IRSAC Issues Annual Report on IRS Divisions

The primary purpose of the IRSAC is to provide an organized public forum for IRS officials and representatives of the public to discuss relevant tax administration issues. The IRSAC reviews existing tax policy and offers recommendations on emerging tax administration issues. The IRSAC suggests operational improvements, offers constructive observations regarding current or proposed IRS policies, programs, and procedures, and advises the Commissioner and the IRS with respect to issues having substantive effect on federal tax administration.

The 2004 IRSAC is well suited to convey the public's perception of IRS activities and advise the IRS, from that perspective, on various aspects of tax administration. The membership includes nine heads of private companies that assist smaller firms and individuals with filing tax returns; five current or retired corporate tax executives, including two former international presidents of the Tax Executives Institute; a lawyer who is a former chair of the Tax Section of the American Bar Association; one academic; a tax software developer; an association tax counsel; and two representatives from accounting firm tax practices.

The IRSAC is organized into three subgroups, corresponding to three of the four IRS Operating Divisions: the Large & Mid-Size Business Subgroup (hereinafter the "LMSB Subgroup"); the Small Business & Self-Employed Subgroup (hereinafter the "SBSE Subgroup"); and the Wage & Investment Subgroup (hereinafter the "W&I Subgroup"). Each subgroup has issued a report that is included following this general report of the entire IRSAC. All reports are the products of working sessions held in Washington during the year, onsite meetings, and conference calls between IRSAC members and key IRS personnel. The cooperation and efforts of IRSAC members and representatives of the Service made the work of the IRSAC and these reports possible. The members of the IRSAC extend special thanks to the staff of the Office of National Public Liaison for ensuring that the Council had all resources necessary to perform its advisory function.

The IRSAC was pleased to testify before the IRS Oversight Board on January 29, 2004. The IRSAC testimony recommended that increased efforts be made to enhance enforcement. The testimony stressed the importance of assuring taxpayers that all are being treated equally and all are paying their fair share and commended Commissioner Everson for recognizing the need to find a proper balance between service and enforcement. IRSAC suggested that effective risk assessment and risk management strategies and tools are the keys to improving enforcement and deploying resources to the greatest effect. The multi-pronged attack on tax shelters was cited as an example of effective use of the combined tools of guidance, publicity, and enforcement to address concerns and to foster improved compliance. The IRSAC testimony looked forward to the results of the National Research Program (NPR), which should greatly enhance the Service's risk assessment capabilities with respect to individual taxpayers, particularly when combined with Business Systems Modernization. As it has many times in the past, the IRSAC supported funding that will adequately support IRS objectives in the areas of service, enforcement, and productivity.

The Subgroups were active in responding to operating division requests for assistance and input. Each division asked its Subgroup to concentrate on specific areas, which became the focus of Subgroup activities. As is indicated in the Subgroup reports, each carefully studied the issues presented, interacted with Division personnel, and provided advice and commentary. The IRSAC believes that this aspect of its advisory role is particularly helpful to the IRS in shedding light on public perception and, on occasion, in forestalling missteps.

The Subgroups interacted with Service personnel in various ways. These included regular sessions during the course of IRSAC meetings, conference calls, written commentary, and a field trip by the SBSE subcommittee to Austin, Texas to learn first hand about processes for handling offers in compromise. Throughout these interactions, IRSAC members provided candid advice and commentary with the sole purpose of assisting the IRS to carry out its various missions and functions.

The IRSAC met formally in February, May, July, and September to address issues of Service- wide on which the entire group could provide helpful input. We heard from, among others:

• Frank Keith, Chief Communications and Liaison;

• Nina Olson, Taxpayer Advocate;

• Donald Korb, Chief Counsel and Nicholas DeNovio, Deputy Chief Counsel (Technical);

• SBSE Commissioner Kevin Brown;

• W&I Commissioner Henry Lamar and Deputy Commissioner Richard Morgante;

• Russell Geiman, Acting Director, National Research Program (NRP) and Cliff Jones, current NRP Director;

• Blaise Dusenberry, Special Counsel, Procedures and Administration;

• JoAnn Bass, Director, Strategic Services, MITS, and Tom Parisi, Program, Analyst, MITS;

• Shar Turner, Chief, Payroll and Practitioner Groups, Steve Bayder, IRS Notice Gatekeeper, and Patricia Evans, IRS Notice Gatekeeper;

• Chris Wagner, Deputy National Taxpayer Advocate, and Arlene Kay, Executive Director, Systemic Advocacy.

At each meeting, the Subgroups reported to the whole IRSAC on the issues being worked at the behest of the Divisions. This facilitated tracking the progress of assignments and identifying issues of concern to the entire Council. The remainder of this general report addresses those broader matters that warrant comment from the IRSAC as a whole.

ISSUE One: Fulfilling the IRS Strategic Plan

On July 12, 2004, the IRS unveiled its 2005-2009 Strategic Plan. It states three broad goals: improved service to taxpayers, enhanced enforcement of the tax laws, and modernization of the Service's workforce, process and technology. While the plan makes clear that service and enforcement are priorities of equal weight, there is a renewed and greater or perhaps sharpened focus on enforcement priorities to:

• Discourage and deter non-compliance, with emphasis on corrosive activity by corporations, high income individual taxpayers, and other contributors to the tax gap.

• Ensure that attorneys, accountants and other tax practitioners adhere to professional standards and follow the law.

• Detect and deter domestic and off-shore based tax and financial criminal activity.

• Discourage and deter non-compliance within tax-exempt and government entities and misuse of such entities by third parties for tax avoidance and other unintended purposes.

The IRSAC agrees that the strategic goals set by the IRS reflect the areas of greatest concern in the current environment, specifically:

• Preserving and building on gains in customer service;

• Achieving enforcement that detects, discourages, and deters non-compliance,

• Bringing the forces of modernization to bear on these goals.

The strategic plan properly recognizes the importance of people in an effective service organization. IRS must find ways to ensure that the workforce is fully equipped with skills and training, as well as technology. Key to this is attracting and developing new talent, while making the most of the existing organizational knowledge. The Service also must ensure that it has an adequate number of enforcement personnel.

The IRSAC recommends that the Service also give thought to the human capital represented by the preparer community. We believe that well trained and ethical providers promote compliance and assist the IRS in meeting its goals. Enhanced communications with preparers can be useful. Taking steps to address abuses by paid preparers also is essential. Taxpayers should be protected from unethical service providers. Overall compliance would be improved if -- at a minimum -- existing rules, e.g., penalties, were consistently applied.

The IRSAC urges IRS to continue to explore ways of measuring risk and deploying resources in effective response to identified concerns. The organization-wide response to tax shelters is a good example of marshalling multiple means to attack a compliance problem. We believe that service-wide resources can be applied to other risk areas, such as flow-through entities. Further, in some respects tax shelter activities represent practitioner risks that also are found in other areas, such as EITC scams.

ISSUE Two: Resources and Workload

Inadequate resources and unpredictable funding would hamper the IRS and could prevent it from meeting the goals of the updated strategic plan. The IRS needs full funding for its workforce, both new hires and annual raises, as well as for its strategic initiatives.

As the Commissioner stated in a recent letter to Senator Baucus, shortfalls -- a perennial feature of the budget process -- in IRS funding make the Service less able to fulfill its own service and enforcement plans. In particular, the IRS might not be able hire the 4,100 additional enforcement personnel it believes are needed. Moreover, shortfalls in funding threaten the Service's ability to pay existing personnel, including those hired during FY 2004, and to replace service and enforcement personnel who have retired or otherwise left the IRS. The Commissioner's letter also details some of areas where full funding would be particularly helpful.

ISSUE Three: Strategic Risk Assessment and Management

One of the themes that runs through most of the presentations made to the IRSAC and to the Subgroups is the critical role of "risk assessment" and "risk management." The results of the NRP will provide tools for measuring risk in individual returns. Additional NRP projects will provide risk indicators in other returns over the years. In addition, data mining exercises are identifying other areas of potential risk. The LMSB Subgroup, for example, heard a presentation on a recent study of linked flow-through entities.

The IRSAC believes that the IRS is at the beginning, in a sense, of finding new ways to identify risk and then to manage it. Modernized systems and electronically filed returns will make accurate data available far more quickly to both enforcement personnel and to those who study compliance trends. The IRSAC hopes that these new tools and enhanced means of developing information will assist the IRS in targeting risk areas on as close to a real time basis as possible and, then, rolling out quick responses. As important, IRS agents will be able to hone in on risk areas, leading perhaps to quicker and more focused audits.

ISSUE Four: New Processes

The Divisions individually and collectively have been engaged in efforts to reengineer processes to improve "currency" and to identify trends that may warrant action by the IRS -- in the form of guidance, communications, program changes or specific enforcement activities. Addressing a conference recently, Deputy IRS Commissioner Mark E. Mathews pointed out that the "perfect audit" is not necessarily the one that collects the last nickel of tax. He suggested, and we think rightly, that "the return on investment for that last 50 percent or 70 percent of effort may not be that great."

As the LMSB subgroup reports, the Division has been working various reengineering projects, one of which -- now entering pilot form -- would focus audits on key issues to be addressed even before the return is filed. Other projects, such as the Limited Issue Focused Examination (LIFE), also aim at applying resources to "material" issues. And, SBSE is working with the concept of materiality to assist in defining the scope of audits.

Approaches that aim at reaching more taxpayers in less depth -- but at the right level of materiality -- are productive, and they allow the IRS to use its resources efficiently and effectively. They may run counter, though, to a culture that is devoted to rooting out that last nickel of unpaid tax.

The IRSAC urges IRS to continue to find new ways to perform audits. As Mr. Mathews suggested, the first 30 to 50 percent will find most of the tax due and allow the auditor to move on to another taxpayer. This would be good management of limited resources. However, the IRS will need to constantly communicate its goals and train personnel in audit techniques particularly with respect to measuring risk and defining materiality. Further, the measure of what is a "good" audit many require changes.

Conclusion

The 2004 IRSAC has appreciated the opportunity to serve this year as an advisory sounding board for the IRS. We appreciate the time and efforts of Commissioner Everson, the Division Commissioners, and the many other IRS personnel who facilitated our meetings and activities. We trust that the Service will continue to grow the ways it employs and deploys the collective knowledge and talent found in this IRSAC and those of the future.

• EITC - Earned Income Tax Credit

• ITIN - Individual Taxpayer Identification Number

• Notice Redesign

• E-Services

LMSB COMPLIANCE REENGINEERING

• LMSB Productivity Improvement Phase II (IDR, 5701 and 30-Day Letter Processes for Current cases/cycles

• Schedule M-3 Reporting Book-Tax Differences

• LMSB/SBSE Flow-Through Compliance Committee

• Compliance Assurance Process (CAP)

• Remote Examination Process

• Strategy to Re-emphasize Penalty Administration

• Other Tax Shelter Matters and Settlement Initiatives

• Joint International Tax Shelter Information Center (JITSIC)

SMALL BUSINESS/SELF-EMPLOYED SUBGROUP ISSUES

• Offer In-Compromise Program

• Abusive Tax Schemes - Shelter and Scams

• Tax GAP

• Partnership and Flow-Through Entities

• E-Services

• The Office of Professional Responsibility

The members of the Wage and Investment Subgroup (W&I Subgroup) of the Internal Revenue Service Advisory Council appreciate the opportunity to interact with the Internal Revenue Service to improve communications with the taxpaying public. In addition, the members applaud the Service for the time and cooperation of the W&I Subgroup representatives and management with whom we have met to resolve issues. We look forward to our continued involvement with the W&I division of the Service so that we create a win-win situation for the Internal Revenue Service, practitioner community and the taxpayers.

II. EARNED INCOME TAX CREDIT (EITC)

The Wage and Investment (W&I) Subgroup of the Internal Revenue Service Advisory Committee (IRSAC) has been requested to assist the IRS in its efforts to:

Compliance has reduced audit cycle time by 7.51% from prior year.

We applaud the service on the implementation of new outreach tools. These tools include, but are not limited to, such items as an EITC Eligibility Checklist for tax year 2004, a flier "Will you qualify for the EITC this year?" and postcards designed in both Spanish and English offering to assist low-income taxpayers in determining if they are eligible for EITC.

By June 2004, of the 25,000 taxpayers selected for review under the "qualifying child test", the IRS had received responses from 16,400. This number filed their returns, claimed EITC and a child's exemption. The IRS has completed reviewing and processing approximately 50% of these cases.

For the "filing status test", 26,800 of the 36,000 taxpayers selected have responded to the IRS communication. These taxpayers filed single or head of household status and claimed EITC. The IRS has completed reviewing approximately 65% of these cases.

Regarding the "under-reporter test", the IRS has successfully completed reviewing all 300,000 EITC returns with unreported income resulting in assessments of $121.5 million.

Recommendations:

The Wage and Investment subgroup of IRSAC recommends that the IRS continue to increase outreach to EITC eligible individuals who do not file a return or file and fail to claim the allowable EITC.

We suggest that the IRS develop more multi-language self-help tools.

We request that all IRS employees communicating with taxpayers be educated as to the document requirements for claiming EITC. Some areas currently have different criteria as to the documentation necessary to qualify for EITC.

As for the qualifying child, one of the current proofs of residency test is that if the taxpayer has a post office box, they must submit the Postal Form 1093 for proof of residency. The US Post Office will not release the taxpayers completed Form 1093 except in response to a subpoena or court order. We recommend that the IRS permit use of an alternative to the Post Office form, such as, but not limited to, a utility bill that shows both the mailing address to a post office box as well as the actual residential service address.

III. ITIN PROGRAM

The Wage & Investment Subgroup has been working on enhancements and the streamlining of the acceptance agent procedures and requirements.

W&I Subgroup recommend that the IRS develop an outreach program that will encourage more providers to serve as acceptance agents.

The IRS educate state agencies that an ITIN should not be used for anything other than tax reporting.

IV. NOTICE REDESIGN

The W&I Subgroup continue to work with Ann Gelineau, Jay Duffy, and their Dynamic Processing Team on notice redesign and simplification. During the current phase of the program, balance due notices (CP 501, 503 and 504) are being addressed along with delinquency notices (CP 515 and 518). During subsequent phases, the teams will be looking at notices used by the Automated Collection System, Automated Substitute for Return, Backup Withholding, Refund Hold and Installment Agreement programs.

Issues that are being addressed:

The W&I Subgroup recommend that:

The Wage & Investment Subgroup of IRSAC supports the Internal Revenue Service's E-Services program. At this time, we would like to suggest enhancements to the program that are in the best interest of the service, taxpayers, and the practitioner community.

II. ISSUES AND RECOMMENDATIONS

A. LMSB COMPLIANCE REENGINEERING

C. TAX SHELTER STRATEGY

I. INTRODUCTION

The Large & Mid-Size Business Subgroup (hereinafter the "LMSB Subgroup") consists of professionals who represent large and mid- sized businesses and in-house tax counsel from large multinational firms and associations. The members of the LMSB Subgroup come to the task without personal agendas. Rather, the overriding LMSB Subgroup agenda is to provide assistance to the IRS generally and LMSB specifically for the purpose of insuring efficient and fair tax administration and the development of equitable tax policy.

The Subgroup has been busy since February 2004 with five separate multi-day meetings conducted in Washington D.C. and several conference calls with LMSB personnel and executives. The LMSB Subgroup is most grateful for the time devoted by the executives and personnel of the Large & Mid-Size Business Operating Division and the staff of the National Public Liaison. Without their time and assistance, the year would have been less meaningful.

We have structured this Report around the four issues of primary importance to LMSB which were identified at the beginning of the year. Although not exhaustive, the list of issues helped us to focus on areas where we could be the most effective in providing assistance to LMSB. The report which follows identifies the issues and recommendations that were developed by the LMSB Subgroup during this year.

II. ISSUES AND RECOMMENDATIONS

Phase II was the second phase of a three phase approach to implement LMSB improvement initiatives. These initiatives have the goal of creating measurable improvements in case currency, cycle time and in direct examination time. Phase I, which created case delivery improvements and implemented an aged inventory closure initiative, was completed, and a break through team was organized to work on Phase II. The LMSB Subgroup strongly commends the members of the break through team and LMSB for their efforts and improvement initiatives, and we fully support efforts to increase productivity and reduce cycle time. We were presented with the preliminary report from the break through team and we responded with a written document discussing our concerns and recommendations.

Phase II strategies originally included recommendations for changes in Information Document Request (IDR) management, and for changes to Form 5701, the Revenue Agent Report (RAR) and the 30-Day Letter. The proposal would have established arbitrary rules for IDR processing times, eliminated the RAR by combining it with the 30-Day Letter and eliminated extensions to respond to the 30-Day Letter. Based on the comments and suggestions of the LMSB Subgroup and outside stakeholders LMSB did not implement the Phase II proposals.

The LMSB Subgroup strongly supports the goal of currency and shortened cycle times. Accordingly, we made several recommendations to improve Phase II of the LMSB Productivity Improvement Plan. We are pleased that LMSB did not implement Phase II as originally proposed.

Recommendations

The Treasury Department and the Internal Revenue IRS issued a new draft schedule for Form 1120, Corporation Income Tax Return, which will be required for LMSB taxpayers instead of Schedule M-1, and a new Revenue Procedure. The purpose of this new Schedule M-3 is to increase transparency of corporate tax return filings by requiring greater disclosure and consistency among taxpayers in reporting transactions with significant book-tax differences.

LMSB has recognized from empirical research that the larger the difference between book and taxable income, the larger the risk in the return. In addition, many taxpayers and tax shelter promoters take undue advantage of the differences between rules for financial accounting and rules for tax accounting. Schedule M-3 is intended to be utilized by US corporate taxpayers with total assets of $10 million or more. It is anticipated that the schedule will be finalized for use with federal income tax returns for tax years ending on or after December 31, 2004. Recently released Revenue Procedure 2004-45 allows all taxpayers that are required to disclose significant book-tax differences on Form 8886 (in accordance with the Regulations for Section 6011 relating to tax shelter disclosure), the option to use the corporate Schedule M-3 to report such differences instead of Form 8886. The purpose of the Revenue Procedure is to alleviate burden (double reporting of significant book-tax differences) in as much as Schedule M-3 requires the reporting of all book-tax differences. The Revenue Procedure should also encourage taxpayers to adopt the new Schedule M-3 earlier. Commissioner Everson believes that the new schedule will help target examination efforts on higher risk areas and thusly improve and speed the audit process. The LMSB Subgroup concurs.

We congratulate Commissioner Nolan and LMSB on this initiative. We believe that it is another "breakthrough" initiative that will result in increased effectiveness in the usage of IRS resources. We agree with Commissioner Nolan that it will allow agents to swiftly focus on emerging issues and will result in a more current and efficient examination procedure aimed at those returns with the greatest compliance risk. We believe that this will also have the effect of increasing taxpayer satisfaction, through reduced overall taxpayer burden.

Recommendations

In order to help ensure the effectiveness of this new initiative, the LMSB Subgroup has the following recommendations:

The Large and Midsize Business Operating Division continues to pursue innovative methods to identify tax returns, which will provide its division with the greatest potential for change. One of its latest innovative processes is the establishment of its Flow-Through Compliance Committee ("FTCC"). The FTCC was established by the Enforcement Council in October 2003 and given the direction to develop a process to identify issues on flow-through returns not normally captured during the course of an LMSB examination, and to develop return selection criteria using data mining techniques such as Compliance Risk Patterns (CRISP'S) and Predictive Association Rules ("PAR")

The LMSB operating priorities included coordination with SBSE, TEGE, Appeals, Counsel, and CI on:

• Abusive tax avoidance transactions that affect high wealth individuals and mid-market corporate taxpayers.

• Enhance tax shelter promoter compliance.

• Take actions to increase examination compliance on tax shelter promoter activity including identification of investors.

• Improve workload selection models for flow-through entities ("FTE").

The increased filing of returns for partnerships and S- corporations leads one to conclude that increased flow-through examinations may lead to a higher rate of compliance. Over the last three years, FTE tax return filings have collectively increased 11.6%, whereas corporate returns, over the same period, have increased an average of 4.85%.

TAX RETURNS FILED  FY 00 GROWTH OVER PY  FY 01 GROWTH OVER PY  FY 02 GROWTH

In the LMSB Subgroup report dated November 6, 2003, it was noted that close to sixty percent of the pass-through entity filing populations involved a tiering paradigm such that the entity itself is either a member/partner/shareholder of a higher level entity or it has member/partners /shareholders that are flow-through entities themselves. Since that report was issued, it was noted that the LMSB examination plans do not reflect appropriate levels of coverage to examine FTE taxpayers. The FY 04 and 05 compliance plans for LMSB agents working Forms 1065's and 1120S follow:

            Form 1065                                Form 1120S

Given the above projected levels of coverage, it appears that LMSB/SBSE are not dedicating sufficient staff years to address compliance issues identified by FTCC. In FY04, collectively 248 DESY's were dedicated to examining only 9,041 tax returns. In FY 05 the divisions increased DESY's by 10.9% to 273 agents with coverage exceeding 12,684 returns. With the increased filing of forms 1065 and 1120 averaging 11.6 % clearly each of the divisions are barely maintaining a level of coverage rather than increasing coverage of the overall population.

Recommendation

The LMSB Subgroup recommends that LMSB redeploy resources to reflect the overall population of tax returns filed in the pass- through arena. Rather than deploying a specific number of agents dedicated to pass-through entities, LMSB/SBSE should deploy a set percentage of DESY's dedicated to examining pass-through entities. This application would ensure that as inventory grows minimum audit coverage of the FTE population will also be maintained. As FTCC develops a list of issues that warrants examination, it is important that LMSB provide the resources to examine these returns.

LMSB continues to find ways to strive to reduce cycle time and achieve voluntary compliance, while rewarding compliant taxpayer behavior. The LMSB Subgroup believes the Compliance Assurance Process ("CAP") pilot examination program provides a sound basis for achieving these results. The CAP pilot program invites a group of large taxpayers to participate in an early examination process, whereby the taxpayer is examined during the course of the tax year rather than after filing as in traditional post filing processes. Because the traditional CIC process fails to resolve issues for compliant taxpayers and identify and deter abusive activities by noncompliant taxpayers in a timely manner, we believe this innovative process will identify key examination tools and measurements that can be utilized in other CIC cases and can be implemented in similar IC cases.

As highlighted by LMSB in its presentation to the LMSB Subgroup, audit resolution for the largest CIC taxpayers takes on average 60 months from filing date. For those 27% of CIC taxpayers with unagreed issues it takes an average of 86 months to reach resolution. This long cycle time inhibits early identification of significant tax issues, timely processing of issues, and adversely impacts taxpayer's business planning while increasing examination management costs for both taxpayer's and the IRS. The CAP pilot requires that the IRS and the taxpayer cooperate to look at key events and transactions early in the tax year and resolve any uncertainties by the filing date.

Through a Memorandum of Understanding ("MOU"), the IRS and the CIC taxpayer enter into an agreement which outlines the objectives of the process, the participants, and each party's roles and responsibilities during the course of the examination. The LMSB Subgroup was provided a draft of the MOU, and although conceptually we are in agreement with its content, we believe that it would be more acceptable and result in more CIC taxpayers signing the document, if the language used in the MOU were more "taxpayer friendly", and if the MOU included a statement that existing IRS policies regarding privileged documents and tax accrual work papers will be followed. The LMSB Subgroup has provided its recommended draft language to LMSB for consideration.

We believe the MOU is the focal point of CAP and may cause the greatest issues and concerns with those CIC taxpayers that volunteer for the program. While the MOU sets forth and describes the process and expectations of both parties, we believe that it needs to be a contract of process versus a contract of requirements.

With the advent of the Sarbanes-Oxley legislation, the changed corporate environment provides a unique opportunity to improve the overall compliance process. Using "tools" implemented by the law, the CAP process can leverage off those corporate governances.

Benefits of CAP:

• Provide quicker resolution of issues and cases, while providing prompt guidance to industry issues

• Address emerging issues that may impact other taxpayers, and simultaneously avoid any controversy and reduce prolonged litigation

• Provide real-time response to transactions, thus eliminating the IRS agents' need to "catch up"

• Resolve issues prior to filing with a greater certainty of final resolution

• Be consistent with the financial statement model of examining a taxpayer promptly

• Complement current corporate governance and accountability, while providing timely and more concise financial reporting

• Reward compliant behavior

• Allow for redeployment of CIC Revenue Agents to non-compliant taxpayers and an expansion of IC and flow through examinations

• Reduce or eliminate need for post-filing examination

• It may increase costs for both the IRS and the taxpayer during the initial phase, however, it should save time and resources for both in the long run

• Because this is a real-time process of reviewing significant transactions, the IRS risks being viewed as a tax advisor to the taxpayer

• Can the IRS effectively and efficiently deal with the more complex real-time issues, such as research and development and foreign tax credits, by the filing date?

• Will external auditors feel compelled to become more involved or collaborate on treatment of transactions with IRS auditors or the resolution thereof?

• Will the IRS and the taxpayer be able to provide appropriate resources?

• Because new programs sometimes generate unanticipated problems, can the IRS and taxpayers remain flexible and collaborative throughout the entire process?

• CAP Account Coordinators, who are the taxpayer's primary contact, are not IRS management officials. With this status, do the coordinators have the flexibility to manage the process, people, and issues to meet the real-time needs of the taxpayer and the IRS?

The Remote Examination Process (REP) is an alternative to the traditional full blown examination. The program, as planned, consists of an offsite examination of one or two pre-identified significant issues. The REP is primarily aimed at Industry Cases (IC). These companies are generally non-public companies and as such are largely outside the reach of the impact of Corporate Governance on Tax Administration (Sarbanes-Oxley). The REP, as currently envisioned, appears to include only C Corporations in Activity Codes 219, 221 and 223 (assets between $10 million and $250 million).

The LMSB Subgroup congratulates Commissioner Nolan and LMSB for this innovative program. We believe that this program will help to accomplish many of the goals of Commissioner Everson and will increase taxpayer compliance and more efficiently utilize IRS resources by increasing audit coverage, increasing currency and reducing average examination time. We believe that the program will also help the IRS achieve some of its other goals by attracting new, highly qualified employees who possess great skills but are unable to participate in the traditional forty hour workplace, such as single parents, and handicapped persons. Since this program does not require on-site visitations, it permits the development of a more flexible workplace and work schedule.

Recommendations

LMSB views the REP as one of the "breakthrough" ideas being developed to increase enforcement and to increase voluntary compliance. Accordingly, LMSB Subgroup recommends:

Recent corporate scandals such as WorldCom and Enron have resulted in new legislation, Sarbanes-Oxley, which promulgates rules and procedures that are meant to help prevent future such scandals. Sarbanes-Oxley implements a strict regime of corporate governance, part of which requires the Chief Executive Officer and the Chief Financial Officer to attest to the correctness of reported financial statements, including the numbers reported on those financial statements together with the notes thereto. It is noted that particular attention is paid to the tax provision. Companies are required to implement strict policies and procedures in an effort to publish correct financial data. The company's outside auditors are then required to attest that the company has or has not implemented the requirements of the legislation. Under this legislation, if the published financial data is not correct, severe financial and jail term penalties may be applied to the offending individuals.

It is the LMSB Subgroup's opinion that the IRS should be able to rely on this legislation to allow increased efficiency in administering the tax system. Sarbanes-Oxley generally applies to companies whose shares are listed on a US stock exchange. These are also the companies on which the IRS focuses a great deal of its audit resources.

We believe that the IRS can reduce its audit time and audit coverage of companies subject to Sarbanes -Oxley because appropriate reliance can be placed on the accuracy of published data, particularly the tax provision. We are not suggesting that the IRS ignore this population entirely, but rather implement a compliance assurance test similar to those employed by the outside auditors who sign the financial statements (CAP, discussed above, is an example of such a process). This should allow the IRS to become more current with respect to this particular population, and on an ongoing basis should allow the IRS to focus more time and resources on the examination of taxpayers that are currently not subject to audit. One might expect that taxpayers who have not been subject to audit in the past may not be in complete compliance with the tax law. Together with other initiatives of the IRS, this should result in greater audit coverage of midsized taxpayers who may be a compliance risk. The IRS should be able to refocus resources to "touch" more taxpayers and thereby improve tax compliance.

Recommendation

The IRS should leverage the Sarbanes-Oxley legislation to develop and utilize a compliance assurance process in order to reduce audit time and coverage of the largest taxpayers and reallocate resources to the mid sized taxpayer base which is not currently the focus of examinations.

The LMSB Subgroup strongly supports the IRS in its "crackdown" on abusive tax shelters and tax shelter promoters. Tax shelters are destructive to the underlying fabric of the tax system and strong administrative action is appropriate in response to abusive tax shelter activity.

The IRS has begun to take a much harder line with taxpayers who engaged in tax shelter activity. This new approach is evidenced best by the settlement offer that was made in connection with transactions described in Notice 2000-44; in order for a taxpayer to settle the case without trial, the IRS required the imposition of penalties except in the case of taxpayers who had voluntarily disclosed their tax shelter activities during the limited period provided in Notice 2002-2. Based on anecdotal evidence, we believe that the IRS is taking a similar "tough" position in its settlement discussions concerning other listed transactions.

We generally support the approach that has been taken by the IRS. Consistent application of penalties is an important aspect of tax administration. Taxpayers who engage in tax shelter activities need to know that they will have to pay penalties (and not just tax plus interest) if they are caught. The threat of penalties provides a significant deterrent to taxpayers.

We also support the imposition of penalties on tax shelter promoters. We understand that the IRS has made investigation of tax shelter promoters a priority, as it should be. The only way to inhibit future tax shelter activity is to find and penalize the persons who sell them.

We are concerned, however, that the "hard line" that has been taken with respect to taxpayer penalties may also result in a strain on the IRS's resources if the IRS is unable to settle a large percentage of individual tax shelter cases. Some individuals may have legitimate arguments that they are not subject to penalties because they relied upon tax professionals. Whether or not these arguments will be persuasive in court is not certain, so that the IRS may eventually be subject to some unfavorable decisions. This could be particularly true with respect to penalties that are imposed on unsophisticated individual taxpayers, since a taxpayer may be able to avoid penalties by claiming that he relied upon the advice of counsel.

The IRS will need to continue to focus on finding the "happy medium" in settlement guidance for tax shelter cases so as to provide incentives to taxpayers to settle cases, preserve the fundamental principle that improper taxpayer behavior must be penalized, and recognize taxpayers' rights. We believe that the IRS is aware of this tension, but continued diligence is required.

Recommendations

One of the more difficult problems raised by tax shelter cases involves how to settle them. Should there be global settlements? What role should Appeals play? Should a hearing before Appeals on a tax shelter case be barred, as such hearings were barred in the settlement concerning Notice 2000-44 transactions? Can Fast Track be used to resolve tax shelter cases? Should taxpayers who engaged in tax shelters be forced to choose between trial and complete concession?

Again, there are no clearly correct answers to these questions. We are concerned that Fast Track may not be the appropriate vehicle for the settlement of tax shelter controversies; anecdotal evidence indicates that tax shelters are rarely settled in Fast Track conferences. It may be more appropriate for the IRS to offer taxpayers the ability to go to Appeals in connection with tax shelters, although access to Appeals could be denied in those situations in which forcing taxpayers to choose between a settlement and litigation is in the best interests of the IRS (as was the perception within the IRS with respect to Notice 20004-44 transactions). Ideally, the IRS would prepare guidelines under which Appeals could resolve each type of tax shelter, taking into account the IRS's view of the law and each taxpayer's particular circumstances. Such an approach would be fair and relatively expeditious.

The most important aspect of tax shelters is to prevent them before they happen, which occurs only if the IRS targets the promoters as well as the taxpayers involved. That appears to be the approach that the IRS is taking, and we commend it. The imposition of penalties against promoters may be as (or more) important in preventing a re-occurrence of the tax shelters that emerged over the last decade as any other single step that the IRS has taken. We also believe that the focus on mid-market compliance (discussed below) is an integral aspect of this issue, because "touching" more taxpayers makes it more likely that abusive tax shelters can be identified before they spread.

Recommendations

We received limited information concerning this initiative. However, given the growth of tax shelters from a domestic to an international problem, this seems like an excellent idea. We should also encourage other countries to adopt disclosure mechanisms (as contained in our new provisions under Section 6011) so that they may be able to ferret out tax shelter strategies that are not, as of this time, known to the IRS.

The LMSB Subgroup has consistently expressed concern that the mid-market taxpayer base has gone basically un-audited for many years. The IRS has dedicated significant resources to auditing the largest taxpayers on a continuous basis, simply because they are the largest taxpayers. We continue to believe that this is not the best use of resources. We commend LMSB on their initiatives designed to improve currency and reduce cycle time, on the new auditing techniques and processes that have been developed and used such as LIFE, and on the "breakthrough" ideas that are being developed such as REP and CAP. We believe that all of these efforts should be aggressively pursued, and that they should result in the ability to reallocate resources to examine mid-market taxpayers, to "touch" more taxpayers who have historically not been "touched" by the IRS. Focusing on mid-market taxpayer compliance is a component of each of the other three issues identified as having primary importance to LMSB and covered in previous sections of this report. Re-focusing resources to this basically untouched taxpayer base should pay dividends to the IRS by significantly increasing taxpayer compliance.

Recommendation

We believe that LMSB should use all of the tools, techniques, and new processes that have been developed to free up resources and reallocate them to examining, or in some way "touching" , a significant number of mid-market taxpayers.

II. ISSUES AND RECOMMENDATIONS

ISSUE ONE: OFFER IN COMPROMISE PROGRAM

ISSUE TWO: ABUSIVE TAX SCHEMES - SHELTERS AND SCAMS

ISSUE THREE: TAX GAP

ISSUE FOUR: PARTNERSHIPS AND FLOW-THROUGH ENTITIES

ISSUE FIVE: E-SERVICES

ISSUE FIVE: THE OFFICE OF PROFESSIONAL RESPONSIBILITY

I. INTRODUCTION

The IRSAC Small Business & Self-Employed Subgroup (hereafter "SB/SE Subgroup") is comprised of tax professionals who represent tax preparers and small and medium sized businesses, having significant representation in professional organizations comprised of such preparers. Many of the current SB/SE Subgroup have had three years of experience in their capacity as Subgroup members and, during this time, have had the opportunity to become knowledgeable about SB/SE operations and programs. The SB/SE Subgroup is thankful to the IRS for arranging meetings with key leadership personnel in Washington D.C. and visits to key field locations such as the Offers in Compromise Group 10 Field Office in Austin, Texas.

An Executive Summary of our Issues and Recommendations highlights several key observations:

ISSUE ONE: OFFER IN COMPROMISE PROGRAM (OIC)

In OIC taxpayers with admitted tax debt who can't full pay ask to pay a personal maximum. In contrast are the large numbers of delinquent taxpayers that know the IRS has no effective way to collect and ignore their responsibility to settle their obligations. Year after year these "unreachable" tax receivables swell while legislative permission to engage outside collection agencies is sought. The OIC should become the model, the funnel, the vortex for pulling these citizens who ignore their tax obligations into monitored compliance and payment agreements. The SBSE subgroup has been following the progress of the OIC program for the last 3 years with the encouragement and support of the IRS. Over the last 3 years we have seen significant improvement in inventory management and cycle time.

The OIC inventory of cases has dropped from 94,931 in FY 2001 to 49,683 in FY 2004. The total OIC inventory thru June 2004, at 49,683, is at the lowest level since May 1999.

This drop in caseload is a result of the implementation of the centralized sites at Brookhaven and Memphis in July, 2001. The implementation of these Centralized OIC processing sites (COIC) along with revised, streamlined procedures in the areas of returns and financial analysis have contributed significantly to reversing the past history of growth in case inventory. Positive improvements noted are:

These actions have helped reduce cycle time and increase the number of cases that are worked. Along with the COIC sites and the processing fee the technology being used to help case building was improved and decreased the length of time that it is taking to complete cases. The result is a drop from an average 18 months in FY 2001 to 6 months in FY 2003. Congratulations IRS, this is a great accomplishment. The OIC application fee, along with the new return procedures have contributed to a 30% reduction in OICs that have to be closed as process able returns. COIC also reports that the quality of responses to additional information requests has improved considerably. The investment of field-based revenue officers into the OIC program has been reduced from almost 1100 in FY-01 to approximately 435 today.

OIC Handbook (IRM 5.8) was revised in May 2004. The revision includes considerable feedback from OIC employees, as well as other stakeholders such as TAS and Appeals. It addresses a variety of common complaints from external stakeholders and taxpayers. There are new procedures on process able returns designed to improve communication and service to taxpayers, as well as mitigate any unintended negative impact of the OIC application fee. Along with the new procedures on process able returns there is also new procedures for taxpayers who "substantially complied" to our requests for additional information, and return reconsideration procedures for taxpayers who did not respond timely due to circumstances beyond their control.

The exhibits that follow illustrate that the OIC program has made major improvements and is setting goals and achieving them.

 

1991 - 2004

 

 

 

 

October 2001 thru September 2003

 

 

 

 

October 2002 thru January 2004

 

 

 

Although the OIC program is improved there is a still concern that far too many scarce IRS resources are utilized compared to the amount of actual tax assessed and collected; particularly given the billions in receivables that remain uncollected and untouched.

ISSUE ONE: RECOMMENDATIONS

It has been said that there are two types of tax debtors -- the "can't pays" and the "won't pays." Those who seek out scams, or who fall for a shelter con artist, are gullible due to their own greed.

The IRSAC has heard a number of presentations on tax schemes. In a news release dated March 1, 2004 (IR-2004-26), the Service details in plain English the types of scams the average American is likely to stumble over. "Put it all in a trust! Deduct everything - your home, your kids, and your food. Deduct other people's kids! And deduct all your income because taxes are illegal!"

Another production, Publication 3995, was released just over a year ago. Called "Recognizing Illegal Tax Avoidance Schemes" and subtitled "Is It Too Good to Be True?" this two page document furnishes the reader with tools for critically evaluating any tax saving pitch. The reader can judge the merits and see the difference between a bona fide scam vs. tax planning with aggressive marketing by comparing the elements.

The IRSAC commends IRS on these clear, straightforward documents. They provide a valuable service to the taxpaying consumer who can fall prey to skillful marketing of fraudulent and abusive tax schemes.

For the "high end" taxpayer, IRS has provided a number of Regulations, Notices and Rulings which spell out the intricacies of some of the craftiest scams. Titles like "Lease Strips" and "Producer Owned Reinsurance Corp" and "Debt Straddles" clog the comprehension pathways of the average, middle class tax practitioner. In Notice 2003-76, the Service collected over a dozen years worth of these Abusive Transaction promulgations, and numbered them. A paragraph each was provided to describe the content. These leave the reader with the impression that abuses are only found in the LMSB world. Currently, there are 31 of them. They are listed with links to each at this address:

http://www.irs.gov/businesses/corporations/article/ 0,,id=120633,00.html

Sadly, as soon as the IRS bears down on the abusive schemes, the promoters close up shop and reopen elsewhere remarketing another tactic. They peddle watered down versions of complicated schemes to SBSE individuals and investors. Those same wordsmiths who produced the publication and the news release mentioned above need to be assigned a more detailed publication. This would be addressed to the middle class preparer who thinks that Notice 2003-76 and Form 8886, "Reportable Transaction Disclosure Statements" are not applicable to his or her practice. For instance, the very existence of a Roth IRA scam means a taxpayer with middle class income. A punch list of questions should be worked out to assist the practitioner with ferreting out the legitimate plans from those requiring disclosure and more. The practitioner needs to know that the middle class is quite capable of tools such as:

1) The IRS should improve and expand informative publications to educate taxpayers and preparers about abusive tax schemes. The practitioner needs to know that in today's world, Form TD F 90-22.1, "Report of Foreign Bank and Financial Accounts" might be the most important form they screen for. The Service should not stop there, and should translate into plain examples how schemes can be adapted to the SBSE realm. We can't just settle for the 31 nasties on an interview sheet: "You can be caught" and "it rips off every taxpayer in the country" just doesn't inspire much contrite compliance. It is more likely to be labeled as a scold with no enforcement teeth behind it. Go for the heart. Fill the remainder of this publication with true life stories. Turn, for example, to the testimony of Dale F. Brown. He testified on July 21, 2004 to the Senate Finance Committee holding hearings on Bridging the Tax Gap. Reprint his story. He explains how he was lured down the easy money path and ruined his life in the process. There are others. Their families are suffering as much or more than they are.

Dale wished that he had seen a story like his years ago, in time to reverse his course. He wished it was written up in Parade Magazine or aired on TV or radio. Unfortunately, the IRS has little budget to run public service announcements on radio or to buy prime air time during sports playoffs. Still, enough true stories posted on the IRS web site or other public venues might get the message moving.

We compliment Commissioner Everson on his brilliant telephone call to the "Car Talk" radio show. He exposed the negative issues surrounding donated cars and promoted legitimate deduction methodology. He made excellent use of his gravitas as Commissioner.

2) The Service should give taxpayers information on how to cope if they have been scammed or burned by a promoter or an unscrupulous preparer. A flowchart, some FAQ's on the Web or other quick start method would point victimized taxpayers to file complaints with the Office of Professional Responsibility or with other consumer watchdogs, such as the BBB, Attorney General or Small Claims Court.

ISSUE THREE: TAX GAP

The tax gap is the difference between what the Internal Revenue Service collects from taxpayers and what taxpayers actually owe. Recent estimates hold it to be over $311 billion annually. The overall compliance rate is now 85% and declining. This growth in noncompliance threatens the integrity of our voluntary tax system. Senator Baucus challenged the IRS on April 13, 2004 to raise the voluntary compliance rate to 90% by 2010.

The IRS Oversight Board was created in 1998 to provide long-term guidance and direction to the agency. The 2004 report listed the agency's first priority as closing the compliance gap. It commissioned a public opinion survey of taxpayer attitudes, and received the results last year. Nearly one in five taxpayers thinks occasional tax cheating is acceptable.

The National Taxpayer Advocate, in her 2003 Annual Report to Congress, called the Tax Gap the second largest problem facing taxpayers today. It costs each taxpayer $2,000 per year.

On July 21, 2004, the Senate Finance Committee held a hearing entitled "Bridging the Tax Gap." Commissioner Mark Everson was summoned to the Hill, as were Taxpayer Advocate Nina Olsen and representatives of TIGTA, GAO, and other stakeholders.

The Commissioner and the Oversight Board seek budget increases for the IRS to increase enforcement. Congress believes that more can be done by the Service to make better use of existing IRS resources, coupled with changes to the tax law.

Noncompliance types are classified in three groups. First is filing, as in non-filing and/or late filing. Second is reporting. Returns are filed with incomplete or incorrect information. Paying compliance refers to tardy and partial payments as well as non payment.

The IRS has reengineered the examination and collection processes. A virtual mosaic of new strategies are in various stages of deployment for coping with the multitude of this group. The National Research Project will also furnish sorely needed target data for areas of high noncompliance.

Self-employed taxpayers account for the largest segment of the overall tax gap; 26% of it. This amounts to $81 billion in unpaid income taxes and $51 billion in unpaid self-employment taxes. One in ten self-employed taxpayers never files; 82% of the unfiled returns have balances due. One in six pays late. In fact, they also account for half of the income tax portion of the tax gap! A full 40% of the payroll tax gap comes from Schedule C filers.

The ranks of the self-employed continue to grow. Some are the proverbial proprietors founding their own firm, making their own dream. Many more are involuntarily self-employed. They may be immigrants barred by language, experience, education or documentation. They are factory workers, whose livelihoods have been outsourced beyond our oceans, pensions and reach. They are wage earners who moonlight nights and weekends to make ends meet, or just make party money. And, they are wage earner wannabes, who get handed checks or cash (wink wink), each week, and a 1099 at years' end. They need their jobs, they want their jobs, they won't complain, and they remember how easy was to do their taxes, when the withholdings were done at work. They want help, they want it now, and they want it from the IRS Commissioner. They want help in systemic processes that makes it easy to succeed at paying their taxes. Make tax paying easy and effortless for the self-employed. Offer withholding at the source!

One can comb American history, government reports and internal service research to find many of the following ideas. Studies have shown repeatedly that withholding the tax at the source is the most effective device for proper collection. Tax withholding was first set up during the Civil War. It was discontinued after the war debts were recouped.

When contemporary wage withholding was legislated in 1942 to collect the Victory Tax, most personal service and labor earnings were in the form of wages. The growth of self-employment has eroded the success of wage withholding for income and social tax collections. Policy changes should enable all who want to pay as early as possible to do so with minimum friction. Setting up processes for the masses who will be served by withholding enablement serves two goals:

It brings in the "swing" payers who cannot budget or keep books, or who are otherwise just passive, overwhelmed or otherwise disconnected; It allows the Service to test withholding, matching, collection and filing methods prior to mandates, should they be legislated.

Currently, procedures block the ability of taxpayers who want to pay timely. Procedure and policy changes could remove compliance obstacles.

Businesses with bona fide contractors have no direct way to offer withholding as an option. Today, withholding is only available if the contractor signs, under oath, on form W-9, that he or she is subject to backup withholding. So, the contractor needs to commit perjury to work around the form language and request payer to withhold. There is no range of tax rate. No other passive option of voluntary compliance is offered! Not on the form, not in the instructions or the publications is there any voluntary, passive payment compliance opportunity. Furthermore, that W-9 stays on file forever. It is not updated annually like a W-4, which addresses withholding rate changes for employees.

The self-employed are expected to be proactive. They must gauge their annualized tax balances of both income and self-employment taxes. Then, they need to save their funds. Four preset payment dates which range from two to four months apart are presented as the only venue for fiscal compliance.

ISSUE THREE: RECOMMENDATIONS

Address the causes of non compliance, and reduce the opportunities for noncompliance! Enable and simplify voluntary payment and filing compliance!

1. Make available voluntary withholding at the source.

The IRS should make it simple for any taxpayer to withhold and prepay taxes from any income type. Streamline and encourage both sides of the process, for the payor and the payee. Then, encourage it.

2. Estimated Tax Adaptations

With EFTPS, any taxpayer can set up online voluntary Estimated Tax drafts from their bank account. Taxpayers and practitioners should be provided screen picture samples of weekly or monthly estimated tax management. Anyone with paper ES payment vouchers can pay more often than once per "quarter." IRS needs to tell some taxpayers that frequency is good, welcome and not penalized.

3. Data Mining

Touch the more compliance resistant occupations by utilizing their trade associations and their licensing authorities. Furnish timely articles for their periodicals. Speak at the conventions. Have the compliance presentations pre-qualified where possible for continuing education credit. Work with state and local governments issuing the licenses to include tax information handouts. Check the feasibility of the various trade unions carrying the message. Post notices or leave handouts with tax information, criminal referral numbers and education opportunities in malls and superstores with community bulletin boards or handout racks.

4. Tip Reporting

The public's attitude towards taxation needs to be refocused, emphasizing integrity, responsibility and commitment to the public good. Our system is voluntary. Proper voluntary compliance will maintain the integrity of the nation's tax system. Therefore, the IRS should continue to inform the public about the ways it is enforcing the law. Enforcement needs to be perceived as fair and evenhanded, and likely to occur when a taxpayer is noncompliant.

ISSUE FOUR: PARTNERSHIPS AND FLOW-THROUGH ENTITIES

The IRS is aware of the continuing rise in filings for flow- through entities. Their studies show the number of filings has risen steadily over the past 4 years from 1998 to 2002 by approximately 4% per year. The K-1 matching program was a major compliance initiative, which resulted in a high no change rate. A high no-change rate implies to the Service that its classification and selection criteria are not efficient in selecting the returns most in need of examination. Because the IRS has not increased resources for compliance for the 1065 and 1120S return types, it is important for them to have a better method of "targeting" the returns which will net a result of an increase in collectible tax. In resolving mismatches in the K-1 matching program, agents have gained a better understanding of current business practices although the process was labor intensive. They need to build automated selection models because manual selection processes are unaffordable. Past methods of identification were a DIF score used for pass through entities which is a 15 year old formula and needs to be reevaluated. The Service performed a High Income Study of individuals with Total Positive Income (TPI) in the ranges of $250K to $1million and over $1million using 4 measurement techniques and found 60% of issues were in the flow-through entities reported to these individuals. This study suggests there needs to be more compliance resources devoted to understand and plan targeted enforcement strategies for the flow- through entities.

The SB/SE Subgroup supports expanding the National Research Project into the flow-through area to get more information about current business practices and update the DIF score tabulation formulas. The SB/SE Subgroup also supports the K-1 matching program and its continuation for increased compliance.

The SBSE Subgroup suggests that high no change rates are not the only measurement to use to evaluate the effectiveness of a compliance initiative. The mere fact taxpayers got notices made them aware that flow-through entities were not exempt from examination. The resulting increase in compliance cannot be easily measured. The SB/SE Subgroup feels effective tax administration is to "Touch More Taxpayers" regardless of whether or not more tax is collected and the process will encourage more compliance. The SB/SE Subgroup supports the changes which have been made in page two of Schedule E which help to identify possible differences in matching K-1's to individual tax returns and also educates the taxpayer of the presence of the matching program. The SB/SE Subgroup also supports a uniform K-1 to better compare information reported on the K-1 form to individual taxpayer returns.

ISSUE FOUR: RECOMMENDATION

1) The SBSE Subgroup recommends continuing the current compliance initiatives. The SB/SE Subgroup would like to see more resources devoted to compliance for flow-through entities even if it means reallocating compliance resources from individual taxpayers as there is a feeling among individual taxpayers that corporations "get away" with more non-compliance than individuals do.

2) The SB/SE Subgroup supports the compliance initiative to further investigate any S-Corporation in a service type business with no wages or salaries reported on form 1120S or with an unreasonably low officers compensation reported. Other areas of possible compliance deficiencies include the following:

• Reporting of multi-year losses for an S-Corporation without basis for those losses.

• Final year issues for both partnerships and S-corporations

• Employment tax issues regarding misclassification of employees

• Invalid TIN's

• Improper classification of partners as active or passive

E-services is a suite of web-based products designed to allow tax professionals and payers to do business with the IRS electronically. E-services is an important element of the IRS Business Systems Modernization agenda and of the President's E- Government initiative. It is an essential ingredient toward the achievement of the IRS mandate of 80 percent electronically filed returns by 2007.

The SB/SE Subgroup believes that e-services has the potential to significantly improve the interaction between IRS and the tax preparing public. It will have an impact similar to that of e-pay and e-file and, quite simply, could completely change the way IRS provides service to tax professionals. Since e-services is available 24/7, tax preparers have the ability to receive needed information at any time - a vast improvement over telephone-based customer service methods, especially during the January-April tax period.

The first, basic e-services (registration, PTIN and e-file applications, TIN matching) were launched in October 2003. In the spring of 2004, IRS added important new "premium" features to e- services: Disclosure Authorization, Electronic Account Resolution, and Transcript Delivery System. While the combination of basic and premium services reduces telephone calls and provides a more cost effective, efficient experience for both IRS and e-services users, the premium services create the biggest impact. However, the premium services are available only to tax professionals who are active participants in the IRS e-file program and who e-file more than 100 individual income tax returns per year. These restrictions preclude the use of e-services by many individual income tax return preparers and by all business tax preparers and payroll processors.

Especially noteworthy is the lack of e-services for the 2,200 registered Reporting Agents. They represent the payroll provider industry that services more than one million employers with a combined total of more than 35 million employees - one third of the entire private sector workforce. By partnering with the Service, Reporting Agents have been instrumental in the development of the e- file and EFTPS systems. Nevertheless, Reporting Agents have been excluded from e-services to the detriment of both the Service and the tax paying public. In terms of cost reductions, there is a compelling case for e-services to Reporting Agents. This is a group that is computer literate and has been requesting e-services through their organizations. They would embrace e-services immediately on behalf of over one million business taxpayers and would significantly reduce IRS' resources that are devoted to the human handling of Reporting Agent inquiries.

The SB/SE Subgroup commends the Service for the e-services features that were developed this past year. Since e-services are so new, and adequate capacity and turnaround times must be ensured, it is understandable that the Service has proceeded at a measured pace in further implementations.

ISSUE FIVE: RECOMMENDATIONS

The Office of Professional Responsibility (OPR) is charged with the oversight of those who may practice before the Internal Revenue Service as defined by Circular 230. This group comprises a relatively small percentage of the approximately 1.2 million preparers. Best estimates are that between 300,000-600,000 tax return preparers are not regulated by any licensing authority. In addition, they are not subject to any minimum requirement of competency or requirement to engage in continuing professional education for their field of endeavor. Those who are licensed and so regulated by virtue of Circular 230 or by state licensing, may be punished for substandard work by OPR. The rest, who are unregulated are subject only to the civil suit process brought by their clients or criminal/civil suit brought by the Justice Department.

Fraudulent preparation, failure to sign as the paid preparer and promotion of abusive tax shelters are some of the more egregious acts of those less than qualified in the tax preparation field. Preying upon unsuspecting clientele who assume there is oversight and control of this field, is made easy under the current system. In the past OPR generally waited for the problem to be brought to them, either the taxpayer filed a formal complaint or another operating division of the Service would sometimes forward such concerns internally. OPR has developed an internal communication and action process to address the numerous issues that involve this office. The sharing of information and concerns regarding the preparer/practitioner community by internal stakeholders has been almost nonexistent. At the present OPR has recognized 68 separate areas of concern where the internal IRS process needs improvement to elevate the involvement, awareness and strengthen IRS' programs in the tax preparer/practitioner arena. The areas fall into four separate categories: a) Communications-Education and Outreach, b) Penalties, c) Fraud/Referrals/Ethics, and d) Legislation and Regulation. Within each area there are Recommendations, Resolutions, Stakeholder ownership and Status to help improve the communication process as well as the result. Of the 68 areas 58 have been addressed and completed or are of such a nature that they are ongoing. One of the areas under Communication-Education and Outreach is to encourage best practices and positive behavior of a tax preparer, as well as educating the public on choosing a preparer and the importance of a preparer's signature. The 68 internal process improvements were identified just a few months ago and are already seeing improvement. The SB/SE Subgroup fully supports this process. Elevation of the office of OPR was long overdue and will only increase overall compliance especially in the practitioner community.

The SB/SE Subgroup understands that there is an issue as to once the program is completed and functioning who should have ownership, since there are many stakeholders involved. The options are a) leave the program with OPR, b) hand the program to SB/SE, or c) give each item back to the major stakeholder.

ISSUE SIX: RECOMMENDATIONS