America; they are responsible for conducting the tax affairs of their companies and for ensuring their compliance with the tax laws. Hence, TEI members deal with the tax laws and with the Internal Revenue Service on almost a daily a basis. (Most of the companies represented by our members are part of the IRS's Coordinated Examination Program, pursuant to which they are audited on an ongoing basis.) They also have day-to-day dealings with senior corporate management and corporate boards of directors and, accordingly, know first-hand the strengths and weaknesses of the corporate governance model. TEI believes that the professional training and experience of our members enable the Institute to bring an important, and balanced, perspective to the issues involved in efforts to restructure and reform the IRS.

II. Setting the Tone for a Constructive Debate

A. The Emerging Consensus At the outset, TEI commend the members of the National Commission on Restructuring the IRS, the House Committee on Ways and Means, and this Committee for their unstinting efforts to identify areas of concern, to seek out the views of interested parties, and to craft thoughtful solutions. We especially commend the members of Congress who have cosponsored comprehensive restructuring legislation, and who have remained open to modifications in an effort to develop a bipartisan consensus for enhancing the management and of the IRS. Even though TEI disagrees with certain provisions of H.R. 2676, the Institute is convinced that the proposed legislation holds great promise for improving the Internal Revenue Service. The daunting support the bill garnered in the House of Representatives (426 to 4), coupled with the Clinton Administration's constructive support, speaks volumes not only of the bill's appeal but of the care the sponsors have taken in addressing a plethora of complicated issues.

This is not to say, of course, that the bill cannot be improved. As this statement makes clear, TEI clearly believes it can. As the legislative process moves forward, however, TEI believes it is important that the perfect not become the enemy of the good. We also believe it is imperative that everyone concerned -- Congress, the Administration, the IRS itself, stakeholders in the private sector, and the public -- acknowledge that consensus has already been attained on a wide variety of issues, including the critically important issue of Executive Branch governance. Hence, the biggest obstacle to reform -- acceptance of the need to bring greater continuity, accountability, and expertise to the management and oversight of the IRS -- has already been removed. The key now is to ensure that whatever changes are adopted do not impede the IRS's ability to do its job -- collecting the revenue necessary to run the government -- today and into the future.

B. The Need for a Balanced Approach. TEI is especially pleased that nearly all parties recognize that there is no single solution to what ails the IRS. What is needed is a balanced, integrated approach. One change -- say, the appointment of an IRS Oversight Board -- will not transform the agency unless it is effectively coupled with others, including coordinated and streamlined congressional oversight, stronger leadership by the Commissioner and senior IRS management, an increased focus on customer service, and the assurance of effective performance measures. Indeed, one of TEI's primary concerns is that the establishment of an oversight board not become just another layer of bureaucracy within the IRS. By itself, such a board will not make the agency more responsive and may even impede the government's ability to improve the development and administration of our tax laws. In tandem with other changes, however, enhanced Executive Branch oversight of the IRS can increase management accountability and contribute to a tax system that properly focuses on customer service without minimizing the importance of ensuring taxpayer compliance.

C. Focusing on the Future. Once again the focus of these hearings should be on the future. We should concentrate on clearly defining expectations, on streamlining and strengthening oversight of the agency by both the Treasury Department and Congress, and on providing the IRS with sufficient (and stable) budget resources to modernize its systems, to serve the public, and to ensure compliance with the tax laws. To the extent TO has a regret about the process that has brought us to this point (including the Finance Committee's hearings last fall), it is the tendency by some to "play to the gallery" and engage in unconstructive, vitriolic criticism of the IRS and its personnel. To be sure, IRS management can be improved, but there is plenty of blame to go around. Unfounded, misplaced, and exaggerated attacks on the agency may have surface appeal and score well in public opinion polls, but in our view, they are not constructive; they are part of the problem, not the solution. The keys to giving the American people the tax system they deserve are to remain focussed on the future, to resist the temptation to micro-manage the IRS's day-to-day activities, and to complete the legislation as soon as possible so the IRS can get on with its work.

III. The Need for Meaningful Simplification

Although the focus of these hearings is on improving the Internal Revenue Service, we believe it both proper and fair to observe that Congress itself bears a full measure of responsibility for the problems that plague the tax law and its administration. TEI respectfully submits that the biggest steps Congress can take toward meaningful reform are, first, to resist the temptation to use the tax system to address every social or economic ill that confronts the Nation and, second, to work to simplify the tax laws already on the books. Without a doubt, the taxpayer rights title of H.R. 2676 is important and TEI agrees that many of the proposed protections are laudable and merit enactment. At the same time, it should be remembered that the biggest abuses come not from excessive actions by IRS personnel but from the highly complicated laws and onerous administrative procedures that Congress enacts and the President signs into law One need look no further than the complexity, complications, and confusion spawned by the Taxpayer Relief Act of 1997 for a prime example of how not to write the tax laws. As Winston Churchill might have said, never have so many provisions inflicted so much complexity for so (relatively) few tax benefits.

TEI believes that the complexity of current law is a primary impediment to the effective operation of the tax system and the efficient management of the Internal Revenue Service. Stated simply, if the law is unadministrable, how can the IRS be expected to administer it in an efficient manner? Accordingly, TEI supports the provisions of the bill that would require Congress to focus more finely on the complexity of tax law proposals, for example, by requiring the Joint Committee on Taxation to prepare a "tax complexity analysis" for legislation reported out of the tax-writing committees and for all conference reports that would amend the Internal Revenue Code. By requiring that some attention be paid to exploring the relative complexity of tax law proposals and less complex alternatives, H.R. 2676 may enable Congress to make meaningful incremental changes. We also support the requirement that the IRS provide Congress with an independent view of tax administration and, further, that the tax-writing committees receive testimony from front-line IRS technical experts on the administrability of pending changes. At the same time, we believe it would be imprudent to divorce totally the IRS's role in evaluating the administrability of legislation from the Treasury's tax policy responsibilities. It is the Treasury that should be ultimately responsible -- and accountable -- for determining the Administration's position on proposed legislation.

The provisions in H.R. 2676, however, are not a panacea. For example, the availability of a tax law complexity analysis, with or without a complementary point-of-order mechanism, would not have prevented the 1997 tax law from being so complicated. The troublesome provisions were enacted not because their mind-numbing complexity was unknown but because it was ignored. TEI well appreciates that other policy objectives may sometimes outweigh the goal of tax law simplification, but until the Administration and members of Congress (and, concededly, private-sector interest groups) go beyond paying lip service to simplification and exercise self-discipline in championing complex measures, the goal of tax law simplification will remain illusive.

IV. Ensuring Effective Oversight of the Internal Revenue Service

Tax Executives Institute supports the provisions of H.R. 2676 that would establish a joint government-private sector oversight board to institutionalize enhanced Executive Branch oversight of the IRS As previously explained, however, we do not believe that the establishment of a board by itself will solve the IRS's problems. Indeed, unless care is taken in establishing the board, it may become just another layer in the bureaucracy, impairing the IRS's ability to manage its affairs rather than facilitating it.

A. Composition of the Oversight Board. As approved by the House of Representatives, the Oversight Board would have eleven members -- eight "private-life" members who would be appointed by the President with the advice and consent of the Senate, plus the Secretary of the Treasury (or, if the Secretary so designates, the Deputy Secretary), the Commissioner of Internal Revenue, and a representative of a union representing a substantial number of IRS employees.

TEI supports the decision to provide for a reasonably balanced oversight board. Having representatives of both government and the private sector on the board would afford the IRS the benefit of private-sector expertise (which would be lacking on a government-only board) while recognizing the unique mission of the IRS as a tax-collection agency. TEI commends the decision to include the Commissioner, as well as the Secretary of the Treasury, on the board -- the Secretary (or Deputy Secretary) because he or she is ultimately accountable for the proper oversight of the IRS, and the Commissioner because he or she effectively serves as Chief Executive Officer of the agency. Although TEI appreciates the reasoning underlying the decision to include a union representative on the board (specifically, the buy-in of IRS employees will be critical if the agency is to meet the challenges of the 21st century), the Institute generally believes that members should be selected solely on the basis of their expertise in areas such as general management, finance, technology, and personnel. In other words, no particular group should be guaranteed a position on the board. Hence, we support the delineation in the statute of the various "skill sets" -- management of large service organizations, customer service, federal tax law (including tax administration and compliance), information technology, organization development, and the needs and concerns of taxpayers -- that should characterize the private-sector representatives on the board.

B. Duties of the Oversight Board. Under H.R. 2676, the principal function of the oversight board would be to oversee the Internal Revenue Service in the administration, management, conduct, direction, and supervision of the execution and application of the internal revenue laws, related statutes, and tax conventions to which the United States is a party. The board would be involved in (1) reviewing and approving IRS's strategic plans (including the establishment of its mission, objectives, and standards of performance), (2) reviewing operational functions of the IRS (including plans for modernization of the tax system, training, and education), (3) providing for review of the Commissioner's selection, evaluation, and compensation of senior managers, and (4) reviewing and approving the Commissioner's plans for major reorganizations. In addition, the board would review and approve the budget request prepared by the Commissioner (to ensure that it supports the IRS's annual and long-range strategic plans), which would be submitted to Congress without revision. (The President's ability to submit his own budget request for the IRS would not be affected by the legislation.) H.R. 2676 provides that the oversight board would have no responsibilities with respect to (1) the development and formulation of federal tax policy relating to existing or proposed internal revenue laws, (2) specific law enforcement activities of the IRS, including compliance activities such as criminal investigation, examinations, and collection activities, and (3) specific procurement activities. Finally, the board would have authority to recommend candidates for Commissioner to the President and to recommend removal of the Commissioner.

TEI has no serious quarrel with the duties that the legislation proposes to assign to the oversight board. In general, however, TEI believes the board should serve in an oversight rather than a decision-making capacity. Hence, although we believe the IRS can learn much from the private sector, we recognize that the corporate governance model is not perfect and we have residual concerns about the requirement that the board-approved budget be forwarded to Congress, even though the IRS's budget would formally be presented (with or without changes) as part of the Administration's overall budget proposal. (The proposal could blur the lines of accountability or heighten the possibility of conflict between the board and the Administration.) Hence, we believe it is important to remember that, with or without a board, it is the Secretary of the Treasury who will remain ultimately responsible and accountable for management of the IRS.

Moreover, although we support the proposed prohibition on the board's becoming involved in the development and formulation of federal tax policy -- as well as the proposed prohibition on board members' receiving confidential taxpayer information -- experience teaches that the dividing line between policy and administration is not always easy to discern and maintain. For example, budgetary decisions regarding research or compliance programs could well affect how the tax law is interpreted or applied, thereby affecting policy. Hence, we agree that the presence of private-sector representatives on the oversight board raises conflict-of-interest issues of real moment. While these issues cannot be minimized or ignored (and, in our view, they would be exacerbated if board members were granted access to confidential taxpayer information), they should not be overstated. Institutional protections can and should be implemented (just as they have been in the private sector where the same individuals serve, for example, on multiple boards of directors).

C. Appointment of the Commissioner. Under H.R. 2676, the Commissioner would continue to be appointed by the President with the advice and consent of the Senate, but the oversight board would have authority to recommend candidates to the President and, in appropriate cases, to recommend removal of the Commissioner.

TEI strongly agrees that the Commissioner should continue to be appointed by the President. We also agree that the President should retain the authority to dismiss the Commissioner, who will be responsible for all functions of the IRS, including those beyond the board's areas of responsibility (such as specific enforcement and customer service functions).

V. Other Measures to Improve Tax Administration

A. Continuity and Flexibility of Management. Under H.R. 2676, the Commissioner of Internal Revenue would be appointed to a five-year term. We agree with this provision, as well as with the provisions to accord the Commissioner greater flexibility in hiring, firing, and salary decisions. The goals of continuity and accountability at the top of the agency win be advanced by appointing the Commissioner for a fixed five-year term and granting the Commissioner I broader authority to manage the IRS.

Indeed, we believe that granting the Commissioner greater discretion in recruiting, rewarding, and retaining the agency's top managers is critical to fulfilling one of the objectives of IRS restructuring and reform -- ensuring that taxpayers deal only with IRS employees who are trained adequately and possess the skills and tools necessary to do their jobs well. Continuity among the IRS's senior managers -- assuming they are qualified to do their jobs -- is essential if the IRS is to operate efficiently and regain the trust of Congress and the American people. Thus, we believe care must be exercised to balance the twin goals of flexibility and stability, in our view, the last thing the IRS needs is massive turnover in senior management ranks whenever a new Commissioner is appointed.

B. Stability of Funding. TEI believes that the Internal Revenue Service should receive stable funding. If the leaders of the IRS are to undertake the proper planning to rebuild the agency's credibility and effectiveness, the agency must be assured that programs initiated and funded in one year in furtherance of the IRS's strategic plan are not eviscerated in the next.

To be sure, the nature of government is such that Congress will re tam authority to set the IRS's budget and to readjust priorities as tames change and developments warrant. At the same time, we believe more can be done to stabilize the IRS's operational budget and insulate the agency from political winds. Hence, TEI supports the inclusion in the final legislation of provisions stabilizing funding for tax law enforcement and processing, assistance, and management. (The National Commission on Restructuring the IRS recommended funding be maintained at current levels for the next three years.) Moreover, although recognizing that Congress remains ultimately responsible to the American people for how the tax system operates, we believe the overall management of the agency would benefit from the implementation of multi-year budgets. More immediately, Congress must ensure that the IRS is given adequate funding to address both its modernization challenges and Year 2000 Compliance activities.

C. Streamlining of Congressional Oversight. Title IV of H.R. 2676 addresses congressional accountability for the IRS. TEI agrees that congressional oversight of the agency should be streamlined. Reforming the Internal Revenue Service requires more than the IRS -- and the Executive Branch officials who oversee it -- getting its house in order. With due respect, it requires Congress to get its house (or houses) in order Currently, there are seven congressional committees and subcommittees that engage in oversight activities. The US. General Accounting Office not only undertakes projects assigned to it by those bodies but also "self-initiates" numerous projects each year. And each of those projects -- regardless of whether it leads to hearings or legislation -- consumes considerable IRS resources and may send mixed signals to the agency and the public about the proper direction for tax administration.

While responsible oversight is absolutely essential to effective government, TEI agrees that steps can be taken to streamline congressional oversight activities and to make it at once less reactive, more constructive, and more integrated. In our view, coordinated, as opposed to reactive and sometimes disjointed, oversight by Congress must be part of the drive toward continuity and accountability. Thus, TEI supports the proposal that the Joint Committee on Taxation review and approve requests for investigations of the IRS by the GAO, an recommends at its coordinating role be extended to requests by committees or subcommittees. Such a process will permit Congress to eliminate overlapping investigations, ensure that the GAO has the capacity to handle the requested investigation, and ensure that investigations focus on areas of primary importance to sound tax administration.

TEI also supports the proposal that joint hearings be held annually to review the IRS's strategic plans and budget and, further, to review the IRS's progress in meeting its objectives, improving taxpayer service and compliance, and implementing its modernization initiatives. In our view, the involvement of the oversight board in reviewing the IRS strategic plans and budgets should imbue them with greater credibility and contribute to a more positive -- and coordinated -- reception of the agency by Congress.

Finally, we recommend that Congress carefully weigh the potential costs and benefits of requiring the IRS (or its constituent offices or advisory groups) to complete numerous studies (as H.R. 2676 would do) and to make periodic reports on various specific subjects (such as electronic filing), which can consume considerable IRS resources and distract the agency's management from attaining its policy objectives. Congress's role should be to provide oversight and ratify the IRS's strategic decisions, not become involved in managing day-to-day operations. In our view, the oversight board's involvement in the IRS's strategic planning and budget processes should help restore congressional confidence in the agency, thereby facilitating coordinated and streamlined legislative oversight.

VI. Strengthening Tax Rights

TEI agrees that further steps should be taken to preserve and strengthen taxpayer rights. Thus. we support efforts to ensure not only that taxpayers are treated fairly and impartially by the IRS, but also that they are able to seek redress or review of IRS actions by the courts and to resolve conflicts creatively and expeditiously with IRS cooperation. An essential ingredient in protecting taxpayer rights is an independent, effective taxpayer advocate program. TEI has long regarded the IRS's problem resolution program as one of the agency's success stories, and we believe increased attention should be given to promoting the independence and effectiveness of the Taxpayer Advocate. Thus, although TEI believes that the Taxpayer Advocate should be appointed by, and report to, the Commissioner, we believe it would be appropriate for the oversight board to play a role in the Taxpayer Advocate's selection. We are also pleased by Commissioner Rossotti's testimony last fall, obviously before any legislation was enacted, that he intends to look outside the IRS for the next Taxpayer Advocate.

TEI offers the following comments on specific taxpayer rights proposals in H.R. 2676:

A. Refining IRS Performance Measures TEI believes that, for IRS reform to be successful, the agency must address training, operations, technology, culture, and taxpayer education. More particularly, the Institute believes it is critical for the IRS to refine its performance measures to guard against real or perceived "quotas" as well as the evaluation of examination and collection personnel on the basis of increased production.

Earlier this month, IRS issued an internal audit report on the use of enforcement statistics in the direction, achievement, and evaluation of the collection function. The report discussed the IRS's focus on increasing productivity and concluded that dollars collected had become the most important factor in setting program goals and evaluating program accomplishments. In response to the report, Commissioner Rossotti outlined a number of steps the IRS has already taken to address the concerns, including a redirection of the efforts of the IRS's Measures Advisory Group to identify performance measures that will promote quality and appropriate case actions consistent with customer service and taxpayer rights.

Although the IRS's internal audit report focussed primarily on the collection function, concerns about the improper use of statistics go beyond that. TEI has previously voiced concerns that the National Office's concentration on increased production (as measured by "dollars recommended" during the examination process) could impair the overall effectiveness of the Coordinated Examination Program by encouraging revenue agents to pursue questionable issues. In response to such concerns, the IRS has undertaken to ensure that case managers and team members are not evaluated on the basis of "dollars recommended." Any perceptions to the contrary, by IRS field personnel as well as the public, must be corrected.

The adoption of meaningful performance standards is essential to the long-term success of the IRS's examination programs. Measures for over all programs and functions and for the individuals who execute them must be in harmony if the IRS is to achieve its mission of collecting the proper amount of tax (not the highest amount of tax) from taxpayers. The Institute is committed to working with the IRS to improve various performance measures, not only eliminating any hint that the IRS uses "dollars recommended" in evaluating agents but also encouraging the use of innovative techniques such as case management settlement authority, advanced issue resolution, early referral to Appeals, and the involvement of taxpayers in the audit planning process. We believe that District Offices should be evaluated on a range of performance criteria, including an in-depth review of any gap between the dollars proposed and the dollars sustained. Criteria such as the number of agreed issues, the number of issues sustained in Appeals, and the currency of audit activity should also be used, especially in long-term evaluations. The IRS's goal should be to conduct cost-effective, quality examinations with the least burden on both the taxpayer and the government. Although TEI has no formal position on whether the restructuring legislation should be amended to specifically address the issue of IRS performance measures, the Institute stands ready to assist the Committee should it decide to do so.

B. Shifting the Burden of Proof. H.R. 2676 would shift the burden of proof in tax cases from the taxpayer to the government (once the case reaches court and assuming certain net worth requirements are satisfied). Although this provision has been promoted as advancing taxpayer rights, it would undermine the 50year old principle that taxpayers have the responsibility of proving the correctness of items reported on their tax returns. TEI regrets that it could diminish the level of voluntary compliance and lead to a more intrusive IRS. Accordingly, the Institute recommends that it be stricken from the IRS restructuring bill.

Currently, the burden of proof in tax cases is on the taxpayer in that the IRS's determination of tax liability will be presumed correct unless the taxpayer can rebut it. Proponents of shifting the burden of proof argue that it is inconsistent with the rule that the individuals; are "innocent until proven guilty." Except in criminal cases, however, the burden of proof already generally rests with the party who has control over the facts (here, the taxpayer). Otherwise, the party with the facts but not the burden could prevail by concealment.

The burden-shifting proposal is subject to several limitations. First, it only applies to those cases that go to court each year. (Only one percent of all tax returns are audited, and of those, fewer than 2,000 land in court.) Second, it applies only where the dispute between the taxpayer and the IRS is "reasonable" and where the taxpayer has "fully cooperated" with the IRS. And third, the proposal does not overturn specific recordkeeping requirements Congress has already enacted. Whether the burden-shifting law is as narrow as its proponents contend, however, will not truly be known until the courts become involved and define nebulous terms such as "fully cooperated" and "reasonable." This prospect that prompted many commentators to lament that the burden-shifting proposal is unduly cumbersome, raising more questions than it answers. The technical problems with applying the proposal were carefully analyzed by Chief Judge Mary Ann Cohen of the U.S. Tax Court in a letter to the Committee dated December 19, 1997, and we urge the Committee to consider her comments carefully before proceeding.

Indeed, in our view the real problem is not with the few cases in which the taxpayer satisfies the statute. It is with all the other cases. The message that the burden-shifting proposal sends will be mixed. Listen to the sound bites, and what you hear is not a limited proposal but an extraordinarily broad one -- one that promises to get the IRS out of taxpayers' lives. Scan the headlines, and what you see is that the limitations and nuances have been lost and that taxpayers are being told (or, at least, are hearing) that they will not have to keep records or substantiate their claim . The sky might not fall in those cases where the burden ultimately shifts, but the overall effect of the legislation may be to undermine voluntary compliance.

Indeed, TEI is very much concerned about how the IRS might respond to burden-shifting. Although advertised as a "get the IRS out of your life" proposal, it may ironically move the tax system in the opposite direction. This is because, if the burden of proof is shifted, the IRS will likely intensify its enforcement activities to sustain its heightened burden. In other words, the few taxpayers who push their cases to court and satisfy the myriad requirements of the statute (after hiring lawyers to help them navigate the complicated provision) may find themselves better off than in the past, but most of us will probably be worse off. As former IRS Commissioner Fred Goldberg once testified, "Change the bur den of proof and IRS tactics of today will seem like child's play ... Ifs hard to imagine a more well-intentioned idea that would have more undesirable consequences."

Concededly, the proposal to shift the burden of proof in tax cases resonates with taxpayers. It is fraught, however, with risks for the tax system. Indeed, it is the archetypal "easy solution" that journalist H.L. Mencken warned exuded to every human problem: It is neat, it is plausible, it is wrong Because shifting the bur den of proof could lead to a more intrusive IRS, decrease tax revenues, and cause a less efficient tax system, the proposal should be removed from the IRS reform legislation.

C. Authority to Award Coots and Fees. H.R. 2676 would amend the Internal Revenue Code's current provisions relating to awarding tax payer costs where the IRS's position is not substantially justified, thereby enabling more taxpayers to recover the cost of disputing proposed IRS adjustments. TEI supports the proposal and urges Congress to carefully weigh proposals to eliminate the "net worth" limitations on awarding costs and attorney's fees (which currently operate to deny most corporations any relief even where the IRS's position is wholly unsupportable).

D. Eliminating the Interest Differential. Under current law, the Internal Revenue Code imposes a higher interest rate on tax deficiencies than it pays on tax refunds, which can have the effect of penalizing taxpayers who simultaneously owe and are owed funds by the IRS. H.R. 2676 would eliminate the harsh effects of the Code's interest rate differential (though only on a prospective basis) by (1) eliminating the differential in its entirety in respect of noncorporate taxpayers and (2) providing for other taxpayers that, during periods of overlapping interest (or mutual indebtedness), a net interest rate of zero would apply on equal amounts of tax underpayments and overpayments. The provision, however, would only apply in respect of income and self-employment taxes.

TEI strongly supports the elimination of the interest differential during periods of mutual indebtedness. Indeed, we urge the Committee to consider eliminating the differential not only for noncorporate taxpayers but for everyone, thereby ensuring that the Code's interest provisions operate not to penalize (for example, in the case of so-called large corporate underpayments or overpayments) but rather only to compensate for the use or forbearance of money. Moreover, we urge Congress to confirm in the legislation (not merely in the committee reports) that the IRS has the authority -- and the responsibility -- to deal retrospectively with the inequities of the interest rate differential by implementing comprehensive crediting (netting) procedures for all open years.

E. Extension of Privilege of Confidentiality to Non-Attorneys. H.R. 2676 would in effect extend a privilege of confidentiality to communications between taxpayers and non-attorneys authorized to practice before the Internal Revenue Service. Thus, accountants and enrolled Agents who represent taxpayers in noncriminal proceedings would be able to interpose a privilege to prevent the IRS from securing communications that would have been privileged had they arisen in an attorney-client relationship.

As an organization whose members include both attorneys and accountants and whose members routinely engage the professional tax services of both attorneys and accountants, TEI has no formal position on the privilege proposal. We do, however, wish to make the following observations that may be of benefit to the Committee as it assesses the proposal. First, taxpayers (including the companies represented by TEI members) are interested in securing the best advice and counsel available, regardless of the professional status of their advisers. Second, we are convinced that there are occasions where the guarantee of confidentiality -- and the candor it encourages between clients and their advisers -- can contribute to the quality of that advice. Third, we are concerned that, because the proposal is framed in terms of limitations on the IRS's summons authority (rather than as an amendment to the Federal Rules of Evidence), the benefits of the privilege might well be vitiated by the knowledge that, if a dispute proceeds to court (or involves the IRS Criminal Investigation Division or a grand jury), the promise of confidentiality would disappear. That is to say, because the non-attorney privilege would apply only at the administrative level in respect of noncriminal ax matters (and not at all in respect of state tax matters), its overall effect might well be muted.

Finally, we are concerned by the so-called law of unintended consequences, which would come into play with an amendment to the IRS's long-standing authority to issue summonses for relevant materials. More to the point, we are concerned that limiting the IRS's authority to reach communications between taxpayers and their non-attorney advisers might well prompt the IRS to pursue relevant information through other, more intrusive means. All these concerns prompt us to urge the Committee to move cautiously in this area.

F. Limitation on Authority to Require Production of Computer Source Code. H.R. 2676 would limit the MSs authority to issue a summons for third-party tax-related computer source codes, i.e., the human readable instructions for any computer software program that is used for accounting, tax return preparation, tax compliance, or tax planning, along with design and development materials related to such software program. The proposed legislation would provide exceptions for criminal offenses or internal use software. The House report on this provision notes its belief that "the intellectual property rights of the developers and owners of computer programs should be respected."

Mr. Chairman, this is an extraordinarily sensitive issue, and many taxpayers have found themselves often caught in the middle. Although taxpayers are indisputably obliged to make their own "books and records" available to the IRS, they are finding their audits held hostage while the IRS seeks access to software programs that are not in the taxpayers' possession and indeed do not relate specifically to any transactions they have engaged in. While taxpayers accept their responsibility to substantiate items on their returns, they must also respect their licensing obligations to third-party vendors whose very business may depend on the computer code's remaining confidential. In at least one appellate case, the court recognized the need to balance these competing interests by imposing restrictions on the IRS's use of a third-party software program. To date, however, the IRS has refused to accept similar limitations in other cases and persists in involving taxpayers in costly litigation to obtain the source codes despite their tenuous relevancy. No satisfactory explanation for the IRS'S position has been offered, other than an assertion of its unfettered right to the information.

Given the attenuated relevance of the source code information to the examination of the taxpayer's return -- and the highly sensitive nature of the trade secrets inhering in the code -- TEI is at once frustrated and disappointed that matters have reached this point. Although the Institute has previously supported the development of an administrative solution to this matter, we now believe a consensus exists for legislative action.

VII. Conclusion

Tax Executives Institute appreciates this opportunity to provide its comments on proposals to restructure the Internal Revenue Service. I should be pleased to respond to any questions you may have.