TEI Testimony on the Internal Revenue Service's budget for FY 2005.

March 30, 2004

On March 30, 2004, Tax Executives Institute testified before the Subcommittee on Oversight of the House Committee on Ways and Means on the Internal Revenue Service's budget for the fiscal year beginning October 1, 2005. TEI Executive Director Timothy J. McCormally presented the Institute's testimony.

Good afternoon. I am Executive Director of Tax Executives Institute, the preeminent association of business tax professionals. The Institute is pleased to participate in today's hearing on the tax filing season and the Internal Revenue Service's budget.

Background

Tax Executives Institute was established in 1944 to serve the professional needs of in-house tax practitioners. Today, the Institute has 53 chapters in the United States, Canada, and Europe. Our 5,400 members are accountants, attorneys, and other business professionals who work for 2,800 of the leading companies in North America and Europe; they are responsible for conducting the tax affairs of their companies and ensuring their compliance with the tax laws. Hence, TEI represents the business community as a whole, and our members deal with the tax code in all its complexity, as well as with the Internal Revenue Service, on almost a daily basis. TEI is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike.

The companies that employ TEI's members have almost without exception been assigned to the IRS's Large and Mid-Size Business (LMSB) Division. The largest 1,600 taxpayers within LMSB are part of the Coordinated Industry Cases (CIC) program; this means that they are subject to heightened scrutiny and, indeed, continual audit by the IRS. As non-participants in the so-called audit lottery, TEI members and the companies they represent have a keen interest in ensuring the efficient operation of the IRS and the proper balance of the agency's taxpayer service, enforcement, and other activities. Specifically, TEI has long supported adequate funding for the IRS, particularly in respect of training and technology, and collaborative efforts between taxpayers and the IRS. We are pleased to offer our views on the IRS's budget for fiscal year 2005.

Increased Demand, Decreased Resources

The Bush Administration has proposed a budget for the IRS for fiscal year 2005 of $10.674 billion, a 4.8 percent increase from 2004. The proposal would increase funding for the agency's enforcement program by $366 million while decreasing funds for business systems modernization by $105 million. According to the Administration, the reduction in funding for the modernization program flows from independent studies concluding that the program should be resized. The IRS Oversight Board has also recently recommended that the IRS reduce the number of modernization projects to permit better management of the program.

Given current budgetary constraints, TEI agrees that the IRS must reexamine its goals and objectives. If the agency is to respond to taxpayer needs and to administer the tax code in a fair and efficient manner, it must have the resources necessary to fulfill its mission. TEI has consistently supported both adequate funding for the Internal Revenue Service--including its training and modernization programs--complemented by over-sight by the IRS Oversight Board, the Treasury, and Congress. We know the Subcommittee shares our concern and urge you to continue to support adequate funding of the IRS to fulfill its responsibilities for taxpayer service and enforcement.

Our testimony today focuses primarily on two areas where adequate funding is particularly crucial: (i) the need to attract, train, and retain top-notch tax professionals, and (ii) the need to obtain currency on audits. But before addressing these issues, we believe that it is appropriate to note how the complexity of the tax code strains the limited resources of both the IRS and taxpayers and impairs the fair and efficient operation of the tax system.

Achieving Simplification

Complexity and changes in the tax system have important ramifications for tax administration and compliance. During the five-year period ending in 2002, there were 19 enacted tax bills that changed 292 tax code sections and required 515 changes to forms and instructions. More changes--including the introduction of a new Schedule M-3 (which is intended to advance the goal of currency by providing the IRS with much more detailed and timely information on the differences between financial and tax accounting)--are inevitably on the horizon. And each change, no matter how laudable in isolation, will require revision of forms and instructions, as well as new training efforts that cannot help but detract from the IRS's goals of achieving currency on audits.

More than five years ago, TEI joined with the American Institute of Certified Public Accountants and the American Bar Association Section of Taxation to recommend changes to simplify the law not only for taxpayers--both large and small--but the government as well. We believe that even small changes--such as harmonizing the various definitions of "child" as the Administration has proposed--can have a positive effect on job performance. Larger changes--such as the repeal of both the individual and corporate alternative minimum tax--can have significant effect on taxpayers' ability to comply with the law and the IRS's ability to perform efficient and effective audits. Enactment of simplifying measures can ease pressures and make workers more productive. In this regard, we are pleased that the Bush Administration has included several simplification provisions in its 2005 budget request.

Incremental simplification is commendable, but steps must also be taken to address systemic and structural complexity in the tax law. For example, the international tax provisions are among the tax code's most complicated and need significant reform and simplification. Several pending bills--such as H.R. 2896, the American Jobs Creation Act of 2003, and S. 1637, the JOBS Act of 2003--contain previsions to address this complexity. We urge Congress to move forcefully to make the law less complex and therefore more cempetitive and efficient.

Achieving a Well-Trained Workforce. Management of Human Resources 

Effective management of human resources is not a new challenge, but it is one that demands more attention as the government's workforce ages. The IRS Oversight Board's 2003 report to Congress observed an increased demand for IRS services and a decreased level of resources. Specifically, the Board documented a 16-percent increase in the IRS's workload between 1992 and 2002 and, during the same period, a 16-percent decrease in the number of full time equivalent employees (from 115,205 to 96,714). The Board explained that the result of these trends is a huge gap between what taxpayers need and what the IRS can deliver. Closing the gap is one of the IRS's greatest challenges, the Board concluded.

During the past few years, the LMSB workforce declined by 600 employees, 40 percent of LMSB's revenue agents will be eligible to retire in FY2006, and that number will rise to more than 50 percent in FY2008. Among the division's managers, approximately 40 percent are currently eligible to retire.

These statistics underscore what may be the greatest challenge for the IRS over the next five years--its personnel. LMSB is responsible for ensuring compliance by approximately 180,000 entities each of whom has more than $10 million in assets. These taxpayers are the largest enterprises, and correspondingly have the most complex issues and the most complex organizational structures. They themselves employ qualified tax attorneys and accountants and, in return, they require experienced, well-trained agents to understand the complexities and to audit those returns. The success of the agency--and the LMSB Division and CIC program in particular--depends on an effective, efficient, well-trained, and motivated staff. Adequate funding for new hiring is an obvious prerequisite to achieve this goal.

We urge the Subcommittee to ensure that the IRS receives the funding it needs to maintain a qualified workforce.

Achieving Currency: Tools for Enforcement

Adequate funding is required if the IRS is to maintain effective enforcement strategies. LMSB has initiated several important initiatives to enhance collaboration between taxpayers and IRS personnel; to focus on significant (as opposed to immaterial) issues; and, more generally, to empower its agents to resolve issues and settle cases more quickly and efficiently. Over the years, TEI is pleased to have cooperated in numerous efforts to bring greater efficiency to the examination process.

One recent effort deserves mention--a project to develop a focused audit planning process, which was rolled out to taxpayers and LMSB personnel in October. The goals of the LMSB-TEI Joint Audit Planning Process are two-fold: (i) to establish accountability in executing a jointly developed audit plan, and (ii) to develop an issue-focused plan to, if you will, separate the "wheat from the chaff" and thereby increase audit efficiency. The resulting report emphasizes that the keys to a successful audit are communication, trust, and openness.

1. Joint Audit Planning--The Benefits of Collaboration.

This project produced a planning and monitoring tool that lists the steps a taxpayer and audit team can take to enhance the quality and timeliness of tax examinations. A key to this initiative is the delineation of both the individual and the joint responsibilities of all participants--the taxpayer, team manager, audit team, specialists, and Counsel--thereby focusing time and resources on the most important areas.

The Joint Audit Planning Process brings home the message that, even though taxpayers and the IRS sit on opposite sides of the table, they share an interest in ensuring that the resources expended in examining corporate tax returns are used efficiently and wisely. The initiative also underscores the continuing merit of collaborative efforts.

Several other innovative procedures--such as Limited Issue Focused Examination (LIFE), Pre-Filing Agreements, Fast Track Mediation and Settlement, Accelerated Issue Resolution, and Early Referral to Appeals--have also been introduced in the past few years to improve the examination process and promote currency. The Advance Pricing Agreement (APA) program--begun more than a decade ago--is also a worthwhile process that should be continued and encouraged; the program permits the tax system to work more efficiently and effectively without costly litigation by resolving fact-intensive pricing issues before tax returns are filed. In TEI's view, the APA program is a model alternative dispute resolution process that benefits the government and taxpayers alike.

An informal survey of TEI members recently confirmed that LMSB's LIFE initiative--which focuses on materiality of issues and risk analysis of issues to be audited--is streamlining the examination process. We understand that LMSB's interim review of LIFE validates this conclusion, and accordingly strongly recommend that future initiatives be designed to complement and supplement these programs, not replace or supplant them. In addition, we believe that these audit techniques could be adapted for other divisions and may resolve some of the frustrations felt by personnel concerning their ability to make decisions.

2. Overriding Importance of Training. Training is a critical element to the success of these initiatives. Procedures such as LIFE and other initiatives empower personnel to make quality decisions at the lowest level, to resolve disputes fairly and more quickly, and to husband and preserve resources. Training also enhances employee job satisfaction and encourages employees to continue pursuing public service careers. Many agents are still receiving the training needed to implement the initiatives discussed in this testimony. In addition, it is our understanding that more significant changes are under consideration that will require even more training. While LMSB and the IRS generally should remain open to new ideas and programs, the costs and consequences of change cannot be ignored. Each new program creates new training needs, and a "flavor-of-the-month" approach to examination techniques has the potential for causing confusion and malaise in the field. Steps must be taken to ensure that agents receive consistent and timely training.

TEI recommends that funding be provided to permit continued training of revenue agents in alternative dispute resolution techniques.

Tax Executives Institute commends the Oversight Subcommittee for holding this public hearing. TEI looks forward to working with the Subcommittee and the IRS itself to improve tax administration.