Tax Clinic Director Says Tax Law Simplification Would Improve Compliance

Thank you for the invitation to appear before you today as you consider measures that might be undertaken by organizations, other than the Internal Revenue Service, to improve tax compliance and reduce the "tax gap.

I am the Director of the Janet R. Spragens Federal Tax Clinic at American University, Washington College of Law. Our clinic, one of the first of its kind, is in its seventeenth year of providing representation to low-income taxpayers having controversies with the Internal Revenue Service. The clinic is a one-semester, six-credit-hour curricular offering available each semester to third-year law students. This year, twelve students are participating each semester. The students undertake supervised representation of low-income taxpayers before the Internal Revenue Service and in court as part of an experiential course. I emphasize the controversy orientation of our work; clinic students do not, as part of clinic, prepare current income tax returns for taxpayers. Students are asked, however, to undertake training and to volunteer with the VITA or Volunteer Income Tax Assistance Program as a pro bono activity outside of clinic.

The educational goals of our clinical program include the professional development of practice skills in our students as well introducing them to the meaning and importance of equal access to process and to justice.

As you know, our clinic was conceived of, and founded by, my long-time colleague, Janet Spragens, who passed away last year. Professor Spragens was a regular invitee before this Board, and I thank you for your invitation and for continuing to seek the views of our organization.

Because of the nature of our work as legal advocates in individual controversy matters, I suspect there is little direct action we are in a position, as an academic law clinic, to take to reduce the "tax gap" -- a term we understand to include owing but uncollected revenue attributable to (1) unreported income, (2) underreported income/overclaimed deductions and/or credits, and (3) underpayments of amounts reported or otherwise assessed.

We do, however, believe that programs such as ours contribute significantly to educating taxpayers about the law, educating taxpayers about "the system", educating legislators and administrators about issues and processes we perceive as requiring adjustment or correction to increase systemic fairness, etc. We also see our role as educating our clinic students to be tomorrow's tax lawyers and advisors who understand the ethics of practice as well as the importance of fairness and equity in the substantive tax rules as well as the administrative and judicial processes. These influences are critical in improving understanding of and confidence in our tax system. While understanding and confidence alone may not be enough for a healthy, compliant system, they are assuredly necessary ingredients.

I would like to address briefly the nature of our client base and the legal posture in which many taxpayers approach us for assistance. Against this background, I would like to address some of the legislative and administrative "mind the gap" proposals that have been put forth and their impact on our client base.

Low-Income Client Base. The vast majority of taxpayers coming to our clinic are wage earners with earnings reported on W-2 forms. Most have duly filed returns, and the controversies they present tend to involve family status (dependency exemptions, deductions, earned income and child tax credits, filing status, etc.); social security, pension, disability income; proceeds from litigation; itemized deductions; cancellation of indebtedness income; gambling income and offsetting losses; prizes and awards; marital status, etc. Because of the nature of the income, tax controversies tend to result from either underreporting (including questions about eligibility for claimed benefits) or underpayment.

Anecdotally, we observe that most errors made by these taxpayers are generally attributable to the sheer complexity of the law, an honest misunderstanding of facts or law, or a reliance on paid tax return preparers. Our clinic intake of wage earners includes day care aides, construction workers, bus drivers, clerks, retirees, cashiers, landscapers, janitors, repairpersons, stock room clerks, sales personnel, etc. With respect to family status issues they face, Congress has addressed a major issue of aligning the definition of a "qualifying child" for the various family status tax benefits, although the National Taxpayer Advocate has raised some fine tuning points which should be addressed. However, the law is still not susceptible of easy understanding or even easy application -- as recent studies observe that many people organize in households far different from the "traditional nuclear family." Applying complex law to complex household situations, not always contemplated by the drafters of the law, can present challenges.

The largely minimum-wage-population with whom we work turns, more often than not, to paid tax preparers. These preparers may lack basic competence or, more disturbingly, may actively promote fraudulent return preparation.

Much has been said about "overclaims" of the earned income credit; however, our experience shows that many, if not most, of the taxpayers whose credits are challenged are able to establish entitlement to all or part of the amount claimed. Moreover, we see a noticeable amount of underclaimed credits and deductions. When EICs are erroneously claimed, the probability is high that a paid preparer is involved and there is a good chance that a refund anticipation loan was involved in the return preparation.

To the extent we see individuals who have failed to file returns, they have come to us because they want to "close the gap" and catch up on delinquent filings -- either because of an IRS examination or deficiency notice or, more likely, because of their own desire to come forward on their own and fulfill their obligations. Often, they have gotten behind due to disruptive life events such as death of a loved one, severe illness or disability of the taxpayer or a loved one, unemployment, divorce, etc. At our clientele's income levels, withholding taxes generally cover the lion's share of liability. Filing returns is simply a chore that many have had difficulty tackling in a timely manner.

We also see taxpayers who are, or who are treated as, independent contractors. These individuals tend to have issues regarding their worker status in the first instance. In many cases, they appear to be low-paid, low-skilled individuals anxious for work and having little bargaining power. When they do find work having all of the characteristics of employment (other than an employer willing to fulfill its payroll tax obligations) they are often in no position to challenge an employer's mischaracterization of them as contractors. When they file returns they are unaware of the self-employment tax or, if aware, simply unable to pay it at the end of the year. For workers at this level of income and sophistication, the notion of fulfilling estimated tax payment and filing obligations may be unrealistic.

For others who are clearly self-employed (taxi drivers, handymen, painters, street vendors, etc), tax issues often focus on deductibility of expenses or substantiation of expenses. In many cases, these workers tend not to be avid recordkeepers and often rely on paid preparers as well.

Procedural Status of Cases. Until the past several years, our clients tended to have cases in IRS examination, IRS appeals, or a tax court deficiency posture. With the increased emphasis on efficiency and expediency as part of IRS modernization, the sad result is the over-acceleration of the processing of low-income taxpayer matters. The administrative process, such as it is, now takes place long distance, via computer generated correspondence. It occurs with such rapidity that many unsophisticated and non-English speaking taxpayers find that they have missed a fleeting chance to question a proposed adjustment. We have seen Notices of Deficiency issue as soon as a month or two following an April 15 filing deadline. Some taxpayers miss the court petition deadline for simple failure to open their mail in a timely manner while others may not understand the Notice.

The net effect of the streamlined administrative process is that more disputes are forced into the collections process. Many of these cases are susceptible of quick substantive resolution but for a human contact and a meaningful precollection discussion opportunity.

Accordingly, much of our clinic's work has shifted to the collections phase where taxpayers often seek audit reconsideration of the underlying liability or collection alternatives. We observe that taxpayers are often left to the discretion of the IRS to allow substantive issue review on reconsideration or to attempt substantive issue review in the collections process.

Early initiation of return examination is actually a good thing and likely saves on interest and penalties. However, early and severely abbreviated administrative review tending to leave many taxpayers behind is counterproductive. Taxpayers feel they have been denied process; they question the fairness of the system. This leads to an erosion of confidence necessary for good compliance. A fair tax system requires that the taxpayer have a meaningful opportunity to understand his or her obligations. We urge that efforts to accelerate the pre-assessment process be reexamined and that the Service squarely acknowledge the importance of meaningful opportunity for dialogue between taxpayer and examiner during the audit process.

Observations Regarding the "Tax Gap". Again, given our clinic's role representing individuals as their lawyers on particular post-filing deadline matters, we would see our role of providing free legal assistance to individuals unable to afford needed representation and our role in educating taxpayers and tax administrators as a critical enhancement of our system. We believe our contribution to closing the gap comes about through our efforts to improve understanding of, access to, and the perception of fairness about our tax system.

We are aware of numerous suggestions put forth regarding the tax gap, and we offer the following comments regarding some of the proposals, as we understand they would affect low-income earners: