[House Hearing, 113 Congress] [From the U.S. Government Publishing Office] THE INTERNAL REVENUE SERVICE AND SMALL BUSINESSES: ENSURING FAIR TREATMENT ======================================================================= HEARING before the COMMITTEE ON SMALL BUSINESS UNITED STATES HOUSE OF REPRESENTATIVES ONE HUNDRED THIRTEENTH CONGRESS FIRST SESSION __________ HEARING HELD JULY 17, 2013 __________ [GRAPHIC] [TIFF OMITTED] Small Business Committee Document Number 113-030 Available via the GPO Website: www.fdsys.gov U.S. GOVERNMENT PRINTING OFFICE 81-937 WASHINGTON : 2014 ----------------------------------------------------------------------- For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC 20402-0001 HOUSE COMMITTEE ON SMALL BUSINESS SAM GRAVES, Missouri, Chairman STEVE CHABOT, Ohio STEVE KING, Iowa MIKE COFFMAN, Colorado BLAINE LUETKEMER, Missouri MICK MULVANEY, South Carolina SCOTT TIPTON, Colorado JAIME HERRERA BEUTLER, Washington RICHARD HANNA, New York TIM HUELSKAMP, Kansas DAVID SCHWEIKERT, Arizona KERRY BENTIVOLIO, Michigan CHRIS COLLINS, New York TOM RICE, South Carolina NYDIA VELAZQUEZ, New York, Ranking Member KURT SCHRADER, Oregon YVETTE CLARKE, New York JUDY CHU, California JANICE HAHN, California DONALD PAYNE, JR., New Jersey GRACE MENG, New York BRAD SCHNEIDER, Illinois RON BARBER, Arizona ANN McLANE KUSTER, New Hampshire PATRICK MURPHY, Florida Lori Salley, Staff Director Paul Sass, Deputy Staff Director Barry Pineles, Chief Counsel Michael Day, Minority Staff Director C O N T E N T S OPENING STATEMENTS Page Hon. Sam Graves.................................................. 1 Hon. Nydia Velazquez............................................. 2 WITNESSES Hon. Daniel I. Werfel, Principal Deputy Commissioner, Internal Revenue Service, Washington, DC................................ 3 APPENDIX Prepared Statements: Hon. Daniel I. Werfel, Principal Deputy Commissioner, Internal Revenue Service, Washington, DC................... 35 Questions and Answers for the Record: Questions and Answers from Hon. Sam Graves to Hon. Werfel 41 Questions and Answers from Hon. Blaine Luetkemeyer to Hon. Werfel 53 Questions and Answers from Hon. Mick Mulvaney to Hon. Werfel 53 Questions and Answers from Hon. Chris Collins to Hon. Werfel 66 Questions and Answers from Hon. Tim Huelskamp to Hon. Werfel 72 Questions and Answers from Hon. David Schweikert to Hon. Werfel 77 Questions and Answers from Hon. Tom Rice to Hon. Werfel 78 Questions and Answers from Hon. Donald Payne, Jr. to Hon. Werfel 83 Questions and Answers from Hon. Yvette Clarke to Hon. Werfel 86 Additional Material for the Record: Additional Questions and Answers from Hon. Sam Graves to Hon. Werfel..................................................... 88 THE INTERNAL REVENUE SERVICE AND SMALL BUSINESSES: ENSURING FAIR TREATMENT ---------- WEDNESDAY, JULY 17, 2013 House of Representatives, Committee on Small Business, Washington, DC. The Committee met, pursuant to call, at 1:00 p.m., in Room 2360, Rayburn House Office Building. Hon. Sam Graves [chairman of the Committee] presiding. Present: Representatives Graves, Chabot, King, Coffman, Luetkemeyer, Mulvaney, Tipton, Hanna, Huelskamp, Schweikert, Bentivolio, Collins, Rice, Velazquez, Clarke, Hahn, Payne, Meng, Schneider, Chu, and Barber. Chairman GRAVES. Good afternoon, everyone. I would like to call this hearing to order. Under the House rules, one of the responsibilities of this Committee is the study and investigation of the problems of all types of businesses, including those concerning tax issues. Today we are carrying out that duty and we are very pleased to have Acting Commissioner of the Internal Revenue Service, Mr. Werfel, here with us. Small businesses are vital to job creation and innovation in the U.S. economy, accounting for over 60 percent of new net private sector jobs. At the same time, these businesses have fewer resources than large firms to deal with an increasingly complex maze of tax laws and regulations. Over the past few years, the IRS has increased the number of small businesses that it audits. This has been explained as a way for the IRS to close the ``tax gap;'' that is, the difference between what the IRS believes is owed and what taxpayers pay voluntarily on time. We certainly support taxpayers paying what is due, and most small business owners do pay their taxes. As the IRS Taxpayer Advocate has recommended, Congress should vastly simplify the tax code to increase tax compliance. In May, the Inspector General for Tax Administration issued a report that found the IRS had used inappropriate criteria to target certain conservative organizations that sought nonprofit status. Since that time, Congressional investigations have raised additional questions about the IRS's improper targeting, and whether the IRS may have also improperly targeted the tax returns of small businesses for added scrutiny or audit. We must ensure that all taxpayers, including small businesses, are treated fairly. In May, I sent a letter to Mr. Werfel requesting information about how the IRS selects and classifies small business taxpayers for closer review and audit, the number of small businesses it audits, and the cost, duration, and yield from all of those audits. Who decides which small businesses are selected? How is the criteria developed? When does it change? And last evening, after a month delay, I did receive a letter providing responses to some of those questions, and we hope to learn more of those answers today. As elected representatives, we must make sure that our government is accountable, and restore the American people's faith in their leaders. And with that, I will now yield to Ranking Member Velazquez for her opening statement. Ms. VELAZQUEZ. Thank you, Chairman Graves. One of the focuses of this committee is to ensure small businesses are given the tools to comply with regulations without increasing their costs. No place is this more true than when it comes to taxes. In the past, small businesses have told us that complexity and uncertainty create difficulty when filing tax returns. Many business owners worry that one simple mistake can lead to a costly and timely audit, and at a time when many businesses are striving to expand, every hour and dollar counts. Small firms spend up to 66 percent more on tax compliance than their larger competitors and face constant changes to the tax code, creating further confusion and hindering job creation. They should not also have to face intense scrutiny from the IRS through business audits. Nevertheless, audits of small businesses, particularly pass- through companies, continue to rise. While the vast majority of small business taxpayers comply with tax laws, it seems they may be under increased scrutiny by the IRS, all because a few bad actors misreport their income. Seeing as our nation's fiscal constraint are an ongoing priority, I understand that closing the 450 billion tax gap is critical to our long-term prosperity, but so are small businesses. Any effort to increase tax compliance must be done in a way that is responsible, fair, and not unduly burdensome to small firms. I am grateful that the IRS commissioner took time out of his schedule to testify before us today, but it is unfortunate we are turning a relevant topic into political theater. It is my hope we can move past the unsubstantiated belief that the IRS politically targeted certain small firms and instead have a productive discussion to ensure small businesses are not unfairly harmed by overzealous auditing. Today's hearing will give us a better grasp of the amount and scope of small business audits since it is necessary to have an accurate picture of enforcement policies. I am looking forward to learning about the factors considered in deciding on an audit and about the average result. I believe this data is even more important right now as the agency seeks to be more efficient due to financial realities. We will also discuss whether the private costs and burdens of an audit are contemplated and thereby justified in light of potential revenue gains of an audit. This hearing will also allow us to examine what is being done to minimize this burden for small entities. Small firms should be able to look to the IRS for help in answering questions quickly and accurately. For this reason, it is vitally important that we encourage better taxpayer service. The agency's move to increase staff levels in its Taxpayer Assistance Program is an important step in delivering these resources, and I am also pleased to see a greater emphasis on ACA education activities. With the proper tools, America's small firms can sustain the economic growth currently underway by investing in their operations without fear of an onerous audit. With that I would like to thank Commissioner Werfel for being here today, and I yield back the balance of my time. Chairman GRAVES. Thank you. And our first witness, or obviously our only witness today, is Daniel Werfel, who is the acting commissioner of the Internal Revenue Service. Commissioner Werfel was appointed to lead the IRS in May of 2013 and prior to his appointment he held several positions with the Office of Management and Budget, including controller and the Department of Justice. Thank you for being here again and I look forward to your testimony. STATEMENT OF DANIEL I. WERFEL, PRINCIPAL DEPUTY COMMISSIONER, UNITED STATES INTERNAL REVENUE SERVICE Mr. WERFEL. Thank you, Chairman Graves, Ranking Member Velazquez, and members of the Committee. Thank you for the opportunity to appear before you today to discuss tax matters affecting small businesses. The IRS takes seriously the need to provide excellent service to small business taxpayers. This service includes helping them understand and meet their tax obligations. Our assistance takes many forms. For example, to increase understanding of changes in tax law and in filing requirements, we sponsor meetings, symposiums, and seminars for small business owners and the tax practitioner community each year. We also provide virtual assistance through our website, IRS.gov, which contains a section devoted to small businesses. It has a wealth of videos, audio presentations, and seminars on a wide range of tax topics. Even as we work to ensure that our service to small businesses meet high standards, the IRS must also carry out a rigorous enforcement program. In fiscal year 2012, the IRS audited approximately 1.65 million returns, of which 21 percent were small business returns. The 2012 small business audit rate equates to only 0.2 percent of all returns filed and 1.3 percent of all small business returns filed. In going about our work in the enforcement area, the IRS strives to ensure the taxpayers receive fair treatment. For instance, we recognize that individual taxpayers and businesses being audited may be dealing with financial hardships, and we have encouraged our employees to be flexible in these situations. One major example of our efforts in this regard is the Fresh Start Initiative. Under Fresh Start, we have added flexibility to our collection program in 2011 and 2012 to help taxpayers who are struggling financially. We are also focusing on reducing taxpayer burden through such efforts as simplifying forms and publications and streamlining policies and procedures. For example, in January of this year, we announced a simplified method for claiming the Home Office Deduction. This new option will significantly reduce the paperwork and recordkeeping burden associated with calculating the deduction. Ensuring fair treatment also involves making sure taxpayers, including small business owners, have recourse in tax disputes with the IRS. We are taking action to raise taxpayers' awareness of the tools at their disposal for resolving issues such as the Taxpayer Advocate Service. We need to be sure taxpayers know how to engage the Taxpayer Advocate Service when they feel they are being treated inappropriately or encounter excessive bureaucratic obstacles. It is important to note that all of our initiatives for assisting taxpayers depend on the IRS receiving adequate funding. It is imperative that we have the ability to continue reaching out to small business owners to provide the help they may need in meeting their tax obligations. Since fiscal year 2010, the IRS has absorbed cuts and appropriated funding that totaled nearly $1 billion or nearly 8 percent. This includes a reduction of $618 million as a result of sequestration this year. At the same time, we have made major strides in reducing costs and finding efficiencies in our operations. We estimate that we will have achieved $1 billion in budget savings and efficiencies between 2010 and 2013. But additional significant cuts to the IRS budget have the potential to weaken our ability to deliver our service and enforcement programs, including those dedicated to assisting small business owners. Before I conclude, I want to want to briefly mention the work we have been doing over the past several weeks to chart a new path forward for the IRS as these efforts are important to all taxpayers, including the small business community. We have initiated a robust action plan to address needed improvements that we believe will help restore and sustain the public's trust in the IRS. The report we released last month describes a number of important findings, aggressive actions, and next steps for the IRS. The problems with the 501(c)4 application process that were uncovered by the Treasury Inspector General for Tax Administration have created significant concerns for individuals and taxpayers, and it is incumbent upon us to take swift action to fix the problems that occurred. We are also reviewing the full range of IRS operations, processes, and practices to focus on how we deliver our mission today and how we can make improvements in the future. And that way, we will better understand organizational risks wherever they exist in the IRS. The IRS is committed to correcting the problems that have occurred and to continuing the important work of the agency on behalf of the taxpayers. Mr. Chairman, Ranking Member Velazquez, that concludes my statement. I will be happy to answer your questions. Chairman GRAVES. Thank you very much, Commissioner. You obviously do not have an easy job; that is for sure. The first question, real easy, has anyone in the IRS ever improperly targeted small businesses for additional scrutiny? Mr. WERFEL. I am not aware of improper targeting of small businesses. Let me explain the context of how I am answering that question because I think it is important. The TIGTA report that was released in May dealt in the area of 501(c)4 review. That is a particular part of the law where the political activities of the entity under the law are relevant to their application for benefit. In this case, a tax exempt status. So the IRS, it is incumbent because it is in the law. We have to do an evaluation. Now, that evaluation involves assessing the degree to which the entity is involved in political campaign intervention. And in this case, as the IG reported, the way in which that was carried out was done inappropriately. But shifting over to small businesses, as a general matter, throughout our small business--throughout the tax code and throughout our implementation efforts under the small business, it is rare or virtually nonexistent that the political activity of an entity would be relevant in terms of any increased scrutiny that we would provide. So separating the two in terms of is there a risk that what was found in the IG report transfers over to small businesses, I have two responses to that. One is the risk of inappropriate political labels being used is extremely low because political activities are not relevant to the evaluation that we do. And second, as the report that we issued last month indicates, because of the importance of the findings in the IG report and because of the public concern about those findings which I think are very well justified, we are engaging in a process right now with each of our operating divisions, including our small business and self- employed division, to review the criteria by which small businesses or any taxpayers--but in this case small businesses--are selected for additional scrutiny. To do basically a fairness review, are we doing it exactly right or is there any evidence of any problems, we will surface them. So we are going through that review right now. Chairman GRAVES. And again, I am glad you are talking obviously to the folks below you. That is what I am worried about, is if you can be sure that they are not, without your knowing it or whatever the case may be, that they are not improperly targeting those small businesses. Mr. WERFEL. I think one of the things we do is we have procedures in place for how a small business or other taxpayer may be selected for an exam, and we review those procedures on an ongoing basis, and we are going to do a special review as a result of what happened in the IG report of those procedures and those protocols, to make sure they are fair in design. They also have to be fair in implementation and effective in implementation. But that is part of it. It is about training. It is about making sure the architecture of the protocols that we use to essentially select taxpayers for additional scrutiny, is that architecture fair, reasonable, effective? And is it being carried out fair, reasonably, and effective? And we are dedicated to making sure, and I think the IG report is a helpful reminder in some ways to make sure how important it is that we are diligent about that in all areas of the IRS. Chairman GRAVES. Well, and that is obviously what I am very interested in, too, is the process of how you select, or what goes into that criteria on how you select, small businesses for additional scrutiny. I know you cannot tell us what those triggers are or what those specific items are on a tax return, but my question is when a small business is identified for further scrutiny or a tax return is kicked out based on whatever trigger that is, well, what happens then? What is the next step in that process? Mr. WERFEL. Let me start with--make sure that everyone on the Committee understands that so much of the footprint of that work in terms of reviewing returns and selecting is automated and based on a computer application. And that is helpful in a certain regard because to the extent you can take some of the human element out of it, you create a better sense of objectivity about how things may be selected. And so we have this process. We call it discriminate function or in the halls of the IRS it is called DIF for short. And it basically establishes a set of scores that based on the information that is on a return, just what is on its face, it basically gets us a risk score for potential noncompliance. And the key is how do we structure and program the DIF for what returns may be selected? And that is informed based on ongoing literature and analytics around where we have tended to see noncompliance over time. And critical to that is something called the National Research Program, which is a broader, statistically based study of taxpayer compliance across the broad spectrum of the tax code. And based on those findings, which we get periodically, we learn, okay, this is an area that is growing the tax gap because we are having areas of noncompliance here and then we can translate that into our computer program and say if you see something similar--trend, pattern, behavior--then it should be flagged for a potential audit or exam. That does not mean the taxpayer necessarily did something that was noncompliant but we need some type of mechanism to make sure our resources are most effectively following where the risks may be and that is the process. So once that is flagged then it would go into our exam phase and we would initiate a process and it could be either a field exam or a correspondence exam. We have a great many number of more correspondence exams than field exams because the correspondence exams are less burdensome on the taxpayer, less burdensome on the individual. We found over time that by sending a letter to a taxpayer informing them of certain questions or flags we see in their tax return, that can be a very effective mechanism in terms of reconciling a difference that we want understood rather than going through and sending a team of IRS people out to a particular location. Chairman GRAVES. Well, sooner or later there is a subjective component to that. I mean, somebody has to make a decision on whether or not that business is going to be audited or given further scrutiny. Who does that? What division? Mr. WERFEL. So there is a process in place. You are right. It is a combination. We have structures in place that will enable us to target our resources to higher risk areas, and what we try to do is make sure that those structures are as objective as possible based on substantive analytics, based on an automated review of returns which is becoming much and much easier and more effective as e-file numbers increase. And so we are heading into, you know, we are in there but we are really in a modern era now where we can get tax return information electronically. They come in and we can do automated reviews of them immediately. And where does the human element come in? It comes in in a couple of places. First of all, it is humans. It is IRS employees that are designing these protocols and programming the computer in terms of how it structures its risk. And then at some point when you determine a problem and you start to see that you have interacted with the taxpayer and you are starting to see how the information is arising between the problem we think may exist and the taxpayer's reaction, then the human intervention comes in to make sure that we are managing this to a successful resolution. And to make sure the process has as much integrity as possible there has to be a series of reviews and checks and balances to make sure that the technology that we are using is fairly structured and architected and that the individuals carrying out on that technology are carrying out in a fair and effective way. And we have existing mechanisms in place to do those reviews. We have an inspector general as an example who, in this one case in 501(c)4, found a major problem and now obviously we have a lot of cleanup to do and fixes to do in that area, but that also, as part of a checks and balances, has led to us now reviewing all the various procedures that I just outlined. We are now doing special additional reviews to make sure that there is fairness in the entire lifecycle. Chairman GRAVES. Is there any other reason that you know of why a small business would be targeted other than some of the things you just told us? Mr. WERFEL. I really do not. I think if the program is working as designed and as intended--and I think there is always a risk of variation, there is always a combination of a mistake that could happen, and unfortunately, there have been cases within the IRS where someone acts inappropriately and there is underlying malfeasance or misconduct. Those are rare but they happen, and I am not aware of any of that happening with respect to the selection of a small business. But what I am suggesting is that we do not have any particular evidence at this time that the objective and analytical criteria that we put in place to review small businesses for potential increased scrutiny has any fundamental flaw that would lead one to the conclusion that there was unfair targeting. I do not have any evidence of that but the review that I have asked the new chief risk officer at IRS to carry out--and by the way, that new chief officer I hired away from the Government Accountability Office and he was a leader within GAO and has a lot of knowledge and experience in terms of understanding risk and how to review these types of activities--he is the one that is leading this review. And my commitment has been--it is to this Committee and to other Committees, we want to share the results of that review with Congress because when I go back to that audit report that we have referenced, one of the concerns that I have in looking backwards at this and seeing what happened and dissecting it is that there was not enough sharing of information with appropriate committees as these risks were emerging. And so I want to change that dynamic within the IRS so that not only are we more systemically evaluating our risks on an ongoing basis, but as we are learning information we are bringing it to the attention of the appropriate committees. Clearly, the review that we do within our small business and self-employment area is highly relevant to this Committee and I look forward to sharing the results of our reviews with you so you can kind of roll up your sleeves and help us make sure that we are doing things appropriately. Chairman GRAVES. Who is it that is doing that review? Mr. WERFEL. Well, we have, again, I have a chief risk officer named David Fisher. He was my first hire when I arrived at IRS on May 22nd. Previously, the IRS had not had a chief risk officer position, and based on what I was perceiving coming into the job as this situation, I felt it needed a chief risk officer. That individual is working with our various operating division heads. So in this case, for Small Business, he will work with Faris Fink and Ruth Perez, the commissioner and deputy commissioner for our Small Business operation. Chairman GRAVES. Well, we would like to continue to work with you on that process as it moves forward. Mr. WERFEL. Absolutely. Chairman GRAVES. Ms. Velazquez. Ms. VELAZQUEZ. Thank you, Mr. Chairman. Commissioner Werfel, the Taxpayer Advocate recently conducted her own study of small business audits and that report identified geographies and industries where business owners are more likely to game the system. For instance, low compliance was correlated to taxpayers who have less trust in the government and belong to associations whose members had similar feelings. With that in mind, was there politically motivated targeting of small businesses through audits? Mr. WERFEL. Again, I do not believe--I certainly do not have any evidence of it, and I think part of the risk that created the problem with the IG report on 501(c)4 was that there was relevancy to the political activities that were going on and that created additional risk. We have to operate within that risk because that is the law. In this case, we did not manage that risk effectively and that is part of the findings. But to your point, to the extent--and that is why this is so important. To the extent that an individual or a small business or a large business has a lack of trust in the IRS, that does a lot of damage to our voluntary compliance tax system. So maintaining that trust is our bottom line, and right now we have some work to do but I would point out that one of the jobs I have in building that trust is making sure that the public, this Committee, and other committees understand the nature of the problem that we had in the tax-exempt organizations world and whether it was systemic throughout IRS. And as I have mentioned in my report, we do not have evidence that those types of issues with respect to the use of inappropriate political labels for screening is systemic throughout the IRS. There is no evidence of that but we are doing extra due diligence to look at potential other areas just to make sure that we are answering taxpayer questions. Ms. VELAZQUEZ. So let me ask you, does the IRS intend to use those findings as a blueprint for auditing specific types of businesses in certain locations around the country? Mr. WERFEL. I do not think there is any--I would have to go back. I do not believe or have specific knowledge that some of the risk factors that would be placed into our audit selection programming would involve the type of criteria that you mentioned. I will go back, but I do not believe they do. I think it is more about we do research. We randomly select as part of a statistical study tax forms and we look at them and we conduct audits of them and we learn where there is underreporting. We learn where there is underreporting of income. We learn where there may be a lack of filing or something like that. And it could be things like confusion over how to fill out a schedule. There is a whole host of reasons why you might see a material difference between what should have been reported on a tax return and what is not. And we use that study. I do not believe we use kind of the feelings about the IRS in any way, shape, or form as a basis by which to audit. Ms. VELAZQUEZ. Thank you. Commissioner, the most recent Enforcement and Service Results report revealed that returns examined by the IRS of large firms has remained pretty steady over the last few years, even as more large corporate returns were filed. Yet, audits of small businesses have increased even though fewer returns were filed. Can you please explain why more attention is given to smaller firms rather than larger companies despite the fact that there was a reduction in the small corporate returns filed? Mr. WERFEL. So I think it is something that we will have to work with you on to understand those numbers because as I understand those numbers, and Mr. Chairman, we responded to your letter and I apologize for the delay in getting that response, but the statistics that we provided to this Committee in that response show a relatively stable audit coverage rate for small businesses over the last few years. We are holding essentially steady that the audit footprint is roughly 1.4 percent of all small business returns and roughly 0.2 percent. And that is true from fiscal year 2010, 2011, and 2012. There are slight increases or decreases in the numbers, but from a macro standpoint our audit footprint over small businesses has remained relatively constant. And so I want to learn more about the data and statistics that you are referring to that point to an increase. We do not have that same information. Ms. VELAZQUEZ. I just would like to see some reconciliation between your numbers and this report. Mr. WERFEL. Yes. I think we need to work through that, the numbers. And maybe the response that I provided to the chairman can be a first step in making sure that there is a consistent understanding of what the trend might be with respect to the audit coverage on small businesses. What I am reporting to you now, based on the best information I have available, is that that audit coverage footprint has remained relatively constant between 10, 11, and 12. When you get---- Ms. VELAZQUEZ. I guess you need to do a better job at putting that out there. Mr. WERFEL. That could be true. We may need to publicize that. To the extent we can, we can certainly work with---- Ms. VELAZQUEZ. Because otherwise you are going to be hammered constantly, and the constant comment is that the IRS goes after small businesses because you need to close that gap. And that is what is out there. That is the perception. And time and again that is what people hear. Mr. WERFEL. I understand. Ms. VELAZQUEZ. As you may have already guessed, one of the most frequently asked questions from our nation's employers is how the employer mandate will affect their business. Unfortunately, we cannot adequately address their concerns because the final rules have yet to be released. Can you provide any information as to when we can expect the final rule on the employer mandate so that employers can get some certainty? Mr. WERFEL. So the employer mandate, let me comment on that. First of all, part of the challenge and approach on the Affordable Care Act implementation from the IRS's perspective, and I think from HHS's perspective, is to have a back and forth with the business community in terms of the impact of this legal impact the ACA is going to have on them. So there are a lot of moving pieces with respect to our readiness for ACA implementation. We have systems that we need to deploy. We need to get our tax filing that are relevant to the ACA ready to go, and we are making good progress and are hitting all our milestones. But also, employers have to get ready as well. And so we have an ongoing dialogue with them. And based on that ongoing dialogue regarding what the law requires and based on that what we think employers are going to need to do to meet the statutory mandate, they reached back to us and said we have concerns about the start of this occurring in year one. And we made a judgment, or the Treasury Department made a judgment call that there was a need to have a transition period before those employer requirements would trigger. In terms of the regulations, there are a lot of different regulations so I want to make sure that I am answering which question--which regulation you are asking for, but I can get you--I can do it now or I can do it later--but I can get you information in terms of what the exact schedule is on any given ACA regulation. Ms. VELAZQUEZ. Thank you. Chairman GRAVES. Mr. Rice. Mr. RICE. Thank you, sir. Thank you, Mr. Werfel, for being here today. What is your history with the IRS? Mr. WERFEL. I am a career civil servant. I joined the government in 1997 and I am coming up on my 16 year anniversary in the government. My main interaction with the IRS, prior to joining the IRS in my current capacity, was I spent a large part of my career on financial management, and in particular, efforts to reduce fraud, error, and waste in the federal government. My prior position, which is a Senate-confirmed position of controller of OMB, that is one of the main things you do at OMB as the controller--you work on government-wide efforts to reduce fraud and error. So my main interaction with the IRS was around things like EITC improper payments and things like that. Mr. RICE. In your last job, you were managing a department or a bunch of people? Mr. WERFEL. Yes. When I achieved my highest level within the Office of Management and Budget, let us say as of May of this year, I was managing somewhere between 100 and 150 people. Mr. RICE. And you achieved that in May of this year? Mr. WERFEL. Well, no, I started January of 2012, I think is when I started managing a larger footprint of people within OMB. Mr. RICE. How many people work for the IRS? Mr. WERFEL. Roughly 85,000. But I would point out, just based on your question, that one of the things about the position that I held within OMB is I had leadership responsibilities over the entire financial management community. I ran the day-to-day operations of the Chief Financial Officer's Council and coordinated the activities of all CFO offices across government. And when you are doing things like implementing the Recovery Act or preparing for a potential government shutdown, the reality is the project management of that and the scope of what I was leading was large. Much larger than just---- Mr. RICE. You know, it seems to me--I do not know you. I have only met you today and I have seen you in testimony and other things, but you seem to be a very forthright and competent guy. But man, you have stepped into a big mess here. And I sure hope that you are a good manager because they need a good manager. This entity is completely out of control as far as I can tell. You have had your past commissioner just resign. You had two directors plead the fifth in the last month. You have had disclosures. You spent $50 million on conventions at some of the worst economic downturn in United States history in the last 80 years, and disclosures that the IRS cannot even tell us what they spent because their accounting records are not that good. And at a time when we are lambasting corporate executives for money they spend on conventions and denying their deductions and lambasting them for the mode of travel they take, and yet we are spending an average of $250,000 per convention at the IRS. So this entity is completely out of control as far as I can tell. Mr. WERFEL. Can I respond to that? Mr. RICE. Okay, go ahead and respond. Mr. WERFEL. I think one of the reflections that I have, having arrived at the IRS and coming up on my two month mark, is that it is complex. There is a mixture---- Mr. RICE. Well, yes, it is complex. How many employees? Mr. WERFEL. There is a mixture--there are very, very effective managers and leaders within the IRS. There are a lot of results that I can point to at the IRS that are extremely commendable and impressive that we need to build on. And I think it is worth noting---- Mr. RICE. My friend, when you have got three of your top people either resigning or pleading the Fifth to avoid criminal prosecution in the last month, this thing is completely out of control. And somebody, some strong manager is going to have to go in there and grab control or I do not know where we are headed with this thing. Let me ask you this. Do you think they are ready to add to their responsibilities significantly? Do you think they are ready to take on the administration of the Affordable Care Act? Mr. WERFEL. I think what the IRS does is it carries out the laws that are passed and it more often than not--in fact, a great majority of the time does so effectively. When we make a mistake, it is very public and very significant and we take it seriously. We are going to be ready to implement the ACA. That I am convinced of based on everything I have seen in terms of the project plan, the schedule, the milestones we have hit. Mr. RICE. Let me reclaim my limited time. As a taxpayer and a CPA for 25 years, I can point to numerous examples where the IRS is absolutely unresponsive and incapable of handling the job that it already has. And then you add to this all these disclosures and confusions and scandals that have come out in the last three months, and I am really, really concerned about the IRS doing its existing job, much less taking on further responsibilities. Thank you very much. Mr. WERFEL. Okay. Chairman GRAVES. Ms. Hahn. Ms. HAHN. Thank you, Mr. Chairman. I just was going to follow up on the Affordable Care Act question. Clearly, the IRS has a huge role to play, but I even think before this law is rolled out and implemented, I think you have a role to play in reaching out to Americans, particularly small businesses. I hold small business workshops in my congressional district out of Los Angeles all the time, and I have done several specifically on the Affordable Care Act, what it means to small businesses, and when the tax issue comes up, you know, there is a lot of uncertainty, there is a lot of anxiety. I think there is a lot of misinformation out there, so I am happy to do my part to educate folks on the Affordable Care Act. But it is not just negative, right? There are some tax credits that are going to be very valuable to small businesses as this is rolled out. What are you all doing to partner with HHS, Small Business Administration, to help educate and possibly diffuse some of these misconceptions and anxiety that is out there, particularly as it relates to small businesses? I do not see you out there yet. Mr. WERFEL. Well, that is a good question. Certainly, let me distinguish between myself personally and the IRS team. The reason why I say that is because I was in Atlanta last week and I met--not only did I go and visit with the Wage and Investment employees in the Atlantic campus in the Atlantic region, but I also had the opportunity to meet with members of the public, members of the tax professional community, tax preparer community, university community. It was a diverse group. And one of the points that was raised to me, and it was raised in several different ways, was concerns about small business. And the reality is that in order for small businesses to maintain their competitive edge to be sustainable in today's economy, they need an effective IRS that they can work with. And we did not get perfect scores from the small businesses that I met with, but they are extremely appreciative of the important role that we play and they are very concerned about, for example, our resources and the diminution of our resources and how that impacts their ability to do a bunch of things, not only contact someone at the IRS but also the way in which we modernize our forms and our files, et cetera. So I have started that dialogue and I am finding it useful. And I think it is something useful that I can bring back to Congress, and in particular the Budget Committees, and explain that significant cuts to the IRS budget, certainly they impact the IRS but they also impact small businesses within all of your jurisdictions. In terms of the Small Business Division, they do a lot of outreach. I was very impressed with the number of symposiums and meetings, and whether they are done electronically or in- person, and obviously, the Affordable Care Act is on everyone's mind right now because it is new and because it creates a different footprint of requirements. Their tax forms are going to start looking different in the coming years and obviously there are implications for them. So we are definitively committed to having an open dialogue with small businesses and large businesses for that matter about their responsibilities under the ACA. And if there are other suggestions you have--but I think if I walked you through the series of symposiums and forms and meetings you would find them overly impressive, but you would also see that we are somewhat constrained by our resources in terms of how much we can do. Ms. HAHN. I got it. But I do think it is important and I just have not seen any of these out in the Los Angeles area. Let me just quickly follow up on one more question. More and more businesses are shifting their operations onto computer and Internet platforms, from sales to accounting, invoices, inventory tracking, and other operations. So it is more important for the IRS's e-platforms to work well. I know, again, sequestration, really, you guys have taken a big hit on that. But, and I know you face a lot of obstacles, but within the constraints that you have, what procedures are you considering to operate a more efficient tax administration system as it relates to our new emerging technologies? Mr. WERFEL. Well, I will tell you, I have a lot of budget meetings as the head of the IRS, and it is often about how are we going to apply a diminishing resource base to a growing set of responsibilities and requirements. Just to give you an example, there is a lot of concern out there from certain parts of our constituents in terms of the pace by which we are putting forms in an online way because it makes their life much easier if they can do things in a digital environment versus a paper environment. But we have resource constraints in terms of our ability to modernize those forms, and we have to make choices, like am I going to invest in modernizing this particular form or am I going to have more people at the call center so that we can improve our overall service numbers? Or am I going to keep the Taxpayer Assistance Centers open for a longer period of time so members of a local community can come in and get direct feedback on their tax questions? These are the types of issues that behind the scenes at the IRS we are grappling with. One part of the answer that I wanted to provide you is we try to make really smart decisions about these tradeoffs. So, for example, if we see a form that has usage rate of 12 percent versus a form that has a usage rate of 78 percent we are going to say, okay, well let us not digitize the 12 percent one even though there is a very loud community of concern if we do not, we are going to go with the 78 percent one. Those are the types of tradeoffs we are making behind the scenes, but ultimately, taxpayers are concerned because they are not getting the full complement of modernization and service that they are hoping for. Ms. HAHN. Thank you. Thank you. I yield back. Chairman GRAVES. Mr. Collins. Mr. COLLINS. Thank you, Commissioner. I would like to maybe rock-n-roll through a little bit of this. I am chairing the Subcommittee on Health so I get more calls from small business on the Obamacare than anything else. But I would like to begin by just asking--if you could be quick and direct that would be good--do you do your own tax return? Mr. WERFEL. I do. Mr. COLLINS. Good. A lot of people do not. When we get to the 50 workers, there is a lot of confusion. Is it 30 hours a week or 130 hours a month? Mr. WERFEL. So orient me back. You are talking about the 50 FTE cutoff? Mr. COLLINS. We have 12 buckets. Each month we create a new bucket of whether or not, you know, how many FTEs we had in January, February, March, April, May. Then we add them up, divide by 12, and see if that averages 50 or more. And a lot of companies, to set the stage, are very worried about weeks. Monday through Wednesday are in one month; Thursday through Sunday are in another month; their payroll records are by week. So right now there are 12 buckets. Each month you have to do the calculation. And people are doing it right now because I should say the employer mandate has not been eliminated. The employer mandate is the law of this country and it goes into effect January 1. And if people are going to comply, they have to be complying in about five months. You may not enforce the penalty, but that does not mean the law has been delayed. Most of the companies I talked to want to--they do not want to be lawbreakers, so you need to be able to define for them how they are not lawbreakers whether or not you enforce the penalty. So for each bucket each month, is it 130 hours in the month as opposed--so if you worked 40 hours, 42, then 26, and 12, as long as it added up to less than 130? Mr. WERFEL. I apologize. I am not going to be able to speak specifically to the tech--I can certainly get you an answer to that question but the underlying technicalities of how you would evaluate your status of having 50 FTE versus 49 FTE in terms of whether your responsibilities trigger for the employer responsibilities, that is something I am going to have to get back to you on with more technicality. I just do not have that at my fingertips. Mr. COLLINS. So the acting commissioner of the IRS does not know the rules today which we are demanding small businesses adhere to and they are lined up at my office, whether it is a donut shop or a franchise, they are desperately wanting to comply with a law that takes place January 1; the fact that you are not enforcing it until a year from January 1, it is still the law, and I am certainly disappointed that you cannot answer something. That is one of the most fundamental basic questions I had to ask. But let me keep going here. Mr. WERFEL. Please. Mr. COLLINS. If a company had a husband, a wife, and three kids under 26--so that is five full-time workers--is that one health plan they have to offer? Let us say they do not offer a health plan. Husband, wife, and three kids under the age of 26. Do they get penalized five times $2,000 or one family times $2,000? Mr. WERFEL. I mean, again, we are going to start to devolve into a situation where there is going to be a lot more facts that are going to need to be asked, and I am going to have particular subject matter expertise as the head of the IRS, the but the head of the IRS is not going to be the one doing those calculations and providing that legal and technical advice. So it is a question of how we use our resources effectively. You can go through the tax code in great detail and catch me in a lot of things that I am not going to know, especially being two months on the job, but my commitment here, what I am saying here as the acting commissioner and what I am very committed to you is making sure that your constituents or you, yourself, have the answers to those questions because I have professionals at the IRS who are ready, willing, and able to make sure that those answers are as crystal clear as possible. That is the commitment I can make as the head of IRS. Mr. COLLINS. What I would like to do after this is give you a very detailed list. Mr. WERFEL. Please. Mr. COLLINS. These are the exact questions the owners of the donut shops and small businesses, they are the exact questions they are asking because they want to comply with the law. They do not want to be lawbreakers. And it starts right now. I mean, here we are in July. This is the qualifying year, and today the IRS cannot tell them whether these employees qualify or not. How do you calculate a bonus? If I give someone a bonus, do I back that into so many hours because somebody has done well? W-2 wages, 9.5 percent of W-2. What about 401(k) deductions? Where do they enter in? These folk want to comply with the law. We cannot get any answers out of your organization. So the fact that you are not going to enforce the penalty does not mean the law does not go into effect. And I know most people, if they are driving down the street and the speed limit is 45, they adhere to the speed limit. They do not go 100 miles an hour because somebody said the state police was not going to be there. So I am very concerned because the clock is moving. Come January 1, that starts the next year so I would like to follow up with these questions and hopefully in a very prompt manner you can get them back so I can answer the questions of my desperate small business owners. Thank you. Chairman GRAVES. Ms. Meng. Ms. MENG. Thank you, Mr. Chair and Mr. Werfel for being here. The fiscal year 2014 IRS budget request provides for an increase of over 7 percent for taxpayer services. I understand better taxpayer service and education leads to higher compliance rates. Could you explain if and how this increase in taxpayer service will be used to assist our small business taxpayers? Mr. WERFEL. Yes, certainly. The reality is, not to oversimplify but to provide you kind of the basic frame, the way we think about it, two of our core basic missions are services and enforcement. And on the enforcement side, you know, we have a very robust analytic frame that shows that for every dollar that we spend on enforcement activities there is a very significant return on investment for that dollar. And so when we defund our enforcement activities, ultimately it means less receipts to the federal government and that has real deficit impact. In terms of our service levels, we invest in a whole variety of different ways to make sure that we are serving our taxpayers--small businesses in particular. Those involved, for example, our phone banks. One of the main ways in which people get answers to the questions and get peace of mind and a sense of what they need to do and cut down on the amount of time that they have to spend trying to figure out what the tax code means is calling up an IRS individual and getting them on the phone and working through the issues. And what our budgets are intended to reflect is we aim to meet certain levels of service metrics. We have metrics for everything, and our levels of service metrics are down. They are down significantly because of the inability of us to fund individuals and hire individuals to train them to be in our call centers to answer these questions. It also limits our ability to invest in web tools and other technologies so that a small business can say, well, I can either call or now the IRS has this new format on the web that makes my life a lot easier. This is great. Let me go on and access it. And when we defund the IRS we miss out on opportunities to help taxpayers navigate what I think we can all agree is a complex set of laws and regulations. And so when I am sitting here on other committees defending the president's budget, I am not doing so I think without strong analytics that tie these increases to both return on investments for the taxpayers so that more receipts come into the federal government as appropriate and we have a better situation bottom line on our deficit and that we are financing and funding the right activities within the IRS to improve our service to small businesses, to families, to corporations, et cetera. And I think we could spend time, and I am happy to do so, in terms of how the specifics of the president's 2014 budget, what that buys you in terms of improved service levels. But it is really about services and enforcement and there is a modernization element to all of it because as we improve services and enforcement, a lot of that is about investing in new technologies and make sure the IRS is along in the 21st century with other government entities and corporations. Ms. MENG. Thank you. I yield back. Chairman GRAVES. Mr. Bentivolio. Mr. BENTIVOLIO. Thank you very much, Mr. Chairman. Mr. Werfel--did I pronounce that correctly? Mr. WERFEL. You did. Mr. BENTIVOLIO. Thank you very much for being here today. You said you had 85,000 employees in the IRS, plus or minus roughly. Mr. WERFEL. There are part-time employees. There are contractors, but we usually rely on about 85,000 as a rough estimate. Mr. BENTIVOLIO. One of the prerequisites for becoming an IRS agent, if I am not mistaken, is you have to have a background in accounting. Is that correct? Mr. WERFEL. I think it depends on what type of work you are going to do. Mr. BENTIVOLIO. But pretty much accounting. Mr. WERFEL. Accounting is an important part, yes. Mr. BENTIVOLIO. Could you tell me again what you said earlier today during the introduction on the sequester? Mr. WERFEL. Yes. Mr. BENTIVOLIO. How it affected the IRS? Mr. WERFEL. Yes. Under the Budget Control Act, between the sequester and something called the 0.2 percent rescission, it is about a little over 600 million. But just the sequester itself, $594 million reduction in our budget authority for this year as a result of the sequester. Mr. BENTIVOLIO. And so how much is that in relation to your overall budget? Mr. WERFEL. It took our budget from 11.9 billion down to 11.2 billion, both the sequester and the rescission. Mr. BENTIVOLIO. What percentage would that be? Mr. WERFEL. It is in and around 8 or 9 percent. Mr. BENTIVOLIO. Eight or 9 percent. People in my district have been taking cuts of 15-20 percent. In some cases, now they have to work part-time. That is the only job they can get because, well, the employer mandate, you can only have so many hours and then they have got to kick in a lot of money. Amazing. And you cannot find a 9 percent cut in the IRS budget when you are doing all these fancy conventions and videos? Mr. WERFEL. We found the cuts. We are operating on that lower base. It is a question of making sure we are transparent about what we are giving up by operating at that lower base. And ultimately, if the powers that be decide we should operate at that lower base that will happen, but I want to make sure that we are transparent with you and the American people about what tradeoffs are involved in operating at that lower budget level. Mr. BENTIVOLIO. And in regards to picking and choosing winners and losers conservative groups, so on and so forth, you said, if I am not mistaken, you do not believe that small businesses, or any business for that matter, is being singled out because of their political beliefs in any way, shape, or form. Mr. WERFEL. What I am suggesting is that other than the TIGTA report which shelved the 501(c)4 applications, I have no other evidence at my disposal. And I do not want to speculate, but I have no other evidence of similar type of targeting of other entities. But I have asked my chief risk officer to help coordinate a review across the IRS to look at that question so I can provide a more definitive answer. Mr. BENTIVOLIO. In that review, would you employ, let us say, cross-referencing somebody who donated to a political campaign from a FEC report to whether or not their small business was audited? Mr. WERFEL. Again, I would say if there are any types of flagging of a taxpayer for additional scrutiny that was based on political activity, I think that is something that we should be extremely concerned with. Mr. BENTIVOLIO. What would raise the red flag--10 to 1? For every, you know, maybe 10 businesses because the employer or the owner of the business contributed to a campaign or was involved in some tea party group or something like that? Mr. WERFEL. A single instance of inappropriate behavior by the IRS should be flagged and addressed. I mean, we have situations in which we have employees that unfortunately at times--you know, it is 85,000 people, so we have TIGTA reports that demonstrate a situation of employee misconduct. TIGTA can write an entire report and spend a lot of resources about one instance of employee misconduct. That is important to us not only to enforce accountability for that individual and to be transparent about it, but also to make sure there is no other systemic behavior going on similar to that particular issue of misconduct. So we care about every incident. Mr. BENTIVOLIO. Okay. So you are going to check and cross- reference? Mr. WERFEL. Well, what we are going to do--well, then you are getting into the feasibility about what we can do, and what we are going to do is a variety of different steps, including evaluating the architecture of our screeners, our filters, how things are flagged for additional scrutiny. We can evaluate that architecture. We can make sure that we are documenting it, updating it frequently, benchmarking it against other parts of the IRS and other ways of looking, doing checks and balances to make sure it is appropriate. There is a whole process that we can go through that I think reflects very strong management approaches in terms of how you mitigate risk and error in your operations. It is very difficult to eliminate risk and error, but I think high-functioning organizations work on very robust and sophisticated frameworks to understand their risks and errors and put in place compensating controls to mitigate them to appropriate levels. And that is what we are engaging with in the IRS right now. Mr. BENTIVOLIO. I see I am out of time. Thank you very much. Mr. WERFEL. Thank you. Chairman GRAVES. Mr. Barber. Mr. BARBER. Well, thank you, Mr. Chairman. And thanks to you and the ranking member for convening this important hearing. And thank you, acting commissioner, for being here. And I have to say thank you for taking on this really sweet opportunity you have been given. It is always good in my mind when someone is willing to step up in the middle of a crisis and say I am going to tackle it and try to get things done. I really have to say from what I have seen and heard today and what I have seen and heard you say in other hearings, I think you are very forthright, and I believe you are doing everything you can to restore public trust in the IRS. The citizens of this country have to trust their government. And what happened at the IRS, I think we would all agree, was egregious. The behavior undermined confidence and trust. It was wrong. It has been acknowledged that it was wrong and I believe you are doing what you can to restore trust and good management. And I appreciate the fact that you have hired someone to take a look at risk who will keep an eye on those things for you. I have a couple of questions because I think it has been asked and answered, the questions related to targeting, and I am not going to go over that same territory, but I have a couple of questions related to other matters that I think impact adversely or make things difficult for small businesses. For example, recent IT reports have indicated that there is a very high rate of IRS audits that lead to no significant increase in revenue. In fact, in 2011, 62 percent of S corps cases were closed with no recorded change in revenue, and yet these audits, as you can imagine, cost affected businesses a great deal of money and time. So what steps can you take in your position as acting commissioner to ensure that small businesses are not unnecessarily audited? I mean, there has to be a cost-benefit analysis here of the amount of investment we have in audits and the end result with 62 percent cases closed without a recorded increase or change in revenue seems to me that there might be some overreaching here. So could you respond to how you might take another look at this? Mr. WERFEL. Yeah, absolutely. I think if you are going to evaluate your mechanisms to enforce compliance, you want to evaluate them across a series of different variables. One of the ones that we are obviously prioritizing right now is fairness and selection and I think that is appropriate given the IG report raised significant questions and it provides us and inspires us to want to look across the IRS and give taxpayers comfort that we are doing that review and sharing our findings and rooting out any potential areas of concern. But I think you also want to look at the effectiveness of your selection. And I mentioned earlier that we have ways of improving on a continuous basis our models for how we would select a taxpayer for audit. In a limited resource environment--this is very intuitive--in a limited resource environment, when you are trying to do your best and spend the taxpayer dollars as wisely as possible, you are going to try to target those dollars in a way that has the highest impact in terms of driving greater compliance. And if we see issues, whether it is identified by the inspector general, GAO, or internally we discover it, audits that we are doing are not resulting in any change or any additional revenue collected. And that is relevant data in terms of updating how you are going to do your selection going forward. So it is a continuous model of trying to make sure that we are as focused as we can on the areas of noncompliance because one of the goals here is to narrow the tax gap that we have because I think small businesses, they certainly do not want to be audited. They certainly do not want to be audited excessively. I completely understand that and we support that, but I think they also want to make sure that everyone is playing on the same fair ground and that if they are complying with the tax laws, which a vast, vast majority of them are voluntarily without ever having gotten audited, they want to make sure that the IRS is doing our part to make sure the other small businesses are being compliant as well on a voluntary basis. And so I think there is mutual interest in making sure that our models for how we select taxpayers for audit are effective, sophisticated, fair. And so I think we are on the same page in terms of improving not just the fairness but also the effectiveness of them. And those TIGTA reports are relevant as we go back and relook at those models. Mr. BARBER. Just a quick follow-up on that. You talked about closing the tax gap, and I agree we need to do that. So the than auditing small businesses, which may produce limited results, what other measures can the IRS take to close the tax gap? Mr. WERFEL. Well, I mean, it is in large measure around a combination of enforcement activities. What we try to demonstrate each year as we are planning and showing Congress our budget and the American people our budget, you know, these are the types of enforcement activities that we would engage in. We can do things like increase our efforts on identity theft. We can increase our computer sophistication when a return comes in in terms of identifying a return that might have fraud in it or might have an understatement of their income leading to a higher refund than they were otherwise eligible for. But remember earlier when I was answering a particular question before I said there are two arms to this. There is enforcement and services. And services are important as well because effectively serving our taxpayers does two key things. It helps them navigate the complex tax code more effectively and allows them to be compliant, but it also builds trust to the sense that they are having a positive experience, they are getting the answers they need from the IRS, we are helping them navigate. It inspires that type of voluntary compliance framework to work more effectively. So again, when we talk about our budget and the investments that we make, my goal is to just make sure that there is a substantive discussion around the tradeoffs that are involved at our different budget levels. I understand we are in a tight budget environment, and I understand that small businesses around the country are tightening their belts. We have to tighten ours. There are ways in which we are. It is a public dialogue about those tradeoffs involved in our budget. Mr. BARBER. Thank you. And thank you, Mr. Chairman, for the additional time. Chairman GRAVES. Mr. Tipton. Mr. TIPTON. Thank you, Mr. Chairman. Thank you, Mr. Werfel, for taking the time to be here. You had commented in your oral testimony about being committed to good service, having knowledge of struggling taxpayers, and trying to be able to develop policies to be able to help them. You certainly understand that the IRS is not viewed as warm and cuddly and caring. You know, it gets back to actually paying these taxes. Mr. WERFEL. I understand that. I definitely understand that. Mr. TIPTON. You know, but you followed that up with needing adequate resources to be able to help those taxpayers. We actually calculated it out. Even with sequestration, it was 5.8 percent reduction. Can you assure this Committee, can you assure this Congress, and most importantly, can you assure the American people that you are not going to have any more Star War parodies; that you are not going to have any more line dances? And you had noted that you had gone through in part of your previous life in terms of looking out for waste, fraud, and abuse in government, what is being done to make sure that we really are spending those taxpayer dollars correctly? Mr. WERFEL. I am glad you asked that question. I have a couple of responses. First, when I arrived at the IRS, what I found is that while there are incidences out there--things like videos and the expensive conference in Anaheim--and videos are okay but we want to make sure that the videos are for the appropriate purpose and at the appropriate level of funding for those videos because we use videos to train our employees. It helps us cut down on travel. There can be a lot of value to videos. But we have to eliminate our extraneous expenditures. And what I found was a lot of procedures were put in place before I arrived. The IG report that came out on the Anaheim conference, the videos that are garnering some attention were made in some cases 2010, in some cases 2011. I am not excusing them, I am just saying what has the IRS done since then and where are we today? In July of 2013, what does our footprint look like? And we do not do conferences like we did in Anaheim anymore. That is a vestige of a past. We have new controls in place around video costs and content. Again, not excusing the prior activities, and there may be more that come out that occurred in 2010, 2011 before these procedures were put in place. But what I can assure you is that strong, robust procedures have been put in place to constrain both conference spending and any spending of extraneous costs on videos, I cannot say we are at zero risk but we are at a significantly lower risk than we were previously. And that is part of the trust building with the American people, is demonstrating how we are cutting our costs in those areas. There are very impressive results in this area. Mr. TIPTON. But the bottom line, I guess, and I know you can understand this, what the American people's frustration, my frustration is, when we look at the IRS, just saying, ``Hey, we are going to correct the problem. We are sorry. It will not happen again,'' and they move on down the road, do you apply those same standards to American taxpayers? Mr. WERFEL. Again, as I said, I am not excusing the behavior. I am just providing an explanation of what steps are taken when a problem occurs. There are varying different types of mistakes and we can talk about mistakes from the IG report that led to a change in leadership at five positions within the IRS from the commissioner down to the lowest senior executive within that managerial chain. They are all---- Mr. TIPTON. Maybe we ought to move maybe to the root of the problem really because when we look at it you noted with Mr. Collins you do your own taxes. Do you do TurboTax or do you do the long form? Mr. WERFEL. I do not want to give any favorite to anybody. I use a provider. I use a software. Mr. TIPTON. You use a provider for that. Do you know how many small businesses fill out their own tax returns and send them in? Is there any kind of data on that? Mr. WERFEL. I think small businesses are roughly about 80 percent professional preparers. Mr. TIPTON. Eighty percent. How many pages are there in the tax code? Mr. WERFEL. Oh, gosh. Mr. TIPTON. Seventy thousand plus? Seventy thousand plus? Mr. WERFEL. Something like that. It is a very high number. Mr. TIPTON. If I call up the IRS today wanting to be able to pay my taxes, to be able to do it lawfully, will whoever answers that phone guarantee me that their answer is correct? Mr. WERFEL. That is not the way the process works. Mr. TIPTON. That is not the way the process works when we sign the tax return. So the IRS cannot figure it out. The IRS cannot guarantee us that they understand the policies that are in place, and yet we are trying to tell the American people you must obey the law. Does this not really call for legitimate tax reform to get a flatter, fairer, and simpler tax code and to reduce the number of employees that you would need to manage just by making it sensible for the American people to work with? Mr. WERFEL. I will answer that question. I have been asked that question numerous times. It is a very important and good question. Two things. One, as a general principle, the IRS administers whatever law Congress passes, and we rely on the Treasury Department to articulate---- Mr. TIPTON. That is not completely true though, is it, simply from the standpoint? Do you not issue rules and regulations that are not approved by Congress? It is your assumption that it meets the legislative directive? Mr. WERFEL. Right. Mr. TIPTON. But you do not come back and ask us if it meets the legislative directive. Mr. WERFEL. We get feedback if there is a concern about it but the reality is--I want to answer your original question. Mr. TIPTON. I will tell you, as a member of Congress, a lot of the frustration really is we give the feedback and it falls on deaf ears. It is kind of the assumption we are going to be here longer than you are and we are going to do it our own way. And that is the real frustration I think with a lot of the bureaucracies here in D.C. Mr. WERFEL. If that is the message you are getting that is unfortunate. We want to partner with Congress. These are not easy issues. As you mentioned, the tax code is complex. Our responsibility at the IRS is to do what we can to carry out those complexities in the most efficient and effective mechanism. Very often we are successful. There are situations in which we are not. Those situations are normally publicized and raised as significant concerns and it is all valid. I think we have the same objective. Our collective objective is to provide a fair and efficient and effective tax system for the American people. From IRS's standpoint, we do deal with a lot of complexities. We want to partner with both the public and Congress and others in terms of how we can continuously improve. We have problems. I understand that. Whether it is the conferences or the IG report, what I am here to say is not to excuse them. I am here to provide transparency on the nature of the problem, what we are doing to try to fix it, how we are holding people accountable--we can certainly talk about that--how we are fixing it, and what are our future barriers right now. What barriers do we face right now to that goal of more effective tax administration? I just want to have a dialogue about that. And we are working on solutions at the IRS right now and we want to work with you on those solutions. Mr. TIPTON. Thank you, Mr. Chairman. Far past time. Chairman GRAVES. Ms. Chu. Ms. CHU. Thank you, Mr. Chair. We know that small firms, especially those that are already complying with the tax laws, fear an audit as they are expensive and time-consuming, and I know that the average amount of time an employee spends on a correspondence audit in 2008 was 1.6 hours while for a field exam was 46.4 hours. So that is quite a difference. Does the IRS estimate the audit costs for taxpayers? And how will you ensure that increased audits do not unnecessarily burden compliance small businesses? Mr. WERFEL. Well, we certainly look at--we certainly track the duration of an audit. I do not know whether we have an information mechanism that can give us detailed costs on an audit. I mean, we would want to be sensitive to the community in terms of not asking them for information that would increase their burden in terms of having them tracking their costs for complying with a particular audit. But I think the goal here is to achieve the right footprint. What is the optimal? The audit footprint that we maintain should have the right mixture of both correspondence and field. It should have the right mixture because the audits serve multiple purposes; right? They establish a base by which a voluntary compliance system is going to work more effectively because they deter bad behavior and incentivize good behavior. But they also, if they are driven effectively by the right risk algorithms and the right analytics, can really uncover a lot of money. And I think our revenue that we brought in from the IRS based on our enforcement activities exceeded $50 billion last year. So there are multiple benefits there and I think the goal is to evaluate the various policy tensions that are involved in structuring those and making sure that we are making the appropriate adjustments, whether it is to Congressman Barber's question of making sure that if we are having fruitless audits, I mean, the shame of it would be if we did not learn from those fruitless audits and incorporate into our process going forward. And so that is the goal. These are some of the guiding principles that the IRS has. And again, there are a lot of imperfections but the objectives I think are the right objectives. And in many cases we are successful. Ms. CHU. Well, one of those big decisions for a small business is the classification of workers and it continues to be a daunting decision for many small employers as to whether to work as an employee or an independent contractor. As part of the Fresh Start Initiative, which helps taxpayers and businesses address their tax responsibilities, the Voluntary Classification Settlement Program was introduced. Can you describe this program and also tell us how successful this settlement program has been and what about the Fresh Start Initiative as a whole? Mr. WERFEL. That is a good question. One of the messages we have is about the IRS looking to work with taxpayers in a way to help them navigate our system. But it is not just complying with every letter of the law. It is, are there changes that we can make and adjustments we can make to provide increased flexibility. So if something like they owe a debt to us and they are having trouble making up that debt, we have programs in place, like you mention, like the Fresh Start Initiative that can help kind of relevel--understand the financial hardships that a particular taxpayer might be having right now; adjusting, whether it is the payment schedule or the approach we take with that taxpayer. It is one of those things--and there is also, as you mention, voluntary reports that taxpayers can come in and provide us if they think they have a concern with their taxes. We open up our doors for them to talk about it. We create, to the best of our ability, a nonthreatening environment for them to come in and go over those issues. And we work with them collaboratively on a path forward that makes sense, that gives them peace of mind but also brings them closer into compliance. It is that type of work that I think is very critical. It demonstrates that the IRS is not in a place where if it is not--every I is not dotted and T is crossed exactly the way it is supposed to be that some kind of hammer comes down. It is demonstrating that there are avenues that you can take with the IRS to work through issues. And in particular, if there is an entity or an individual with financial hardship, we have programs in place that have proven successful over the years in providing whether it is a safe harbor or a new approach for taxpayers. They are very successful. They are very popular. I am concerned about their sustainability based on budget. It is another one of those areas where I would like to present a potential tradeoff depending on our budget levels. But I think you are raising an important point about our programs and our ability to work with taxpayers in this way. Ms. CHU. Thank you. I yield back. Chairman GRAVES. Mr. Schweikert. Mr. SCHWEIKERT. Thank you, Mr. Chairman. Mr. Commissioner, in some of the discussion you have had here today you have talked about noncompliance and triggers, what sets off inquiries. I would like to do something a little bit different in some of the questions. Let us paint a scenario and then see if you can help me work through it. I am a small business and all of a sudden I have a spike in business or a crash in my business or whatever it may be, so I have more money flowing into my bank accounts. Does the IRS in their data collection see that? Mr. WERFEL. Likely, no. I mean, we do not access private bank accounts. There could be situations--we have third-party reports, like a 1099. So we might see a change in their interest income. Mr. SCHWEIKERT. So you might see depending on the model of the business because most of what we would call small businesses are going to be pass-through type entities. So there might be K1s or other types of partnerships or interlocking---- Mr. WERFEL. The nature of the changing circumstance of a particular entity depends on existing mechanisms. So, for example, we get 1099 forms that report to us, you know, things like interest income and other things. So we might have insight, and that is all about trying to use third-party data sources. Mr. SCHWEIKERT. And you are heading already where I wish to go. I am trying to understand what data accumulation the IRS collects to decide that I have a noncompliance or I have something here I need to investigate or I have someone here I need to send a letter of inquiry or someone here I need to audit. How many layers of information collection are there out there? Are you collecting from private sources? Are you collecting through regulatory sources? How does the triggering mechanisms end up working to now saying this business, something different is happening. Let us go investigate them. Mr. WERFEL. I want to keep it general because, again, there are certain parts of our business operations that are confidential. Mr. SCHWEIKERT. And that is a different discussion whether they should be confidential in the government. Mr. WERFEL. But the answer to your question, again, it is one that might not be able to be effectively answered in two minutes. It varies. We might, you know, someone might come in with information, a tip, or something like that that we would use. That could be. But a large footprint of what happens is that the taxpayer will file their tax returns and then we get information after the filing is done through third-party sources. Mr. SCHWEIKERT. Walk me through that information because you spoke earlier that much of what happens is automated in the background. That sort of indemnifies bad acts from individuals. I am now trying to understand what--not necessarily bad acts but how much data accumulation is happening. Mr. WERFEL. I will do my best. Mr. SCHWEIKERT. And it is a fair question because we all live in the databasing of America, but for you, does that databasing trigger when my constituents get audited? Mr. WERFEL. Let me answer to the best of my ability and then I might want to bring in reinforcements to help me answer. Mr. SCHWEIKERT. Okay. Mr. WERFEL. And I am going to make the assumption that the tax return is filed electronically. But even if it is not it just takes a little bit more time as we process a paper return. But there is an upfront review of the tax return that is done-- -- Mr. SCHWEIKERT. It is automated? Mr. WERFEL. Most of it is automated. It picks up on math error. It picks up on different indicators of potential fraud or error. So that happens. Mr. SCHWEIKERT. And then it is bounced against---- Mr. WERFEL. Well, then what happens is it is flagged for potential--we might not process the return immediately. If we think there is identity theft we might hold it before we just all of a sudden process the refund. Different events would occur. That is based on a data entry. I am just trying to give you the difference because there are two points. There is data entry and then there is later. Mr. SCHWEIKERT. In my last 60 seconds, and I know this is really complicated, let us go from the other side. You have third-party vendors providing you data that all of a sudden this business has a much greater velocity of deposits, withdrawals, deposits, withdrawals. Mr. WERFEL. Yes, we can get that. That information does come in. Mr. SCHWEIKERT. So it is not about what they filed; it is we are picking up something else over here. Mr. WERFEL. Well, we will run a comparison. Mr. SCHWEIKERT. But does this set off a trigger to go look at their filing? Mr. WERFEL. It could. In other words, what happens is once the filing is done and we get all the 1099 or the third-party data in, we will basically run kind of an aggregate comparison. And where we see material anomalies between what was reported on the tax return versus this other information that maybe dictates that it was a materially higher revenue amount for the taxpayer than was put on their tax return, that could trigger, for example, a correspondence. They might get a letter and they might say we want you to look at this. Mr. SCHWEIKERT. Just because I am thinking about it, as we go through certain business cycles, you know, sometimes a business gets a contract they may not be making a lot of profit on it but that contract may have a lot of in and out, in and out through their bank accounts, through their vendors, through other mechanics. Mr. WERFEL. Yes. Mr. SCHWEIKERT. Does that trigger? Mr. WERFEL. I do not know. It would depend on the circumstances. In a very general matter, we would look for a material difference between what a 1099 is telling us about income going into a particular entity and what they reported on their tax form. If we see a material difference we will flag it and we will ask the taxpayer about it, whether it is through a field exam or a correspondence exam, it will depend on the situation. Mr. SCHWEIKERT. Thank you, Mr. Commissioner. Thank you for your patience, Mr. Chairman. Chairman GRAVES. We have a series of three votes. Would you be able to stay? Mr. WERFEL. Yes. Whatever you need. Chairman GRAVES. Okay. We will recess briefly and come right back and start with Mr. Payne when we get back. And please get back as quickly as possible. We are recessed. [Recess] Chairman GRAVES. We will go ahead and bring the hearing back to order, and we will start off with Mr. Luetkemeyer. Mr. LUETKEMEYER. Thank you, Mr. Chairman. Mr. Werfel, on May 22nd we had Secretary Lew in front of us in the Financial Services Committee, and at that time I brought up to him an issue that was of concern to me with regards to the activities of the department within your agency that oversaw the--well, that Ms. Lerner was in charge of and oversaw the applications for tax exempt organizations. And in discussing those with him he said he was going to meet with you that following afternoon with your new job and give you directions on what he wanted to do and the situation you were in. One of the things I brought up to him at that meeting was that not only was it disclosed at that point that the IRS was unfairly targeting conservative groups--tax exempt conservative groups--but I wanted to make the point out to him that they were not enforcing the law against some liberal organizations. There was an instance that was brought up to me by a group within my state of some activities with regards to a particular group, and I spent three years working with Ms. Lerner to try and get an investigation of that group. Myself and the other group they are working with submitted over 3,000 documents to her and never received a single remark from her with regards to how the investigation was going, whether anything was done. And so Secretary Lew pledged to me that day that he would talk to you about that and have that be investigated and that be in the report, the 30-day report that you submitted. I did not see it in the report. Did he ask you to review that situation? Mr. WERFEL. I think one of the first things I would respond with is I have some restrictions in terms of what I can and cannot talk about with respect to an individual taxpayer because it seems that your question orients around an individual taxpayer. And delving into the specifics of the situation with that taxpayer would require a 6103 waiver or something like that. So I apologize. I do not know the answer to your question unless I can get more specifics. Mr. LUETKEMEYER. My question is did he ask you to investigate that situation? Mr. WERFEL. He asked me--maybe this is a good way of answering it--he asked me to broadly review a variety of different activities within the IRS to ensure fair enforcement. With respect to a particular activity, I do not have a recollection of him raising a particular taxpayer or a particular issue, but I have to go back and consult. Mr. LUETKEMEYER. Well, one of the concerns I have is that your report, the reports that you did over a 30-day period, does not indicate any sort of investigation or oversight or even a mention of looking at the fact that there may have been a lack of enforcement by the IRS with regards to other organizations. It would lead me to believe that there was not a follow-up or he did not ask the question. Mr. WERFEL. Let me respond in a couple of different ways. First of all, the 30-day report is a point in time. More work is needed and there is more evaluation that is underway. So to the extent that there is some topic or area that is not as robustly covered in the report that should be based on input from this Committee and others, that is something long overdue. That report was intended to set up a dialogue. Secondly, I would have to reengage with Mr. Lew to kind of remind ourselves of conversations we had two months ago. But as a general matter, because the issue involves a specific taxpayer, I may not be able to cover it in a public report. It may be something that I need to deal with, and unless you have a waiver from that taxpayer, it may be something that I cannot even articulate in specifics with you just based on what the law is, not because I do not want to help. Mr. LUETKEMEYER. Okay. Will you pledge to me today to investigate those folks if I send you a request? Mr. WERFEL. I will pledge to certainly look into it. Look into the matter. Mr. LUETKEMEYER. And respond in a timely fashion? Mr. WERFEL. I will respond to the extent I can permitted by law. Yes. Mr. LUETKEMEYER. But again, what my suggestion may be is that it may be appropriate for the taxpayer to provide a waiver so that I can talk directly about the situation with a particular taxpayer to you, which is done. Mr. WERFEL. Well, they are not going to do that because they are of a different political ilk and so they are not going to be willing to do that. That is the problem is that they are being very punitive in the way they go about their activities. They are in direct violation of something you said a while ago to a degree in which they are engaged in political activities that are absolutely in violation of their 501(c)3, I believe. Mr. WERFEL. Let me make one point since you raised the question, if I could, and that is one of the things that was in my 30-day report but as circumstances evolve it merits more discussion and attention. And I think this has been publicly reported but the facts in this case as we review more documents and talk to more people is that there is a diversity across the political spectrum of entities that were, for example, included on these lookout lists that were screened for additional scrutiny. And the reason why I am raising it is just kind of in response to the question of to the extent there was activity by the IRS that leaned in one way, aggressive scrutiny towards one end of the political spectrum and another way less aggressive scrutiny, as the facts and circumstances emerge in this case, I just want to make sure it is clear that there is a diversity across the political spectrum of entities that had issues that are covered by that TIGTA repot. Mr. LUETKEMEYER. Well, the point I am trying to make, Mr. Werfel, is this. Ms. Lerner had a political bent. She obviously was trying to be punitive in the way she looked at the conservative groups. I am saying that there is another side to this that nobody has thought about, nobody has investigated, nobody has said anything about. And that is a fact that she did not enforce the law on the other side of the political spectrum and let them get away with stuff that did not provide fair treatment to all parties who were involved in this 501(c)3 exemption. That is the point I am trying to make is there needs to be a realization and acknowledgment to the fact that she, as a member of this organization, refused to investigate it and that has to be investigated. Mr. WERFEL. I am not aware of evidence that would support your conclusion. Mr. LUETKEMEYER. It is in the file. The IRS has got it. Over 3,000 pages of documents. If you want me to send it again, I will be glad to do it. Mr. WERFEL. I am telling you I am not aware of the evidence that would support it. Mr. LUETKEMEYER. Okay. Are you willing to look into it then? Mr. WERFEL. Yes. I mean, one of my main objectives is to look into this entire situation. Mr. LUETKEMEYER. Okay. I am way over time. I will yield back but I think there is an important question that also needs to be asked today by somebody. Do you share your databases with anybody? Mr. WERFEL. We, under the law, we have certain legal responsibilities to share our data, for example, for the administration of tax purposes, yes, we share our data but we do so in a way that has an enormous number of safeguards. Mr. LUETKEMEYER. Could you share a list with the Committee of all the agencies, all the departments across government that you share your list with? And if anybody on the private sector, any third-parties get access to that information? Mr. WERFEL. I can. I can give you a head start on your answer, too, which is if you go to section 6103 there is a particular set of exceptions that dictate when the IRS can share information outside the IRS. Mr. LUETKEMEYER. Will you be willing, Mr. Werfel, to give us a list? Mr. WERFEL. Yes. Mr. LUETKEMEYER. Of every agency in state government and all the third-party contractors that collect data that you have access to and that you have sharing agreements with? Mr. WERFEL. We will do our best to provide you a comprehensive list. Mr. LUETKEMEYER. Okay. Thank you very much. Chairman GRAVES. Mr. Huelskamp. Mr. HUELSKAMP. Thank you, Mr. Chairman. I appreciate, Mr. Commissioner, for you being here today. I would like to cover a couple things that we have briefly discuss previously and want to know under what specific statutory authority was the employer mandate penalty delayed? Mr. WERFEL. I do not have the details on the legal analysis. The role of the IRS in that decision was to be consulted on the operational implications of this transitional relief period that the Treasury Department announced early in July. Mr. HUELSKAMP. And did the White House visit with you directly about that period? Mr. WERFEL. No. Mr. HUELSKAMP. And so how did you find out about it? Mr. WERFEL. It was a combination of two factors. One, the first step was that Treasury engaged IRS staff and consulted them on the, again, the administrative implications of a transitional relief period. And then I, in a subsequent meeting with the Treasury Department, learned that they were considering it. And again, the IRS footprint in this is what are the administrative implications? Mr. HUELSKAMP. In the follow up to that, in the proposal you talk about voluntarily complying. Obviously, the penalty has been suspended. The 4 in 2014 has been changed to 2015 but will there be any implications particularly for small businesses if they do not voluntarily comply? Mr. WERFEL. No. Again, the definition of small business is one that we have to make sure that we are clear on because if you have more than 50 FTE, then you have these employer reporting requirements and particular responsibilities. If you have less than 50 FTE, the situation for you as an employer is very different. But there will be no penalty. We encourage voluntary reporting but no penalty for not reporting and no responsibility payment in the first year. Mr. HUELSKAMP. Will there be any implications in terms of your algorithms in terms of selection for audit if folks do not voluntarily comply? You can guarantee that will not be part of that. Mr. WERFEL. No, I will talk to the team about it and make sure but there is no intent to do that at all. Mr. HUELSKAMP. Well, speaking of determining who receives an audit, a few weeks ago it was noted that approximately 24,000 refunds were sent to one address in Atlanta. Mr. WERFEL. Yes, I am aware of that situation. Mr. HUELSKAMP. How exactly does your algorithm ignore addresses? That does not show up? You do not compare addresses? That is not in the algorithm to determine whether or not we have some fraud going on? Mr. WERFEL. That is a very important question. And what happened there, I think there was illegally obtained taxpayer identification numbers and the way in which this individual or entity sought to defraud the government, they were able to orient those in a way that we did not pick up on it as quickly as we should have. We are learning from that experience but I agree. Mr. HUELSKAMP. Do you know how they missed it? I mean, this is not just--that is the one big instance. There are 154 different addresses that received more than 1,000 refunds to those addresses. So you do not take the address into account at all in the algorithm in determining who to audit? Mr. WERFEL. I think we do but I have to get back to you to answer the question why this particular fraud scheme alluded us. Mr. HUELSKAMP. And these folks that put this algorithm together or are investigating that, are they the same folk that will put together the Obamacare reporting system that will be implemented obviously for individuals beginning January 1st? Mr. WERFEL. Not exactly. But there will be some overlap between the work that is done in terms of our enforcement of ACA and those that would look at individuals. It depends on the nature of the ACA enforcement, but there will be some overlap. Yes. Because the way it works in the IRS is we set up by wage and investment deals with individuals, small businesses deal with small businesses, so I would have to go back and understand exactly how that Atlanta-based scheme played out and who was involved. But there could be some overlap. Yes. Mr. HUELSKAMP. Well, again, it was not just Atlanta. There were 153 other addresses. Mr. WERFEL. Yes. No, I understand. Mr. HUELSKAMP. And I want to make sure that we are clear on the IG report. I have very specific, a couple regulations that are very detrimental to small businesses. One is regulation by the IRS that will require businesses with non-audited financial statements to evaluate each and every expense over $100 to determine whether that item must be depreciated; that will kick in on January 1st. And the second one would require that any small business spending more than $100 to repair any buildings, unit, or property subject, every single expenditure over $100 up to nine different tests to determine if the amount spent is an improvement. Now, that is a mouthful. I mean, that is your mouthful, not mine. But as an absolutely ridiculous example, if a small business owner, for example, would replace a toilet in a building at a cost of $400 under this guidance, they will be forced to depreciate that toilet over 39 years for a net deduction of $10 every year. Now, there are a couple of very specific regulations coming on January 1st impacting small businesses. Can you explain the rationale behind these? Mr. WERFEL. No. What you described sounds nonsensical. I would like to look into it. Mr. HUELSKAMP. Okay. Can you provide a written response to the Committee? Mr. WERFEL. Yes. Mr. HUELSKAMP. Again, I believe one of these, perhaps both of them, were delayed for a year. And again, there is no specific, I do not believe, statutory authority, which is much different than the Obamacare penalty delay. But this is coming January 1st. I am hearing this from small businesses, and it is an absolute paperwork nightmare. I would appreciate very quick response. Mr. WERFEL. I appreciate you raising the question. Mr. HUELSKAMP. Because they are preparing for that. We are already, obviously, into the month of July and they have to start gathering this information to prepare for next January 1st. Mr. WERFEL. I appreciate you raising the concern. Mr. HUELSKAMP. I yield back, Mr. Chairman. Thank you. Chairman GRAVES. Mr. Mulvaney. Mr. MULVANEY. Thank you. Mr. Werfel, I am going to ask you a couple of questions about the revelations that came out of Senator Grassley's office in the last couple of days. Mr. WERFEL. Yes. Mr. MULVANEY. Do you know the donors or candidates whose information was supposedly improperly scrutinized? Mr. WERFEL. I talked to my staff and I think my staff spoke to the inspector general shop, so we were able to learn that information. Mr. MULVANEY. Do you intend to tell those folk that their information was inappropriate? Mr. WERFEL. I think that is consistent with the appropriate process. Mr. MULVANEY. Have you all figured out yet, I think there is a report today saying that there were several instances where the disclosure may have been inadvertent, one where it was intentional and that that was conducted by a person who was not a member of your agency? Mr. WERFEL. We have been able to confirm that the one willful, unauthorized disclosure did not occur within the IRS. Mr. MULVANEY. How is it possible that somebody who is not within the IRS had access to that information to begin with? Mr. WERFEL. It is a good question. As I mentioned earlier, there are legal frameworks, programs, and policies in place in which the IRS will share taxpayer information with other federal agencies and with state agencies. In particular, for example, for the implementation of Medicaid. These are the way the programs work. We set up safeguards to ensure that those informations are not breached. Mr. MULVANEY. But you do not think it was a hacker? You think it was somebody who was--without telling me who it was because I do not want to know who it was because that is an ongoing investigation I take it. Mr. WERFEL. That is right. Mr. MULVANEY. It is somebody that was properly given the information; they improperly shared it beyond that? Mr. WERFEL. It could be one of a number of things but it may be that you have, let us say, hypothetically an individual in a state revenue office who did not have a need to know the information but accessed it anyway. Something like that. Mr. MULVANEY. Gotcha. Mr. WERFEL. Is what we are talking about. Mr. MULVANEY. In the cases where it was inadvertently scrutinized, do you know which members of your agency participated in that? Mr. WERFEL. I do not have the full details yet, but in any case in which the IG reports that situation to us, we look into it and we make sure that we are taking the appropriate procedures to make sure that such an inadvertent disclosure does not happen again. Mr. MULVANEY. Switch with me for a second to your Internet e-mail policy. According to the 2009 IRS employee handbook, your agency says the Fourth Amendment does not protect e-mails because Internet users do not have ``a reasonable expectation of privacy in such communications.'' Especially in light of the fact that your agency is going to be overseeing or implementing large portions of Obamacare, is it still the position of the IRS that it has the right to search, collect, and review Internet or e-mail data without a search warrant? Mr. WERFEL. I think there is a Supreme Court decision on this. Mr. MULVANEY. It is a Sixth Circuit case. It is not a Supreme Court case. I am not exactly sure. Mr. MULVANEY. Would you mind letting us know in writing as to what the policy is? Mr. WERFEL. I will. I will. Mr. MULVANEY. Thank you very much. If a small business owner who also happens to be either a participant in a conservative group or a donor to a conservative group or a donor to a conservative candidate has been audited in the last say 48 months and they are naturally suspicious as to whether or not they have been targeted improperly, what is the appropriate steps for them to take to answer that question to their satisfaction? Mr. WERFEL. I would offer two, and several are taking these steps. One, if they believe it was inappropriate, they can refer the matter to the Treasury Inspector General for Tax Administration. And I believe TIGTA is receiving those and doing the appropriate investigations. Or they can go to the National Taxpayer Advocate and raise the issue. Now, the National Taxpayer Advocate is more aligned to--``not that I necessarily feel I was treated inappropriately'' but ``I am having trouble with the bureaucracy.'' So it really depends on the circumstance. But if the taxpayer believes that there was really wrongful conduct going on, they should refer the matter to the IG. If I find such an issue, I certainly would refer it to the IG and have them do the appropriate investigation. Mr. MULVANEY. So if a large donor to Mr. Huelskamp, for example, was audited for the first time in his history and is concerned that he has been targeted, you think the appropriate step is to call the inspector general? Mr. WERFEL. If the person has a basis to believe that there was something inappropriate going on, but just based on the fact pattern that you provided, it would be very difficult for the IRS to know. Mr. MULVANEY. How would they know if there is a basis? Mr. WERFEL. Well, it is a good question. But I would articulate, I mean, I think out of an abundance of caution, if they felt that they were being mistreated by the IRS, they should raise the issue. But I would also articulate that I am not sure the IRS would have that information, nor know how to influence the audit footprint. Mr. MULVANEY. Are you all worried and have talked about any potential legal liability that you may have to folks that have been targeted? Mr. WERFEL. We have several lawsuits pending as a result of the IG report that was issued in mid-May. Mr. MULVANEY. Have you budgeted for any losses related to that lawsuits? Mr. WERFEL. Well, the budgeting process around litigation loss in the government is somewhat complicated. There are judgment funds that are reserve funds that pay out for those things. So the answer to your question is I have to go back and look at how we are dealing with our litigation exposure. This would not be the first time we are under litigation and we have certain budgetary procedures in place. Mr. MULVANEY. That makes sense. And finally--and I appreciate the extra time, Mr. Chairman--I was a little bit surprised because, again, I never worked for the government-- when Ms. Lerner was asked to resign several weeks ago, she declined and then she was placed on administrative leave, I believe, with pay. Okay, this is something that is completely foreign to those of us who came up in the private sector. Why was she not fired? Mr. WERFEL. So if I could, can I lift up the discussion? Mr. MULVANEY. Sure. Mr. WERFEL. Because the Privacy Act---- Mr. MULVANEY. Better than dragging it down. Yes, go ahead. Mr. WERFEL. I have to lift it up to more generalities because the Privacy Act would preclude me from commenting on a particular employee's status with respect to a disciplinary action. Mr. MULVANEY. Understood. Mr. WERFEL. But let me say this. It is a good question, and I am glad you raised it. There are very specific laws and regulations in place that govern civil servant employment--how you hire them, how you pay them, how you potentially separate from the government from them, whether it is retirement, buyout, or a disciplinary action leave. And what we do in the IRS and what I am making sure that we do is to the extent appropriate we will take the most aggressive possible action we can where we believe an individual can no longer hold a position of trust within this agency. And that is generally the steps we take. Now, there is a process, a due process that goes on and it was built to protect federal employees for a whole variety of different reasons, and there is probably a valid public policy debate we could have on those rules where if you have concerns that an individual can no longer hold the position of public trust within the government, the first step in that process is to place them on leave--it is paid leave--while you build the record and give them a chance to respond to that record about what the ultimate disposition of their employment should be. The rules and regulations are just set up that you default while that discovery is being done and while that due process is being done, the individual is paid. It would be a violation of the law for me in a situation where I felt that an individual could no longer hold the position of public trust to move to immediate termination. There are circumstances where you can do it but it has to do with criminal violations. Mr. MULVANEY. Just to wrap up and try to bring it back to Ms. Lerner, is that due process still ongoing or have you all made a determination as to whether or not she is able to stay with the organization within a position of trust? Mr. WERFEL. I cannot comment on that particular situation. I will say that as a general---- Mr. MULVANEY. You can tell me if it is still ongoing or finished, can you not, without telling me any of the details? Mr. WERFEL. No. I can tell you in a setting that is not public. I can share that information. Mr. MULVANEY. Is she still employed by the IRS? You can tell me that. Mr. WERFEL. Yes, she is still employed by the IRS. Mr. MULVANEY. Thank you, Mr. Chairman. I appreciate the additional time. Chairman GRAVES. Thank you very much. And with that I want to thank acting commissioner Werfel for being here today. We are going to continue to monitor the IRS and its treatment of small businesses. And I appreciate the fact that you designated Faris Fink as our point person and included us as a part of this review process that you are talking about. He is obviously the commissioner of Small Business and Self-employed Division and we want to interact with him. In addition, we are also going to have some questions. There will be Committee members on both sides of the aisle that will have questions and I want you to commit to respond to those in a timely manner and as quickly as possible and as fully as possible. With that, I would ask unanimous consent that members have five legislative days to submit statements and supporting materials for the record. Without objection, that is so ordered. And with that the hearing is adjourned. Thank you. [Whereupon, at 3:33 p.m., the Committee was adjourned.] A P P E N D I X WRITTEN TESTIMONY OF DANIEL WERFEL PRINCIPAL DEPUTY COMMISSIONER INTERNAL REVENUE SERVICE BEFORE THE HOUSE SMALL BUSINESS COMMITTEE ON THE IRS AND SMALL BUSINESSES: ENSURING FAIR TREATMENT JULY 17, 2013 Introduction Chairman Graves, Ranking Member Velazquez and Members of the Committee, thank you for the opportunity to appear before you today to discuss tax matters affecting small businesses. The mission of the IRS in regard to small businesses, and indeed to all taxpayers, is to provide quality service by helping them understand and meet their tax responsibilities, and to enforce the law with integrity and fairness to all. The IRS takes seriously the need to provide excellent service to small business taxpayers. Small businesses and self- employed taxpayers in the U.S. are vital to our country as engines of economic growth, and the IRS needs to do its part to ensure that they can move full speed ahead and flourish. This assistance takes a number of forms to help taxpayers avoid unintentional errors in attempting to comply with the tax laws. Small businesses, from sole proprietors who file Form 1040 with a Schedule C to small corporations and partnerships, continually must face the task of familiarizing themselves with complex aspects of the tax code. Some of these provisions change from year to year, making it important for taxpayers to update their understanding each year. Assisting taxpayers with questions before they file their returns prevents inadvertent errors and reduces burdensome post-filing notices and other correspondence from the IRS. The IRS believes it is important to conduct outreach to small businesses on changes to the tax law and the latest in filing requirements. The operation of this outreach reflects the widespread use of tax professionals by small business owners. Because the vast majority of small businesses and self- employed individuals use professional return preparers, the IRS partners with thousands of industry and small business organizations, including minority-owned business associations, tax professional and payroll associations and other government agencies to extend and amplify our outreach and education efforts. A major component of our outreach efforts involves the meetings, symposiums and seminars we sponsor for small business owners and the tax practitioner community each year. In FY 2012, the IRS held more than 2,000 of these events, which were attended by more than 163,000 business owners and tax professionals. Increasingly, the IRS is employing technology to reach small business owners and help them fulfill their tax obligations. Our website, IRS.gov, includes a section that is devoted to small businesses and contains a wealth of videos, audio presentations and webinars on a wide range of tax topics, such as employment taxes, electronic filing and retirement plans geared toward small business. We also assist business taxpayers by operating a special toll-free telephone line dedicated to small businesses, corporations, partnerships and trusts. Callers can get help with, for example, business returns or business accounts, employer identification numbers and federal tax deposit issues. A separate toll-free line for practitioners is staffed by IRS representatives specially trained to handle their questions and resolve their clients' account-related issues. IRS-published products are also important resources for small business taxpayers. These include the Tax Calendars which provide highlights on tax topics, resources, instructions and important dates. Our electronic publication, e-News for Small Businesses, includes the latest IRS news releases and announcements. The quarterly SSA/IRS Reporter is a collaborative effort with the Social Security Administration that provides information on payroll taxes and other employee issues. IRS Enforcement Programs Even as we seek to ensure that our service to small businesses meets high standards, the IRS also must carry out a rigorous enforcement program. This includes administering a balanced examination program that helps ensure that taxpayers accurately report their income, deductions and credits. This also includes administering our collection program, which seeks to collect assessed tax liabilities. The IRS collected more than $50 billion in total enforcement revenue in Fiscal Year (FY) 2012, the third year in a row the enforcement revenue exceeded that level. The amount collected in 2012 was actually lower than in 2011 and 2010, for a number of reasons. For example, the economic slowdown contributed to lower enforcement figures, as most enforcement dollars collected resulted from audits of returns for years during the slowdown. Another factor behind the FY 2012 numbers reflected changes in agency staffing and budget resources. After a nearly flat budget in FY 2011, the IRS' FY 2012 budget was reduced by $305 million. This reduction affected the level of staffing available to deliver service and enforcement programs. Overall full-time staffing has declined by more than 8 percent over the last two years, and staffing for key enforcement occupations fell nearly 6 percent in the past year. In 2013, the IRS absorbed an additional $618-million reduction in its budget due to sequestration, which will have further negative impacts on IRS performance, including performance in enforcement programs. In FY 2012, the IRS audited approximately 1.65 million returns, of which 21 percent were small business returns. For FY 2011 the percentage was 22 percent, and for FY 2010, 21 percent. This group includes filers of Schedule C and Schedule F, along with small corporations, S corporations and partnerships. The 2012 small business audit rate equates to only 0.2 percent of all returns filed, and 1.3 percent of small business returns filed. In conducting its examination program, the IRS uses a variety of techniques to focus exam resources on the areas of greatest compliance risk. As returns are processed, a majority of them are scored by a computer program for compliance risk, with a higher score indicating a higher probability that a change will be recommended during an examination. While the computer score is the most frequent reason for selecting a return for examination, there are other reasons a return may be selected. These include the need to reconcile what is reported on a taxpayer's return with third-party information provided on forms such as W-2s or 1099s. In addition, a small business may be randomly selected for audit under our National Research Program. The results from examinations conducted under this program are used for research purposes. The information gained from these audits helps us improve our audit selection criteria and update our estimates of the tax gap, which is the amount of taxes owed but not paid on time. The type of audit a taxpayer may undergo depends on the number and complexity of issues involved. A single issue questioned on a return will generally give rise to a correspondence audit, while multiple issues will likely result in a face-to-face exam. For all exams, the average additional tax recommended in FY 2012 was $23,345. Within that total, the average additional tax recommended for self-employed individuals was $11,880 and for small corporations, $28,988. For all taxpayers, the average cost to the IRS of a correspondence exam in FY 2012 was $400, compared with $324 in FY 2010. The average cost of a field exam to the IRS in FY 2012 was $6,232, down from $7,248 in FY 2010. Ensuring Fair Treatment for Small Business Taxpayers In going about our work in the enforcement area, the IRS realizes that many small businesses face substantial economic challenges, even as the economy recovers. We have worked diligently to communicate to our employees the importance of recognizing that individual taxpayers and businesses being audited may be dealing with financial hardships, and we have encouraged our employees to be flexible in these situations. Increasing our employees' flexibility allows them to respond appropriately to taxpayers with financial troubles. Even as our economy recovers, too many small business owners continue to struggle to make their payrolls, secure lines of credit, contribute to their employees' retirement plans and stay current with their taxes. For that reason, we will continue to make sure that our employees have the guidance and the discretion they need to assist small businesses with the service they need and deserve. One major example of our efforts to help individuals and small business owners in this regard is the Fresh Start initiative, which began in 2011. Under this initiative, we have increased flexibility in our collection program to help taxpayers who are struggling financially. For example, we made it easier for taxpayers to obtain lien withdrawals after paying back taxes owed, and allowed liens to be withdrawn when a taxpayer signs a Direct Debit Installment Agreement (DDIA). Another provision helps more small businesses get access to Installment Agreements if they sign up for a DDIA and have less than $25,000 in unpaid taxes. We also changed our rules for Offers in Compromise (OIC) so that more taxpayers could qualify for a streamlined OIC. We have continued to refine the Fresh Start initiative, and further increased flexibility in our collection program in 2012. This includes easing failure-to-pay penalties for unemployed taxpayers, and expanding our Allowable Living Expenses (ALE) standard. The standard is used to provide taxpayers a fair and consistent amount to live on while they repay tax debts. As part of our work to ensure fair treatment for small business taxpayers, we continue our focus on taxpayer burden reduction, through such efforts as simplifying forms and publications and streamlining policies and procedures. For example, as part of our effort to implement Executive Order 13610, ``Identifying and Reducing Regulatory Burdens,'' in January 2013 we announced a simplified method for claiming the home office deduction. This new option is expected to help owners of home-based businesses by significantly reducing the paperwork and recordkeeping burden associated with calculating the deduction for business use of a home. Another aspect of ensuring that small business owners receive fair treatment involves ensuring that they have recourse in tax disputes with the IRS. It is important to note that my plan of action for improving IRS operations, which I will describe in more detail later in my testimony, includes enhancing mechanisms for taxpayer recourse. The IRS does have the Taxpayer Advocate Service (TAS) to assist taxpayers having difficulty resolving issues with the IRS, but we concluded in our recent report that these mechanisms are not well understood by taxpayers and therefore are not being sufficiently leveraged. Therefore, we are taking action to raise taxpayers' awareness of their rights and of the tools at their disposal for resolving issues, such as TAS. We need to be sure that all IRS employees are aware of their responsibilities with respect to ensuring taxpayers know their rights, and in particular, ensuring that taxpayers know how to engage TAS when they feel they are being treated inappropriately or are encountering excessive bureaucratic obstacles. The IRS leadership is committed to working with the National Taxpayer Advocate to evaluate the training provided to all IRS employees in this regard and modify it, as appropriate, to make necessary improvements to fill whatever gaps may exist in the current process or actual behavior. It is important to note that all of the outreach, education and burden-reduction initiatives I have described in my testimony depend on the IRS receiving adequate resources to fund them. It is imperative that we be able to continue to reach out to small business owners to help them file income and payroll taxes, understand tax law changes and seek help from us in cases of financial hardship. The IRS has absorbed significant cuts in our budget in the last few years, and we have made major strides in reducing costs and finding efficiencies in our operations. Additional significant cuts to the IRS budget have the potential to weaken our ability to deliver our service and enforcement programs, including those dedicated to assisting small business owners. Charting a Future Path for the IRS Before concluding my testimony, I want to give the Committee a brief overview of the work we have been doing over the past several weeks to chart a new path forward for the IRS, as these efforts are important to all taxpayers, including the small business community. We have initiated a robust action plan to address needed improvements that we believe will help restore and sustain the public's trust in the IRS. The report we released last month describes a number of important findings, aggressive actions and next steps for the IRS. The problems with the 501(c)(4) application process that were uncovered by the Treasury Inspector General for Tax Administration (TIGTA) have created significant concerns for individual and business taxpayers, and it is incumbent upon us to take swift action to ensure accountability, fix the problems that occurred and thoroughly examine other aspects of IRS operations. Over the past month, an ongoing review of the events described in the TIGTA report has shed further light on the management failures that occurred within the IRS and the causes of those failures. There was insufficient action by IRS leaders to identify, prevent, address and disclose the problems that emerged with reviews of applications for tax-exempt status. Our report outlines management deficiencies and the steps that must be taken to correct them. Of note, there is no current evidence of the use of inappropriate screeners or other types of criteria in other IRA operations beyond those discussed in the TIGTA report. We recognize, however, that there is public concern over the criteria the IRS adopted to review applications for tax-exempt status, a concern shared by the Committee as expressed in its recent letter to the IRS. Because we realize that more needs to be done to evaluate our screening criteria and procedures, we are establishing a review process by which screening criteria and procedures across the IRS will be periodically assessed to safeguard against any risks of inappropriate criteria. We are also continuing to review the full range of IRS operations, processes and practices to focus on how we deliver our mission today and how we can make improvements in the future. In that way, we will develop a better understanding of organizational risks wherever they exist in the IRS. We have a great deal of work ahead of us, and the IRS is committed not only to correcting the problems that have occurred, but also to continuing other important work of the agency. Conclusion Mr. Chairman, Ranking Member Velazquez, thank you again for the opportunity to testify today on the IRS service and enforcement efforts in relation to small businesses. As we continue to chart a path forward for our agency and determine what improvements are needed in IRS operations, we will do everything possible to ensure that small businesses are treated fairly and given the assistance they need to comply with our nation's tax laws. This concludes my statement, and I would be happy to answer your questions. 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