House Hearing, 108TH Congress - Free Electronic Filing and National Taxpayer Advocate Annual Report

FREE ELECTRONIC FILING AND NATIONAL
TAXPAYER ADVOCATE ANNUAL REPORT
HEARING
BEFORE THE
SUBCOMMITTEE ON OVERSIGHT
OF THE
COMMITTEE ON WAYS AND MEANS

U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
FEBRUARY 13, 2003
Serial No. 1085
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE

87113 WASHINGTON : 2003
For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 5121800; DC area (202) 5121800
Fax: (202) 5122250 Mail: Stop SSOP, Washington, DC 204020001
VerDate Jan 31 2003 11:33 Jun 02, 2003 Jkt 087113 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 E:\HR\OC\87113.XXX 87113
COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
E. CLAY SHAW, JR., Florida FORTNEY PETE STARK, California
NANCY L. JOHNSON, Connecticut ROBERT T. MATSUI, California
AMO HOUGHTON, New York WILLIAM J. COYNE, Pennsylvania
WALLY HERGER, California SANDER M. LEVIN, Michigan
JIM MCCRERY, Louisiana BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan JIM MCDERMOTT, Washington
JIM RAMSTAD, Minnesota GERALD D. KLECZKA, Wisconsin
JIM NUSSLE, Iowa JOHN LEWIS, Georgia
SAM JOHNSON, Texas RICHARD E. NEAL, Massachusetts
JENNIFER DUNN, Washington MICHAEL R. MCNULTY, New York
MAC COLLINS, Georgia WILLIAM J. JEFFERSON, Louisiana
ROB PORTMAN, Ohio JOHN S. TANNER, Tennessee
PHIL ENGLISH, Pennsylvania XAVIER BECERRA, California
J.D. HAYWORTH, Arizona KAREN L. THURMAN, Florida
JERRY WELLER, Illinois LLOYD DOGGETT, Texas
KENNY C. HULSHOF, Missouri EARL POMEROY, North Dakota
SCOTT MCINNIS, Colorado MAX SANDLIN, Texas
RON LEWIS, Kentucky STEPHANIE TUBBS JONES, Ohio
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia
ALLISON H. GILES, Chief of Staff
JANICE MAYS, Minority Chief Counsel
AMO HOUGHTON, New York, Chairman
ROB PORTMAN, Ohio EARL POMEROY, North Dakota
JERRY WELLER, Illinois GERALD D. KLECZKA, Wisconsin
SCOTT MCINNIS, Colorado MICHAEL R. MCNULTY, New York
MARK FOLEY, Florida JOHN S. TANNER, Tennessee
SAM JOHNSON, Texas MAX SANDLIN, Texas
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records
of the Committee on Ways and Means are also published in electronic form. The printed
hearing record remains the official version. Because electronic submissions are used to
prepare both printed and electronic versions of the hearing record, the process of converting
between various electronic formats may introduce unintentional errors or omissions. Such occur-
rences are inherent in the current publication process and should diminish as the process
is further refined.
ii
VerDate Jan 31 2003 10:53 May 27, 2003 Jkt 087113 PO 00000 Frm 00002 Fmt 0486 Sfmt 0486 E:\HR\OC\87113.XXX 87113
CONTENTS
Page
Advisory of February 6, 2003, announcing the hearing ....................................... 2
WITNESSES
Internal Revenue Service:
Hon. Robert E. Wenzel, accompanied by Terry Lutes, Director, Electronic
Tax Administration .......................................................................................... 6
Nina E. Olson, National Taxpayer Advocate ..................................................... 30
Electronic Tax Administration Advisory Committee, Kevin Belden ................... 19

Free File Alliance, Michael F. Cavanagh .............................................................. 25
SUBMISSION FOR THE RECORD

Americans for Tax Reform, Grover Norquist, statement ..................................... 44
iii
FREE ELECTRONIC FILING AND NATIONAL
TAXPAYER ADVOCATE ANNUAL REPORT
THURSDAY, FEBRUARY 13, 2003
U.S. HOUSE OF REPRESENTATIVES,

COMMITTEE ON WAYS AND MEANS,
SUBCOMMITTEE ON OVERSIGHT,
Washington, DC.
The Subcommittee met, pursuant to notice, at 3:00 p.m., in room
1100 Longworth House Office Building, Hon. Amo Houghton
(Chairman of the Subcommittee) presiding.
[The advisory announcing the hearing follows:]
(1)
2
ADVISORY
FROM THE COMMITTEE ON WAYS AND MEANS
FOR IMMEDIATE RELEASE CONTACT: (202) 2251721

February 06, 2003
No. OV1
Houghton Announces Hearing on

Free Electronic Filing and National
Taxpayer Advocate Annual Report
Congressman Amo Houghton (RNY), Chairman, Subcommittee on Oversight of
the Committee on Ways and Means, today announced that the Subcommittee will
hold a hearing on Free Electronic Filing and the recently issued Annual Report of
the National Taxpayer Advocate. The hearing will take place on Thursday,
February 13, 2003, in the main Committee hearing room, 1100 Longworth
House Office Building, beginning at 3:00 p.m.
In view of the limited time available to hear witnesses, oral testimony at this
hearing will be from invited witnesses only. Witnesses will include Internal Revenue
Service (IRS) Acting Commissioner Robert Wenzel, the National Taxpayer Advocate
Nina Olson, Electronic Tax Administration Director Terence Lutes, and Electronic
Tax Administration Advisory Committee Chairman Kevin Belden. However, any in-
dividual or organization not scheduled for an oral appearance may submit a written
statement for consideration by the Committee and for inclusion in the printed
record of the hearing.
BACKGROUND:
The Subcommittee will hold a hearing to evaluate the legislative recommenda-

tions of the National Taxpayer Advocate and the leading problems faced by tax-
payers, as described in the Taxpayer Advocates Annual Report. In addition, the
Subcommittee will hear testimony from IRS officials concerning the IRS Free Filing
initiative. Free Filing, a partnership with the private sector consortium of electronic
tax preparers is designed to increase the number of taxpayers filing electronically.
In announcing the hearing, Chairman Houghton said: We will hear about the
new initiative that allows more taxpayers to file their taxes for free over the Inter-
net. This will substantially increase the number of people filing their taxes elec-
tronicallybenefiting taxpayers and the IRS. I also look forward to a discussing
ways to improve our tax laws and streamline the functioning of the IRS with Nina
Olson, National Tax Payer Advocate.
FOCUS OF THE HEARING:
The hearing will focus on the IRS Free Filing initiative, electronic tax administra-
tion, and the National Taxpayer Advocates annual report.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Please Note: Due to the change in House mail policy, any person or organization
wishing to submit a written statement for the printed record of the hearing should
send it electronically to [email protected], along with a
fax copy to (202) 2252610, by the close of business, Thursday, February 27, 2003.
Those filing written statements who wish to have their statements distributed to
3
the press and interested public at the hearing should deliver their 200 copies to the
Subcommittee on Oversight in room 1136 Longworth House Office Building, in an
open and searchable package 48 hours before the hearing. The U.S. Capitol Police
will refuse sealed-packaged deliveries to all House Office Buildings.
Note: All Committee advisories and news releases are available on the World
Wide Web at http://waysandmeans.house.gov.
The Committee seeks to make its facilities accessible to persons with disabilities.
If you are in need of special accommodations, please call 2022251721 or 202226
3411 TTD/TTY in advance of the event (four business days notice is requested).
Questions with regard to special accommodation needs in general (including avail-
ability of Committee materials in alternative formats) may be directed to the Com-
mittee as noted above.
Chairman HOUGHTON. The hearing will come to order. Good

afternoon everybody, and we are delighted that you are here. I am
flanked by two very distinguished peoplenot frankedand we are
going to learn about an innovative agreement that the Internal
Revenue Service (IRS) has entered into with the private sector to
bring free electronic filing to millions of taxpayers this year, the
Free File Initiative, and I want to believe that both government
and taxpayers are going to benefit. Many taxpayers will no longer
have to pay an average of $12.50 per return to e-file, and they will
receive tax refunds on an average of 14 days instead of 4 to 6
weeks. The government is going to benefit from reduced errors in
processing costs. Last year, 47 million taxpayers filed their tax re-
turns electronically, and the initiative should lead to many millions
of additional e-filed returns.
So, before us today on our first panel is one of Americas most
dedicated public servants, Bob Wenzel, who is now the Acting Com-
missioner of the IRS. Mr. Wenzel was nearing what he thought
was the end of a 35-year career with the IRS when the outgoing
Commissioner, Charles Rossotti, asked him to reconsider his retire-
ment plans and twisted his arm a little bit. So, to his credit and
to our great benefit, Mr. Wenzel took up Mr. Rossottis offer and
served an additional 5 years as Deputy Commissioner. It has now
been over 40 years since Bob Wenzel first joined the IRS. Few indi-
viduals can point to such a long and distinguished career in public
service. He is a great example for us all.
Now, also on our agenda is a review of the National Taxpayer
Advocates (NTAs) annual report to Congress. As was the case last
year, Nina Olsons report is an excellent and invaluable resource,
and due to the leadership of Ms. Olson and her predecessors, the
Taxpayer Advocate has become the tax systems most effective
guarantor of taxpayer procedural rights. She has brought us a
number of thoughtful recommendations that we are going to review
today.
So, now I would like to yield to a good friend of mine, the new
Subcommittee Ranking Member and the best-looking Ranking
Member we have had in many years since Mr. Pickle, Mr. Pomeroy
of North by-God Dakota.
[The opening statement of Chairman Houghton follows:]
4
Opening Statement of the Honorable Amo Houghton, a Representative in
Congress from the State of New York, and Chairman, Subcommittee on
Oversight
Good afternoon. Today we are going to learn about an innovative agreement that
the IRS has entered into with the private sector to bring free electronic filing to mil-
lions of taxpayers this year: the Free File Initiative. Both government and tax-
payers will benefit. Many taxpayers will no longer have to pay an average of $12.50
per return to e-file and they will receive tax refunds in an average of 14 days, in-
stead of four to six weeks. The government will benefit from reduced errors and
processing costs. Last year, 47 million taxpayers filed their tax returns electroni-
cally, and the Initiative should lead to millions of additional e-filed returns.
Before us today on our first panel is one of Americas most dedicated public serv-
ants, Bob Wenzel, who is now the Acting Commissioner of the IRS. Mr. Wenzel was
nearing what he thought was the end of a thirty-five year career with the IRS when
incoming Commissioner Charles Rossotti asked him to reconsider his retirement
plans. To his creditand to our great benefitMr. Wenzel took up Mr. Rossottis
offer and served an additional 5 years as Deputy Commissioner. It has now been
over 40 years since Bob Wenzel first joined the IRS. Few individuals can point to
such a long and distinguished career in public service. He is truly an example for
us all.
Also on our agenda is a review of the National Taxpayer Advocates Annual Re-
port to Congress. As was the case last year, Nina Olsons report is an excellent and
invaluable resource. Due to the leadership of Ms. Olson and her predecessors, the
Taxpayer Advocate has become the tax systems most effective guarantor of tax-
payer procedural rights. She has brought us a number of very thoughtful rec-
ommendations that we will review today.
I would now like to yield to a good friend of mine, the Subcommittees Ranking
Member, Mr. Pomeroy from North Dakota.
Mr. POMEROY. Mr. Chairman, I am overcome by an introduc-

tion of that nature. I want to congratulate you as you begin an-
other year as Chairman of this Subcommittee on Oversight, and
your agenda for the very first meeting, I think, is consistent with
the leadership you have brought to oversight using the powers of
this Subcommittee to explore how we can improve the Tax Code,
how we can make it easier for individual tax filers, and how we can
capture their feedback through the Taxpayer Advocate position, al-
ways working to improve the Tax Code, make it more fair and easi-
er to comply with for the taxpayers of this country.
I know of your own interest, Mr. Chairman, in tax simplification,
and in a place where there are often many partisan issues that di-
vide us, this ought to be our overarching topic that unites us, and
I am very much looking forward to participating in bipartisanship
initiatives with you as we seek to improve the Tax Code.
I appreciate your recognition of Mr. Wenzel in light of the long
and illustrious career he has offered on behalf of all of us. Con-
gratulations to you, and it is a capstone achievement to serve as
Acting Commissioner. Have you had that opportunity in the past,
Mr. Wenzel?
Mr. WENZEL. First time.
Mr. POMEROY. Well, it is a very appropriate capstone on a ca-
reer of great public distinction, and we appreciate your efforts.
With that, lets hear from our witnesses, Mr. Chairman.
[The opening statement of Mr. Pomeroy follows:]
5
Opening Statement of the Honorable Earl Pomeroy, a Representative in
Congress from the State of North Dakota
I am honored to have been elected as the Ranking Member on the Ways and
Means Oversight Subcommittee. Working with Chairman Houghton, on a bipartisan
basis, we will monitor the tax, health, Social Security, trade and human resource
issues within the Committees jurisdiction. This is a challenge I proudly accept.
It is appropriate that our first hearing of the 108th Congress focus on the Internal
Revenue Service. Clearly, the IRS must administer our tax laws in a fair and effi-
cient manner and the Subcommittee is responsible for overseeing its operation. I
look forward to todays discussion of the IRS new tax return Free File Program
and the Taxpayer Advocates annual report to the Congress.
The Free File Program is designed to provide low-income taxpayers with a no-cost
way to prepare and electronically transmit their tax returns to the IRS. I support
this initiative which is new for the 2003 tax return filing season. As we proceed,
I want to make sure that taxpayers have easy access to the Free File Program and
that the initiative works as intended.
Finally, I am pleased to receive the Taxpayer Advocates Annual Report on IRS
operations. I look forward to working with the Subcommittee to address the issues
raised by this study. I am particularly interested in pursuing the legislative rec-
ommendation designed to better enable married couples, who own a farm or other
small business, to file a simplified tax return. By simplifying the process of report-
ing, both spouses will be eligible for Social Security and Medicare benefits and avoid
tax penalties for incorrect filings. I will continue to seek the assistance of my local
Taxpayer Advocate from Fargo, North Dakota as the Subcommittee considers this
issue.
I thank Chairman Houghton for scheduling this important hearing and look for-
ward to the testimony of the hearing witnesses.
Chairman HOUGHTON. Thank you very much. Would you like

to make an opening statement, Mr. Portman?
Mr. PORTMAN. Mr. Chairman, I appreciate just a very brief one
to say I am very excited about the Free Filing initiative. The IRS
Commission, which met for 2 years on the issues of how to reform
the IRS, determined after a lot of research on the filing problems
that it was far more effective and efficient to file electronically. In
fact, we found that not only was it less than half the cost of filing
by paper, but the error rate was so much less. At that time the
error rate was 22 percent; 11 percent by the taxpayer, 11 percent
by the IRS. The error rate with electronic filing was 1 percent or
less. That alone has significant cost savings not just for the IRS,
but also for the taxpayer the downstream costs were enormous. So,
I am just delighted that after going back and forth on this issue
for really the last 4 years, we finally have an understanding with
the private sector that we will be able to offer free filing that cov-
ers 60 percent of all taxpayers.
This is a breakthrough, Mr. Chairman, and I think absolutely es-
sential if we are going to come close to meeting our target, which
is quite ambitious, of 80 percent of filers are filing electronically.
We are now, I think, at about 36 or 37 percent. We will hear more
about that.
I just wanted to commend the Service for finally working with
the private sector, and commend the private sector folks who have
been part of this in coming up with an arrangement which I think
will be very helpful to meeting our shared goals. Thank you, Mr.
Chairman.
Chairman HOUGHTON. Thank you very much. Ms. Tubbs
Jones, would you like to make a statement?
6
Ms. TUBBS JONES. Well, I would like, thank you, Mr. Chair-
man. I would likegood afternoon. This is my first Subcommittee
on Oversight hearing. I have managed to visit Health today, this
afternoon, and I am serving on Social Security and Select Revenue
Measures. I am glad to have an opportunity to meet you, Mr.
Wenzel, and you, Mr. Lutes, as well; look forward to having an op-
portunity to get to know this process a little more. I get lots of IRS
calls in my congressional office, so I will be glad to know who I can
pick up the phone and call and get some results. So, thank you
very, very much. Mr. Chairman, looking forward to serving with
you, sir.
Chairman HOUGHTON. Thank you very much.
Mr. Kleczka.
Mr. KLECZKA. Mr. Chairman, I dont have any opening com-
ment except to say it is good to be back to the Subcommittee on
Oversight after an absence serving on the Committee on Budget,
so, Mr. Chairman, you will have to put up with me for a couple of
years.
Chairman HOUGHTON. Okay. That is great. Well, now I would
like to call the first panel, who are already there. Mr. Robert
Wenzel, who, as we said earlier, is the Acting Commissioner, and
then Mr. Terry Lutes, who is Director of the Electronic Tax Admin-
istration (ETA) of the IRS. I dont think you are going to be giving
any testimony, but you will be here; is that right, Mr. Lutes?
Mr. LUTES. Yes.
Chairman HOUGHTON. Okay. Mr. Acting Commissioner, the
floor is yours.
STATEMENT OF THE HONORABLE ROBERT E. WENZEL, ACT-
ING COMMISSIONER, INTERNAL REVENUE SERVICE, ACCOM-
PANIED BY TERRY LUTES, DIRECTOR, ELECTRONIC TAX AD-
MINISTRATION
Mr. WENZEL. Mr. Chairman and distinguished Members of the
Subcommittee, thank you for this opportunity to discuss the joint
IRS-private sector Free File Initiative. Also let me thank you, Mr.
Chairman and Members of the Subcommittee, for your leadership
and efforts to promote electronic filing and make it available to
more taxpayers.
As you mention, accompanying me today is Mr. Terry Lutes, our
IRS Director of Electronic Tax Administration.
As you know, the IRS Restructuring Reform Act of 1998 man-
dated that at least 80 percent of individual tax returns be filed
electronically by the year 2007. We have certainly made progress
toward that goal. Last year 35.6 percent of individual returns were
e-filed, and this year we expect the number to climb to over 40 per-
cent. Nevertheless, even with a 16-percent annual growth rate, the
IRS would fall short of the 80-percent goal.
Now, to meet this ambitious objective, we must make it not only
technologically possible, but also attractive for practitioners and
taxpayers to make a permanent change to electronic filing. Cost to
the taxpayer has been a barrier to further e-file growth. For years
the IRS and the tax community would grapple with this issue and
had very little success resolving it. That has changed dramatically
with Free File.
7
Free Files roots can be found in the Presidents fiscal year 2002
management agenda, which championed e-government services. We
were also guided by two principles; that is, no one should have to
pay to file, and secondly, the IRS should not get into the software
business. Through Free File, Americas taxpayers can now access
free online tax preparation and electronic filing services through
irs.gov, or firstgov.gov. Free File will be available this year through
April 15, and some companies will also offer free services through
October 15 for taxpayers needing an extension.
The partnership agreement requires that the Alliance as a whole
provide free tax preparation and filing to at least 60 percent of in-
dividual taxpayers, or approximately 78 million Americans. Many
are taxpayers who prepare their own taxes and still file paper re-
turns.
Initial Free File reports are very encouraging. As of February 5,
Alliance Members have processed and transmitted almost 639,000
tax returns. This represents approximately 23 percent of the total
2.9-million-e-filed returns.
Mr. Chairman, we are also absolutely committed to protecting
taxpayers privacy and confidentiality. Taxpayer information and
data will be protected, and the Alliance members must adhere to
IRS strict privacy standards. We even required each participating
company to obtain both a privacy and security seal certification.
We also took into consideration taxpayers who do not have access
to a computer. Low income should never be a barrier to quality
service, including free electronic filing. Free tax preparation and e-
file are available in many communities at our Volunteer Income
Tax Assistance and Tax Counseling for the Elderly sites. Volun-
teers there help prepare basic tax returns for low-income tax-
payers, the disabled, the elderly and non-English speakers. Indi-
vidual taxpayers with incomes of $35,000 or less can also receive
free income tax return preparation and e-file help at IRS tax as-
sistance centers around the country. We extend this courtesy re-
turn preparation to all taxpayers also qualifying for the earned in-
come tax credit (EITC).
Mr. Chairman, I also would like to stress that taxpayers are
under no obligation to purchase any product from the software
company or to use refund anticipation loans. Obtaining a fee-based
product is a decision left to the individual taxpayer. The Internal
Revenue Service as well as many of the Alliance company Web
sites also reminds taxpayers that those who e-file and use direct
deposit often receive their refunds in 10 days or less.
Mr. Chairman, in conclusion, Free File is a breakthrough for
Americas taxpayers. We are putting e-file within reach of millions
more taxpayers and delivering on our Presidents commitment to
put the needs of citizens first. This new program may be called
Free File, but what it gives to millions of taxpayers and our gov-
ernment is invaluable. Thank you.
[The prepared statement of Mr. Wenzel follows:]
Statement of the Honorable Robert E. Wenzel, Acting Commissioner,
Internal Revenue Service
INTRODUCTION
Mr. Chairman, and distinguished Members of the Subcommittee, thank you for
this opportunity to discuss the joint IRS-private sector Free File initiative. Accom-
8
panying me today is Mr. Terry Lutes, IRS Director of Electronic Tax Administra-
tion.
Before I begin my formal testimony, let me thank you, Mr. Chairman, for your
leadership and efforts to promote electronic filing and make it available to more tax-
payers. Working closely with you, the Subcommittee, the Administration and the
private sector, we are making steady progress to achieve congressionally mandated
e-file goals and to provide service to taxpayers on a par with the very best private
sector companies. Free File is a big step in that direction.
BACKGROUND
On January 16, 2003, the Treasury Department, the Office of Management and
Budget (OMB) and the IRS launched a free on-line tax preparation and filing serv-
ice called Free File. It was made possible through a partnership agreement between
the IRS and the Free File Alliance, LLCa private sector consortium of tax soft-
ware companies. It could not have come a minute too soon.
The IRS Restructuring and Reform Act of 1998 (RRA 98) mandated that at least
80 percent of individual tax returns be filed electronically by 2007. Electronic filings
benefits are clear and compelling. Taxpayers and the IRS find it more convenient
and economical and less time consuming to do business electronically rather than
sending paper through the mail. Moreover, the government saves money, but the
real benefits are conveyed to the taxpayer. They include reduced preparation time,
faster refunds, accuracy of returns and acknowledgment of return receipt.
We have certainly come a long way from e-files humble beginnings. It began as
a pilot program in 1986 in three metropolitan areas with 25 thousand returns filed
electronicallya miniscule .02 percent of all returns filed. However, e-files growth
literally exploded, and last year, 35.6 percent of returns were e-filed. This year, we
expect that over 40 percent of all individual returns will be filed electronically.
Taxpayers can now e-file from their home computers or by using an authorized
provider. For those eligible, TeleFile, the IRS file-by-telephone system, is the easiest
way to go. To attract potential e-filers, we have added new features and enhance-
ments, such as direct deposit of refunds and payments by credit cards or electronic
funds withdrawal. Taxpayers in 37 States and the District of Columbia can e-file
their Federal and State tax return in one transmission to the IRS. Taxpayers who
need a filing extension can get one automatically by making a simple telephone call.
We are systematically removing the last few barriers to e-file to open up eligibility
to almost every taxpayer. For example, we recently published final regulations re-
placing the temporary ones published last year, enabling virtually all 1040 forms
and schedules to be filed electronically, without any paper signature document.
Mr. Chairman, I also want to note that the IRS is making progress to better serve
the business communitys electronic tax administration (ETA) needs. During FY
2002, over $1.6 trillion came in electronically through the Electronic Federal Tax
Payment System, which now includes an online option. In FY 2002, we received
more than 3.16 million 941 e-file program returns (Employers Quarterly Federal
Tax Return) and 863,000 returns for 941 TeleFile and On-Line Filing Programs. In
FY 2002, over 320,000 businesses used the 940 e-file Program (Employers Annual
Federal Unemployment Tax Return), and more than 21,000 partnerships chose 1065
e-file (U.S. Return of Partnership Income) in FY 2002.
We are also working on new initiatives to develop and mature other additional
electronic products and services for this important taxpayer segment. For example,
later this spring, businesses will be able to apply for an Employer Identification
Number online through irs.gov. We are also building a new e-file system that will
grow and serve taxpayers for years to come. Scheduled to start in 2004, it will ad-
dress the current systems limitation. For example, it will accept complex business
returns, such as 1120s (corporate income tax returns), eliminate software barriers
and resolve standardization issues, such as reject code and validations.
Clearly, we have made considerable progress towards RRA 98s ETA goals. In ad-
dition, improved electronic exchange of information with taxpayers and practitioners
also advances all three of the IRS strategic goals: service to each taxpayer, service
to all taxpayers and productivity through a quality work environment. In its Decem-
ber 2002 report to you on the 2002 Filing Season, the General Accounting Office
stated:
The number of individual tax returns filed electronically grew from about
40.2 million in 2001 to about 46.9 million in 2002, an increase of about 16.5
percent, and the percentage of individual tax returns filed electronically
reached 35.9 percent. This 16.5-percent increase over the number of returns
received electronically in 2001 was more than the IRSs goal of 15 percent
and continued the upward trend in the number of returns filed electronically
since 1995. IRS took some positive steps, including an increased focus on
9
taxpayers and tax practitioners who prepare returns on computer but file on
paper, that helped it achieve that increase and that could lead to further in-
creases in the future.
Nevertheless, even with a 16 percent annual growth rate, the IRS would fall short
of Congress extremely challenging 80-percent goal. To meet this ambitious objec-
tive, we must make it not only technologically possible, but also attractive to both
practitioners and taxpayers to make a permanent change from paper to electronic
filing. For example, to build practitioner interest, the IRS will offer later this year
a suite of electronic services, such as disclosure authorization, transcript delivery
and account resolution, to tax practitioners who file a certain number of returns
electronically. The Electronic Tax Administration Advisory Committee (ETAAC) ob-
served in its 2002 report to Congress that these types of e-services are a major in-
centive for practitioners to e-file their clients returns. The Administration also un-
dertook several initiatives to build taxpayer interest. For example, in addition to
Free File, the President proposed a major incentive in his FY 2004 budget that
would extend to April 30 the due date for returns filed and paid electronically.
However, e-file cost was a far more complex problem. IRS research and GAO re-
ports identified cost as an impediment to further e-file growth. Notwithstanding the
many advantages of preparing and filing a tax return electronically, some taxpayers
are deterred by cost, or find it prohibitive. For years, the IRS and the tax commu-
nity would grapple with this issue and had little success resolving it. That changed
dramatically with Free File.
Free Files roots can be found in the Presidents FY 2002 Management Agenda.
It contained five Government-wide initiatives, one of which was to expand electronic
government. The overarching goal was to champion citizen-centered electronic gov-
ernment that will result in major improvement in the Federal Governments value
to the citizen.
Subsequently, in November 2001, OMBs Quicksilver Task Force established 24
e-government initiatives as part of the Presidents Management Agenda. These ini-
tiatives were designed to improve government-to-government, government-to-busi-
ness, and government-to-citizen electronic capabilities.
One initiative instructed the IRS to provide free online tax return preparation and
filing services to taxpayers. In accordance with this OMB directive, the IRS began
working in partnership with the tax software industry to develop a solution. Two
principles would guide its development: no one should be forced to pay extra to file
his or her return and the IRS should not get into the software business.
The IRS believes that private industry, given its established expertise and experi-
ence in the field of electronic tax preparation, has a proven track record in providing
the best technology and services available. Rather than entering the tax software
business, IRS partnership with private industry will: (1) provide taxpayers with
higher quality services by using the existing private sector expertise; (2) maximize
consumer choice; (3) promote competition within the marketplace; and (4) meet
these objectives at the least cost to taxpayers.
DELIVERING FOR TAXPAYERS
The President stated in the preface to his Management Agenda that good begin-
nings are not the measure of success. What matters in the end is completion. . . .
Not just making promises, but making good on promises. That is exactly what the
Free File partnership didit made good on its commitment and delivered for tax-
payers.
Through the Free File Alliance, LLC (the Alliance), Americas taxpayers can now
access free, online tax preparation and electronic filing services through our rede-
signed Web site at www.irs.gov, which received 3.2 billion hits last year, or by going
to www.firstgov.gov. These free services will be available this year through April 15,
2003. Some companies will also offer free services through October 15, 2003 to ac-
commodate taxpayers who may need an extension.
The partnership agreement requires that the Alliance as a whole provide free tax
preparation and filing to at least 60 percent, or approximately 78 million American
taxpayers. The primary candidates for Free File are those taxpayers who prepare
their own taxes and still file paper returns. Last filing season, the IRS received
nearly 85 million paper returns and nearly 47 million e-filed returns.
Each participating software company sets its own eligibility requirements. Gen-
erally, these requirements may be one, or any combination of the following: (1) age;
(2) Tax Year 2002 Adjusted Gross Income; (3) eligibility to file Form 1040EZ; (4)
eligibility to claim the Earned Income Credit; (5) State residency; and (6) active duty
military status (if applicable). Unless noted, if the taxpayer is married and filing
jointly, only one taxpayer must meet the eligibility requirement.
10
Initial Free File reports are most encouraging. As of February 5, Alliance mem-
bers have processed and transmitted almost 639,000 tax returns. This represents
approximately 23 percent of the total 2.8 million on-line e-filed returns. The Alliance
partners will report the number of Free File returns to us on a monthly basis.
Mr. Chairman, I want to stress that Free File differs markedly from the free e-
filing that some companies offered to select taxpayer groups for several years. It is
far better in a number of key areas.
First, it is a multi-year agreement between the IRS and the Free File Alliance
that provides free services to millions more taxpayers. Previously, free offers were
not consistently available and were subject to modification or discontinuation from
year to year.
Second, taxpayers will have easier access. The Free File Web page hosted on
irs.gov provides in a single location a list of all free offerings.
Third, Alliance members will offer both free preparation and e-file service. The
taxpayer will incur no cost. Previously, some companies charged for preparation
(filling out forms and tax calculations) while offering the transmission free, or pro-
vided the preparation free while charging for transmission, or some variation there-
of. Under the Free File Agreement, both are free to eligible taxpayers.
Fourth, there will be oversight. The Alliance will be managed by the Council for
the Electronic Revenue Communication Advancement (CERCA). The IRS will also
monitor the progress of each Alliance member. Should any problems develop, the
members are required to alert the IRS. If appropriate, the IRS will remove the com-
pany from the online listing until the problem is resolved.
HOW DOES FREE FILE WORK
Before I discuss the actual workings of Free File, I want to reemphasize that the
IRS does not formally or tacitly endorse any of the products or services that any
of the Alliance companies may offer taxpayers. This is a private matter between the
companies and taxpayers. Moreover, using Free File is not contingent on a taxpayer
accepting any of these offers. The key word in Free File is free.
Upon arrival to the Free File page within irs.gov, the taxpayer must determine
eligibility for using a particular companys free service. This can be done two ways.
First, the taxpayer may browse the complete listing of Alliance members and their
free services. Or, a taxpayer can use a questionnaire application (the Free File
Wizard) designed to assist the taxpayer to identify those free services for which he
or she may qualify.
Each Alliance member will identify its company name and will have a simple de-
scription of the criteria for using its free service. Each Alliance members company
or product name will also be linked to additional information about the company
and/or services. Not all taxpayers will be eligible for these free services.
Upon determining eligibility, the taxpayer can link directly to that Alliance mem-
bers free service by clicking their Start Now link. Upon doing so, taxpayers will
be notified they are leaving the irs.gov Web site and are entering the Alliance mem-
bers Web site.
The companys software will prepare and e-file the taxpayers returns using pro-
prietary processes and systems. The company will then transmit the electronically-
filed return to the IRS using the established e-file system, which uses secure tele-
phone lines. Lastly, the company will e-mail the taxpayer an acknowledgment file,
notifying the taxpayer that the return has been either accepted or rejected.
As part of the Agreement, Alliance members will provide appropriate customer
service to their clients. Taxpayers who have service questions or are experiencing
problems with the services being offered by a particular Alliance members software
should contact the customer service function of that particular company. In the
event a taxpayer contacts the IRS first, our customer service representatives will
have contact information for each Alliance member and if necessary, will refer ac-
cordingly.
Mr. Chairman, I want to underscore that Free Files benefits are identical to those
of e-file. They bear repeating: (1) reduced tax return preparation time; (2) faster re-
funds; (3) accuracy of returns; and (4) acknowledgement of return receipt. In other
words, the use of free tax preparation software is comparable to the Alliance mem-
bers paid products.
TAXPAYER SECURITY AND PRIVACY
Mr. Chairman, privacy and security are paramount considerations in all of IRS
electronic services, including Free File. We are absolutely committed to protecting
taxpayer privacy and confidentiality. Taxpayer information and data will be pro-
tected and the Alliance members must adhere to IRS strict privacy standards. To
11
ensure taxpayer data safety, we required each participating company to obtain both
a privacy and security seal certification.
These programs, administered by third party providers, certify that taxpayer re-
turn information will be protected from unauthorized access during the tax prepara-
tion process. We also encourage taxpayers to visit the companys privacy and secu-
rity policy located on their commercial Web site.
Indeed, taxpayer security and privacy are woven throughout the Free File process.
Tax return preparation is accomplished using proprietary software approved by the
IRS. Transmittal is through the established IRS e-file system. As I mentioned, each
Alliance member must obtain a third party privacy and security certification. Alli-
ance members must also comply with all Federal rules and regulations on taxpayer
privacy for paying and free customers. These rules prohibit use of tax return data
for purposes not specifically authorized by the taxpayer.
Finally, the information taxpayers provide through the Free File Wizard will be
used solely to help taxpayers select a free service; thereafter it will be deleted. The
IRS only retains the officially-filed return information.
TAXPAYERS WITHOUT HOME COMPUTERS
Mr. Chairman, as I previously discussed, Free File is premised in part on the
principle that no one should have to pay to file a return. That includes taxpayers
who do not have access to a computer. Low income should never be a barrier to
quality service, including free electronic filing.
Free tax preparation and e-file are available in many communities through the
Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE)
programs. Volunteers help prepare basic tax returns for low-income taxpayers, per-
sons with disabilities, the elderly, and non-English speaking people. Taxpayers can
call 18008291040 to find their nearest VITA or TCE site. They may also call
AARPthe largest TCE participantat 18772277669 to see if there is a Tax
Aide site in their community.
However, Free File will not normally be used at VITA sites for a number of rea-
sons. First, we train our thousands of volunteers to use one standard software pack-
age, versus the many different ones offered by the Alliance companies. This consist-
ency is both cost efficient and produces a much higher accuracy rate in the volun-
teers preparation of taxpayer returns. In fact, we currently enjoy a 98 percent accu-
racy rate at the VITA sites. Second, we transmit large batches of e-file returns at
VITA sites; usually 50100 at a time. Free File is oriented towards the individual
taxpayer and was not intended for such high volume use. Third, some VITA sites
do not have access to the Internet so Free File is not an option.
Individual taxpayers with incomes of $35,000 or less can also receive free income
tax return preparation and e-file help at IRS Tax Assistance Centers (TACs). We
extend this courtesy return preparation service to all taxpayers qualifying for the
Earned Income Tax Credit, without placing the government in competition with pri-
vate industry. All of these returns are e-filed; we do not deal with paper individual
returns. Taxpayers whose income or preparation needs exceed the basic service will
receive service options, such as referrals to local volunteer organizations.
To better serve low-income taxpayers, the IRS Stakeholder Partnership, Edu-
cation and Communication (SPEC) organization is establishing extensive partner-
ships with external groups such as local governments, non-profit organizations, pri-
vate for-profit businesses, and others to create community coalitions. We are focus-
ing our limited resources on providing technical expertise and training while encour-
aging the community partners to supply resources such as volunteers, space and
computer equipment. This business model has rapidly gained national recognition
and acceptance.
Our goal is to make our partners as self-sufficient as possible and to identify those
organizations that could make available needed resources. This new approach allows
the IRS to expand access to low-income taxpayers, provide greater free tax return
preparation and filing, and sustain these services over time.
Mr. Chairman, as previously noted, taxpayers are under no obligation to purchase
any product from the software company (some participating companies do not offer
such services) or to use Refund Anticipation Loans. Obtaining a fee-based product
is a decision left to the individual taxpayer. The IRS, as well as many of the Alli-
ance company Web sites, also remind taxpayers that those who e-file and use direct
deposit often receive their refunds in 10 days or less.
CONCLUSION
Mr. Chairman, in conclusion, Free File is a breakthrough for Americas taxpayers.
We are putting e-file within reach of millions more taxpayers and delivering on the
Presidents commitment to put the needs of citizens first. In addition, we are fol-
12
lowing up on our commitment to provide taxpayers with top quality service. And
we are making the best use of the taxpayers dollars by processing returns faster
and at a lower cost. This new program may be called Free File, but what it gives
to millions of taxpayers and our government is invaluable. Thank you.
Chairman HOUGHTON. Thank you very much, Mr. Commis-

sioner. Just a couple of comments here. First of all, we are going
to have to push this thing along a little bit because we have three
panels. The first is you, Mr. Commissioner, and then I think we
have probably a series of votes coming up. Then second, if I under-
stand correctly, there is an IRS Web site that is to be shown; is
that right?
Mr. WENZEL. Yes. With your permission, we would like to give
you a brief demonstration of our site.
Chairman HOUGHTON. All right.
Mr. LUTES. Okay. Thank you. What I am going to do is just
walk you through it. I think there were screen prints made, copies
were made available, of what I am going to show. First of all, dur-
ingthroughout the filing season when you go to www.irs.gov, a
site which got over 312 billion hits last filing season, and we expect
that to grow this year, on the front page folks are going to see the
link to the Free Filing offering.
By clicking on the Free Filing offering, you go to what we call
the Free File splash page. I am not going to go through this page
in detail; however, there are a number of links here about the in-
formation you need before you start preparing a return, things you
should know. There is a one, two, three as to what the steps are
of the electronic filing process, to help folks understand, and then
there is a series of frequently asked questions around privacy, se-
curity, the nature of the contract and the agreement we have with
the industry and so forth.
When you are ready to prepare the return you click start, and
it will take you to this page, and you have a couple of choices here
as to how to use it.
What I am going to take you to first is the guide me to a serv-
ice. There are 17 companies that have agreements with the Free
File Alliance to provide services for this filing season. How do tax-
payers sort through those companies to determine those that they
are eligible for, because each company determines on its own which
taxpayers it wants to cover with its offering? By going to guide me
to a service, there is a series of six questions the taxpayer would
answer, and if they answered those questions correctly, and then
clicked the submit button, it will then list the offers that they are
eligible to use, and then they can click on the company and begin
the return. I will show you how that happens in just a moment.
The other way to do this, you can either scroll down the page and
see the listing of companies, or if you click browse all the serv-
ices, you lose the top part, and it is easier to browse, and then you
look at the companies, and you can read about the companies, who
they are covering. You can bring up just a longer description of the
companies. When you have selected the company you want to use,
either from the wizard or from this list, you click start now, and
an important thing I want to illustrate is you get a disclaimer that
13
makes it clear to the taxpayer that you are no longer going to be

in a government site. These are commercial products. The same
commercial products that millions of people paid to use last year
are being made available for free, but it is through the commercial
providers. We want taxpayers to understand. Then they click to
leave the IRS site, and then they go to the company site.
Basically, that is the way the process works, and we just wanted
to illustrate that we think we have designed this in a way that
makes it easy for taxpayers to use and understand how the process
will work. Thank you.
Chairman HOUGHTON. Thank you very much, Mr. Lutes. That
is great.
Now, let me just ask a quick question, and then I want to pass
it along to the others. Why did you choose 2007 to get the 80 per-
cent? What are the factors that are now impeding you from reach-
ing that goal?
Mr. WENZEL. That is a good question because I think that when
that was part of the restructuring format of 1998, there was a lot
of discussion with the Congress and the IRS. The thinking was
that might be a realistic year to achieve that kind of percentage.
Back then it was our best thinking that while it was a very, very
ambitious goal, and we certainly, at this point in time, see it as a
real stretch for us to reach that number. We felt it was the right
thing to achieve, and by that year.
Chairman HOUGHTON. Well, it is always good to shoot high,
and obviously that is what you did, but, why not 75 percent, or why
not 50 percent or something? What led you to believe that in that
10-year period you could do this?
Mr. WENZEL. I think that when we looked at what we experi-
encede-file started in the IRS in the filing season calendar year
1986. That first year there was approximately 26,000 returns that
were filed. Then we started to see the growth and the acceptance
by the public throughfrom that year forward. We looked at the
opportunities that we had with additional incentives that we
thought we could put out in terms of encouraging people to convert
from the paper filing to electronic filing. The goal, as you know, is
also for business returns, so it is all types of tax returns filed with
the IRS. Our best feeling was, at the time, that 80 percent, four
out of five returns by that year would be filed electronically.
We haveas I mentioned, in terms of what our current track is,
in terms of reaching that goal, if it stayed the way it is, with what
we expect this year, again we expect a significant growth, we are
predicting about 54-million individual returns will be filed elec-
tronically as compared to 47 million last year. So, that is another
significant growth. We still will not reach the 80 percent, and we
continue to work with the industry to find new and, innovative
ways to reach our 80-percent goal.
For example, in the Presidents fiscal year 2004 budget, there is
a provision that would extend the filing season from April 15 to
April 30 for any individual who would file their tax return with us
electronically. We predict, if that should pass, that would provide
a significant incentive for people that still file on paper to file elec-
tronically. Of note, approximately 132 million form 1040s, indi-
vidual tax returns, will be filed that calendar year, and when you
14
look at when those returns are filed, of significance is that a very

high percentage, almost half, are coming around April 15. Both re-
fund returns and also, of course, the balance due tax returns are
there. We feel that withthe additional 2 weeks from April 15 to
April 30, we will reach that group of taxpayers that wait until the
end of the due date or near the end of the due date. That will en-
courage them to maybe file electronically and help us along toward
that 80-percent goal.
Chairman HOUGHTON. Thanks very much.
Mr. Pomeroy.
Mr. POMEROY. Thank you, Mr. Chairman.
I want to echo my friend Rob Portmans comments about this
being a good thing and commending you for establishing these
partnerships that basically facilitate greater access of the American
public to e-filing; the greatest benefit, internal math checking to
make certain a return is filed correctly, and sparing the time and
disruption that an incorrect return would result, as well as quickly
accelerating the receipt of the tax return.
What can an e-filer expect by way of time line on a tax return?
Mr. WENZEL. If an e-filer files a tax return with us and also
opts to use the direct deposit provision, and they are entitled to a
refund, they will probably receive that refund checkI should say
not the check, but the refund deposit in their bank account within
10 days.
Mr. POMEROY. I think that is terrific.
Now, I used to be an insurance commissioner, so policing market-
place activity is something that comes naturally to me, and I dont
mean in any way to impugn any untoward business practice on
your partners, your private sector partners who have done so much
to advance this service, but there are some oversight questions ap-
propriately directed at their marketplace activities. Are you aware
of whether or not loans are being made, loan services are being
made relative to the return by any of your participating partners?
Mr. WENZEL. Yes, there are several that are offering that serv-
ice. If an individual opts to use that serviceit is not required, it
is still a free service to file the return.
Mr. POMEROY. Mr. Commissioner, I note that you indicate on
page 5 of your testimony that the IRS does not formally or tacitly
endorse any of the products or services that any of the Alliance
companies may offer taxpayers. I will agree with you on formally,
but I dont agree with you on tacitly. As a taxpayer, if I, through
the IRS Web site, find myself essentially in a private product of
preparing my tax return as a part of a public-private partnership,
I do think that there is a tacit acknowledgment by the IRS that
the services sold in conjunction with the private partner are accept-
able for public consumption.
It is my view that loan activity for the dependency of a return
that at maximum is 10 days is highly suspect. If this was an insur-
ance product put before me, I would say, uh-uh. You dont sell this
unless there is confusion in the marketplace, because no one would
reasonably conclude that they need that loan for that period of
time.
Have you scrubbed the products, Mr. Commissioner, to make
sure that they pass the smell test for the American consumer?
15
Mr. WENZEL. Congressman, the refund anticipation loan has

been part of this e-file program for some time, and, our view of that
is that we emphasize as much as we can as how quick a refund
check could come back if you use direct deposit.
Mr. POMEROY. I think you are turning the refund around so
quickly that you just really wouldnt need one of those.
Mr. WENZEL. That is the emphasis that we continue to try to
make everyone aware of. Our experience has been that the con-
sumer, our taxpayer, still has opted to use the
Mr. POMEROY. Well, consumers can be confused Mr. Commis-
sioner. Have you ever sat down with your vendors and said, what
is the compelling market need for a product of this nature?
Mr. WENZEL. In terms of me personally, in the acting capacity
that I have been in, I have not done that.
Mr. POMEROY. I would like the Service to do that due diligence.
In my opinion, the marketplace is owed a wide variety of products,
and consumers can make their choice. On the other hand, if some-
thing on its face really looks as though it probably doesnt serve a
valuable purpose to the consumer, we can draw a conclusion that
this is sold only by consumer confusion, and we ought not allow
products of that nature.
For example, in insurance, I would refuse to approve for the mar-
ketplace illusory policies, policies that appeared to provide some-
thing, but took it all away with loopholes. This, in my opinion, is
kind of an illusory policy. It looks like you are getting a loan, but,
heck, you are going to get your refund in 10 days. You probably
wont get your loan proceeds until 5, 6, 7 days, so you are spending
some money for just a very short, literally maybe a weekends
worth of time, and it just isnt worth it.
What I would like the Service to doI see I am out of time, and
I would just submit for youI know we want to move this hearing
alongseveral specific items where I would like the Service at the
end of this tax year to survey its vendors and get us the informa-
tion. We would like to find out, for example, the number of people
that have purchased these refund anticipation loans from the ven-
dors and such other services as the vendors are marketing.
I just think it is important to keep an eye on this activity. Again,
I dont mean to impugn anything on the valuable private partners
to this initiative. We just want to, as part of our due diligence,
make sure the products are appropriate for the American public.
Thank you very much.
Mr. WENZEL. Congressman, we look forward to providing you
with the information that you requested.
[The information follows:]
Internal Revenue Service
Washington, DC 20224
Answer: First, we should make it clear that companies involved in the Free File
alliance are not our vendors. Rather, we have an agreement with them that is not
contractual in nature. This is a partnership agreement intended to provide the op-
portunity for free filing of Federal income tax returns over the Internet to as many
people as possible. The nature of the agreement was to take the same product that
millions of people have paid for and to make those products available for free.
Taxpayers who use tax preparation software generally want to receive their re-
funds as quickly as possible. We have made strides over the past several years to
accelerate the delivery of tax refunds through the electronic filing system. However,
16
some taxpayers have traditionally sought refund anticipation loans as a way to get
their refunds even faster. The practice of using tax refunds as loan collateral goes
back many years, predating the advent of electronic filing. We anticipate that with
the rollout of the Customer Account Data Engine over the next several years tax-
payers will be able to receive refunds in a week or less, thus, reducing the demand
for refund anticipation loans.
f
Chairman HOUGHTON. Okay. Thank you very much, Mr. Pom-

eroy.
Mr. Portman.
Mr. PORTMAN. Thank you, Mr. Chairman. Commissioner
Wenzel, you were rather generous in your response to our earlier
question about how the IRS came up with this 80 percent, because
we came up with it for you. He was pretty nice to you actually,
Amo, on that one. We came up with it not so much in the legisla-
tion, but it came out of the Commissions work, again, 2 years of
studying this and trying to set an ambitious but, we thought, real-
istic goal.
We are disappointed we are not further along, because we think
electronic filing is both good for the tax system and also very good
for the taxpayer. We also did not put in place any penalties for the
IRS not achieving that goal. We established it as a goal, not a man-
date, and we thought it was appropriate to encourage it.
One of the sticking points had been this notion of getting folks
who have relatively simple returns particularly into the electronic
system in a free way, and the cost, which I think only averaged
last year about $12 or $13, but that cost alone kept people from
filing electronically. Instead they went through the paper route
with all the error associated with that on their part and the IRS
part, and all the additional costs, all the additional costs to you to
have additional people to open those forms and work through the
system, and all the downstream costs we talked about earlier to
the taxpayer where the taxpayer ends up getting, because of a
mathematical error or some other error, a phone call from the IRS
or a letter from the IRS. It begins sometimes a string of back-and-
forth that sometimes our congressional offices get involved with,
which is enormously frustrating to taxpayers and to the system,
and costly.
So, it is a good thing, and the question is how are we going to
do that? I know the private sector was very concerned, as was I,
frankly, about the IRS competing with the private sector, that you
are not really in the software business, and you are not likely to
be as successful, frankly, or as innovative as the private sector in
coming up with new ways to encourage people to file electronically.
So, again, I commend you for working out an arrangement with
the private sector where they are going to offer this as a free serv-
ice at least to folks who are up to the 60th percentile on income.
I think it will be a major push if we advertise it properly, and that
is what I love about your Web site, which has been very successful,
and I think both the private sector and you ought to redouble our
efforts in term of letting people know how this is simpler, easier
and better for them.
A couple of questions, if I might. First on the error rate. What
is the error rate now on paper returns?
17
Mr. WENZEL. The error rate on the paper returns continues to

run as high as 22 percent as you previously mentioned, and it real-
ly hasnt changed that much in years. It still could vary.
Mr. PORTMAN. Roughly of that 22-percent error, which is an
enormously high number, roughly half of that is attributable to the
taxpayer; is that correct?
Mr. WENZEL. What has generally been the trend is taxpayer
error return, third-party preparation error, or the IRS making the
mistakes.
Mr. PORTMAN. A lot of it is transposing the numbers by your
folks.
Mr. WENZEL. Transposition of the numbers.
Mr. PORTMAN. Hit return. You are then putting it into the com-
puter rather than having it come straight through on an electronic
form.
Mr. WENZEL. That is correct, Congressman. It is the key entry
that has a tendency to make a mistake.
Mr. PORTMAN. How about the error rate on the electronic fil-
ing?
Mr. WENZEL. The electronic error rate, again, the numbers that
you mention are right on in terms of somewhere1 percent or less.
It is a very, very low rate.
Mr. PORTMAN. It is an incredible savings and difference.
On the refund anticipation loans, that is one issue out there the
private sector is now going to have an opportunity to have people
go through your site through and then to a free service to file, and
the notion that my colleague from North Dakota mentioned, which
I agree with, is you dont want to have people who are going to get
a quick refund on average 10 to 14 days be pressured into getting
into these refund anticipation loans, which is not necessarily good
for the taxpayer. On the other hand, I am not sure it is as big a
problem as we are making it out to be, because I dont think many
people do that.
Do you have any data on how many folks who file electronically
actually seek a refund anticipation loan?
Mr. WENZEL. I dont have that in front of me. Do you?
Mr. LUTES. Yes. I can address it in general terms. What we cap-
ture is information about financial products related to the return.
There is an financial product indicator that comes to us electroni-
cally. However, financial products include a variety of services, not
only refund anticipation loans. For refund anticipation loans, we do
know is that the majority of those are by taxpayers who go to a
tax professional. The refund anticipation loans on online products,
which these are offering online Web products, according to the in-
dustry is less than 1 percent.
The other thing I would say in response to the question is, if you
go to the sites and you look to the 17 sites, they vary. They are
commercial sites; they vary. Some will have a line item on the front
page that talks about the fact that you can get a quick loan. How-
ever, many of the sites, if you look at their front page, three levels
down, emphasize you are electronically filing; you are going to get
your refund much faster as a result of the electronic filing. They
really emphasize that. For those taxpayers who then do want it
faster, they offer the service. I think there is going to continue to
18
be some demand until we are able to deliver our modernization so

we can deliver refunds even faster than the 10 days.
Mr. PORTMAN. So, you think that 1 percent figure is accurate,
that only 1 percent of taxpayers who file electronically actually
seek a refund anticipation loan?
Mr. LUTES. It is 1 percent who file electronically using the on-
line, using Web or the shrink wrap products. Those who file elec-
tronically using a practitioner, the number is higher.
Mr. PORTMAN. My time is up, but certainly more information
as to the speed at which someone can get a refund is going to affect
that, and I assume that that is something that you can commu-
nicate. Again, I commend you for this program, and I yield back
my time, Mr. Chairman.
Chairman HOUGHTON. Thanks.
Mr. Kleczka.
Mr. KLECZKA. Thank you, Mr. Chairman. Mr. Lutes, one quick
follow-up question to the whole issue of tax refund loans. What is
the average charge for these loans? Lets say I did a paper return.
Do you know what that firm might be charging, because the refund
might be a heck of a lot longer than the electronic?
Mr. LUTES. It varies very widely if you are using a tax profes-
sional, depending upon the complexity of the return if you are look-
ing at the entire charge. Usually the refund anticipation loans typi-
callyand I dont know that this is 100 percent the rulebut typi-
cally there is a flat fee that is charged, and I have seen some in
the range of $60, $50, but usually I think it would be safe to say
that $50 to $70 range would be the charge.
Mr. KLECZKA. Have you seen any higher or done on a percent-
age?
Mr. LUTES. I really cant answer that question because I havent
gone through and looked at all the pricing, because one of the
things to remember is the idea of using a tax refund as collateral
for a loan predates electronic filing. It has been around for years.
What we actually see, we can see on the on-line sites, if we go and
look site by site at what is there. In the practitioner office we dont
have any real system for collecting that data. What we do, though,
is emphasize in our guidelines for electronic filing originators they
have to apply be approved, and we can suspend them.
One of the things that we monitor is people who are implying
that what folks are getting is a faster refund. We make it clear
that they have to communicate clearly to the taxpayer it is a loan,
and there is a fee. This is not IRS doing this. This is a bank.
Mr. KLECZKA. I think it would be wise for the Service to look
at not only the fee being charged for the electronic file, but all
firms charging a fee, just to make sure that our taxpayers arent
being gouged. Thanks.
Chairman HOUGHTON. Okay. Mr. Johnson is not here. Ms.
Tubbs Jones.
Ms. TUBBS JONES. When you are new, you cant even find the
microphone, but I am going to get it together here.
I think also it might be interesting to kind of take a look at the
agreements with the companies toor I would like to have a copy
of the agreement. I am not saying in terms of review. I dont want
to tarry on that part of the conversation. I am sure that a number
19
of my colleagues have asked enough questions. I guess what I

would be interested in knowing is you said that there will be
there are locations where taxpayers can get volunteers to help
them with these services. How is that set up?
Mr. WENZEL. We have had a voluntary income tax preparation
activity for many years, I would say, approximately 30 years,
throughout the country. The AARP is one of the principal organiza-
tions that assist us, retired accountants or just volunteers that be-
long to that organization come in and we train them. There are col-
lege students, a whole range of individuals that this time of year
realize how important it is to meet ones financial responsibility to
our country and want to offer assistance. Those sites are staffed by
these volunteers evening hours, during the day, during the week,
but especially on Saturdays.
Ms. TUBBS JONES. How dosay, for example, if I wanted to
know who was doing volunteer IRS, filing or assistance with filing
in my congressional district, who could give me that information?
Mr. WENZEL. We try to publicize that through our own
www.irs.gov Web site in terms of where the locations are. We so-
licit the support of the volunteer organizations to reach out and
also publicize that. The media is very cooperative in publicizing lo-
cations, times and dates.
Ms. TUBBS JONES. What else did I have? I probably had some
more questions, but since we are near the end of the time, I am
just going to pass on that so that they can be gone since everybody
else is gone. Okay.
Mr. PORTMAN. [Presiding.] I thank my colleague from Cleve-
land, and, Mr. Wenzel, we appreciate your testimony. Thank you,
Mr. Lutes. Appreciate your testimony, and the program will now go
to the next panel.
Kevin Belden will come forward; Michael Cavanagh. Gentlemen,
thank you very much. Chairman Houghton has gone to vote so he
can come back and be with us toward the end of this panel. We
do have another panel: Ms. Olson, who is going to be joining us for
the third panel. We have a vote now, which will be separated by
about a 20-minute period until the next vote, which is a motion to
recommit, so we thought it would be best to try to keep this mov-
ing.
Mr. Belden, thank you very much for being here. Mr. Kevin
Belden is Chairman of the Electronic Tax Administration Advisory
Committee (ETAAC). Then Mr. Michael Cavanagh. Thank you for
being here. Mr. Cavanagh is the manager of the Free File Alliance.
I would like to remind the witnesses that we have a 5-minute
rule on testimony; however, we might be a little generous with that
since Members have all gone to vote. If you could please direct your
testimony to me, and, again, Mr. Houghton should be returning
shortly. Mr. Belden.
STATEMENT OF KEVIN BELDEN, CHAIRMAN, ELECTRONIC TAX
ADMINISTRATION ADVISORY COMMITTEE, AVERILL PARK,
NEW YORK
Mr. BELDEN. Mr. Chairman, Members of the Subcommittee and
distinguished guests, my name is Kevin Belden. I am honored to
serve again this year as Chairman of the IRSs Electronic Tax Ad-
20
ministration Advisory Committee. Other panelists are presenting

detailed information this afternoon about the genesis, the charac-
teristics and benefits of the Free File initiative. My remarks will
focus more on addressing Free File in the larger context of congres-
sional goals for electronic filing.
We are approaching the midpoint between 1998, when those
goals were established, and 2007, when the target was to be
achieved. The goals have been powerful motivators for focusing IRS
resources on electronic filing initiatives. While the IRS has made
considerable progress at the current rate of adoption, electronic fil-
ing rates will fall short of the target.
Initial IRS efforts focused on expanding the availability of elec-
tronic filing particularly for individuals. Those were necessary first
steps, but we have since learned that offering electronic filing op-
tions does not by itself lead to their use. The vast majority of indi-
vidual tax filers are able to file electronically, yet just under 36
percent of all individual returns were electronically filed this past
year.
The key challenge to increasing electronic filing is to stimulate
demand by taxpayers and by tax preparers. To do so the IRS will
need to overcome increasingly challenging barriers to adoption.
Those barriers include cost of electronic filing, the continued pref-
erence for paper filing, lack of awareness of electronic filing alter-
natives, and concern about privacy and security. Some of these bar-
riers can be addressed through education and marketing, but the
bottom line is that the benefits offered today by electronic filing are
not sufficiently compelling for all taxpayer and practitioner seg-
ments. More needs to be done to increase the value of electronic fil-
ing for these segments.
There are approximately 52-million individual tax returns filed
each year by taxpayers who prepare and file their own tax returns.
The new Free File Alliance initiative primarily targets this group
of taxpayers. This innovative approach allows each of the players
in the tax administration value chain to focus on what they do
best. The IRS will receive more electronic returns while avoiding
the cost of developing its own online filing product. The IRS can
then focus its efforts on modernizing its back-end systems and elec-
tronic filing platforms to provide greater value and increased elec-
tronic services, each of which will increase and stimulate the de-
mand for service. The initiative preserves and strengthens govern-
ment and industry cooperative relations, which have led in large
part to the electronic filing gains achieved to date.
However, the Free File Alliance initiative alone will not solve the
problem of attaining the 80-percent electronic filing target by 2007,
in the opinion of the ETAAC. Cost is only one of the inhibitors to
electronic filing, and access to a computer and the Internet is an
impediment for many of the target population. In addition, many
in that segment are comfortable with manual preparation and may
be resistant to change.
Product offerings in future years will need to incorporate free
State filing. Since a number of States are offering free online in-
come tax filing of State tax returns, the Free File Alliance mem-
bers view them as competitors and are not inclined to cooperate in
21
offering free combined filing of Federal and State returns in those

States.
Addressing this challenge will lead to greater use of Free File Al-
liance products in the future. Many of the essential elements for
rapidly expanding electronic filing participation are falling into
place.
Mr. PORTMAN. Mr. Belden.
Mr. BELDEN. Yes.
Mr. PORTMAN. I am sorry to interrupt you. We had hoped that
Mr. Houghton would be back. He is not as fast a sprinter as we
thought. I am going to sprint over and vote, and we will be back.
If you could stop there at your testimony, and then we can pick up
when you come back. We will be recessing just for a short period
of time until Mr. Houghton comes back.
Mr. BELDEN. Be glad to. Thank you.
[Recess.]
Chairman HOUGHTON. [Presiding.] Okay. Lets continue the
hearing. Mr. Belden, good to see you, and I am sorry we werent
here earlier. Anyway, we are delighted to have you here, and
maybe you want to continue your statement.
Mr. BELDEN. Yes, Mr. Chairman. I was just making the point
that while ETAAC is extremely supportive of the Free File Alli-
ance, that it in and of itself is not going to completely solve the 80
percentthe problem of achieving the 80-percent goal. Cost is only
one of the inhibitors to electronic filing, and access to a computer
and the Internet is an impediment for many in the target popu-
lation segment. In addition, many in that segment are comfortable
with manual preparation and may be resistant to change.
Product offerings in future years will need to incorporate free
State online filing since a number of States are offering free online
income tax filing of State tax returns. The Free File Alliance mem-
bers view them as competitors and are not inclined to cooperate in
offering free combined filing of Federal and State returns in those
States.
Addressing this challenge will lead to greater future use of Free
File Alliance products. Many of the essential elements for rapidly
expanding electronic filing participation are falling into place. The
IRS is modernizing its core tax administration systems to make
them more capable, flexible and responsive. New electronic service
delivery channels are being implemented, including secure Web
portals for access to electronic services, and taxpayer account infor-
mation by IRS employees and trusted third parties.
E-services are highly anticipated and will be much appreciated
by the professional tax community. The IRS is also implementing
the first of a series of modernized electronic filing platforms. These
modern new electronic filing platforms are based on industry-ac-
cepted standards for data-sharing and communication, making
them cost-effective for the IRS and attractive for the software de-
velopers and the tax practitioners.
The growth of the Internet and the development of new business
models have prompted a change in the way we think about tax ad-
ministration. The new view, which you might think of as end-to-
end electronic tax administration, acknowledges that third parties
in the tax business are the IRSs partners in serving a common
22
customer, the taxpayer. In this vision taxpayers would have mul-

tiple choices in terms of how they interact with the IRS and what
value-added services they choose to use. They would not be e-filers,
but e-customers.
Tax practitioners would choose from a variety of third-party soft-
ware products offering highly interactive e-services made possible
through online communication with IRS systems. A full range of
these services would be available, allowing each practitioner to
make a clean break from their paper process.
Employers and financial institutions would file withholding infor-
mation returns electronically, providing electronic copies to tax-
payers and their designated representatives. Financial institutions
may integrate tax account information with other customer finan-
cial information into an electronic financial portfolio, allowing on-
line account inquiry, customized financial advice, tax filing and
payment reminders, and electronic tax payments.
The IRS would act as an integrator of this network of tax admin-
istration service providers. Its own electronic tax administration
processes and systems would be designed to facilitate the smooth
interaction of its internal functions with the specialized functions
of its third-party partners and taxpayers while protecting the secu-
rity and confidentiality of taxpayer information.
As has happened with the Free File Alliance, in this environment
the existing tax administration service providers would likely cre-
ate new and innovative offerings, and new providers would un-
doubtedly enter the market with fresh ideas and new business
models. Taxpayers will be the ultimate beneficiaries.
Thank you, Mr. Chairman, for the opportunity to provide
ETAACs views on electronic filing.
[The prepared statement of Mr. Belden follows:]
Statement of Kevin Belden, Chairman, Electronic Tax Administration
Advisory Committee, Averill Park, New York
Mr. Chairman, Members of the Subcommittee and distinguished guests, my name
is Kevin Belden and Im honored to serve again this year as Chairman of the Inter-
nal Revenue Services Electronic Tax Administration Advisory Committee (ETAAC).
Thank you, on behalf of the Committee, for the opportunity to share our views on
the progress and future direction of electronic filing. ETAAC was established to pro-
vide continued input to the development and implementation of the IRS strategy for
electronic tax administration. Members of ETAAC represent a diverse cross-section
of IRS partners, customers and stakeholders, whose interests and insights are crit-
ical to the overall attainment of electronic filing goals.
The Progress of Electronic Filing
Were approaching the midpoint between enactment of the Restructuring and Re-
form Act of 1998which set goals for electronic tax administrationand the year
2007 when those goals were targeted to be achieved. The goals Congress has set for
electronic filing have been powerful motivators for focusing IRS resources on elec-
tronic filing initiatives. However, while the IRS has made considerable progress, at
the current rate of adoption electronic filing rates will fall short of the goals. Initial
IRS efforts focused on expanding the availability of electronic filing, particularly for
individuals. While those were necessary first steps, weve since learned that offering
electronic filing options doesnt, by itself, lead to their use. The vast majority of indi-
vidual tax filers are able to file electronically, but just fewer than 35% (46.3 million)
of all individual returns were electronically filed this past year.
Business electronic filing initiatives to date have been limited, but well received.
Business returns are generally more complex than individual returns, as are the fil-
ing, authentication and signature processes. Work is underway, as part of a com-
prehensive strategy, to develop and market additional opportunities for business e-
filing that add value for businesses while improving IRS internal operations.
23
Taxpayers and government tax agencies are not the only players in the tax ad-
ministration life cycle. Third party tax practitioners and tax software developers are
key links in the value chain. Tax practitioners file 60% of all individual returns and
at least 85% of all business returns using tax software acquired from commercial
developers. Many of the returns prepared and filed by taxpayers themselves are pre-
pared using private sector tax software. The key challenge to increasing electronic
filing is to stimulate demand by taxpayers and tax preparers. That, in turn, is de-
pendent on increasing the value of electronic filing for taxpayers and the IRS third
party partners in tax administration.
To improve the growth rate of electronic filing, the IRS will need to overcome in-
creasingly challenging barriers to adoption. Research indicates that those barriers
include a continued preference by taxpayers for paper filing, lack of awareness of
e-filing and how to do it and concern about privacy, security and the role of third
parties in the process. Some of these barriers can be addressed through education
about the advantages of electronic filingfaster refunds, electronic receipts that
offer proof of filing, convenience, accuracy and reduced likelihood of receiving a no-
tice from the IRS. But the benefits offered today by electronic filing are not compel-
ling for all taxpayer and practitioner segments. More needs to be done to increase
the value of electronic filing for these segments. It needs to become part of a routine
way of doing business.
Free File AllianceAn Innovative Approach to No-Cost Online Filing
There are approximately 52 million individual tax returns filed each year by tax-
payers who prepare and file their own tax returns. At least 30 million of these re-
turns are prepared on a computer, but then printed and mailed to the IRS. The new
Free File Alliance initiative primarily targets this group of taxpayers. The Free File
Alliance eliminates cost as an obstacle for a potential target segment of at least 60%
of individual taxpayers. This innovative approach allows each of the players in the
tax administration value chain to focus on what they do best. The IRS will receive
more electronic returns, while avoiding the cost of developing its own online filing
product. The IRS can then focus its efforts on modernizing its backend systems and
electronic filing platforms to provide greater value and increased electronic services.
The initiative preserves and strengthens government/industry cooperative relations
which have led, in large part, to the electronic filing gains achieved to date. Tax-
payers have a choice of service providers, each offering unique value in a virtual
marketplace.
However, the Free File Alliance initiative alone will not solve the problem of at-
taining the 80% electronic filing target by 2007. Cost is only one of the inhibitors
to electronic filing. Demonstrating the value of electronic filing will continue to be
a challenge. Many in the target segment are comfortable with manual preparation
and may be resistant to change. Free File Alliance products will need to prove their
value by saving time, adding convenience, improving accuracy and contributing to
expedited refunds. To do so, the product offerings in future years will need to incor-
porate free State online filing.
Lack of access to a computer and the Internet will likely be a roadblock for many
in this group. The IRS will need to identify and encourage public access to com-
puters and the Internet in such places as IRS and other government offices, commu-
nity colleges, public schools, libraries and post offices. Additionally, tax preparation
companies may realize significant client development benefits from providing free
Internet access in their offices.
A Foundation for Future Growth
Many of the essential elements for rapidly expanding electronic filing participa-
tion are falling into place. The IRS is modernizing its core tax administration sys-
tems to make them more capable, flexible and responsive. New electronic service de-
livery channels are being implemented, including secure Web portals for access to
internal information resources, services and taxpayer account information by IRS
employees and trusted external customers, including taxpayers authorized rep-
resentatives.
The IRS is beginning to offer electronic services, like the ability to register as a
trusted external customer and for a new business to obtain an Employer Identifica-
tion Number (EIN) online. These e-services are highly anticipated and will be much
appreciated by the professional tax community. The IRS is also implementing the
first of a series of modernized electronic filing platforms, beginning with the Em-
ployment Tax e-Filing System earlier this month, to be followed by Corporation In-
come Tax (1120 and related forms) e-Filing in January 2004. These modern new
electronic filing platforms will be based on industry-accepted standards for data
24
sharing and communication, making them cost-effective for the IRS and attractive
to software developers and tax practitioners.
ETAAC encourages the IRS to continue the current efforts and to expand them
rapidly to include a broader range of e-services and to encompass modernization of
the 1040 e-filing platform, as well as other business tax return types. While these
new e-services and modernized e-filing platforms require an upfront investment of
resources, ETAAC firmly believes that the costs will be more than offset by the ben-
efits, including significantly increased electronic filing by those practitioners who
still file computer-prepared individual income tax returns on paper (30 million such
V-code returns were filed by practitioners last year) and a substantial increase in
the percentage of e-filed business tax returns.
A Future Vision of End to End Electronic Tax Administration
As has happened in the private sector, the growth of the Internet and the develop-
ment of new networked supply chain business models have prompted a change in
the way we think about tax administration. The new viewwhich you might think
of as end to end electronic tax administrationacknowledges that third parties in
the tax business are also the IRS partners in serving a common customerthe tax-
payer.
In the private sector, new end to end business modelsdriven by innovative
thinking and enabled by new technologiesare emerging in industries with charac-
teristics similar to the tax administration environment. Those characteristics in-
clude a diverse customer base, complex and highly-specialized functions, seasonal
peaks and valleys and a high level of dependency on value-adding intermediaries.
Highly-competitive businesses have responded to new market challenges and oppor-
tunities by shifting their view from streamlining internal processes and systems to
integrating internal and external service providers in a seamless, end to end service
delivery value network. That view takes into account business partner capabilities
and needs, creating a flexible, dynamic environment that allows each partner to per-
fect its own specialized processes, reduce costs, enhance value and respond quickly
to customer needs.
For the IRS to achieve the electronic tax administration goals of RRA 98, it needs
to promote an end to end vision of tax administration with these characteristics:
Taxpayers would have multiple choices in terms of how they interact with the
IRS (e.g., directly or through an authorized representative; electronically, by phone
or by mail) and what value-added services they choose to use (e.g., online prepara-
tion and filing services from a variety of competing vendors). In this vision, tax-
payers would not only be e-filers, but e-customers. They could decide among a vari-
ety of options how they would like to view their own IRS account information, per-
haps choosing traditional paper correspondence, maybe through a secure session at
irs.gov, or potentially as part of an electronic financial portfolio offered securely by
a private sector financial institution. Taxpayers would be able to retain their books
and records electronically, a particular benefit to large corporations.
Tax Software Developers would continue to be active participants with the IRS
in defining new services that would be beneficial to mutual customers. The IRS
would define changes requiring software investments in ways that minimize costs
and maximize value for the tax software companies. The IRS would also provide
electronic services and secure account access in ways that would integrate securely
with private sector software. For example, the tax software used by a practitioner
would automatically validate taxpayer identification information in near real time
and securely pre-populate account information, such as Estimated Tax payments,
reducing costs for the practitioner and increasing accuracy for the taxpayer and the
IRS. Tax software companies, in turn, would be prompted by competitive market
pressures to enhance other features of their software, such as providing direct links
into IRS tax research knowledge bases.
Online Filing Providers similarly would have access to electronic services that
they could incorporate into their tax preparation and e-filing offerings. Their serv-
ices would be easily accessed and understood by taxpayers. The new Free File Alli-
ance is an excellent example of how this type of business model could benefit the
IRS, its partners and its customers.
Tax Practitioners, in the end to end vision of tax administration, would choose
from a variety of third party software products offering highly interactive e-services,
made possible through online communication with the IRS systems. A full range of
e-services would be available, allowing practitioners to make a clean break from
their paper processes. Those services would include the ability to e-file all form
types, research taxpayer account information online or through a direct software
interface, correspond electronically with the IRS, easily obtain electronic taxpayer
signatures and maintain all records electronically. Information returns would be
25
filed electronically by employers and financial institutions (2D bar coding of infor-
mation returns would be a helpful interim enhancement), and made available timely
to taxpayers, practitioners and tax agencies.
Other Government Agencies, such as SSA, FMS and State tax agencies, would
exchange information electronically with the IRS to improve compliance, taxpayer
service and processing accuracy. Federal and State filing obligations would be ad-
dressed in a single transaction.
Employers and Financial Institutions would file withholding and information
returns electronically, providing electronic copies to taxpayers and their designated
representatives. Financial institutions may integrate tax account information with
other customer financial information into an electronic financial portfolio, allowing
online account inquiry, customized financial advice, tax filing and payment remind-
ers and electronic tax payments. As an incentive to customers, financial institutions
and other third parties may offer free online tax preparation and filing, provided
by a specialized online filing provider.
Achieving the Future Vision
The IRS would act as an integrator of this network of tax administration service
providers. Its own electronic tax administration processes and systems would be de-
signed to facilitate the smooth interaction of its internal functions with the special-
ized functions of its third party partners and taxpayers. The focus of its electronic
tax administration initiatives would be to increase value and reduce costs for all the
participants in the tax administration service network, while protecting the security
and confidentiality of taxpayer information.
Those initiatives would enhance timely processing of returns and refunds and
speedy resolution of issues, standardize interface and data transfer protocols, pro-
vide simple and comprehensive views of taxpayer account information and facilitate
the ability of third parties to dynamically tailor services to the needs of individual
customers. Key enablers of this future vision, led by the IRS, would be the creation
of natural integration points, such as an electronic means for designating, track-
ing, updating and authenticating authorized representatives, definition of open
standards such as XML for data exchange and development of simple but effective
data encryption and electronic signature mechanisms.
In this environment, existing tax administration service providers would likely in-
novate with new and creative electronic service offerings and new providers would
undoubtedly enter the market with fresh ideas and new business models. Taxpayers
will be the ultimate beneficiaries.
That concludes my remarks to the Oversight Subcommittee. Thank you for the
opportunity to comment on the future direction of electronic filing.
f
Chairman HOUGHTON. Thank you very much, Mr. Belden. Now

Mr. Cavanagh, who is the manager of the Free File Alliance in Al-
exandria. Please submit your testimony.
STATEMENT OF MICHAEL F. CAVANAGH, MANAGER, FREE
FILE ALLIANCE, ALEXANDRIA, VIRGINIA
Mr. CAVANAGH. Good afternoon, Mr. Chairman, Mr. Pomeroy.
My name is Michael Cavanagh, and I serve as the industry man-
ager of Free File Alliance.
Chairman HOUGHTON. Could you put the microphone a little
closer to you?
Mr. CAVANAGH. Is that better?
Chairman HOUGHTON. Yes. Much better.
Mr. CAVANAGH. Okay. Pardon me. I am accompanied by Ste-
phen Ryan, General Counsel to the Alliance, and a partner in the
Manatt law firm.
The Free File Alliance was launched last month on January 16,
at a press conference conducted by the Acting Treasury Secretary,
the Office of Management and Budget Director, and Acting IRS
Commissioner Wenzel. Currently, 17 industry companies offer free
services to taxpayers.
26
We can now report, as you heard from the IRS, that as of last
week almost 650,000 free returns already had been processed,
transmitted and accepted by the IRS. Further, we know that 20
percent of the total traffic of visitors to the IRS site is going to the
Free File page, and that the total number of hits at the site is very
significant. The total number of individuals who will return to file
their taxes through the program before April 15 remains to be
seen, but we fully anticipate that the figure will represent a very
large addition to the 650,000 returns that have already been filed.
We believe that this is a truly unique public-private partnership
that offers American taxpayers significant benefits. It is a far bet-
ter public policy approach than the idea that has been suggested
in some quarters that the government should spend tens of mil-
lions of dollars to enter the tax preparation marketplace, thus sti-
fling competition and dampening the innovation that has been so
notable in the products and services emanating from this industry
over the past several decades. Despite some calls for government
intervention in the marketplace, we have not heard anyone suggest
that government software could possibly display the quality, diver-
sity and continuous innovation so readily visible in the competitive
marketplace.
Mr. Chairman, this initiative obviously provides tens of millions
of Americans with the option of preparing and filing their taxes
electronically online for free. Clearly we cannot say yet how many
taxpayers will take advantage of this offer.
We look forward to answering your specific questions about the
Alliance and its operations.
[The prepared statement of Mr. Cavanagh follows:]
Statement of Michael F. Cavanagh, Manager, Free File Alliance,
Alexandria, Virginia
Good afternoon, Mr. Chairman, and distinguished Members of the Subcommittee.
My name is Michael F. Cavanagh and I serve as the industry Manager of the Free
File Alliance LLC. I am accompanied by Stephen Ryan, General Counsel to the Alli-
ance and a partner in the Manatt law firm.
The Free File Alliance was launched last month, on January 16, at a press con-
ference conducted by the Acting Treasury Secretary, the OMB Director and the Act-
ing IRS Commissioner. Currently, seventeen industry companies offer free services
to taxpayers, each serving at least 10% of American taxpayers, and many consider-
ably more.
We can now report to you that the initial response to the Free File initiative has
been very, very strong. As of last week, almost 650,000 free returns already had
been processed, transmitted, and accepted by the IRS. Further, we know that 20%
of the total traffic of visitors to the IRS site is going to the Free File page, and that
the total number of hits at the site is very significant. The total number of individ-
uals who will return to file their taxes through the program before April 15 remains
to be seen, but we fully expect that the figure will represent a very large addition
to the number of returns already filed.
We believe that this is a truly unique public-private partnership that offers Amer-
ican taxpayers significant benefits. It is a far better public policy approach than the
idea suggested in some quarters that the government should spend tens of millions
of dollars to enter the tax preparation marketplace, thus stifling competition and
dampening the innovation that has been so notable in the products and services
emanating from this industry over the past several decades. Despite some calls for
government intervention in the marketplace, we have not heard anyone suggest
that government software could possibly display the quality, diversity or continuous-
innovation so readily visible in the competitive marketplace.
Mr. Chairman, this initiative obviously provides tens of millions of Americans
with the option of preparing and filing their taxes electronically online for free.
Clearly, we now can say that many taxpayers are taking advantage of this offer.
27
Bringing the program to fruition has taken an intense amount of work over the
past year. First, I would like to acknowledge support that we have received from
a number of Members of Congress.
We would also like to thank the Bush Administration, and within the Administra-
tion, the Department of Treasury, the Internal Revenue Service, and even the De-
partment of Justice (which provided clearance and review). On a personal level, we
would like to thank former IRS Commissioner Charles Rossotti and IRS Director of
Electronic Tax Administration Terry Lutes. Since November, Acting IRS Commis-
sioner Bob Wenzel has taken up the leadership of the program. At the Treasury De-
partment, Christopher Smith, Counselor to the Secretary, and George Wolfe, Deputy
General Counsel, played a critical role in achieving the Agreement.
For industry, there is an important philanthropic basis to the services donated
under this program, but there is also a practical side to the Agreement. It permits
stability in the marketplace of providing tax preparation services and, again, fun-
damentally the continuation of a successful competitive marketplace without gov-
ernment competition.
The Alliance companies are offering readily available commercial products, the
same as are being offered with paid preparation. The members of the Free File Alli-
ance look forward to working with this Subcommittee and others in the Congress
to ensure that this program serves the American taxpayer to the maximum extent
possible.
We look forward to answering your specific questions about the Alliance and its
operations.
Chairman HOUGHTON. Thank you very much. I am just going

to ask one question, and then I will turn it over to you. I guess one
of the things that comes to mind is what is going to happen if the
Alliance members fail to meet their side of the bargain to allow 60
percent of the taxpayers to file online electronically?
Mr. CAVANAGH. Mr. Chairman, one of the questions as this en-
tire project was being discussed over the course of the last year
was would, in fact, there be participants among the private sector
who would partner with the government, and would they, in fact
represent 60 percent of total tax-paying public, would those offers
total that. There was some question.
We had the question answered as we moved into this filing sea-
son. There is well over 60 percent that has been provided with free
service should they choose to use the Free File option. The agree-
ment calls for, if there were ever to be a dip below 60 percent, that
the government would go to the private sector and say that the pri-
vate sector is not living up to its side of the bargain in maintaining
the 60 percent. At that time, the industry would make an effort to
within a period of some months, within 6 months, regain the 60-
percent threshold.
Again, that has not turned out to be an issue as we see things
operating today, but there would be that process that has been out-
lined in the operating agreement.
Chairman HOUGHTON. Okay. Thanks. How about you, Mr.
Belden? Do you have any comments?
Mr. BELDEN. No, nothing to add to what Mr. Cavanagh had to
say on that point, sir.
Chairman HOUGHTON. Good. Fine. Mr. Pomeroy.
As I understand it, the IRS hasfirst of all, let me commend
you, Mr. Cavanagh, and the members of your association. It is ex-
citing for us to see this kind of public-private partnership, and the
response looks pretty promising so far this tax season.
28
As I understand it, there are not particular standards relative to

participating companies? What is the core deal that has to be of-
fered?
Mr. CAVANAGH. Oh, yes, there are specific standards. Each of
the participants has to agree to the details in the operating agree-
ment, and some of those were outlined by the Commissioner. They
must obtain security and privacy seals. They must, of course, go
through a testing with the IRS, and they must agree to live by a
variety of elements of the operating agreement. We have supplied
to the Chairman the operating agreement. So, there is a whole
framework of requirements that each of these companies has
agreed to comply with in order to participate in this Alliance.
Mr. POMEROY. What about theobviously, with the brave new
world of the Internet, there has been a lot of business models that
have rolled out that have not been so successful. We are looking,
and there is a hope here that there will be a business opportunity
for, on the one hand, free filing; on the other hand, there is a busi-
ness relationship that can be established which will make it pay
for the private partner participants.
Is there any review by the IRS of what services are offered that
represent the business plan for how this works with the company?
Mr. CAVANAGH. Well, the principle has been that during this
long discussion we began with former IRS Commissioner Rossotti
back January a year ago, and the concept evolved into what this
would be. One of the real concerns was that industry players might
suggest that they would offer dumbed-down versions to the Amer-
ican public of software and whatever. The commitment was that
there must be commercial services that are offered to the public
would be the ones that would be part of the Free File Alliance.
Now, within thatwithin those commercial products, there in
many instances are various add-ons. You were talking about one
before. There are a whole range of different things that the public
can get, and there never was any sense that in the Alliance process
that there should be any element of service being taken away. The
core tax product must be free, and there must be absolutely no
quid pro quo.
Mr. POMEROY. What worries me is basically we area basic fee
for filing might be easier and more of a straight-up method to have
this paid for than unbundled services that arethat involve a vari-
ety of costs and maybepurchased by people that arent quite sure
whether they need them or not. That is the source of my concern.
Again, I have heard no complaints of untoward market activity.
I am just trying to look at this going forward. So, I certainly, again,
salute your Members. I dont mean to impugn anything inappro-
priate on their behalf.
Do you think there should be some dialog with the IRS or some
review by thein terms of where these products fall? Obviously as
an association you cant really do it. It would seem to be antitrust
activity if you did. Is there an area where this Committee ought
to have some concern?
Mr. CAVANAGH. Well, Congressman, you were referring to one
particular set of products, which the Commissioner and the ETA
Director made the point that indeed that product is primarily of-
fered and primarily used by millions of Americans not in the online
29
arena, but in other arenas. Certainly any product like that is, of
course, appropriate for your oversight. It doesnt have anything to
do with the Free File Alliance.
Mr. POMEROY. What are people buying, the 600,000 that have
filed this year; do you know?
Mr. CAVANAGH. Pardon me?
Mr. POMEROY. I see that my time is expired. I will just close
with whathave you surveyed your members, and what are tax-
payers purchasing by way of add-on services of the 600,000?
Mr. CAVANAGH. No, we are not surveying them on that ques-
tion.
Mr. POMEROY. Perhaps after the tax year we could. It would
be very interesting to see what kind of commercial activity is tak-
ing place.
Mr. CAVANAGH. Yes, Mr. Congressman, yes. Thank you.
Chairman HOUGHTON. There are only two of us here, if you
want to continue asking the questions.
Mr. POMEROY. I think I pretty well got through it. I am inter-
ested in when the Commissioner said there is no express or im-
plicit endorsement of products, the fact that there is a public-pri-
vate partnership and you can access these vendors through the IRS
Web site leaves me a little concerned that there may be an implicit
statement by the IRS that these are appropriate products, and yet
there does not seem to be an active review of whether the products
are indeed appropriate. So, maybe we can install that going for-
ward.
Mr. CAVANAGH. Congressman, but I would just note these com-
panies are not vendors to the Federal Government. This is the
www.irs.gov Web site. These companies are not contracting with
thethrough the IRS to do anything. So, vendorsthat is not the
relationship they have.
Mr. POMEROY. If I refer someone to someone else, I want to
make sure that what they are selling is legit, and I think the same
is true about the United States.
Mr. CAVANAGH. Sure.
Mr. POMEROY. If we refer we want to feel good about the prod-
uct sold. By the way, I believe absolutely there are appropriate
business opportunities for companies providing a service for prod-
ucts that taxpayers need. So, I dont impugn this. This isnt some-
thinga marketplace that I think is judged guilty before proven in-
nocent. I think it is a fine opportunity. I just want to know what
activity is taking place in this marketplace. Thank you very much.
Chairman HOUGHTON. I think that is about all. The only other
question I might have is about the EITC and those people who
were involved in that, how do you reach them?
Mr. CAVANAGH. Well, Mr. Chairman, they are providedthere
are a number of offers that would cover them and would cover
thethose schedules, and so that is certainly included in the pro-
gram. Absolutely.
Chairman HOUGHTON. All right.
Mr. CAVANAGH. Even as I thinkas I saw here today the IRS
was actually showing some the screens that the IRS has developed
for information for EITC. So, that is absolutely an area that is
that is available as part of this Free File Alliance, Mr. Chairman.
30
Chairman HOUGHTON. Okay. Well, thank you very much. I am

sorry this has been sort of a truncated type of thing, but we are
victims of the flow of votes. So, thank you very much gentlemen for
being with us. Now, Ms. Olson, if you could step up here, and we
will see what we can do.
Ms. Olson, what I thought we would do is if you could give your
testimony, and that would fit into our timeframe, then we will
break, and then we will come back for questions afterward. Is that
all right with you?
Ms. OLSON. That sounds wonderful, sir.
Chairman HOUGHTON. All right. Let me give you a chance to
pour yourself a little water. Thank you very much for being so pa-
tient here.
Ms. OLSON. Oh sure.
Chairman HOUGHTON. Thanks again, gentlemen, for being
part of this program. All right. Ms. Olson, who is the NTA of the
Internal Revenue Service. Ms. Olson, we are delighted to have you
here again.
STATEMENT OF NINA E. OLSON, NATIONAL TAXPAYER
ADVOCATE, INTERNAL REVENUE SERVICE
Ms. OLSON. Thank you. Okay. Mr. Chairman and Members of
the Committee, thank you for inviting me to appear before you
today to discuss my 2002 annual report to Congress. I appreciate
your and the Committees interest in the Taxpayer Advocate Serv-
ice (TAS) and your work on tax simplification and taxpayer rights.
I also wish to acknowledge here the efforts and talents of the many
TAS employees who contributed to this report.
Last year I came before you to discuss some of our legislative rec-
ommendations for tax simplification, most notably the uniform defi-
nition of a qualifying child and the alternative minimum tax. This
year we focus on the difficulty facing the IRS to fairly administer
an enormous tax system while respecting taxpayer rights and pro-
viding customer service. The size and scope of the U.S. tax system
makes achieving this balance a challenge.
Our theme this year is taxpayer rights. Taxpayer rights includes
the taxpayers right to expect to be treated promptly and cour-
teously and to be provided accurate information, the right to re-
ceive adequate notice of any disagreement the IRS has with the
taxpayer and the reasons for that disagreement, and the right to
an adequate opportunity to dispute the IRS position before the tax-
payer is required to pay any additional tax. These rights must be
available to the taxpayer without causing the taxpayer undue bur-
den in obtaining them. We are, after all, asking taxpayers to volun-
tarily pay over their taxes to us. We should not make it difficult
for them to do so.
I believe that the next serious challenge to tax administration in
the 21st century will not revolve around the balance between en-
forcement and taxpayer rights or customer service. Rather it will
involve the balance between taxpayer rights, including customer
service, and the drive toward efficiencies as a consequence of the
sheer size and complexity of the U.S. tax system.
Over and over in the reports Most Serious Problems section, we
highlight the difficult choices the IRS must make in its struggle to
31
provide taxpayers with the services they are requesting. Take offer
in compromise, for example. We understand the basis for the Serv-
ices decision to centralize the processing of offers; however, we be-
lieve that centralizing offers does not mean that offers should be
rejected without contact or discussion with the taxpayer. It may be
with a phone call that some apparently unacceptable offers might
turn into valid ones. There might be some vital information or
some special circumstance left off the form, or with one follow-up
phone call the taxpayer might be willing to enter into an install-
ment agreement. Thus the taxpayer might not get the offer he or
she wants, but he will get closure of some sort and a fresh start
toward compliance. Yet direct phone contact with the taxpayers is
the exception, not the norm, in centralized sites.
This emphasis on efficient processing of offers can lead to rework
of the case by Appeals or the Taxpayer Advocate Service or, more
importantly, to a lost opportunity to collect the tax. The IRS simply
does not know what happens to offers after they are rejected. We
do not know if we collect another dime on those rejected offers.
Moreover, the programs own quality measures indicate that much
can be done to improve the IRSs computation of the taxpayers
ability to pay or the correct offer amount.
In addition to the right to communicate with the IRS, the tax-
payer has the right to be advised clearly and specifically about any
proposed changes on his or her income tax return. For example,
under math error authority, the IRS sends a notice to the taxpayer
telling him that it has changed the tax due on the taxpayers re-
turn. Unless the taxpayer timely requests an abatement of tax, the
taxpayer cannot petition the U.S. Tax Court, which is the only
forum in which a taxpayer can litigate a tax before it is assessed
and becomes collectible. When Congress expanded math error au-
thority in 1976, it clearly told the IRS to send taxpayers detailed,
itemized, line-by-line explanations of the error so that taxpayers
could timely respond with an abatement request. Yet math error
notices today do not set out the adjustments line by line, and a
sample of tax cases indicates that taxpayers do not know what is
being adjusted and cannot reach someone in the IRS to explain the
adjustment of the item, so they miss the opportunity to request
abatement.
In 2001, Congress expanded math error authority, effective in
2004, to the use of the Federal Case Registry of Child Support Or-
ders. This 2001 expansion applies math error authority to a ques-
tion that is inherently factual and not ascertainable from the face
of the tax return. It is our recommendation that Congress repeal
the expansion of math error authority it enacted in 2001 and limit
expansion of math error to quantitative, not qualitative, items.
In addition to math error authority, we have identified several
key legislative recommendations in our reports, including the tax
treatment of attorneys fees in nonphysical personal injury cases
and a system of registering, testing and certifying Federal income
tax return preparers who are not already attorneys, certified public
accountants or enrolled agents.
We are also proposing that a husband and wife who jointly own
an unincorporated business and who file a joint Federal income tax
return be permitted to elect out of the partnership provisions of the
32
Code and instead file a joint sole proprietorship or farm schedule

and report each spouses share of self-employment income.
We submit a proposal relating to the taxation of childrens in-
come, also known as the kiddie tax. This proposal goes to tax sim-
plification and the reduction of taxpayer burden. As you know, if
children under 14 have more than $1,500 in unearned income,
their tax must be computed at the parents top marginal rate. Fur-
ther, the parent can elect to include the childs unearned income
on his or her return. Because these options lead to different tax re-
sults, a parent must calculate three returns in order to determine
what is the best tax outcome. This process must be repeated for
each additional child. Add to this the possibility of triggering a
childs alternative minimum tax, and the difficulty of obtaining tax
information from an estranged spouse, and you have a needlessly
complex provision.
We propose that the calculation of tax on childrens income be
severed from the parents tax computation or tax rate. The concern
that taxpayers might shift income-producing assets to children and
thereby take advantage of lower tax rates can be addressed by es-
tablishing an appropriate tax rate on the childrens income.
In the interest of simplification, we also propose that Congress
establish a set standard deduction for dependents rather than the
current floating deduction amount.
Our last proposal addresses the operation of the Office of Tax-
payer Advocate. We are recommending six revisions to our author-
izing statute. All of these revisions derive from the fundamental
premise reaffirmed in 1998 that the Office of the Taxpayer Advo-
cate must be independent, and yet function within the IRS.
We first propose that the NTA be authorized to appoint a counsel
who shall report directly to the Advocate and advise her on matters
pertaining to taxpayer rights.
Chairman HOUGHTON. Ms. Olson, can I just interrupt a
minute? I am going to have to go and vote, and if you wouldnt
mind, we will vote fast, and then come right back. So, you can fin-
ish your testimony, and we will have the questions.
Ms. OLSON. Thank you.
Chairman HOUGHTON. Thank you for your forbearance.
Mr. PORTMAN. [Presiding.] Ms. Olson, a second welcome to the
Subcommittee. I am glad to be with you. We have been tag-teaming
this afternoon, as you know. I understand you had managed to get
through some, but not all, of your oral testimony. If you would be
so kind to continue that, Chairman Houghton and other Members
should be returning shortly.
Ms. OLSON. All right. Let me find my place.
Our last proposal addresses the operation of the Office of the
Taxpayer Advocate. We are recommending six revisions to our au-
thorizing statute. All of these recommendations derive from the
fundamental premise reaffirmed in 1998 that the Office of the Tax-
payer Advocate must be independent, and yet function within the
IRS.
We first propose that the NTA be authorized to appoint a counsel
to the NTA who shall report directly to the Advocate and advise
her on matters pertaining to taxpayer rights, tax administration
and the Office of the Taxpayer Advocate.
33
Currently the NTA receives advice from a special counsel who re-
ports directly to the Chief Counsel of the IRS. Given the unique
role of the NTA to take positions that may be different from the
official position of the IRS, there are times when this reporting
structure creates a serious conflict of interest and limits the Advo-
cates access to independent legal advice.
We believe it is important to maintain the counsel to the Advo-
cates current ability to participate in the day-to-day development
of guidance and regulation. We also believe it is important that the
TAS continue to receive its legal advice on substantive tax law
matters in specific cases from the IRS counsel. However, and fi-
nally, we believe that the conflict of interest on taxpayer rights and
tax administration would warrant independent advice from a coun-
sel that directly reports to the NTA.
We also propose that the Taxpayer Advocate Directive, which is
currently delegated to the Advocate by the Commissioner, and
which authorizes her to act on behalf of groups of taxpayers or tax-
payers at large, be codified to ensure that it cannot be revoked.
We also propose that the definition of significant hardship,
which grants taxpayers access to TAS, be expanded to explicitly in-
clude impairment of taxpayer rights as a grounds for issuance of
a Taxpayer Assistance Order or Taxpayer Advocate Directive.
Finally, we make some recommendations about the ability of and
discretion of the Taxpayer Advocate Service to hold taxpayer com-
munications confidential both from the IRS and in Federal courts.
I would like to conclude by acknowledging again the support your
Committee has shown for my office and indeed the entire IRS. I
know that the key subjects of this years report, taxpayer rights
and making the system simpler and more accessible so it is easier
for taxpayers to comply with their tax obligations, are of special in-
terest to this Committee. I hope our report has been of some assist-
ance to your oversight duties.
Thank you for this opportunity. I also request permission at this
time to submit a written statement for the record.
[The prepared statement of Ms. Olson follows:]
Statement of Nina E. Olson, National Taxpayer Advocate, Internal Revenue
Service
Mr. Chairman and Members of the Committee, thank you for inviting me to ap-
pear before you today to discuss my 2002 Annual Report to Congress. I appreciate
your and the Committees interest in the Taxpayer Advocate Service and your work
on tax simplification and taxpayer rights. I also wish to acknowledge the efforts and
talents of the many Taxpayer Advocate Service employees who contributed to this
Report.
Last year I came before you to discuss some of our legislative recommendations,
most notably the uniform definition of a qualifying child and the alternative min-
imum tax. Our focus was on tax simplification. This year, we focus on the difficulty
facing the IRS to fairly administer an enormous tax system. Combined with the
complexity of the tax lawwell, one can easily declare this task impossible. And yet,
98,000 employees each day show up to work, willing to take on this thankless job
and do the best they can at it. Their efforts are obviously the reason why the Fed-
eral tax system runs as well as it does, despite all the challenges it faces.
The theme of this years report is taxpayer rights. We do not use this term nar-
rowly. Although clearly the concepts of sufficient notice and due process are integral
to taxpayer rights, in this years report we focused on a broader definitionone that
looks at the essential contract between the government, as represented by its tax
administration agency, and the taxpayer.
34
The U.S. tax system is, in fact, a voluntary tax system. Although people may joke
about this, we rely on taxpayers to voluntarily file their tax returns and report the
correct income and deductions and credits and tax. We ask employers to voluntarily
submit the earnings and withholdings of their employees, and we ask the self-em-
ployed to voluntarily report revenue and expenses. And we ask everyone to volun-
tarily pay their correct share of the tax burden. Certainly, in some instances the
IRS must take additional steps to secure this information or payment, but the com-
pliance and enforcement functions of the IRS are only two of many aspects of tax
administration.
The recognition and protection of a taxpayers rights is a necessary and quite pos-
sibly paramount element of a voluntary tax system. By taxpayer rights, I mean the
taxpayers right to expect to be treated promptly and courteously and to be provided
accurate information; the right to receive adequate notice of any disagreement the
tax agency has with the taxpayers return or position and the grounds for that dis-
agreement; and the right to an adequate opportunity to dispute the tax agencys po-
sition before the taxpayer is required to pay any additional tax. These rights must
be available to the taxpayer without causing the taxpayer undue burden in obtain-
ing them. We are, after all, asking taxpayers to voluntarily pay over their taxes to
us. We should not make it difficult for them to do so.
I believe that the next serious challenge to tax administration in the 21st century
will NOT revolve around the balance between enforcement and taxpayer rights or
customer service. Rather, it will involve the balance between taxpayer rights, in-
cluding customer service, and the drive toward efficiencies as a consequence of the
sheer size and complexity of the U.S. tax system.
Right now, the IRS is trying to identify when taxpayers should be spoken with
in person, when they can receive recorded answers to questions, when they can be
asked to leave a message and receive a return call. It is trying to determine what
should be the core services delivered at Taxpayer Assistance Centers, formerly
called walk-in sites. It is also trying to streamline processing of certain offers in
compromise, correspondence audits of underreporter amounts and the earned in-
come tax credit, and even the collection of certain tax debts through the use of pri-
vate collection agencies.
Taxpayers and practitioners, on the other hand, complain of not being able to
reach the IRS by phonethey cannot find the appropriate person to speak with or
identify the management chain of command, or they leave messages that are not
returned. They miss the geographic footprint of the IRS and they are unable to iden-
tify an IRS employees job duties merely from that persons job title. Thus, we iden-
tify the top problem of taxpayers (and IRS employees, I might add) as that of merely
navigating the IRS.
Over and over, in the Reports Top 20 problems section, we highlight the difficult
choices the IRS must make in its struggle to provide taxpayers with the services
they are requesting. Take offer in compromise, for example. This is a program in
which the Office of the Taxpayer Advocate has been very active. We agree with the
IRS that having Revenue Officers work the vast majority of offers, which present
very simple situations, would be an inefficient use of very valuable resources. The
expertise of Revenue Officers should be reserved for those offers that present dif-
ficult questions of valuation or other specific circumstances. We also understand the
basis for the Services decision to centralize the processing of offers, and my office
and I are working with the IRS to improve that aspect of the program.
However, we believe that centralizing offers does not mean that offers should be
processed without contact or discussion with the taxpayer. We understand that ap-
proximately 14 percent of submitted offers are returned to the taxpayer because the
taxpayers own financial calculation shows that he or she can fully pay the tax and
does not need a compromise. Yet it may be, with a phone call, that some of these
offers might turn into a valid offerthere might be some vital information or some
special circumstance left off the form. Or, with one follow-up phone call, the tax-
payer might be willing to enter into an installment agreement. Thus the taxpayer
might not get the offer he or she wanted, but he will get closure of some sort, and
a fresh start toward compliance. Yet direct phone contact with the taxpayer is the
exception, not the norm, in centralized sites.
This emphasis on efficient processing of offers can lead to re-work of the case
by Appeals or the Taxpayer Advocate Service, or, more importantly, to a lost oppor-
tunity to collect tax. The IRS simply does not know what happens to offers after
they are rejected. We do not know if we collect another dime on those taxpayer ac-
counts. Moreover, the programs own quality measures indicate that much can be
done to improve the IRSs computation of the taxpayers ability to pay, or the correct
offer amount.
35
In our report we identify what we believe is a serious taxpayer rights issuethe
IRSs increasing use of a notice called a combination letter, which combines into
one letter the notice of the Services proposed decision as well as notice of the tax-
payers appeal rights. This combination letter pops up in the context of both offers
in compromise and the earned income tax credit. For most other situations where
a taxpayer is offered administrative appeal rights, including audits, the taxpayer re-
ceives two separate lettersone setting forth the proposed change and offering an
opportunity to present more information, and the other outlining the IRSs decision
and explaining appeal rights. In the EITC combo letter, however, the IRS invites
the taxpayer to send in additional information if he or she disagrees with the IRSs
proposed position. At the same time, the taxpayer is advised that he has a right
to appeal, which is explained in an enclosed publication. Yet, that enclosed publica-
tion refers the taxpayer back to the letter for information on how to request an ad-
ministrative appeal.
We simply do not believe that the combo letter format adequately advises the
taxpayer of his or her right to an administrative appeal. It is poor customer service,
leads to rework as audit reconsiderations and refund claims, and imposes an undue
burden on taxpayersall in the name of efficiency and minimizing resources.
In addition to the taxpayers right to be advised, clearly and specifically, about
his or her administrative appeal rights, we believe the taxpayer has the right to be
advised, clearly and specifically, about any proposed changes on his or her income
tax return. As you know, the IRS has the authority under section 6213 to sum-
marily assess mathematical and clerical errors that a taxpayer might make on his
or her return. These errors include errors in addition, switching the digits on a So-
cial Security number, or transcribing the wrong number from one form to another.
If the taxpayer does not agree with the IRS about the adjustment, then the taxpayer
must write the IRS within 60 days and ask it to abate the tax. If the taxpayer
misses the 60 days, the IRS begins collection, and the taxpayer must make a refund
claim. The taxpayer loses the ability to request an administrative appeal or the abil-
ity to go to the United States Tax Court, which is the only forum in which a tax-
payer can litigate a tax before it is assessed and becomes collectible.
When Congress expanded the summary assessment authority in 1976 to clerical
as well as math errors, it clearly directed the IRS to send taxpayers detailed,
itemized, line-by-line explanations of the math or clerical error, so that taxpayers
could timely respond with an appropriate abatement request. Yet math error notices
today do not set out the adjustments line-by-line, and a sample of Taxpayer Advo-
cate Service cases indicates that taxpayers do not know what is being adjusted and
cannot reach someone in the IRS to explain the adjustment to them, so they miss
their opportunity to request abatement.
Today, in the interests of efficiency and driven by concerns about EITC compli-
ance, Congress has expanded math error authority to include matching information
against external databases, despite Congresss original concern that the authority
should only be used where the error and inconsistency is apparent from the face
of the return. In most of these expanded provisions, the correct answer is quan-
titative and not based on facts and circumstances, and the external database is
highly reliable. However, in 2001, Congress expanded math error authority, effective
in 2004, to the use of the Federal Case Registry of Child Support Orders. I have
grave reservations about the currency and adequacy of the FCRs data, but these
concerns will be expressed in a report to be issued by the Treasury Department, in
consultation with my office. My point today is that this 2001 expansion applies
math error authority to a question that is inherently factualwhether a child lived
with a taxpayer for more than half the year. I do not believe this information can
accurately be determined from the face of the return, nor from any existing data-
base. It relies on the specific facts and circumstances of a taxpayers situation, it
is a qualitativenot quantitativeanalysis, and as such is not the proper subject
of a summary assessment, one that can result in the taxpayer losing the opportunity
to petition the Tax Court.
Thus it is our recommendation that Congress repeal the expansion of math error
authority it enacted in 2001 and impose certain requirements for any proposed ex-
pansion of math error authoritynamely, that it apply only in those situations
where inconsistencies can be determined from the face of the return, where items
or schedules are omitted from the return, and where numerical or quantitative
items are reported on the return and can be verified by a government entity that
issues or calculates those items. We believe this approach to summary math error
authority, coupled with clear and understandable explanations of math error adjust-
ments, recognizes the IRSs need to process information expeditiously without vio-
lating a taxpayers right to deficiency procedures in disputes of a factual nature.
36
In addition to math error authority, we have identified several key legislative rec-
ommendations in our report, including the tax treatment of attorney fees in non-
physical personal injury cases, which results in significantly different tax treatment
of Federal taxpayers depending on the underlying State law. We also propose a sys-
tem of registering, testing, and certifying Federal income tax return preparers who
are not already attorneys, CPAs, or enrolled agents. Our proposal is comprehensive
and, we believe, does not require the expenditure of significant resources once the
registration system is established.
We submit a proposal relating to the taxation of childrens incomealso known
as the kiddie tax. This proposal goes to tax simplification and the reduction of tax-
payer burden. As you know, if children under 14 have more than $1,500 in un-
earned income, their tax must be computed at the parents top marginal tax rate.
Further, the parent can elect to include the childs unearned income on his or her
return. Because these options lead to different tax results, a parent must calculate
three returns in order to determine what is the best tax outcome. This process must
be repeated for each additional child. Add to this the possibility of triggering a
childs alternative minimum tax liability, or the difficulty of obtaining tax informa-
tion from an estranged spouse, and you have a needlessly complex provision.
We propose that the calculation of tax on childrens income be severed from the
parents tax computation or tax rate. The concern that taxpayers might shift in-
come-producing assets to children and thereby take advantage of lower tax rates can
be addressed by establishing an appropriate tax rate on the childrens income. In
a related matter, we note that the dependents standard deduction is the only deduc-
tion that is not a set, flat amount. A dependents standard deduction can be any
number between $750 and the single standard deduction amount. In the interests
of simplification, we propose that Congress establish a set standard deduction for
dependents.
As another simplification measure, we have suggested that a husband and wife
who jointly own an unincorporated business and who file a joint Federal income tax
return be permitted to elect out of the partnership provisions of the Code and in-
stead file a joint sole proprietorship or farm schedule and report each spouses
share of self-employment income. Under todays law, a husband and wife jointly
owning and operating an unincorporated businesssay a dairy farm or small shop
or even pet-sitting businessesshould file a partnership return. In practice, most
couples merely report the business income as a sole proprietorship, with only one
member of the couple receiving credit for Social Security and Medicare purposes.
This can lead to disastrous consequences if the uncovered spouse becomes disabled
or dies. Because 97 percent of all sole proprietorship and farm schedules show in-
come below the Social Security wage cap and because we propose to make this pro-
vision elective in any event, no couple would experience a tax increase yet many
would clearly benefit from Social Security and Medicare eligibility. This proposal
clarifies and simplifies the status of husband and wife co-owned businesses and en-
sures appropriate Social Security and Medicare coverage for the working couple.
One of our proposals was actually enacted and later repealed, but we think it is
a good idea so we are proposing it again. Today, under section 3402(i)(1), taxpayers
can increase their withholding from paychecks by a specified amount. They cannot,
however, decrease their withholding by specified amounts. The only way to decrease
withholding is by claiming additional withholding allowances, which requires a com-
plex set of calculations on various schedules or worksheets. We propose that tax-
payers be able to decrease the amount of their withholding by discrete amounts, just
as they can increase their withholding. This approach reflects the way taxpayers ac-
tually think about their withholding and, in many instances, eliminates the burden
of having to fill out schedules and forms.
Our last proposal addresses the operation of the Office of the Taxpayer Advocate.
We are recommending six revisions to our authorizing statute, five of which I will
discuss today. Our proposal for amicus brief authority I will leave to another time.
All of these recommendations derive from the fundamental premise, reaffirmed in
1998, that the Office of the Taxpayer Advocate must be independent and yet func-
tion within the IRS. These recommendations attempt to strengthen that independ-
ence while preserving the Advocates internal placement. These proposals also at-
tempt to strengthen the Advocates ability to protect taxpayer rights.
We first propose that the National Taxpayer Advocate be authorized to appoint
a Counsel to the National Taxpayer Advocate, who shall report directly to the Advo-
cate and advise her on matters pertaining to taxpayer rights, tax administration,
and the Office of the Taxpayer Advocate. Currently, the Advocate receives advice
from a special counsel, who reports directly to the Chief Counsel of the IRS. Given
the unique role of the National Taxpayer Advocate to take a position that may be
different from the official position of the IRS, there are times when this reporting
37
structure creates a serious conflict of interest and limits the Advocates access to
legal advice. We believe it is important to maintain the Counsel to the Advocates
current ability to participate in the day-to-day development of guidance and regula-
tions. We also believe that it is important that the Taxpayer Advocate Service con-
tinue to receive its legal advice on substantive tax law matters in specific taxpayer
cases from the Office of Chief Counsel. Thus, this proposal provides the Office of
the Taxpayer Advocate with dedicated legal counsel on matters specifically related
to its statutory mission, namely taxpayer rights in the context of tax administration.
The other proposals flow from the recognition of our statutory mission. We pro-
pose that the Taxpayer Advocate Directive, currently delegated to the National Tax-
payer Advocate, be codified to ensure that it cannot be revoked. The Taxpayer Advo-
cate Directive grants the National Taxpayer Advocate the authority to direct the
IRS to act or not act with respect to any program or actionactual or proposed
that may create a significant hardship for a group of taxpayers or for all taxpayers.
We also propose that the definition of significant hardshipwhich grants taxpayers
access to the Taxpayer Advocate Servicebe expanded to explicitly include impair-
ment of taxpayer rights as a grounds for issuance of a Taxpayer Assistance Order
or a Taxpayer Advocate Directive.
Finally, we recommend that the provision relating to the discretion of the Local
Taxpayer Advocate to not disclose to the rest of the IRS any information obtained
from the taxpayer directly be amended to make clear that this discretion applies
notwithstanding any other provision of the Code. This discretion applies except in
clear instances of criminal acts or civil fraud. Our proposal clarifies the source of
authority for the approach we have adopted. We also recommend that the confiden-
tiality provisions of the Administrative Dispute Resolution Act with respect to com-
pelling a neutral to testify be incorporated into IRC section 7803(c)(4). These pro-
visions would require a judge to weigh whether the need for a Taxpayer Advocate
Service employees testimony outweighs the chilling effect such testimony might
have on future taxpayers seeking our assistance. We believe this neutral, third
party determination will provide some assurance to taxpayers that their conversa-
tions with the Taxpayer Advocate Service, absent some serious violation or need,
will not be disclosed to the IRS or even in open court, unless necessary to resolve
the taxpayers problem.
I would like to conclude by acknowledging again the support your Committee has
shown for the work of my office, and indeed the entire IRS. I know that the key
subjects of this years reporttaxpayer rights and making the tax system simpler
and more accessible so it is easier for taxpayers to complyare of special interest
to this Committee. I hope our report has been of some assistance to your oversight
duties. Thank you for this opportunity to come before you to discuss these important
matters.
f
Chairman HOUGHTON. [Presiding.] Absolutely. Thank you very

much. You have done a wonderful job. We are honored to have you
here. The fact that you have this job is really because of Mr.
Portman and the structural work which he had done. So, I am in-
debted to him as always.
Anyway, at the end you talked about the confidentiality issue. Do
you think that really is working, the ability to communicate to your
office by taxpayers?
Ms. OLSON. We have not yet fully implemented the confiden-
tiality provisions. We are beginning to, as our new database system
goes online, which enables us to keep information confidential from
the rest of the IRS. In talking to practitioners and taxpayers in
some of our focus groupswe went out to six different focus groups
during the last yearwe found that regardless of income level or
language facility, it mattered to taxpayers that they had someone
independent inside the IRS to speak to and that they could tell us
things. Most people think these things have to do with fraud or
something like that, but they mainly have to do with personal mat-
ters. Taxpayers could tell us things that related to their problems,
they could talk with us, and it wouldnt necessarily need to go to
38
the IRS. It was irrelevant in a way to the underlying tax law, but
they wanted to have an ear in the IRS that they could speak to.
So, I think that that provision is very important. Our employees
understand the importance of it.
We have tried to work with the IRS to convince them that we
will be implementing this and not using it as a way to hide impor-
tant information from the IRS, but rather to bring taxpayers into
compliance and have them feel comfortable coming to us on touchy
issues and coming into compliance with the Internal Revenue laws.
I think confidentiality is vital to that.
Chairman HOUGHTON. All right. Well, I am always in awe of
lawyers, but I wonder why you are adding a counsel to your staff
at this particular time.
Ms. OLSON. We have had several issues in which my office has
taken a different position from the direction in which the IRS has
chosen to go. As you know, I do have the ability through the an-
nual report to Congress and other means to take positions that are
different from the Commissioner. I cannot override the Commis-
sioners decision, but I can be on the record about my position. It
places the counsel that I currently havewho reports to Chief
Counsel, who advises the Commissioner and would advise the Com-
missioner on his positionin sort of an untenable conflict position.
I would like to have sound advice if I am going to take a position.
I dont want to be taking a position that is out of ignorance rather
than sound principle or law.
Chairman HOUGHTON. Right. Well, just one final question for
you, then I will ask Mr. Portman to question. Of all the rec-
ommendations you have made, what is the most important?
Ms. OLSON. Oh, dear. That is very difficult to answer because
they are all so different. In terms of taxpayer rights, I think the
math error authority recommendation is the most important. In
terms of tax simplification, I think it is actually a toss-up between
the childrens income proposal and the husband and wife co-owned
business proposal. I think both of them present simplification
issues. Probably the childrens income affects many more taxpayers
than the husband and wife proposal.
Chairman HOUGHTON. Okay. Well, thank you very much.
Mr. Portman.
Mr. PORTMAN. Thank you, Mr. Chairman. Although you are in-
accurate in saying that Ms. Olson got her job because of our work,
you probably made her mad at me by saying that, because she has
been in the middle of some very, very tough issues, but she has
done well, and she has managed to do what we had hoped would
happen in the legislation that went through this Subcommittee,
which is to have a truly independent Taxpayer Advocate and some-
one who could give us an unvarnished view on not just Tax Code
simplification, which you did well in your report last year, but also
on tax law administration, which you have focused on more this
year. That is extremely important to this Subcommittee and to our
Committee because it gives us the ability to legislate with better
information.
I want to focus on two things, if I could, quickly. One is the offer
in compromise issue. You said that is the number 2 issue for you.
There has been a lot of attention focused on that recently. I know
39
the oversight board met late January and discussed this issue at
some length, and some practitioner groups have raised concerns
with the offer program. On the other hand, I saw that Dale Hart
was recently quoted in the Wall Street Journal, who is the Deputy
Commissioner of the small business area and self-employed, saying
he thought the offer and compromise program had turned the cor-
ner.
So, I am hearing sort of different perspectives on it. We added
under the IRS Restructuring and Reform Act of 1998 (P.L. 105
206) another criteria. You could always do it if there is a question
about liability or collectability, and we added this relatively broadly
defined notion of effective tax administration. Has that created
some of the problems, and where do you think the offer and com-
promise program is at this point?
Ms. OLSON. Well, first let me address why we put it as number
2, because if you look at it in the context of all the business that
the IRS does, we only get 130,000 offers a year, and that is a pit-
tance in terms of all the other work that we do. We put it as num-
ber 2 because it has been around for so long. In fact, 1868 is the
first time it showed up in the U.S. Code, the authority for the rev-
enue officer to compromise tax debts. We have felt that at least
since 1992, the IRS hasnt gotten it right, so we thought maybe by
giving a lot of attention to it and going carefully through what we
thought were problems with the program, we could lay out some
of the adjustments that needed to be made.
Since we started, maybe since 2001, we have had an analyst
dedicated entirely to that program, and much to the Small Busi-
ness and Self Employed Divisions great credit, they have worked
closely with us, and I think it is a successful partnership.
I agree with Deputy Commissioner Hart that the program has
turned the corner. I think that I can live with centralization, but
there are things that we need to do to make the centralized sites
more responsive to taxpayers. It does take some adjustment, but if
we continue to work along some of the lines that we have identified
in the report, we will finally get there.
Now, effective tax administrationthere were three grounds
economic hardship, equity and public policy. I think the IRS has
understood economic hardship pretty well, but I think on the
grounds of equity and public policy, we have had some difficulty in
trying to decide what those words mean. What we came up with,
what Treasury announced through its recent regulation that was
issued this past summer was, on those two categories, equity and
public policy, we want taxpayers, if there is some reason other than
financial inability to pay, or you dont think you actually owe the
tax, to come in to us and tell us why it is that you should be cut
a break as opposed to all the other taxpayers in the world who pay
their taxes. What is so different about your facts and cir-
cumstances?
We would take a look at those factors, rather than giving a list
to which somebody could say, well, you are not on the list, so we
are not going to listen to you. We would see what came in. People
had to answer that first question, though: What is so special about
you? Can you look at your neighbor and say to them with a
straight face, I am going to get a break, but you have to pay?
40
Mr. PORTMAN. It almost becomes a fact and circumstances test,

which again, in the legislation, economic hardship is easier, it is
closer actually to doubt as to collectability, which is already in the
criteria. It is true that equity probably comes down to a facts and
circumstances, more subjective test. You are saying you have flexi-
bility to do that. You feel like you are turning the corner.
Just for those who are listening and might not understand what
we are talking about, this is when a taxpayer does not have to pay
the full amount, the full liability owed. The process of negotiating
with the IRS gives them an opportunity to settle for less than the
full amount, which is a very important way to clear the decks and
to help a lot of taxpayers who do have some specific circumstances
that make it difficult to pay.
I dont have another question, but I will say just briefly, Mr.
Chairman, we appreciate what you do for our taxpayers; also what
you do for us. Keep giving us those simplification ideas. Mr.
Houghton has a bill on simplification that is very important. I have
one, too. We take your ideas seriously, as you see in our legislation,
and this notion of how to tax children, which is a huge simplifica-
tion, is an example of what you need to keep giving us and working
with us. So, thank you for your work.
Ms. OLSON. Thank you very much.
Chairman HOUGHTON. Thanks very much.
Ms. Tubbs Jones.
Ms. TUBBS JONES. I want to pick this Committee. I could be
Chairman soon, right, if I just hang around. I will keep on moving
over here. I am okay. Thanks. Hi, Ms. Olson. How are you?
Ms. OLSON. I am fine, thank you.
Ms. TUBBS JONES. I am trying to get up on this. I dont serve
on this Subcommittee, but I am glad to be here. I was just looking
at some questions I was going to ask you, and I lost my place. If
you will just give me 1 second. Why dont you for one moment talk
about something, anything you would like to talk about no one has
asked you. Have you already been given that authority?
Ms. OLSON. Actually I thought one of the things I would like to
talk about is our first problem, which is navigating the IRS. I
wanted to tell a story. When the report came out, we issued a voice
message to all IRS employees and told them that they could look
at the report. I got back a lot of e-mails from IRS employees from
all over the United States, and one e-mail that I got back was from
a woman who said, I used to beI was a revenue agent in the ex-
amination division before the reorganization, and people could al-
ways find me because if they knew that they were being audited,
even if they didnt know my job title, they could look up exam in
the phone book and find me. Today I am called small business self-
employment technical analyst, branch 2, and how can someone find
me?
I read that e-mail, and I just sort of slapped my forehead; nam-
ing conventions. We have made it so difficult for people to commu-
nicate with us through all of this reorganization by just simply re-
moving common-sense names.
Ms. TUBBS JONES. What is your position with regard to the
Free File, if I may ask?
41
Ms. OLSON. I think that free filing is an important service. I

think that the products we have up there are excellent. I have ex-
pressed my concern during the development of the products and
the consortium negotiations about the additional products that
were present in the software. I do have a strong feeling that we
should not be making available those products through a govern-
ment Web site. I am concerned that the disclaimers are not ade-
quate, in fact, to warn taxpayers, particularly when you look at the
taxpayer population that is targeted for these products. If you look
at their financial literacy levels, their ability to understand con-
tracts, over and over and over again you see that these disclaimers
may not be understood.
Ms. TUBBS JONES. That is an area that I was working on be-
fore I came to this Committee. I was on Financial Services, and the
whole issue of predatory lending, and rent to own, and payday
loans and all of those opportunities where peopleyou get to the
people who are most vulnerable. I am not saying that there should
not be the opportunity, I understand that subprime lending pro-
vides opportunities for those who may not be able to go in the
prime market, but clearly I think there has to be some way that
we can do a few more disclaimers or better notice in the area.
Let me see what else I would like to ask you. Talk to me for a
moment if you have not already about the taxation of attorney fee
awards, if you would.
Ms. OLSON. Well, what we discovered in looking at the case law,
and this came up through our most litigated issues section, we
found that there was a split in the circuits about the taxation of
attorneys fees in what is called nonphysical personal injury suits:
race discrimination, sex discrimination, sexual harassment, age
discrimination; and that in some circuits, depending on the under-
lying State law, the fees may be deductible above the line or below
line. They trigger radically different tax results, including the trig-
gering of the alternative minimum tax. In our report, we gave an
example of a woman who ended up being a successful plaintiff and
paying more in taxes and attorneys fees than she won in the
award. So, she came out in a negative amount. She would have
been better off not prevailing.
So, we proposed several alternatives. The one that we liked was
putting everything what we call above the line so that you dont
trigger alternative minimum tax, basically netting out the attor-
neys fees and making that uniform across the Nation and not de-
pendent on underlying State law.
Ms. TUBBS JONES. Ms. Olson, I just ran out of time. I am look-
ing forward to have the opportunity to get to know you better and
working with you, and hopefully providing some additional infor-
mation to the constituents, my constituents in the 11th Congres-
sional District of Ohio. I thank you very much for your testimony,
though I missed some of it.
Chairman HOUGHTON. Thanks, Ms. Tubbs Jones.
Mr. Pomeroy.t
Ms. Olson, I suppose right up next to the Commissioner we put
the Taxpayer Advocate as one of the most important if not the
most important position in the IRS. It was established with bipar-
42
tisan support. We commend you for your efforts on behalf of tax-

payers. This service is their service, and we want to make certain
that it is fair and equitable in its delivery of services to the Amer-
ican public.
Several things I want to talk to you about, but time is short. Let
me begin by products. It would seem to me as though there is a
substantial contribution by the private partners in this private-
public partnership delivering free e-filing. Obviously they are inter-
ested in participating with the hope of some business opportunity.
Does that right off the bat strike you as inappropriate or so far so
good depending on what they are selling?
Ms. OLSON. Right. I think that is an appropriate arrangement,
I do.
Mr. POMEROY. So, you think there needs to be within the serv-
ice some due diligence as to appropriateness of services rendered?
Ms. OLSON. I would like us to develop standards and really ad-
dress this issue, yes, I would.
Mr. POMEROY. It seems to me incongruous and unacceptable to
have a very thorough due diligence in terms of whether they have
got the security in place, whether they have the technical com-
petence to get it all figured rightundoubtedly give each of the
partners a very thorough review relative to the technical compo-
nents of their ability to deliver e-filing. Then to let them offer ca-
veat emptor whatever they may hope to try to sell, that just doesnt
cut it.
We ought to be able to find some happy medium in terms of ap-
propriate review, again not making the service a regulator as well
as a tax collector, but making sure that those things sold by its pri-
vate sector partners pass the smell test to market suitability. Is
that how you would see it?
Ms. OLSON. I would agree with that, and I would also say that
there needs to be appropriate disclaimers directed to the reading
level and the literacy level of the target audience. We have tar-
geted the Free File to low-income taxpayers.
Mr. POMEROY. Does the Advisory Committee look at this sort
of thing?
Ms. OLSON. The ETAAC?
Mr. POMEROY. Yeah.
Ms. OLSON. I know that they have considered this issue. That
would be an appropriate place, I would think, to start to develop
some recommendations.
Mr. POMEROY. I will direct that inquiry to them. Thank you for
that.
We received from your counterpart in Fargo, North Dakota, a
really fabulous idea that we want to advance, and that is relative
to filing a husband/wife return on a farm, presently, as I under-
stand it, it has to be either in partnership, which involves some
taxpayer complexity, or basically between the two of them they
have to allocate all of the income to one, usually, of course, the
male.
Ms. OLSON. Legally they are supposed to file a partnership re-
turn.
Mr. POMEROY. Within this partnership return is the revenue
attributed to one spouse or the other, or how does that work?
43
Ms. OLSON. In a partnership return they can attribute it to the

extent that they agree. It is completely open. What we find in prac-
tice is that most husband and wife co-owned businesses that arent
incorporated tend to put all the income in one persons name and
report it on a sole proprietorship schedule or in the farming busi-
ness, on a Schedule F. So, what ends up happening is that the
other spouse doesnt have any income reported to them, and the
consequence of that is the spouse doesnt get any Social Security
or Medicare credits.
Mr. POMEROY. Precisely. So, what appears to be, while the easy
route in terms of filing the tax return in a given year, becomes a
pattern, and the income is attributed just to one spouse.
Ms. OLSON. Correct.
Mr. POMEROY. Down the road that might mean the other
spouse, should this marriage end by divorce or death, does not have
the 10 quarters required for purposes of qualifying for Social Secu-
rity; is that right?
Ms. OLSON. That is correct.
Mr. POMEROY. The recommendation from the Fargo Taxpayer
Advocate is that this needs to be attended to in ways that family
farmers can avail themselves of simpler tax filings, but still allo-
cate the income; is that correct?
Ms. OLSON. Right. We recommended that you could use a
Schedule C, for sole proprietorships, or the Schedule F, for farms
and report all the income on one form, but just add two lines to
the form where you could allocate between the husband and wife
at the very bottom of the form what percentage of the net profit
or loss is each persons.
Mr. POMEROY. The Chairman and I each represent farm fami-
lies, and this is an idea we think is very interesting. We will be
looking to see whether or not we want to advance a joint bipartisan
legislative proposal directly as a result of your Fargo, North Da-
kota, Taxpayer Advocate. I am very proud of the job
Ms. OLSON. I am very proud of that person, too.
Mr. POMEROY. Thank you very much.
Chairman HOUGHTON. Thank you. Well, I just have one other
question. You obviously have got a very important job now between
Mr. Rossotti going in andgoing out and Mr. Everson coming in
and Mr. Wenzel leaving, lots on your shoulders.
Let me ask you a question. How many people read your report?
Ms. OLSON. Well, I know
Chairman HOUGHTON. Or even open it?
Ms. OLSON. Well, let me just say that I know that Commis-
sioner-designate Everson has read it; not all of it, but I know that
he has read parts of it. It is surprising how many people read it
if you judge by my e-mail and my voice messages and my mail. We
would like more people to read it because we believe that particu-
larly this year we have shown a spotlight on the way that the IRS
works, and it should actually make taxpayers feel very good as
they read through the top 20 problemsand they see how we iden-
tify a problem and the IRS respondshow much the IRS really is
doing about the problems that it faces.
So, much of what is troubling to the IRS is just a result of the
complexity of the tax system both in terms of the law and the proc-
44
essing, the Administration, and they are doing an enormous

amount. The report really shows that, and citizens should feel good
about it.
Chairman HOUGHTON. One of my hot buttons has always been
the issue of complexity of the Code, and we sit here and we pass
legislation, we think it is for the good of the country, and yet it hor-
ribly complicates the Code. So, I think it might be helpful in fur-
ther meetings that we have that you can sort of keep us up to date
with a scorecard on what we have done, because it is a two-way
street here.
I have one final question. You have this fine report, and there
is a conclusion, section 1 of page 4. What would you like the conclu-
sion to say next year?
Ms. OLSON. I will have to look at what the conclusion says this
year.
I think I would like to see the IRS having made substantial
progress in the five areas that I outlined in the preface underlying
taxpayer rights; the concept of access to information, to the IRS, to
the Taxpayer Advocate Service, to representation from low-income
taxpayer clinic programs, which just came under my jurisdiction,
and free tax preparation. We are along the way. I really want to
see some progress that we can report on, and particularly on that
number 1 issue, navigating the IRS. It is in the social contract be-
tween the IRS, the tax administration system, and its taxpayers.
We have to become accessible to them, or else why should they ever
pay their taxes if they cant reach us to talk about their problems?
I want more progress on that. That is really why we made it num-
ber 1.
I would like to conclude that we had made progress. There are
steps to go, but we have made progress.
Chairman HOUGHTON. All right. Well, thank you. You are a
credit to all of us, and thanks so much for your testimony. Good
luck to you.
Ms. OLSON. Thank you, sir.
[Whereupon, at 4:50 p.m., the hearing was adjourned.]
[Submission for the record follows:]
Statement of Grover Norquist, President, Americans for Tax Reform
On July 31, 2002, the Bush Administration announced a Public-Private Partner-
ship with the high technology industry to increase the availability of free online tax
preparation and e-filing services to American taxpayers. On October 31, 2002, then-
Commissioner of Internal Revenue, Charles Rossotti, signed this historic agreement
in Washington. This innovative initiative is a constructive and thoughtful resolution
of a long-standing public policy problem.
But its only the first step. What happened in Washington needs to be replicated
in every State capital in the union. Heres why.
On multiple occasions over the past five years the Internal Revenue Service has
proposed that it should provide electronic tax preparation and filing services to tax-
payers. One year ago, the Office of Management and Budget revived the idea and
pressed to move ahead. Fortunately, Congress has repeatedly objected to these at-
tempts to have the Nations tax collector take on the additional role of also acting
as citizens tax preparer.
While such an obvious conflict of interest has at times been advanced by some
as representing a new service to the citizen, it would in reality have been a signifi-
cant and intrusive expansion of the role of government, and a major setback for the
American principle of voluntary compliance in our tax system.
Worst of all, it would have served as a disguised revenue enhancement strategy
bracket creep through mission creep.
45
But while Congress rebuffed these attempts to expand the role of government at
the Federal level, there were no similar checks and balances at the State level, and
as a result over the last several years some 26 State revenue collection agencies in-
stituted the very programs the Federal Government has so wisely shunned, and in
the process the States collectively expended literally billions of taxpayer dollars to
pay for the design, development and operation of these government-run online tax
preparation systems.
Their national tax collectors union, the Federation of Tax Administrators (FTA),
reported last year that all of these State online tax systems combined generated
800,000 tax returns in the last tax season. Thats just 1% of State income tax re-
turns, all at a staggering administrative cost. (With this kind of waste, its little
wonder that our State governments are now going broke.) So why do they press
ahead with this effort? Indeed, why did they try in the first place?
We know that at least some State revenue agencies designed their online tax
preparation systems with the intent of using them to increase revenue receipts from
taxpayers, and actually financed the substantial cost of the systems from those pro-
jected new revenues. The Virginia Department of Revenue, for example, has boasted
of their plans, in reports addressed to their Governor, bragging that their new
$125M iFile online tax preparation system would be financed from increased tax
revenues attributed to the successful implementation, and that the system would
assist the tax agency in selecting audits and . . . performing focused, effective, and
timely account collections.
Just last week, the New Jersey Star-Ledger, The Los Angeles Times and other
newspapers across the Nation reported that State tax agencies across the Nation
are using the modern tools of electronic data retrieval and examination to do exactly
what the Virginia Department of Revenue described. The Executive Director of the
national Federation of Tax Administrators (FTA), Harley Duncan, is quoted pro-
moting the value of using data mining to deeply penetrate electronic taxpayer
records, and how State revenue agencies are now using their modern computerized
tools to dig through citizen data files of personal financial information.
It amounts to combing through files that can tell you something about tax-
payers, the FTAs Duncan explained. He went on to justify these new practices by
his members in State tax agencies across the Nation, saying that data mining isnt
enough, in and of itself, to bring States through this particular (budget) crisis, but
if youre . . . looking for $25 million to augment a program, and you can pick it up
by better mining your tax base, thats significant.
This kind of intrusive surveillance, and surreptitious investigation of taxpayer
records and personal financial information, is deeply disturbing, and is but the lat-
est in the long, sorry history of abuses of taxpayers by government revenue collec-
tion agencies. However, this is not unexpected; indeed, it is just one of the dangers
that has long been predicted from the conflict of interest created when tax collectors
are put into the role of tax preparers.
The reality is that when a citizen prepares their taxes online in a State revenue
agency computer system, every keystroke, correction, change and draft created in
the course of preparing that tax return is automatically recorded and stored in the
tax agencys data files. That is the basic nature of server-based online transactional
technology. And when government unwisely decides to provide personal financial
services to citizens, such as tax preparation, the dangers of this technology are sud-
denly very real.
In defending its desire to build these systems and begin preparing citizens tax
returns for them online, the State of California revenue bureaucrats actually had
the temerity to tell the public that (We) will always be beholden to the taxpayers
and have the taxpayers best interest at heart.
That is not reassuring, nor is it credible.
Back in a more sensible past, government tax agencies only received a citizens
final, completed return. And tax agencies only lawfully got their hands on a citizens
preliminary tax information and other personal financial data through official inves-
tigations, and by court order in civil and criminal proceedings. But not anymore.
If a citizen is foolish enough to prepare their tax return on a State revenue agen-
cys online system, they are playing with fire, and, unwittingly, with potential self-
incrimination. If our citizens use the online tax preparation systems provided and
operated by State revenue agencies, they are effectively serving themselves up to
be flagged for examination, investigation and audits.
The high risk of this threat to our citizenry is a prime example of why the Bush
Administration well deserves the bipartisan support it has received for instituting
its Public-Private Partnership solution, where those in need can get free online tax
services, but from the private sector, instead of the government. Under this national
solution, the IRS will still only receive a citizens final, completed tax return. And
46
thats the way it should be in the voluntary compliance system we have in the
United States.
It has been our consistent view at Americans for Tax Reform that changes in tax
policy should be dealt with openly and with full public disclosure and debate. Bu-
reaucratic ambitions for stealth tax increasesenabling government to grow and ex-
pand its mission without oversight or checks and balancesshould never be per-
mitted by policymakers under any circumstances. It is, in reality, a betrayal of the
public trust.
Notwithstanding the vociferous advocacy of these programs by the Federation of
Tax Administrators, as the preferred electronic weapon of choice for its nationwide
membership of professional tax collectors, the fact is that the per-return cost of
these government systems is astronomical, and, in the end, is serving only to pro-
vide employment security for tax bureaucrats. These initiatives are not electronic
government or citizen service; they are electronic fraud and amount to nothing
more than citizen deception.
It is little wonder, then, that this same national tax collectors union has tried
mightily to protect its vested self-interests by going around to newspapers all over
the United States attacking the Federal Free File Alliance initiative. However, the
Bush Administration solution is so cost-effective and even-handed that it puts the
lie to any justification for governments wasting public funds on creating their own
online tax systems.
Some States know better than to pay heed to their tax bureaucrats self-interested
ambitions, and are instead looking for better answers that maintain the integrity
of their relationship with their citizens. After the Federal Free File Alliance Agree-
ment was signed on October 31 last year, the States of New York, Massachusetts
and Michigan had already replicated the Federal initiative and launched their own
Free File Alliances by the following January.
But those States that do not choose this sensible approach are headed down a
road to nowhere. This same folly of building government online tax systems has
been attempted elsewhere, and with results similar to those weve seen in the
U.S.taxpayers shun them.
For example, in the United Kingdom, hundreds of millions of pounds have been
incinerated on these same government online tax systems, but which collected only
75,000 tax returns last tax year (less than 1% of total returns, with much of the
online filing done by panicked procrastinators) in a service that was riddled with
errors, breakdowns and breaches of privacy and security. Polls released just this
week in the United Kingdom have shown that 93% of Britons say they refuse to
even consider using the government online tax system, citing risks relating to secu-
rity, reliability and accuracy among other concerns. A similar system deployed by
the Australian government has been used by only 3% of the taxpayers there.
The decision by the Bush Administration to ultimately reject this path is not only
enlightened, but, most importantly, puts the best interest of the citizen ahead of
that of the bureaucrat. The American taxpayer simply cannot afford the public
waste of government investing hundreds of millions of dollars for bureaucratic feath-
erbedding, duplicating the electronic tax systems already invented, developed and
deployed by the private sector e-commerce industry, with services already available
at low-cost and no-cost to taxpayers today. Whether tax bureaucrats would build or
buy such systems and services is irrelevant. Either way, it would waste precious tax
dollars on expansion of government into a mission that is a gross conflict of interest,
and the taxpayer would end up paying the freight, coming and going.
The new Public-Private Partnership announced by the Administration is a prece-
dent-setting innovation that chooses the consumer benefits of market competition
instead of anti-competitive government expansion, and ensures protection of tax-
payer privacy and taxpayer rights over the threat of government intrusion and con-
flict of interest.
The Administrations voluntary agreement with industry costs the public treasury
virtually nothing, and encourages continued private sector investment, competition
and innovation, while encouraging the private sector to provide free services to
those who truly need them. Congress has already legislatively endorsed the Admin-
istrations policy direction. Now the national solution to this issue should be emu-
lated by all of the Nations governors and State legislatures.
Asking taxpayers to trust the tax collector is ludicrous. Making them pay for such
folly is unacceptable.

House Hearing, 108TH Congress - Free Electronic Filing and National Taxpayer Advocate Annual Report

Uploaded by

Copyright:

Available Formats

House Hearing, 108TH Congress - Free Electronic Filing and National Taxpayer Advocate Annual Report

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

House Hearing, 108TH Congress - Free Electronic Filing and National Taxpayer Advocate Annual Report

Uploaded by

Copyright:

Available Formats

FREE ELECTRONIC FILING AND NATIONAL

TAXPAYER ADVOCATE ANNUAL REPORT

COMMITTEE ON WAYS AND MEANS

FEBRUARY 13, 2003

Serial No. 1085

Printed for the use of the Committee on Ways and Means

U.S. GOVERNMENT PRINTING OFFICE

For sale by the Superintendent of Documents, U.S. Government Printing Office

Electronic Tax Administration Advisory Committee, Kevin Belden ................... 19

SUBMISSION FOR THE RECORD

THURSDAY, FEBRUARY 13, 2003

U.S. HOUSE OF REPRESENTATIVES,

FOR IMMEDIATE RELEASE CONTACT: (202) 2251721

Houghton Announces Hearing on

The Subcommittee will hold a hearing to evaluate the legislative recommenda-

FOCUS OF THE HEARING:

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

Chairman HOUGHTON. The hearing will come to order. Good

Mr. POMEROY. Mr. Chairman, I am overcome by an introduc-

Chairman HOUGHTON. Thank you very much. Would you like

Chairman HOUGHTON. Thank you very much, Mr. Commis-

makes it clear to the taxpayer that you are no longer going to be

look at when those returns are filed, of significance is that a very

Mr. WENZEL. Congressman, the refund anticipation loan has

Chairman HOUGHTON. Okay. Thank you very much, Mr. Pom-

Mr. WENZEL. The error rate on the paper returns continues to

be some demand until we are able to deliver our modernization so

of my colleagues have asked enough questions. I guess what I

ministration Advisory Committee. Other panelists are presenting

offering free combined filing of Federal and State returns in those

customer, the taxpayer. In this vision taxpayers would have mul-

Chairman HOUGHTON. Thank you very much, Mr. Belden. Now

Chairman HOUGHTON. Thank you very much. I am just going

As I understand it, there are not particular standards relative to

Chairman HOUGHTON. Okay. Well, thank you very much. I am

Code and instead file a joint sole proprietorship or farm schedule

Chairman HOUGHTON. [Presiding.] Absolutely. Thank you very

Mr. PORTMAN. It almost becomes a fact and circumstances test,

Ms. OLSON. I think that free filing is an important service. I

tisan support. We commend you for your efforts on behalf of tax-

Ms. OLSON. In a partnership return they can attribute it to the

essing, the Administration, and they are doing an enormous

You might also like