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Hearing of the House Small Business Committee - IRS Oversight: Are Tax Compliance Costs Slowing the Economic Recovery?

HEARING OF THE HOUSE SMALL BUSINESS COMMITTEE
SUBJECT: IRS OVERSIGHT: ARE TAX COMPLIANCE COSTS SLOWING THE ECONOMIC RECOVERY?
CHAIRED BY: REP. NYDIA M. VELAZQUEZ (D-NY)
WITNESSES: DOUGLAS SHULMAN, COMMISSIONER, INTERNAL REVENUE SERVICE; CHRISTOPHER SMITH, S.T.O.P., NORTHLAND LLC.

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REP. VELAZQUEZ: I call this hearing of the House Small Business Committee to order. Every American circles April 15th on their calendar. But outside of a few over-eager CPA's, most people do not look forward to tax day. While this time of year brings an annual headache for us all, it is especially daunting for our nation's entrepreneurs.

Historically, tax code complexity has been the greatest source of frustration for small businesses. No surprise there, the tax code contains over 200 small business provisions. Simplification is key, and this committee has held hearings on this issue. But today, in light of historic economic challenges, that matter has taken a backseat to more immediate concerns.

This afternoon, we will explore ways in which the IRS can help entrepreneurs meet tax obligations during a recession. We will also discuss the role of the agency in handling incentives within the stimulus.

In February, small businesses finally got their stimulus. Within that bill were critical tax incentives, from Bonus Depreciation to Net Operating Loss extension. This is the kind of relief entrepreneurs need. But, like most tax policies, these initiatives are complex. The IRS needs to ensure their meanings are clear. Before small firms can take advantage of incentives, they need to understand how they work. Otherwise, the benefits of this provision, and of the stimulus overall, may be diminished.

Unfortunately, clarification has never been an IRS strong point. After all, we are talking about the agency that handles the 54,000- page tax code. But with new stimulus policies on the books, the IRS will have to improve communications. Part of that improvement process should include increased outreach, and enhanced client services. Entrepreneurs need to know they can count on the IRS to answer their tax questions quickly and accurately. In an era of growing uncertainty, those kind of resources are critical, especially considering recent increases in small businesses' audit.

Unlike big businesses, small firms do not have an army of tax attorneys and accountants. As a result, they are largely defenseless against the IRS, making them easy targets. In the two years between 2005 and 2007, small business audits shot up 41 percent. Meanwhile, investigation of the biggest companies plummeted 40 percent.

It doesn't matter who you are or how big your businesses is, no one has the right to skirt their taxes. But at a time when small business audits are up, and big business audits are down, you have to wonder where are the priorities? Small firms have been battered enough by the recession. The last thing they need is the added nightmare of an IRS investigation. In the face of deepening recession, tax policies should be a means for small business growth, and not the straw that breaks the camels back.

I would like to thank today's witnesses, and especially the commissioner of the IRS. And in advance for the testimony, I know this is on a special busy time of the year, and I am pleased that they both can join us. With that, I would like to yield to Ranking Member Graves for his opening statement.

REP. GRAVES: Thank you, Madame Chairwoman, and thank you for calling this hearing on tax compliance costs for small businesses. I also want to extend my special thanks to our witnesses, Commissioner Shulman, and the witness on the second panel, which is Kit Smith, a constituent from Missouri, who I'm going to introduce later.

And every day it seems that we hear more bad news for entrepreneurs; the faltering economy, federal bailouts of big companies that owe back taxes, studies showing that small companies are increasingly targeted for audits. Our nation's small company owners are in the trenches, day in, day out, working hard during a recession to keep their businesses afloat, contribute to the economy, purchase equipment, and create the majority of new jobs and, of course, pay their taxes. According to the Internal Revenue Service's National Taxpayer Advocate, tax issues present the single most significant set of regulatory burdens for small firms. The Small Business Administration's Office of Advocacy reports that firms with less than 20 employees spend more than $1,200.00 per employee to comply with tax paperwork, recordkeeping and reporting requirements to go along with it. This is twice the cost of compliance for larger firms. And surveys by the National Federation of Independent Business consistently rank federal taxes among the top five issues of greatest concern to entrepreneurs.

Small businesses have good reason to be concerned. Most of them pay their taxes and on time, and they want others to do so, as well. We have heard about the tax gap or the difference between what is legally owed, and what is actually paid voluntarily and on time. One prong of the IRS' strategy is to reduce the tax gap -- to reduce the tax gap is to increase enforcement.

As it appears the IRS has small businesses in its crosshairs. A 2008 Syracuse University study revealed that small businesses were 41 percent more likely to be investigated than large firms, while the audit rate for the nation's largest corporations fell to the lowest level in 20 years. One can only surmise that this is because small firms are less able to hire high-priced attorneys and accountants to fight back.

Today we will hear from one of my constituents, Mr. Smith, who is going to describe the horrific IRS audit of his small business.

If small firms didn't have enough stress trying to run a small company in a recession, we burden them with countless laws, regulations, reporting requirements, and we continue to do so every year. We must simplify our tax code and require the IRS to do a better job of helping small businesses comply. Small businesses deserve better.

Madame Chairwoman, again, I appreciate your work on this and the hearing you're having today.

REP. VELAZQUEZ: Thank you.

And now I welcome the Honorable Douglas Shulman, IRS Commissioner. Mr. Shulman is Commissioner of the Internal Revenue Service. He is the 47th Commissioner, and begun his five-year term on March 24th, 2008. Prior to joining the IRS, he worked for the Financial Industry Regulatory Authority, the private-sector regulator of all securities firms doing business in the United States.

The IRS collects approximately $2.4 trillion in annual tax revenue that funds most government operations and public services. Welcome.

MR. SHULMAN: Thank you, Chairwoman Velazquez. I very much appreciate being at this hearing. Ranking Member Graves, other members of the Committee. I'm happy to have an opportunity today to testify about the Internal Revenue Service's efforts to assist America's small businesses, particularly during the current economic downturn.

As President Obama recently observed, "Our recovery in the present and our prosperity in the future depend upon the success of America's small businesses and entrepreneurs."

I believe, and I've been very public in this belief, that the IRS has two equally important parts of its mission, service and enforcement. We need to provide world class service to the small businesses, the individuals who are out there trying to wrestle with incredibly complex tax code. And we have to have enforcement programs for those who aren't paying their taxes across the spectrum.

I've started two small businesses personally in my career. And therefore I'm acutely aware of the many problems confronting a small business, from struggling with the economic environment to securing a loan, to hiring employees to getting sales to the obligation to pay their taxes.

I've included information in my written testimony about a number of issues. Let me highlight a couple of things we're doing now to try to help small businesses during this recession.

It's inevitable during these kinds of times that taxpayers may fall behind in their taxes. As the IRS Commissioner, I'm very committed to striking the right balance between collecting the revenues needed to fund the government, and using all the tools that we have available to work with small businesses who find themselves unable to pay.

I've told our people from the most senior to the people working on the frontlines that we need to be flexible, principled, and that we need to empower all of our people to use their judgment when they're working with taxpayers.

As the economy got worse last summer, I sat down with our senior team and said, "What can we do for taxpayers, and where are we going to find stress in our system between us and taxpayers." And we did a number of things that benefit small businesses. Let me take you through a few.

First, our employees were reminded of their ability to offer installment agreements at the end of an audit where taxpayers are having difficulty satisfying their obligations to pay immediately. Second, I gave IRS employees more flexibility to suspend collection actions in certain hardship cases. Third, we gave employees more flexibility to work with previously compliant taxpayers and in existing Installment Agreements, who can't pay because of an economic hardship.

Fourth, taxpayers unable to meet the payment terms of an accepted offer in compromise are now being informed of the options available to them to help them avoid a default. And fifth, we're speeding up levy releases by easing requirements on taxpayers who request expedited levy release.

Turning to the American Recovery and Reinvestment Act that you mentioned, Madame Chairwoman, the IRS announced last month that small businesses with deductions exceeding their income in 2008 can use a new net operating loss tax provision to get a refund of the taxes paid in prior years.

This new provision enables small businesses with a net operating loss in 2008 to offset losses against income earned and allows a carryback of up to five years instead of the normal two years.

This could throw a lifeline to struggling businesses with an infusion of cash. I've made sure that we have the resources to move quickly to get cash into the hands of small businesses when they apply for such a refund. We're going to be monitoring this on a daily basis. And if we find a backlog or any clogging in the system, I'm going to apply more resources so that we can implement this smoothlessly and seamlessly.

Madame Chairwoman, the IRS is always looking for ways to better serve taxpayers throughout Outreach and education. As you said, a lot of small businesses don't have all the high-priced lawyers and accountants and other sort of service providers. And so we're acutely aware that we need to be directly helping small businesses.

Last year we participated in over 26,000 meetings with small businesses, reaching directly 142,000 small businesses through Outreach efforts. We hold national and local small business forums to have an avenue of communication with the IRS. At the local level, we have a special business unit that work with the Chambers of Commerce, small business development centers, Better Business Bureaus, and other groups of these small business owners.

We also work with the Small Business Administration to get the word out to taxpayers. We're also very focused, that we're never going to be able to get to all the taxpayers ourselves. And so we try to work with associations to reach taxpayers.

Finally, we recognize that we're not going to be able to reach everybody through direct contact. We have phone-in forums. People can call our 1-800 number if they have questions or concerns. We also have an E newsletter for small businesses with 140,000 small businesses subscribing.

Let me just say that, again, I want to thank you for the opportunity to testify about what we're doing to help small businesses as we're all trying to be on this road to recovery. We've made some progress, but I'm a believer that institutions can always get better. And you have my assurance I'm going to push the institution to work with small businesses. I look forward to working with you, other members of the Committee, and the staff to make sure that this great engine of economic growth and prosperity of the country continues to operate at its full potential.

REP. VELAZQUEZ: Thank you. I recognize Mr. Schrader.

REP. SCHRADER: Thank you, Madame Chair, I appreciate that.

Commissioner Shulman, I won't blame the IRS for all the rules and regulations you have to deal with because obviously they came from somewhere, and often times that's this great, august body as we try and help people. But recognize fully that things are very complex. And (there's ?) been a lot of interest in simplifying the tax code. And as a Chairman of the Subcommittee on Tax and Finance, I'm interested in your thoughts on, for particularly small businesses let's say under that $15 million gross threshold, are there certain ways one could really simplify their filing of taxes, and make it very, very simple?

MR. SHULMAN: Let me say a couple of things about it. One is I couldn't agree with you more. The tax codes, incredibly complex, and we certainly can do better in administering it, but a lot of the complexity is in the law, not in the administration of it. And so I appreciate the observation.

As you know the president has appointed a working group to look at a variety of tax issues, and certainly simplification is one of the things on the agenda. We're going to keep trying to do everything we can to simplify our forum to things like -- for very small businesses, we recently said that you don't need to file quarterly employment taxes. You only have to file annual. We can do things like that.

I don't have, you know, big, broad policies to announce around simplification. Clearly the administration is going to be working with Congress on those kinds of things.

REP. SCHRADER: There's been interest in -- and it's being articulated by different small business groups and members of this Committee with regard to some sort of flat tax for very small businesses. What are your comments on that?

MR. SHULMAN: You know, I'll --

REP. SCHRADER: -- simplification.

MR. SHULMAN: I will reserve judgment on it. I recognize there has been a lot of debate about all the taxes, including the flat tax, and I won't make any comments on it. (Laughter.

)

REP. SCHRADER: I guess I'll defer my questions then at this point. Thank you, Madame Chair.

REP. VELAZQUEZ: Mr. Bright.

MR. Luetkemeyer.

REP. LUETKEMEYER: Thank you, Madame Chair and Ranking Member Graves.

Just kind of quickly, thank you for your service. I know you have a difficult task, and sometimes I'm sure it's not -- it's maligned in many instances. But we're just going to ask you to continue to do the good job you're doing. And obviously most taxpayers are most concerned with fairness. I think that's the issues that most are most concerned with, from the standpoint that while they don't like to pay taxes, they're more than willing to do so as long as they believe that their neighbor and everybody else that they are acquainted with pays their fair share, as well.

And I think it's incumbent on us as legislators to make sure we pass laws that don't impact things in an unfair way. And hopefully you'll enforce those laws in a fair manner, as well. Along that line, I've got an email here if you'll bear with me just a moment. One of my constituents emailed me this, and we're talking about incidents where we have concerns with impacts on small business. And here's a stockbroker. He's with Morgan Stanley. And his CPA files his tax return the 24th of March, and electronically. And he didn't get his refund back in a timely fashion. And tried to check with the IRS office, and the only explanation was that because he had a Morgan Stanley tax ID, it must have been flagged because of the TARP funds.

Are we flagging certain businesses for oversight for further audits? Is this -- I mean, is this by sort of an incidence somebody just shot on the -- you know, off the top of their head or is that kind of stuff going on?

MR. SHULMAN: Oh, I don't think anyone would have said that, so I'm happy to look into that and I encourage you to send it to my office. But individual's file, we're not targeting any individuals because of any broad government programs, so that's a surprise to me.

REP. LUETKEMEYER: Okay. Well, I was just curious, because obviously being that that the Morgan Stanley folks do have some TARP funds, and I'm just wondering if that's your broad category that you were, as well, looking at a little bit differently.

MR. SHULMAN: We certainly are not looking at any individuals. Certainly, there's a lot of new moving pieces that are happening as the federal government is getting involved in trying to shore up financial institution and lots of pieces of the economy.

We're quite aware that when people are -- or when institutions are given support by the federal government, they've got an obligation to pay their taxes. But we're not doing anything to target any individuals of institutions with any sort of other piece. And so if they filed on March 24th. If you file electronically and get a direct deposit, you usually get a refund within about 10 days. If you file using paper and you get a check, it can be up to six weeks.

And so I'm assuming this person, if they filed electronically, is trying to use direct deposit. I encourage them to call our 800 number, and find out where they are in the process. They can let them know.

REP. LUETKEMEYER: All right. Thank you.

To follow up further, I noticed -- one of the things I think is important -- we're talking about small businesses today, and many of them own partnerships, S-Corps, who often times run those dollars through their personal income taxes. And I'm just kind of curious if you have some thoughts or some -- I know that the administration is -- the tax policy in the new budget is indicating they're going to try and tax those individuals over $250,000, which would put a lot of these partnerships and S-Corp folks directly into the category of being taxed.

Do you have an idea of how many businesses that would be or how many individuals file partnerships and S-Corps as a percentage of the small businesses in this country?

MR. SHULMAN: You know, small businesses has come in a number of forms. And that's why sometimes when you look at our statistics, it's hard to get a grasp on small businesses. The vast majority actually come in 1040 Schedule C, so proprietors and others. Then there's a number of C-Corps, which are the small corporations, which is a -- if you look at our statistics there. And then there's lots of people who have flow-throughs, S-Corps, partnerships, LLC.

I don't have the exact number on me now. I can get back to you. What I will tell you, though, is since 2000, the number of flow- through entities, filing returns for those entities, so S-Corps, LLCs, partnerships, has increased about 50 percent, while the number of C- Corporations has been relatively flat.

And for us that's an interesting phenomenon. Because if you think about us doing our job, my belief is anytime you run into a regulatory-type agency or government agency, there's all sorts of incorporations that make a difference, but what really matters is the economics that you're looking at. And so it makes our job much harder, I will tell you. Because it's much more complex to look at a partnership where it's really a network of lots of other activities happening that -- following through that partnership, than it is a C- Corporation where the taxes and the entity all stops right there.

REP. LUETKEMEYER: I see my time is up. Thank you, Madame Chairwoman.

REP. VELAZQUEZ: Mr. Altmire.

REP. ALTMIRE: Thank you, Madame Chair. And, Commissioner Shulman, thank you for being here.

Last week the IRS stated that COBRA provisions in the Stimulus Plan are top priority. And I understand that one of the outstanding items for the IRS is defining involuntarily terminated to determine that eligibility. When does the IRS expect to issue guidance on this matter that affects COBRA obligations and rights?

MR. SHULMAN: You know, we issued the first set of guidance several weeks ago. Today, some Q and As were up -- some questions and answers were put up on the website to try to answer a lot more of those pieces. You know, the COBRA provision is one of the most complex for us to administer, because right now when an employer sends their 941 into us, we actually don't have individual taxpayer information. They just do gross employment tax to us.

And so it's really -- the employer is going to have to do all of the true up with the individuals, which we recognize them, and it's the way the law was written. The decision was to provide this medical benefit through the employment tax system. We tried hard to simplify it.

Your specific issue, I will check and see if it's on the Q and As that went out today. If not, I can get back to you with the date.

REP. ALTMIRE: Okay. Thank you.

And I wanted to ask a question about home-based businesses. For many entrepreneurs running a home-based business, the home office deduction is simply too complex and time-consuming. And it's clear that something needs to be done since only 9 million of the nearly 30 million home-based business even took that deduction. Is the IRS considering writing new regulations that would make it easier for small businesses to take that deduction?

MR. SHULMAN: Yeah. I will tell you -- when I said I've started a couple small businesses, the first one I started, started in my home. And then we moved and then we put phones in, and then we got employees, etcetera and so on. I'm well aware of the complexity of that deduction. I know it's very hard for taxpayers. It's very hard for the IRS. The law is pretty clear about it, and we're trying to administer the law.

But I'm interested in -- but we're going to have to use a broader conversations within the administration and with Congress.

One is, I'd encourage Congress to simplify it, and create a safe harbor. But it wouldn't be out of the question for us to at least explore if there's a way to have some sort of safe harbor, because we recognize is a very complex area of the law.

REP. ALTMIRE: Great. And I'm going to ask one more question to what Mr. Luetkemeyer was asking. With regard -- and you may not have these numbers in front of you I realize, with regard to the flow- through that you were talking about in that $250,000 income threshold, you were addressing the question that you were asked which was: How many total small businesses are there that fall into that category? How many are there that would be over that $250,000 threshold, that would actually be subject to that new level of taxation.

MR. SHULMAN: I mean, I have to take -- come back to you on that. I mean, I think every -- you know, there's a lot of small business owners, the ones who are fortunate enough to make $250,000. It obviously -- if you're a flow-through, it shows up on your individual tax return.

REP. ALTMIRE: Do you have any idea the percentage with regard to other businesses?

MR. SHULMAN: I don't. I'm sorry, but I can get back to you with those numbers.

REP. ALTMIRE: Thank you. Thank you, Madame Chair.

REP. VELAZQUEZ: Mr. Bright.

REP. BRIGHT: Thank you, Madame Chair.

I want to follow up on Jason, and I appreciate what you said about trying to make the IRS more -- you know, do a better job, and you can always do a better job. And I very much appreciate that. And I know you understand, but do your auditors and the folks below understand, the people that are making the decisions that -- you know, that -- what it's like to start a small business and run a small business?

And I also wanted to ask you, too, I mentioned the study, the Syracuse Study from 2007. I didn't know if you were aware of it or not. But my curiosity is, you know, is it more likely for small businesses to get audited than larger business? You know, the study was pretty clear, but, you know, I just ask you to comment on that.

MR. SHULMAN: Okay. Yeah, you know, a couple of things. One on your question about people understanding small businesses. One of the first things I did when I came in, because I'm a big believer that if you're going to run a government agency and if you're going to operate with the power and authority of law that a government agency has, you need to be very focused on understanding the impact on the people that you affect.

And so the phrase I always use with our people is, "We need to walk a mile in the taxpayer's shoes.' And we talk a lot about that. You know, the fortunate thing that we have is everybody who works at the IRS is a taxpayer. So I think everyone files every year and has to wrestle with the codes, so they understand it. And I'm very focused on doing what we can to increase outreach, increase dialogue and make sure people are really kind of stepping out of their mind and sitting on the other side of the table and feeling what it's like.

And so, yeah, I can't say we're all the way there, knowing that no business or government entity is all the way there, but it's a big focus of mine while I'm here.

But let me give you a couple of numbers that I think are interesting. I mean, and tell you one, if you've looked at any of the public comments I've made in the last year and any of my testimony, I've talked about three focus areas. One is international tax evasion, two is large business, and three is high net-worth individuals. And so that's where my emphasis has been.

If you look at businesses with less than $10 million of assets, this is kind of how we break it down, we're eight times more likely to audit a business between $10 and $250 million of assets than we are a business with less than $10 million of assets. And we're 18 times more likely to audio a business with over $250 million of assets. So the big businesses than we are a business with less than $10 million of assets.

And so, you know, I'm the IRS Commissioner. One of my jobs is to have every American feel like we're keeping an eye on everyone, so that your neighbor is paying and your competitor is paying. So I wouldn't say that we don't have good audit coverage everywhere. I wouldn't be doing my job if I said that, but I really do not believe that we're unfairly targeting small businesses. And the numbers pretty much speak for themselves, that you're a lot more likely to get audited, 18 times more, if you're a very business than you are if you're a very small. And you're eight times more likely if you're a mid-size business than a very small business.

REP. VELAZQUEZ: Ms. Dahlkemper.

REP. DAHLKEMPER: Thank you, Madame Chair.

Mr. Shulman, I want to go back to the COBRA issue, because I've had a couple of calls from small business owners regarding this. And although they agreed and they think it's a great way to cover some of their employees that they've had to let go, they're concerned about the upfront payment. And how long currently under your, you know, current guidance, how long until they can be reimbursed for their out- of-pocket expense on that 65 percent?

MR. SHULMAN: Yeah. I mean, I've heard this issue. I think you're referring to people usually have to reimburse for premiums and pay premiums monthly, but don't get reimbursed until the last -- till the end of the quarter. And so I mean, the time that you can take the 65 percent out of your payroll taxes is when you file your 941 quarterly return.

This is a timing issue that's in the law. There's not a lot we can do about it. What we have done is while it was going through the legislative process, first, we made sure Congress knew that this was going to be a problem. Two, is we actually pushed back, and we think we eliminated some more complexity. One of the issues that was on the table is to make this reporting on the W2, which would have made payroll processors and employers all have to change their W2s, which we pushed back and didn't do.

We're well aware that this is an issue for small businesses. We've looked at it. We're going to do what we can, but some of these timing issues are really through the legislation, and there's not a lot we can do.

REP. DAHLKEMPER: And I know it's quite a financial burden on a lot of companies who are just, you know, living on a shoestring right now, so --

Anyway, I appreciate you affirming that. My other question is regarding the meetings and the forums that you said that you had, you know, for small business communities. Often, we have these meetings and we have forums and everyone voices their concerns, but that doesn't lead to any reforms. Can you tell me the specifics of how some action that the IRS is taking, the reforms, as a result of the meetings and the forums that you had last year or anytime in the recent history?

MR. SHULMAN: Yeah. A couple of things. One, is a big purpose of these meetings is because a lot of small businesses aren't hiring accountants and lawyers as others. It's literally to give them face- to-face advice. So a lot of what we're doing is saying, how do you open a business, how do you close a business, how do you work through an audit, what kind of information and record-keeping do you take. So it's not all feedback. You know, a lot of it is education and outreach.

A few examples of things that have happened because of feedback from small business community in recent years; one, is when there's a like-kind exchange of property, a small business sales the building and then buys another building and it's a like-kind exchange of property. They have to actually hold that -- the proceeds in a escrow account.

The law allows that the proceeds in the escrow account need to pay interest and if they're not paying a certain amount of interest, there's imputed interest to the small business. We heard a lot of small business owners say that I wasn't getting any interest and then there's this imputed interest, I have to pay a tax. We've created an exemption for under $2 million.

The other thing we heard is there's a lot of people who are very small businesses and were having to file quarterly employment taxes.

We extended that.

I heard from a lot of small businesses that when you filed an extension of your income tax, especially Schedule C filers, you had to file a four-month extension and then another two-month extension, and through hearing from many people, including small businesses, we made that a one time six-month extension.

The other thing we've done is. we increased the threshold to file the Schedule C E-Z to up to $5,000 of business expenses, and so we tried, through the dialogues, to hear from people. Did we do a perfect job of it? Absolutely not. Could we do better? Yes. But we're quite committed to trying to hear and do what we can, again, within the confines of knowing we also have a job, to fund the government. We need to work with the Treasury Department on these pieces, and there's a lot of issues that are really purely legislative.

REP. DAHLKEMPER: I appreciate that and I think, you know, these are the people who are actually out there every day trying to create jobs and keep this economy going. And seeing what you're doing within the constraints that you have is important. I think a lot of people are doing their job, and your agency really don't know what small businesses are going through every day. I appreciate your listening to them. Thank you, Madame. I yield back. Thank you.

REP. VELAZQUEZ: Thank you. And now the committee is going to stand in recess until we go finish voting on the floor. The committee is called back to order. Thank you, Commissioner, for your indulgence. I will recognize Ms. Clarke.

REP. YVETTE CLARKE (D-NY): Thank you, Madame Chairwoman and ranking member Graves, for holding this hearing on tax compliance costs and whether it's slowing this country's economic recovery. As I've always stated, as we move forth in the 21st century small businesses will become more and more an essential element in driving the U.S. economy. About 30 million small businesses operate in the U.S., which employs virtually 80 million workers. When it comes to tax compliance issues, small businesses benefit from greater flexibility and fewer bureaucratic controls.

But today, during these tough economic times, small businesses are having difficulty staying open. Now is the time for the IRS to do much more in outreach and education to small businesses to answer the many questions and address their legitimate concerns. For small business, the tax code is simply too complex and burdensome, and I hope that our conversation here today will enable us to come out with recommendations to assist in those outreach efforts.

So, Mr. Shulman, a lot of the tax issues are not merely about the money but about the compliance problem when dealing with the government, especially when it comes to reporting. Most sole proprietorships have to pay federal and state payroll taxes, as well as unemployment insurance and, therefore, have to meet so many deadlines. Yet, when the IRS alleges that a small business tax return is incomplete, they attempt to reprimand the small business without any inquiry to determine what may have happened. If that is the temperament and culture of the IRS, do you think that the burden of proof should then be on your agency to show paperwork was indeed not reported by a small business?

MR. SHULMAN: No. Thanks for all of your comments and, you know, I couldn't agree with you more, that in this tough time, one, everyone's counting on small businesses bouncing back. The president's been very clear that small businesses and entrepreneurs are a central part of the engine that is important for the country. I talked quite a bit in my oral testimony about the outreach efforts we have, about the things that I ask every person in the agency to do around making sure we're flexible with businesses who are experiencing hard times.

I guess I have not experienced the culture that you're talking about. We've got a lot of employees and there's always going to be exceptions, but, in general, our people, I think, try to work with taxpayers. They have a job to do, obviously, to make sure that they audit businesses and individuals, non-profits, to make sure they're abiding by the law. When it comes to paperwork, one of the things that I know for sure -- I've talked with our Commissioner of Small Business who's here today, actually gone out and done round tables with our agents.

We seldom disallow expenses because records aren't there for small businesses. Our agents usually work with the taxpayer to try to reconstruct those records, so I guess I wouldn't necessarily agree with the characterization, but I very much agree with the sentiment that you put forward, which is that we need to go out, we need to be reasonable, we need to work with taxpayers, we need to assume that the majority of small businesses are wrestling with an incredibly complicated code and just trying to get it right.

REP. CLARKE: Fair enough, Mr. Shulman. The hope is that there can be that level of engagement sustained in terms of quality across the span of the agency. As you said, you set forth a certain culture within the agency and you hope that it's followed through to the end and certainly there are nuances within each individual business that you may confront, and so we're looking for that consistency and quality, commitment to small business, and I'm glad to hear that that is your goal, your aim, your philosophy within the agency.

I understand that recently you held a program called Super Saturdays and this program provided free tax help to communities nationwide. My question is, why has there been no Super Saturday directly focused on small business, especially during these tough economic times?

MR. SHULMAN: We had, last year actually was the first year we did Super Saturday while we were trying to get 120 million stimulus checks out to the American people, and there's a whole category of seniors and veterans who usually wouldn't have to file a tax return but did last year because of the stimulus. It was such a success and, frankly, we had employees from all over the agency work directly with taxpayers.

One of the things I talked about before is key, and a focus of mine is to make sure we walk in the shoes and we understand what it's like to be a taxpayer, so having our executives from across the country deal face to face with taxpayers was a great experience, so we did it again. We opened up on Saturdays. We had people come in. This was open to individuals, it was open to small businesses, to any taxpayer.

Last year we actually held 2,600 seminars, education events, forums for small businesses, and I'll refer you to my written testimony so I don't go through it again, but I think we have a lot of outreach for small businesses. We could always have more, and one of my jobs is to triage the resources between our phone people, people who make the Internet work, people who do service, people who do enforcement, you know, the whole -- small businesses, large businesses, individuals, both service and enforcement, and so we're just trying to balance that, but you have my commitment that we're very focused on trying to give support to small businesses.

REP. CLARKE: Thank you very much. My time has expired and I yield back.

REP. VELAZQUEZ: Mr. Commissioner, the IRS procedures require consideration of whether a collection against a taxpayer would impose an economic hardship. In a March 11 release, the IRS stated it would be flexible when considering collectability during this time. Could you be more specific, and you mentioned that you were telling your staff to be more flexible, to even suspend collections or work out agreements. Can you be more specific regarding any procedures the IRS plans to implement in light of the economic downturn?

MR. SHULMAN: Yeah, a couple of things we did. When I mentioned postponing collection?

REP. VELAZQUEZ: Mm-hmm.

MR. SHULMAN: We give thresholds which aren't public about how much tax is due, where the front line employee who's talking to the taxpayer can actually take that collection case and put it back to the queue because of economic hardship. We actually raised those thresholds, meaning it can be a larger amount of tax, and our front line employee has that flexibility, so that's one of the things we did.

In the past if you missed one payment, if you either had had an offer and compromise or an installment agreement, it was an automatic default. We actually gave, again, flexibility to people that you could miss more than one if you showed some economic hardship.

We gave some flexibility that that can be a discussion with people because, as you have all mentioned, at the end of the day you've got to trust the judgment of your people out in the field. If you're going to tell them to use their judgment, you've got to trust them, so we gave them more flexibility and less rigorous documentation requirements.

With liens, we actually have now made it clear, a lot of small businesses, the way they get a loan is they actually have the security be their house, and so we've actually made it that if somebody in this down real estate market is either trying to refinance their house or renegotiate or sell their house, that our lien won't stand in the way of that action as people go through this time, so there's more which I'd be happy to give you.

What we've tried to do is do all this, but also we have to protect against a flood of people who can pay their taxes saying they can't pay their taxes, and so we're just trying to get this balance right.

I think some have criticized and said I've leaned too far towards the taxpayer. I think in these times it calls for extraordinary measures, and that's why we took some of them.

REP. VELAZQUEZ: Okay. You mentioned that you're going to pay more attention to recoup some of the money in terms of international tax evasion, do more audits of international tax evasion, is that right?

MR. SHULMAN: Yes.

REP. VELAZQUEZ: So do you have the manpower, the resources to go after this type of tax evasion?

MR. SHULMAN: I mean, a couple issues. One is once you leave our border, and we don't have all the authorities that we have inside the border to follow the money trail, we have to coordinate with other governments. There's a lot of diplomacy that's needed and it's easier to hide money, so it's some of the toughest work that we do. We're in the continuing resolution -- when we started continuing resolution at the end of last September, we essentially had a freeze on staffing.

What I did was move some staffing from other areas so that we could keep staffing up in international. And you might have seen in President Obama's budget he put a line item for robust international enforcement efforts from the IRS, and we anticipate getting significant increases in agents, both civil and criminal for international lawyers so that we can work through some of the complex issues that are --

REP. VELAZQUEZ: Are you saying you're reprogramming the manpower that you have so that you're going to use the staff for international compliance?

MR. SHULMAN: It's a priority. I've already done some shifts and, certainly, as we get more staff it's going to lean towards international.

REP. VELAZQUEZ: So, my concern is how then will you have the people in your staff, the number that is required to be able to answer the questions coming out from small businesses who need to call the IRS or for you to process some of the returns in an appropriate manner?

MR. SHULMAN: Yeah, we have three appropriations. We have a support appropriation, we have an enforcement appropriation and a service appropriation. This is in our enforcement appropriation that comes. We're not planning on taking people out of service roles. We really triage our enforcement people and so it's a perennial issue.

I mean, we -- an interesting statistic: we've had a nine percent decline in staffing over the last five years and a ten percent increase in returns filed, but we've got a 23 percent increase in productivity. Technology and electronic filing helps, the Web helps, but we're always having to manage resources, but a lot of people ask you when you become IRS Commissioner, "You going to focus on enforcement? You going to focus on service?" I've been very clear. I'm going to focus on both, and I by no means am going to overemphasize enforcement at the expense of service.

REP. VELAZQUEZ: Okay. So, we know that so many businesses are experiencing a downturn and many will be taking advantage of the expanded net operating loss provision in the recovery bill. What special steps have the IRS taken to ensure a timely processing of returns so many small businesses can get an infusion of capital?

MR. SHULMAN: Yeah, right when this conversation started around increasing net operating losses, we brought together our team to work on this. We assigned an executive to review the procedures and make sure there wasn't any clogs in the system.

There's two ways to get expedited returns. One is by filing an 1139 for the Schedule C for corporations and one is for the 1045 for the Schedule C filers. We have actually staffed up and so some of these areas, as we've been triaging, we've made sure there's enough staff there. I'm very confident that we're going to get these out quickly. We've made a commitment that all of them will get out within 45 days, but I've challenged the staff to get it sooner, and that's quicker than these usually get processed. And I'm going to be monitoring it daily, and if we see a surge beyond what we're expecting, we'll put more staff. I mean, we're going to make sure that we do this right. We recognize how important it is.

REP. VELAZQUEZ: It is important since small businesses right now are having problems getting access to capital. You know, the credit crunch is incredible and it's impacting them, so this is a tool that would help get money back to small businesses. And I hope that our offices will not be inundated with phone calls telling us that they're not getting the rebate that was promised to them.

MR. SHULMAN: Yeah, no, I do, too. I mean, one is, I know a lot of this came through with your leadership. Clearly, the president has asked every agency to prioritize the stimulus or the Recovery Act and making sure we implement it well. The Treasury Secretary has asked me this, as well, and this is something that I'm personally engaged in, and if your office gets any information to the contrary, please reach out because we're focused on this.

REP. VELAZQUEZ: Thank you. Mr. Bright.

REP. BOBBY BRIGHT (D-AL): Thank you, Madame Chairman. I just want to follow up again with Representative Altmire, and he had asked you and he expressed concern and I am, too, concerned about the possible consequences to small business when it comes to the taxing, and $250,000 for couples and $200,000 for individuals, how many small businesses that's going to affect and you had said before that you were going to get that information, and I definitely want to make sure that we get that information. I would like that information, and I think it's something that's very important, and I would like to know just how many that is going to affect. And I'd appreciate that.

MR. SHULMAN: Yeah, absolutely. We will follow up.

REP. VELAZQUEZ: Ms. Clarke, any other questions?

REP. CLARKE: Mr. Shulman, yeah, I guess we keep reiterating how hard these times are for small businesses, but, I guess, you know, it's a point that's worth driving home because they're really having a hard time paying tax with liabilities which not only impacts their businesses, but their families, too. You know, I believe that this is a time when some of the reporting responsibilities really need to be reexamined when it comes to small businesses.

For example, credit card companies can report to the IRS sales as small businesses such as restaurants, which in the past was a chronic source of non-compliance. Do you agree that the IRS should be trying to reduce the non-compliance burden on small businesses and what is your agency doing to come up with new guidance to address this matter?

MR. SHULMAN: A couple things. One is, you know, we have to balance -- I think the biggest compliance burden is the law. Very complicated. My favorite statistic is that the tax code is four times as long as War and Peace. And we're going to do everything we can, within the confines of the laws that are passed by Congress. And to date, to make things simpler, we've done a number of things that I've walked through earlier that I'd be happy to go through with you, meet with you individually or send you a letter about, that we've done to try to reduce the burden on the administrative side.

You mentioned the credit card reporting.

A lot of information and all the statistics show there's always higher compliance when there's third party reporting. The best compliance is the teacher, or the fireman or the employee who has a W- 2 because we know we're going to get information and they get reported to them in a simple format, exactly what their wages are. They copy it onto their 1040, they send it in to us. It's much easier. My hope is that information reporting like credit cards, ultimately, and first of all reporting's not going to happen until 2012, so there's plenty of time to get a lot of input from the community as we do that, but more importantly my hope is third party reporting actually can simplify and get the information in a simple format for people. And so that's always my hope.

REP. CLARKE: Thank you very much, Commissioner. Thank you, Madame Chair. I yield back.

REP. VELAZQUEZ: Sure. Commissioner, I have the last question and that is, a major concern for some taxpayers is the lack of review of certain civil penalties and one of the most draconian penalties we found on 67078. This section imposes mandatory penalties of up to $200,000 for failure to make disclosures of certain listed transactions. Unfortunately, there is no regulatory process or public comment period involved in determining what should be listed, a list of transactions, so is it possible for the IRS to suspend these penalties until a better review process is implemented?

MR. SHULMAN: Yeah, I mean, we've actually looked at this. I would agree with you that -- let me step back for a minute. I mean, the list of transactions were an important thing that the IRS did, which was to put taxpayers on notice that there's certain transactions designed for big corporate tax evasion kind of transactions, tax shelters, that we're going to be look at that you need to file information on. We recognize that some taxpayers have gotten caught up in this that the law never presented. We're trying to have dialogue about that.

Right now we think our hands are tied, that the legislation, if I have this correct, and I'll come back to you, is actually (that ?) we don't have a lot of leeway for us to suspend it, but this is something that we're going to want to talk to, you know, we're in discussions and the administration are going to need to be in discussions with Congress because we recognize this is an issue.

REP. VELAZQUEZ: Very good. Thank you, and let me take this opportunity to thank you. And I'm sorry that we have so many votes on the floor, but this is the way it goes here.

MR. SHULMAN: The people's business.

REP. VELAZQUEZ: Okay, so thank you so much.

MR. SHULMAN: Thank you very much.

REP. VELAZQUEZ: The gentleman is dismissed. So now we call on the second panel, and I will bring Mr. Christopher Smith to the microphone.

MR. CHRISTOPHER SMITH: Thank you, Madame Chair. I'm pleased to introduce Kit Smith, he's a constituent and owner of Stop Restoration LLC and Stop Northland LLC in Pleasant Valley, Missouri. Mr. Smith is certified in fire and water restoration, mold remediation, door and window installation. He's also a certified restoration remediation recovery instructor. He's a non-combat disabled veteran. Mr. Smith served six years in the United States Navy. He's been an entrepreneur and owner of his own small business since he was 16 years old.

Mr. Smith, thanks for coming, and we want to welcome you to the committee and we appreciate you coming here to Washington to tell us about your story.

MR. KIP SMITH: Chairman, Chairwoman Velasquez and ranking member Graves, my name's Kip Smith, and I'm owner of a small business in Pleasant Valley, Missouri. I'm pleased to be here today to testify of the burden of tax compliance for small businesses.

My company's been battling with the IRS since 2007 on a matter that generated an audit going back to 1989. It started because an employee had embezzled $58,000. She was trying to hide this by switching my EIN numbers around and making deposits with them to the state of Missouri and the IRS. This encompassed a sole proprietor, a corporation and two LLCs. The deposits owed for the tax periods in question were, in fact, paid.

The IRS person who received the deposits placed the money where they deemed needed and not where it was supposed to go, per the forms that the deposits accompanied. The agent and I proceeded to uncover the fact that the payments were made. They were misplaced and the agent would locate and identify where to correctly put the payments. After a short period of 30 to 45 days I received a call from the agent and was informed that there was a small refund from past years and that the payments would need to be placed correctly if I agreed, and, of course, I did.

I was then informed that there was a slight overpayment on my part and did I wish a refund or place it on account. I chose the refund. After about a month or so I received a call from the agent stating that there was a mistake by them in the calculations placement of the funds and I needed to repay approximately $2,300. I gave the agent the check number and wrote the check for the amount and put it in the night mail.

When we thought the audit was about done, up pops a new IRS agent on the phone stating that I owed approximately $2,300. I disagreed and after two to three minutes on the phone I asked if the phone agent could give the particulars to my office staff so that we could again research this. To my complete amazement, my office staff came in and proudly proclaimed she had my amount reduced to approximately $1,800.

How on earth can an employee negotiate with an IRS agent the amount of a tax due when during an audit they ask specific questions to qualify you as the appropriate person to be liable? I just paid this tax for the third time. The tax advocate informed me of information that contradicted the supervisor's statement made to me via my message machine. I informed the tax advocate that they were hiding a big mistake. (Clears throat.) Excuse me. The agent was no longer to speak with me and I was informed this matter was closed. (Clears throat.) Excuse me.

Who regulates this arm of government? What oversight do they have? How far can they can go? Why do they have immunity from repercussions? They need checks and balances, one to ensure the tax paid is -- the tax due is paid, but, two, that when they're wrong they don't cover it up, destroy lives or businesses.

The burden placed on my business was, alone, was over 150 hours of my personal time at $175 an hour to keep my doors open, well over 100 hours of my staff time and reams of paper and phone bill time. I cannot even think of the amount of business I lost focusing on this instead of my company. I'll never get over this loss.

We, as small businesses, need a flat tax so we can plan for what tax is due instead of wondering what will be due. This would take the unknown out of taxes. It's funny but not too long ago I had an IRS agent on the phone. She stated to me, "Mr. Smith, the IRS does not make mistakes." And I still have that tape.

Can you believe the audacity? We are all human. Heck, I may have made a mistake coming here. The stimulus package -- there's nothing in the stimulus package for my business. I cannot afford to go further in debt, period. Buy equipment? Get an SBA loan for $35,000? No to further debt.

What small businesses need is the ability, the available loan opportunity just to lower their loan payments, lower taxes to be able to afford and retain good employees instead of having to lay them off, lower taxes to afford to give themselves a raise. I haven't had one in five years. Lower taxes to ensure the benefits package available and matches the larger institutional ones, lower taxes to be able to afford, without a loan, improvements to facilities and equipment. The stimulus package should not help mega-companies that affect our economy. They need to fail just like if I failed. No one would help me except me. If the big dogs fail, let them.

Then smaller entrepreneurial companies will sprout up and take over where they failed. That's the spirit of America. Freedom and hard work. The stimulus package should not be for earmarked projects. They don't help small business. The package is wild spending of money that isn't even printed yet. We need Congress to control spending and lower taxes. Small business will help pull us out of this faster.

Government is in place to keep peace, not to create jobs. They (implement ?) laws and govern, not dictate how much someone can make.

The government can help create jobs by helping people who create jobs. Us, the small business people of America, who give every day! In my state of Missouri, 90 percent of the employed people are employed by companies with fewer than 25 employees. Small businesses. Unbridle the small business community. Give them the ability to rebuild the economy and watch what we're capable of, but don't give us more burden, more taxes, and more administrative burdens such as more COBRA regulations. Thank you for the opportunity to testify today.

REP. VELAZQUEZ: Thank you, Mr. Smith. Mr. Graves.

REP. SAM GRAVES (R-MO): Thank you, Madame Chair. Someone suggested, and I actually brought up a Syracuse University study, that small businesses are targeted because they don't have the ability to hire expensive counsel or, you know, expensive representation to work with the audit, and I was curious if you were able to do that and if you've heard of other small businesses that have been targeted by audits who aren't able to hire counsel or get the expensive resources to, you know, to be able to represent themselves before the IRS.

MR. KIP SMITH: Mr. Graves, with the amount of burdens placed on -- by local taxes, increased property taxes, and the tax burden that we already have, I couldn't afford an attorney. I hired an attorney in the first place, and it came to no resolve. It wasn't worth the money that I was spending, so I opted to go through this myself with the agent, and it was successful.

And I know of other gentlemen and women in business who have had similar type of situation, not to this complete amount, but they have had the same situation, where they've had employees that are embezzling, whether they have a gambling problem or whatever it is, that embezzle money and now we're at a disadvantage because we don't have the capital to fight the IRS.

REP. GRAVES: In your opinion, was the IRS, I mean, was it a situation where, you know, one agent didn't know what the other agent was doing, the left hand doesn't know what the right hand's doing? Or is this a situation of, as far as they were concerned, you were guilty until proven innocent or, you know, in your opinion, at least, how did you feel and, you know, what could have made it a whole lot more user- friendly, I guess, approach, you know, in working with you on this? What would you have done different if you were --

MR. KIP SMITH: I really appreciate that question. The original agent that came into my office and flapped her badge, flipped her badge, was awesome. She uncovered -- she went back to 1989, like my testimony said, and she uncovered where these payments went. She found them. She was diligent in her job and she did it well.

Where the breakdown came was when we got the phone call from an agent on the phone that said mysteriously we owed this money again, and I went and said, "What's going on here?" I tried to talk to that agent. I was not allowed to. I went to the tax advocate, thanks to your office, and that's an oxymoron because she's an employee of the IRS. And, through her, we contacted this Department again and I was given conflicting stories. I did talk to the agent very shortly and very briefly, and I was told I had to go to the supervisor.

The supervisor told me that I had to go to the tax advocate, and I told the tax advocate this, and she said, "No, that's not what he said," and he left a contradictory response to that on my answering machine, so I couldn't figure out -- I'm thinking, okay, why doesn't the IRS just -- and I asked him, "Why don't you just bring this file that the original agent did, let's sit down at a table and let me see what you have so that I can see where she went," and all's they would divulge to me was this unknown, unbeknownst jumble of figures that, unless I was an IRS agent, I wouldn't know how to discern what was there!

But she went back all the way to 1989 and uncovered money that they owed me from a long time ago, but they didn't give that up. But she found out where I made the payments and where they were sidelined because this person was trying to throw a smokescreen and she found out that we, in fact, did make the payment. And then I found out I had to do it again, so I would say that they -- in this case, that they should have brought the file, sat down with me and said, "Mr. Smith, this is what we found." They wouldn't do it. They said, "You're not allowed to talk to the agent and this matter is closed." And I think that's wrong.

REP. GRAVES: Thank you, Madame Chair.

REP. VELAZQUEZ: Ms. Clarke. No questions? Okay. So we got some stuff here from the IRS and I guess if there is some pending issues, we could use the opportunity after the hearing, continue the conversation. With that, I ask unanimous consent that members will have five days to submit a statement and supporting materials for the record. Without objection, so ordered. This hearing is now adjourned. Thank you.

END.


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