Testimony before National Commission on Restructuring the Internal Revenue Service: November 8, 1996.
Tax Executives Institute is the professional association of in-house tax officials. 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 of ensuring their compliance with the tax laws. Most of our members work for companies that are part of the Internal Revenue Service's Coordinated Examination Program, pursuant to which they are audited on an ongoing basis. In other words, our members deal with the IRS on almost a daily basis, and we believe that their experience enables us to bring an important, and balanced, perspective to the Commission's work.
What Are the Causes of
There is no denying that the American tax system is complicated and that it imposes tremendous burdens and costs on business and individual taxpayers, both by itself and in tandem with the state, local, and foreign tax regimes with which it coexists and must interact. Much of the complexity is unavoidable, and TEI believes it is imperative that we all recognize that. We live and conduct business in a complicated, sophisticated, and ever-changing marketplace, and it would be foolhardy to think that the tax law - especially as it applies to multinational enterprises - will ever be truly simple. This is not to say, however, that it cannot be simpler. It can. Hence, TEI is convinced that both the tax laws and their administration can be improved. Laws can be simplified, recordkeeping requirements can be reduced, tax forms and schedules can be streamlined, audits can become more efficient, and burdens can be minimized.
In addressing the problems of tax law complexity and taxpayer burden, it is critically important to assign responsibility for the current system to the proper parties. Accordingly, we feel a need to begin by expressing our serious reservations about the untempered attacks that have been launched on the IRS in recent months. No one likes to pay taxes, but the orderly collection of taxes and the efficient administration of the tax laws are in the best interests of the country. What is not needed is an emotion-laden vendetta against the Internal Revenue Service, an agency charged with enforcing the laws that Congress enacts. To demonize the IRS for the flaws in the tax system is misplaced and counterproductive.(1)
Hence, although the tax collector has been a favorite target for criticism since biblical times, it is important to recall what Marc Antony said in Julius Caesar, "The fault...is not in our stars but in ourselves." Where does the responsibility for imposing the burden lie? Walt Kelly's Pogo put it more bluntly than Shakespeare: "We have met the enemy and he is us."
Those Who Make the Law
In TEI's view, there is plenty of blame to go around.
* It lies with the President, other Administration officials, and members of Congress who propose and support frequent tax law changes without giving proper heed to the burdens they would impose. A primary cause of tax law complexity is instability in the tax law. Changes are proposed year in and year out. In 1996 alone, six bills were passed that effected major changes in the Internal Revenue Code. The magnitude and rapidity of change only compound the already complicated nature of the law. Taxpayers typically have to contend simultaneously with three or more sets of rules: one (or more) for the past (in respect of years under examination by the IRS), one for the present (in respect of current year compliance activities), and one (or more) for the future (in respect of both planning and compliance). And this does not even take into account the need for complicated transitional rules for migrating from one set of rules to another.
* It lies in the slapdash manner in which legislation is frequently drafted, in the vague mandates that Congress sometimes imposes on the IRS to implement by regulation what Congress only sketchily directs, and in the insufficient lead time that Congress provides to taxpayers and the IRS to implement changes. Where law changes are retroactive, the problems are exacerbated. Hence, even when a change is favorable from a substantive point of view (e.g., the recent retroactive extension of the educational assistance exclusion), it may impose tremendous recordkeeping and compliance burdens.
* It lies in the search for more revenue without raising tax rates. Each "revenue enhancer" or "loophole closer" that the Administration proposes and Congress effects adds complexity to the Code. Each time a legitimate deduction is curtailed (as was the case with the 1993 proscription on the deductibility of lobbying expenses), a new set of recordkeeping requirements is imposed. And each time the Code deviates from generally accepted accounting principles that business taxpayers employ for financial reporting purposes (which has been done almost with impunity since 1982), there is a layer of complexity added to the tax law.
* It lies in the decision to use the tax code not only to raise revenue but to promote social and economic policies. Whether the goal of special provisions is to encourage home ownership through the mortgage interest deduction, to provide an incentive for research by means of the R&D credit, to aid low income Americans by the Earned Income Tax Credit (or Work Opportunity Tax Credit), to spur investment in Puerto Rico through special incentives, or to enhance capital formation through the adoption of special provisions relating to capital gains, each provision - regardless of its merits - spawns tremendous compliance and planning burdens.(2)
* And it lies in the decision to do all these things but then impose a "backstop" in the form of a horrifically complex alternative minimum tax scheme.
Those Who Interpret the Law
The responsibility for the heavy burden that the tax system imposes, however, does not rest only on those who craft and enact the tax statutes. It also lies with those who interpret them.
* Hence, it lies with the IRS and Treasury, which have issued only limited published guidance on the proper treatment of certain expenditures as ordinary or capital in nature (thereby affecting their current deductibility) and hence spawned considerable audit activity as field agents have sought to capitalize expenses that have long been treated as currently deductible. Indeed, some have argued that the IRS's actions in the aftermath of the Supreme Court's decision in INDOPCO v. United States, 503 U.S. 79 (1992), effectively constitute a significant hidden tax on business.
* It lies in the IRS's aggressive expansion of the amorphous concept of "clear reflection of income" to override longstanding taxpayer positions.
* It lies in the IRS's adoption of vague and sometimes torturous "anti-abuse" rules that are engrafted on various sets of substantive regulations, including rules relating to partnerships and joint ventures.
* And it lies with efforts to apply the current tax law - which was developed to deal with a manufacturing-based ("bricks and mortar") economy - to one that turns on services, information, and other intangibles. In many respects, the "round peg" of the Internal Revenue Code is being forced into the "square hole" of an ever-changing international marketplace, and the result has been uncertainty - and mind-numbing complexity. We note that the Treasury Department will soon issue a "White Paper" on issues raised by the continuing expansion of electronic commerce and other technology issues; we intend to discuss the implications of the White Paper during a liaison meeting with Assistant Secretary Lubick later this month.
Those Who Administer
Finally, responsibility lies with those who administer the tax law. This, of course, is no small or easy task. The IRS laws the same instability in the tax law, the same complexity, and many of the same burdens that taxpayers do. The IRS must fill in the gaps in the law, sort out the ambiguities, and provide guidance to its field agents (as well as to taxpayers) on what the tax law means and what it requires of taxpayers. Although there is clearly room for improvement, we believe the IRS has done a commendable job in dealing with the challenge of administering the tax law.
The Coordinated Examination Program (CEP) reflects the IRS's effort to deal with the special challenges posed by the tax returns of the largest companies in the country. Companies in the CEP program are under continual audit by the IRS. A team of two or more agents maintain offices on the taxpayer's premises and interact on a daily basis with the taxpayer's personnel. The IRS team will often include economists, engineers, international examiners, and computer specialists. These agents will issue a multitude of information document requests (IDRs) and prepare a large number of Notices of Proposed Adjustments (NPAs) to which the taxpayer must respond. During the past five years, the IRS has successfully undertaken a number of initiatives to reduce the burden on companies that are part of the CEP program and generally to make the CEP program operate more efficiently. TEI is pleased to have cooperated with the IRS in these endeavors.
On the whole, Tax Executives Institute is supportive of the CEP program. And we believe the IRS has made strides in recent years to improve the program. At the same time, we continue to have concerns about the effectiveness of communications from the IRS National Office through the Regional and District Offices to the individual field agents who conduct CEP examinations. Hence, although the National Office has developed programs to reduce taxpayer burdens and enhance the management and conduct of CEP cases, we must confess considerable frustration over the inconsistent implementation of these initiatives by field personnel.
Specifically, some taxpayers have seen a decline in voluminous and unfocused IDRs as a result of initiatives to involve the taxpayer more in the audit planning process, while other taxpayers continue to receive extraordinarily large numbers of requests that sometimes bear little or no relation to the taxpayer's business. Moreover, taxpayers continue to be concerned that the IRS's metrics for evaluating agent performance and its establishment of compliance and program production goals have contributed to an environment in which proposed adjustments have greater weight than sustained adjustments. Although these matters will be thoroughly discussed with Commissioner Richardson and other top officials of the IRS during the TEI-IRS liaison meeting later this month, we raise them here because they illustrate the need to ensure that proper attention and oversight are provided to the IRS in respect of its training initiatives, measurement systems, and internal communications.
What Can Be Done:
Some Modest Proposals
Regrettably, diagnosing the problem - identifying the causes of complexity and burden in the tax law - is not the same as prescribing a cure. We recognize that the tax system is driven by competing interests that must be balanced as legislation is crafted and implementing regulations and procedures are developed. We also recognize that there may be circumstances where concerns about administrability - about burden - are properly "trumped" by overriding policy goals. That does not mean, however, that administrability concerns should be given short shrift. Indeed, TEI recommends that steps be taken to ensure that concerns about administrative burdens be given proper weight.
Specifically, we believe that Congress should take steps to place greater emphasis on the administrability of particular proposals during the legislative process. One means of doing this would be for the tax-writing committees to ask the IRS - as well as the public - to testify on the compliance burdens posed by all proposed tax legislation. Ideally, this testimony would be designed to ensure that clear, administrable, and cost-sensitive rules are enacted into law by addressing the following issues:
* The ability of the IRS to administer the provision and the estimated cost to the IRS of doing so; and
* The ability of taxpayers to comply with the provision and the estimated cost to taxpayers of doing so.
TEI believes that the IRS's more active participation in the legislative process - on the sole question of administrability - is critical to reducing the complexity of the tax law and the attendant burden on taxpayers. Administrability can be measured in many ways, but perhaps the most vivid and immediate picture is painted by the forms and schedules required to translate a statutory provision into a set of instructions for taxpayers to use in navigating their way through the maze that the Internal Revenue Code has become.
If substantive provisions were not added to the Code until the IRS had the opportunity to develop what the resulting form would look like, perhaps those provisions could be streamlined and made more administrable. Indeed, we understand that on occasion pre-enactment forms have been developed and some modifications have been made to the relevant provisions to simplify the "translation" process. We recognize that political and budgetary exigencies frequently operate to deny the tax-writing committees sufficient time to consider fully the administrative aspects of proposals and that the development of pre-enactment forms in every instance may prove impossible. Nevertheless, it should become an aspirational goal. We also recommend that the IRS prepare - and Congress review - so-called administrability impact statements in respect of pending legislative proposals.
Last year, TEI was pleased to meet with the IRS's Corporate Return Streamlining and Electronic Filing Workgroup, whose objectives are to streamline the current filing requirements for Form 1120 (Corporation Income Tax Return) and to support the planned development of corporate electronic filing systems. We support those objectives and believe that the starting point for streamlining Form 1120 should be for the IRS to identify its minimum requirements in respect of tax return information and formatting. Conforming tax return filings with financial statements (e.g., as reported to the Securities and Exchange Commission) would save taxpayers considerable resources. Consequently, we recommended to the IRS that a taxpayer's basic financial statement information be utilized to the fullest extent possible and that reclassification of data be minimized, if not eliminated altogether.
In assessing whether such a change is feasible from the IRS's perspective, we believe the IRS should go through Form 1120 on a line-by-line basis, asking the following questions:
* Is the requested information really needed and is value added by requiring its submission at the time the return is filed? For example, does it enable the processing of the return at the Service Center and the posting of necessary information to the taxpayer's account? Does it facilitate the selection of returns for examination?
* Is the information already available or can it be provided in a less burdensome manner (e.g., in a format already developed for other government agencies, such as the SEC)?
The structure of Form 1120 is important, but in our mind's eye there is an even more fundamental question in determining how the corporate return can be streamlined: Is the IRS willing to consider significant changes not only in the information that is required to be reported, but in how the agents go about auditing compliance with the tax law? The answer should be yes, for an affirmative response holds the promise of liberating taxpayers from needless burdens and concomitantly enhancing IRS productivity.
Specifically, we believe the IRS should eliminate the reconciliation of the taxpayer's detailed general ledger to specific line items on the tax return. Too frequently, taxpayers encounter agents who spend substantial amounts of time reconciling specific line items on the general ledger to specific line items on the tax return. But what is the value-added by such a process where the company has sound, verifiable internal controls that are complemented by externally audited and certified financial statements?
We believe that to ask the question is to answer it: There is little, if any, value in requiring taxpayers to shoehorn their thousands of general ledger accounts into Lines 1 through 26 on page 1 of Form 1120. We submit that the IRS'S better large-case agents recognize this themselves and do not use page 1 in their examinations. Stated differently, they currently do not audit the tax return (i.e., Lines 1 through 26); they audit the company's financial records. If the IRS acknowledged this and consequently redesigned Form 1120 to conform to financial statements, taxpayer burden could be materially reduced without diminishing the IRS'S ability to ensure compliance with the tax laws.(3)
Finally, we believe that efforts should be made to remove from Form 1120 and other corporate forms requests for information other than that required to determine the company's tax liability. (Much of the data reported on the tax return are sought by the Treasury's Office of Tax Analysis, for example, to estimate the revenue effects of legislative changes and for other statistical purposes.) Although we acknowledge that legitimate needs may exist for such information, we believe those seeking to impose generalized reporting requirements on all corporations bear a heavy burden of demonstrating that their requests should be granted. Hence, we believe several core questions must be posed in respect of such requests:
* What value is added by the information? To what use is the information put? Is that use justifiable? In this regard, we recommend that information requests should be "zero-based budgeted"; hence, the OTA and the other agencies seeking information through the IRS forms should be required to make an affirmative showing that information will advance some definite tax policy or tax administration goal, not simply that it would be "nice" to have it. With government at all levels seeking to reduce the intrusiveness and burden of regulations, such an approach seems especially prudent.
* At what cost is the information to be secured? The greater the cost to taxpayers in securing the information (or in recasting it in the required format), the greater the need that should be demonstrated.
* Do alternative means exist of collecting the same or comparable information? Alternative means of securing desired information in a less burdensome manner should be explored. For example, if is it possible for the OTA to secure information of comparable value by surveying selected taxpayers, rather than imposing recordkeeping and reporting requirements on all taxpayers, then we believe such an alternative path should be taken.(4)
In summary, TEI believes there are real benefits to be achieved in streamlining corporate filing requirements.
Requirements - Harnessing
the Advances of
Some of the most significant burdens imposed on corporate taxpayers relate to the requirement that extensive records be maintained in respect of taxable years subject to audit. Although taxpayers clearly have a responsibility to maintain records to support the positions taken on their tax returns, we believe much can be done to minimize the burden that currently exists (especially for those corporate taxpayers that have many years open to IRS examination).
* For example, earlier this year the IRS issued a proposed revenue procedure that would reduce taxpayer burden by permitting the use of imaging systems for the retention of books and records. TEI was pleased by the issuance of Notice 96-10, and filed comments urging the IRS to move forward to ease taxpayers' recordkeeping burdens by permitting them to take advantage of technological improvements in the records storage and management area. We also encouraged the IRS to prepare and release a revised version of Revenue Procedure 91-59, which sets forth the basic requirements that the IRS considers to be essential in cases where a taxpayer's records are maintained within an Automatic Data Processing (ADP) system.(5)
The IRS should be encouraged, at both the national and local levels, to move forward in providing taxpayers with digital imaging and general record retention guidance.
Renewing a Commitment to a
In the absence of a qualified workforce at the IRS, the best statutes, regulations, and procedures will not guarantee that taxpayers will not be unduly burdened. As previously stated, TEI and its members have been frustrated at times by the IRS's inability to implement its quality and currency initiatives on a consistent, nationwide level. This frustration will no doubt grow unless the IRS is able to secure and retain a qualified and trained workforce that is given the necessary tools to do its job effectively. Qualified agents and specialists will not spend their - and the taxpayer's - time pursuing marginal issues, and will be able to complete their examinations more efficiently.
Hence, we recommend that Congress provide adequate resources to the IRS to train its agents and modernize and streamline its systems. We further recommend that the IRS devote adequate time and resources to implementing its initiatives down through the Regional and District Offices to the field agents who conduct CEP audits. To this end, we also recommend that a review be undertaken of the IRS's measurement standards to ensure that field personnel are not evaluated on the basis of "proposed adjustments" where the bulk of those adjustments may be rejected by IRS Appeals personnel or the courts. Hence, we believe that, in evaluating agent performance, due consideration should be given to the level of adjustments sustained as well as to the agents' effective implementation of procedures to reduce taxpayer burden.
Tax Executives Institute appreciates this opportunity to present its views to the National Commission on Restructuring the Internal Revenue Service. I would be pleased to answer any questions you may have. (1) For all its faults, the American tax system continues to operate more efficiently and effectively than comparable systems in other countries. Recent attacks on the legitimacy of the U.S. tax system and on the IRS seem to ignore this, and when they come from respected government leaders, they cannot help but breed disrespect for and undermine public confidence in the fairness of the system. They may well lead to greater noncompliance to the ultimate detriment of all those who pay their fair share of taxes. (2) TEI here takes no position on whether any or all of these incentives should be retained or discarded. Our point is simply that using the tax law for more than just raising money is not a cost-free proposition; it can exact a very real cost in terms of complexity and burden. It is for Congress, with appropriate input from the Administration and the public, to determine (3) TEI recognizes that not all corporate taxpayers currently have audited financial statements, though most assuredly the corporations that account for the largest bulk of corporate income taxes do (whether or not they are publicly traded). Consequently, we believe that corporations without audited financial statements should be accorded an election either to report their income based on internally generated financial statements or to use Form 1120 in more or less its current form). (4) The goal. of' course. is to reduce the aggregate burden imposed on taxpayers. Consequently, removing the requests for extraneous information from IRS forms should not be accompanied. tit for tat. by the issuance of independent requests for the same information, which might well prove even more burdensome. This is especially the case if the removal of the information requests from the tax return were to prompt programming changes to commercially available software that otherwise facilitates the taxpayer's responding to the request. (5) TEI previously worked with a group of IRS representatives in developing a proposed revision of Revenue Procedure 91-59, which the Institute submitted to the Commissioner in 1993. TEI's goals in proposing a revision of Rev. Proc. 91-59 were: (i) to eliminate the seemingly rigid and unforgiving requirements of the current procedure; (ii) to provide taxpayers with specific guidance on what their obligations are (while recognizing that the procedure must have a certain "one size fits all' quality - since it applies to all taxpayers and all types of computer/data processing systems); (iii) to empower taxpayers to decide what records to keep and how to respond to changes in their data processing systems (as well as to lost or damaged records); (iv) to set forth rules for how taxpayers can secure IRS assistance in fulfilling their record retention obligations (through either record retention agreements or record evaluations); and (v) to infuse the rules with enough flexibility to permit taxpayers to utilize technological advances to minimize recordkeeping burdens. Although disappointed that a revised procedure has not yet been released, we remain hopeful that revised guidance
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|Author:||Murray, James R.|
|Date:||Nov 1, 1996|
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