Summary

Besides the burdens of high tax rates, the income tax system is too complex. The IRS has too many powers, and taxpayers too few rights.

Inflation has combined with the income tax code to make it more unfair while making it more complex. Taxpayers have found tax breaks increasingly important for their financial position.

To reduce tax compliance burdens, the following actions are essential:

• Income tax indexing must be preserved.

• Congress should take serious steps toward a simplified flat rate tax system.

• The taxpayer safeguard amendments of TEFRA must be strengthened and expanded. In particular, taxpayers should not have to prove the position of the IRS was unreasonable in order to qualify for fee awards before the Tax Court. Other key safeguards should include:

1.  Requiring a court order to levy property, but only after the IRS has exhausted other methods of collection.

2.  Requiring that installment agreements be binding.

• Requiring a Miranda type warning to advise taxpayers of their rights before an audit interview.

• Tax form simplification should not result in taxpayers paying higher taxes. Form 1040EZ and the new Form 1040A do not do enough to alert taxpayers of deductions, adjustments to income, and tax credits for which they may be eligible.

• An amnesty program should be developed to bring non-filers and those taxpayers who have not reported certain types of incomes into the system. An amnesty program would benefit the IRS by bringing new taxpayers and more income into the system, while benefiting those taxpayers who need a fresh start without worry of criminal prosecution.

Mr. Chairman, and members of the Subcommittee, thank you for the opportunity to present testimony on taxpayer compliance burdens and legislative and administrative options to provide relief. I commend the Subcommittee for taking the initiative in holding hearings on these important issues.

The National Taxpayers Union has long been concerned about the heavy burden from a tax code with excessively high rates, complexity and uncertainty. In addition to these burdens, taxpayers must contend with the Internal Revenue Service (IRS), an agency which has extraordinary powers.

Our tax system is on thin ice. Recent public opinion surveys by the Advisory Commission on Intergovernmental Relations show that the federal income tax is now perceived as the "worst tax - that is, the least fair." Tax protests by tax resisters are becoming more frequent and seem to be attracting a wider following. In the past, the problems of tax administration and tax compliance were easily papered over because tax rates for most taxpayers were not as high then. The past 20 years has changed this. Inflation has boosted taxpayers into ever-higher tax brackets, making deductions, tax credits and other tax loopholes increasingly important for taxpayer solvency.

Recent tax law changes have boosted penalties, interest, and reporting requirements, while doing little to protect taxpayers from unreasonable IRS actions or to provide for redress for unfair IRS actions. Information from the IRS, which was never easy to obtain, has been seriously slowed by recent legislation.

Tax Indexing Must Be Preserved

Income tax indexing must be preserved if we are to prevent the burdens of tax compliance from becoming heavier. There are excellent, and more important, reasons for preserving tax indexing on the basis of equity, government accountability, and economic efficiency. But income tax indexing is also important for simplicity and compliance. The "zero bracket amount" or standard deduction has been at $3,400 for joint returns and $2,300 for single returns since 1979. The Consumer Price Index is expected to rise over 45 percent between 1979 and 1984. More taxpayers are finding it worthwhile to itemize deductions, resulting in more complexity in filing and recordkeeping. 22.9 million taxpayers itemized deductions in 1977, while 31.5 million taxpayers itemized in 1981. Income tax indexing would prevent erosion in the value of the zero bracket amount and hold the numbers of taxpayers eligible to itemize relatively constant from year to year.

Income tax indexing prevents marginal tax rates from rising. As marginal tax rates rise, there is greater incentive to search for every additional dollar of deductions. Playing the audit "lottery" becomes more rewarding. Income tax indexing would prevent this situation from getting worse by keeping marginal tax rates stable.

Income tax indexing also removes an element of unfairness from the income tax system. Citizens rightly blame the federal government for causing inflation. The tax windfall that Congress reaps through the lack of income tax indexing is widely perceived to be unfair. Taxpayers in lower tax brackets commonly find that their income taxes rise at double the rate of inflation. It's the modern day version of taxation without representation.

Massive Tax Simplification Needed

Congress should continue to explore ways toward massive income tax simplification and adopt a flat rate tax such as S. 557 by Senator Dennis DeConcini. The administrative burden of complying is caused by the complexity of the tax code. A simplified flat rate tax system would make almost all of these problems a thing of the past. The Finance Committee indicated last September that it would hold additional hearings on this issue. To date, these hearings have not yet been scheduled. We hope that they soon will be.

In announcing today's hearings, the Subcommittee indicated several areas of concern, including paperwork reduction and the current regulations backlog. Progress on these two problems is hampered by the steady stream of tax legislation that has been passed by Congress recently. A moratorium on new tax legislation would allow the IRS, not to mention taxpayers, to catch up with what Congress has wrought.

Taxpayer Safeguard Amendments Must Be Improved

The IRS's powers are unprecedented among government agencies, surpassing those of the FBI, the CIA and local police. Taxpayers' rights are few and far between. Even many of those rights can be ignored if the IRS decides that tax collection is in "jeopardy."

Americans are justifiably proud of our system of justice where people are presumed innocent until proven guilty. Unfortunately, when dealing with the IRS, the system is reversed.

Little imagination is needed to see that the IRS's powers represent a tremendous potential threat to our liberties. Numerous horror stories have surfaced documenting IRS abuses. Taxpayers have been personally harassed by IRS agents in some cases. These abuses have been documented in previous hearings and in various news accounts and I will not discuss them here.

There remains little redress for taxpayers to battle unfairness. The IRS can simply assert a tax liability, knowing that it is often easier and cheaper for the taxpayer to pay than to battle unfounded IRS claims.

Last year, the National Taxpayers Union, Citizens Choice, the National Taxpayers Legal Fund, and other organizations closely worked together to identify some of the most common IRS abuses, and recommended a set of moderate, but important, reforms to be adopted by Congress. Although the National Taxpayers Union was not pleased with the overall content of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), we were pleased to see some of our recommendations incorporated in the taxpayers' safeguard amendments contained in TEFRA. Unfortunately, the most important one, award of attorneys' fees in tax litigation, was watered down to the point of being almost useless, while many of the more important reforms we recommended were not adopted.

The following provisions were adopted. First, the amount of property exempt from levy was raised, including the exemption for wages, salaries, and other income. Liens on property must now be released within 30 days once a tax liability has been satisfied or a bond has been accepted. The IRS must also, in normal situations, give notice in writing before making a levy on salary, wages or property. Property can now also be redeemed up to 180 days after sale, rather than 120 days. It also provides for compensation in case of wrongful levy.

Fee Awards: Taxpayers Should Not Have to Show The IRS Was Unreasonable

In the provision allowing for award of attorneys' fees, there requirement that the taxpayer not only substantially prevail but establish that the position of the United States in the civil proceeding was unreasonable." This is a very difficult burden of proof. The government has the facts in its control as to why it pursued its action. At the very least, the burden should be on the IRS to prove that it was not unreasonable. This small, but important, change must be made if this provision is to be an effective taxpayer protection.

We have suggested in previous testimony that a formula approach to fee awards may be worth trying. The court now must decide whether or not the taxpayer "has substantially prevailed" in the "most significant issue or set of issues" or "has substantially prevailed with respect to the amount." It would be easier and more predictable to require that awards be based on the claim made by the IRS versus the assessment left once the case has been re- solved by the Tax Court. For example, if there was a $10,000 claim by the IRS, but after litigation only a $1,000 assessment remained, the taxpayer could be said to have won 90 percent of the case, and would therefore be reimbursed for 90 percent of fees.

A Court Order Should Be Required to Levy Property

The IRS should have to obtain a court order to seize property. To obtain the order, the IRS should have to show by a preponderance of evidence that the taxpayer does indeed owe taxes to the United States. That taxpayer should also be given the right to contest the order before a court. Most important, a court order to levy property should be made only after the IRS has made a reasonable effort to enter into an installment agreement with the taxpayer and has exhausted all others methods for collection of the tax. Seizure of property is a serious step. Every effort should be made to collect the tax in the least radical way. Should seizure be necessary, the independent judgment of a court is essential to protect our citizens' basic rights.

Installment agreements agreed to by the taxpayer and the IRS should be binding, not only on the taxpayer but on the IRS. The only exception that should be permitted is where the taxpayer has clearly failed to provide adequate and accurate information concerning his financial position.

Written advice given to taxpayers by IRS employees should be binding. If the set of facts given by the taxpayer is correct, then advice rendered should be binding. When the IRS gives oral advice, the taxpayer should be informed that that advice is not binding on the IRS unless it has been put in writing. Taxpayers should be informed that oral advice cannot be guaranteed. This would not be difficult to do. It's not hard to imagine that a recording can be made for taxpayers who call the IRS telephone assistance lines. The recording could explain to the taxpayer that the oral advice is believed to be accurate but cannot be guaranteed. Alternatively, the IRS's information publications could give notice that oral advice can't be guaranteed.

Taxpayers should be allowed to have an audit at a place mutually convenient to the IRS and the taxpayer, provided it occurs within 60 days of the audit notice. Taxpayers should have the option of having the audit at the office of their attorney or other tax form preparer. Taxpayers should have the option of recording the interview. The IRS could also record the interview provided that the IRS informs the taxpayer of the recording and will make available the transcript if the taxpayer pays the cost of reproduction.

Audit Warnings Needed

The IRS should also give a warning in writing prior to the beginning of any interview stating that the taxpayer has a right to presence of an attorney or tax counselor familiar with the return. This statement should also include a Miranda-type warning that any statement made can be used against the taxpayer.

Although the taxpayer safeguard provisions in TEFRA did raise the amount of property exempt from levy, the amounts are still far too low. The exemption for personal property is a paltry $1,500 while the exemption for books or tools of a trade or profession is a mere $1,000. These limits should be raised to at least $10,000 and $6,750, respectively.

The current 30 day requirement for release of a lien is fair and reasonable time. However, the ten day notice before property is levied is not enough. If the IRS needs 30 days to release a lien, certainly the taxpayer would also need at least 30 days to seek alternatives to prevent the levy from occurring. Ten days is just not enough time to arrange for the special financial changes that may be needed.

Freedom of Information

Section 701 of the Economic Recovery Tax Act of 1981 put a big loophole in the Freedom of Information Act as it applies to the Internal Revenue Service. It said Nothing...in any...provision of law shall be construed to require the disclosure of...data used or to be used for determining [audit] standards, if the Secretary determines that such disclosure will seriously impair assessment, collection, or enforcement under the internal revenue laws. This provision was placed into law with no public hearings. As it is written, it gives the IRS a virtual carte blanche to refuse to disclose data of almost any type. A data blackout will make it virtually impossible for independent tax researchers to monitor how fair or effective the IRS is in administering our tax laws. The IRS is hardly the best judge of whether or not to disclose data that may reveal its inefficiencies or unfairness. Freedom of Information is a good principle which should apply to all federal agencies, including the IRS. We have no quarrel with preventing the disclosure of data that could harm tax collection. But the decision on what disclosures could be harmful should be made by the courts, not the IRS.

Tax Form Simplification

There is no question that tax forms need to be simplified. But simplification should not cause taxpayers to pay higher taxes. Unfortunately, Form 1040EZ is probably causing people to pay more tax than required.

The instructions for using Form 1040EZ say absolutely nothing about whether you should use Form 1040A or even Form 1040. All they say is whether you can or can not use this form. There should at least be a sentence in the instructions, preferably highlighted, saying "you may want to use Form 1040 or Form 1040A and pay less tax if you can: itemize your deductions; claim adjustments to income; claim tax credits you can't claim on Form 1040EZ."

Worse, on Form 1040A next to the box for single filing status are the words "see if you can use Form 1040EZ." This implies that single taxpayers should stop using Form 1040A and instead use Form 1040EZ if possible.

The new splashy and simplified graphics do make the short forms easier to work with. But they don't do enough to alert people to possible tax refunds or means of reducing their tax. For example, the old instructions for Form 1040A used to have a heading in bold, on page 2, titled "Who Should File a Tax Return." The paragraph that followed clearly said that even if you did not have to file a tax return "you should do so if Federal income tax was withheld from your pay, or if you can take the earned income credit. If either of these apply, you may be able to get money back from the government." The new instructions do not put this information in bold type. It is stuck at the bottom of page 3 in lighter type, has no headline and is only identified by the word "note." It is easily missed.

Other forms are slightly improved, but not significantly so. For example, Schedule A is better laid out this year than it has been in the past. Unfortunately, if you have a casualty or theft loss, you are required to file another form, Form 4864. In the past, you did not have to file a Form 4864 unless you had more than one casualty or theft loss.

Schedule SE, which has also been revised, is only slightly improved. Still, the obvious step toward simplification was not taken. The IRS should consider designing a form or worksheet for self-employed taxpayers who have no farm or partnership income.

Other worthwhile steps toward tax simplification are the creation of "safe harbors" for deductions. One example is the sales tax deduction for each state. Another example is the 20› per mile deduction for non-reimbursed automobile expenses. Also potentially helpful would be the proposed $14 deduction for business meals while away from home. But safe harbor deductions should realistically reflect a reasonable deduction and periodically be adjusted for inflation. Otherwise taxpayers will stop using them, causing additional complexity and compliance burdens for the taxpayer and the IRS.

Congress should eliminate penalties, under limited circumstances, for not paying estimated tax on time. Many retirees are penalized for not filing and paying estimated tax on time at the end of the first tax year during their retirement. Many of these people have been paying their income taxes on time for decades and some of them have never even heard of estimated taxes. Virtually all of them are willing to comply the next year but feel as if they have been unfairly treated for their mistake. I doubt that the IRS views this as being "reasonable cause" for abatement of penalty. A good solution would be to allow any taxpayer a one-time lifetime exemption for one tax year from penalty for non-timely payment of estimated tax.

Taxpayer Assistance Programs

Taxpayer assistance programs leave much to be desired. The thing that would gall most taxpayers most, if they knew, is the fact that there is a double standard in advice given. There's one quality of advice given to corporations and another given to individual taxpayers. Corporations can obtain rulings whose results are guaranteed. On the other hand, taxpayers who rely on oral or even normal written advice usually can't get a guarantee. In fact, some taxpayers have been slapped with negligence penalties for following oral IRS advice.

Amnesty Arrangements for Non-Filers

An amnesty program could benefit both the IRS and taxpayers. A properly designed amnesty program would benefit the IRS by bringing in untold billions of dollars from the underground economy into the light. The non-filer problem could be significantly reduced.

In the book "When You Owe the IRS", author Jack Warren Wade, Jr. gives an example of a taxpayer who had not filed his returns for 11 years. Once the first filing deadline passed the taxpayer became too frightened to file in the following years. Even so, he would have been owed refunds for a total of $700 for the first six years. Then for the next three years, he owed money while in the last 2 years he was again due a refund, which in this case was large enough to pay all the back taxes. That year he came in and filed the return with Wade, who was then an IRS employee. The taxpayer "admitted that this problem had been bothering him for all 11 years. He had suffered two heart attacks, an ulcer, a nervous breakdown and countless sleepless nights worrying about what would ever happen if he got caught."

No doubt there are many taxpayers who would like to surface, but are scared about what the IRS might do to them. An amnesty program would allow taxpayers to voluntarily disclose past due taxes without worrying about criminal prosecution and jail. Various penalty and interest charges would still apply.

From the taxpayers' perspective there are several key provisions that should be considered as part of any amnesty program. First, the taxpayer must be certain that no criminal prosecution would result. This certainty may require legislation, particularly if the program lasts for more than a year.

Otherwise, taxpayers may fear that the IRS could retroactively revoke the policy.

Second, there should be a requirement that the taxpayer not be contacted by the Internal Revenue Service concerning the tax return not filed or the income not reported in order to be eligible for amnesty. This is necessary to prevent the general public from thinking the program is insurance for those people who purposely evade taxes.

State and local authorities should be given time to implement similar programs. There is an exchange program between the IRS and state income tax collection agencies. An amnesty program would be far less effective if it became clear that taxpayers might be subject to criminal prosecution for not filing state and/or local income tax returns or not reporting some income on those returns.

A statute of limitations on owing tax should be considered. Some taxpayers may find it financially impossible to come forward voluntarily and pay their tax bills. There is currently a statute of limitations of six years on prosecution for failure to file a return but no limitation on owing tax. It may be worthwhile to also put a statute of limitations which limit tax liability to the six most recent years of liability, or net worth, whichever is larger. This would still enable the IRS to collect a large sum of monies owed, while not proving to be an impossible amount of tax to pay.

At the very least, the statute of limitations for obtaining a refund should be extended so that it parallels the statute of limitations on paying a tax. This would reduce the liability for those who came forward under an amnesty program as well as for future taxpayers who inadvertently let one filing deadline pass and then became afraid to file in the following years.

There is, evidently, a de facto voluntary disclosure policy which is known to sophisticated attorneys who specialize in tax fraud cases. But it's doubtful that the typical citizen is aware of such a policy. Instituting an amnesty program would end this double standard.

Mr. Chairman, I sincerely appreciate the opportunity to participate in these hearings. The National Taxpayers Union stands ready to assist you, the members of the Subcommittee, and the Subcommittee staff in reducing the burden of taxpayer compliance.

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