[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
COMPLEXITY IN ADMINISTRATION OF FEDERAL TAX LAWS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON OVERSIGHT
of the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
SECOND SESSION
__________
JUNE 29, 2000
__________
Serial 106-95
__________
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE
69-865 DTP WASHINGTON : 2001
_______________________________________________________________________
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC
20402
COMMITTEE ON WAYS AND MEANS
BILL ARCHER, Texas, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
BILL THOMAS, California FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana JIM McDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
A.L. Singleton, Chief of Staff
Janice Mays, Minority Chief Counsel
______
Subcommittee on Oversight
AMO HOUGHTON, New York, Chairman
ROB PORTMAN, Ohio WILLIAM J. COYNE, Pennsylvania
JENNIFER DUNN, Washington MICHAEL R. McNULTY, New York
WES WATKINS, Oklahoma JIM McDERMOTT, Washington
JERRY WELLER, Illinois JOHN LEWIS, Georgia
KENNY HULSHOF, Missouri RICHARD E. NEAL, Massachusetts
J.D. HAYWORTH, Arizona
SCOTT McINNIS, Colorado
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C O N T E N T S
__________
Page
Advisory of June 22, 2000, announcing the hearing................ 2
WITNESS
Internal Revenue Serivce, Hon. Charles O. Rossotti, Commissioner. 5
COMPLEXITY IN ADMINISTRATION OF FEDERAL TAX LAWS
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THURSDAY, JUNE 29, 2000
House of Representatives,
Committee on Ways and Means,
Subcommittee on Oversight,
Washington, DC.
The Subcommittee met, pursuant to notice, at 10:07 a.m., in
room 2167, Rayburn House Office Building, Hon. Amo Houghton
(Chairman of the Subcommittee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE COMMITTEE ON WAYS AND MEANS
Subcommittee on Oversight
Contact: (202) 225-7601
FOR IMMEDIATE RELEASE
June 22, 2000
No. OV-21
Houghton Announces Hearing on Complexity in Administration of Federal
Tax Laws
Congressman Amo Houghton (R-NY), Chairman, Subcommittee on
Oversight of the Committee on Ways and Means, today announced that the
Subcommittee will hold a hearing on the Internal Revenue Service (IRS)
report to Congress regarding complexity in the administration of the
Federal tax laws. The hearing will take place on Thursday, June 29 ,
2000, in the main Committee hearing room, 1100 Longworth House Office
Building, beginning at 10:00 a.m.
The sole witness will be Charles O. Rossotti, Commissioner of the
Internal Revenue Service . However, any individual or organization may
submit a written statement for consideration by the Committee and for
inclusion in the printed record of the hearing.
BACKGROUND:
In section 4022 of the Internal Revenue Service Restructuring and
Reform Act of 1998 (RRA) (P.L. 105-206), Congress required the IRS to
report annually regarding sources of complexity in the administration
of the Federal tax laws.
Congress instructed the IRS to take into account the following
factors in making its report: (1) frequently asked questions by
taxpayers, (2) common errors made by taxpayers in filling out their tax
forms, (3) areas of law that frequently result in disagreements between
taxpayers and the IRS, (4) major areas in which there is no, or
incomplete, published guidance, or in which the law is uncertain, (5)
areas in which revenue agents make frequent errors in interpreting or
applying the law, (6) the impact of recent legislation on complexity,
(7) information regarding forms, including a listing of IRS forms, the
time it takes taxpayers to complete and review forms, the number of
taxpayers who use each form, and how the time required changed as a
result of recent legislation, and (8) recommendations for reducing
complexity. The report to be presented by the Commissioner is the first
annual complexity report to Congress since the enactment of the RRA.
In announcing the hearing, Chairman Houghton stated: ``I have long
sought simplification of the Federal tax laws. I am hopeful that the
Service's first complexity report will highlight the most problematic
provisions and lead to possible legislation to reduce unnecessary
complexity for taxpayers.''
FOCUS OF THE HEARING:
The focus of the hearing will be to discuss the most complex
provisions in the Internal Revenue Code as identified by the IRS and
possible remedies.
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and Means, U.S. House of Representatives, 1102 Longworth House Office
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noted above.
Chairman Houghton. The hearing will come to order.
Commissioner, we are delighted to have you here.
Before I begin, I want to tell you a story. George Lyman
Kittridge was a great Shakespearean scholar at Harvard and he
used to stride up and down the platform. One day he fell off
the platform and nobody could see him. He brushed himself off
and said, ``This is the first time I have ever been on the
level of my audience.''
[Laughter.]
Chairman Houghton. We are trying to have a little more
informal attitude here and I hope it will be all right with
you, sir.
We are here to discuss, as most of you know, an issue that
is near and dear to all our hearts, which is simplifying the
Tax Code. One of the most important provisions in the IRS
Restructuring and Reform Act that we passed nearly 2 years ago
directed the IRS to study and report back to us on the sources
of major complexity in the Code.
We get plenty of input from the Treasury and from the Joint
Committee on Taxation, but who better to study this issue than
you, Commissioner, and the employees at the Service who answer
taxpayer questions through TeleTax, customer service call
centers, the Internet, and a variety of areas? Who better than
the agents who review the millions of errors in tax returns
each year?
A provision we pass may make good sense in terms of
fairness and equity but may be absolutely unworkable in the
real world. We need your help in making the law more easy to
understand.
Your first report to Congress focuses on provisions that
affect individual taxpayers and small businesses. These are the
taxpayers least able to fend for themselves in terms of time
and resources. I hope that future reports expand beyond the
specific provisions you will discuss today, and I hope that
future reports will be expanded to cover other taxpayer groups
as well.
You have stated in the report that reducing complexity will
reduce taxpayer burden, both in time and money spent, and
increase taxpayer compliance. I agree, but I would add that
reducing complexity will also restore faith in the tax system.
I hope that we in Congress heed the call to keep simplification
in mind as we pass tax bills in the future.
I would like to yield to our ranking Democrat, my friend,
Mr. Coyne.
Mr. Coyne. Thank you, Mr. Chairman.
I want to thank you for holding this hearing here today--a
very important hearing--and also to welcome Commissioner
Rossotti to the hearing as a witness today.
Today's hearing will address the recommendations of the
Commissioner's first annual report on tax law complexity. This
report was mandated by the IRS Reform and Restructuring Act of
1998. It s completion marks an important milestone in our
efforts to implement the law and offers suggestions for making
the tax law simpler and more equitable for all taxpayers.
Aside from this report, there are many other proposals
before this Committee to reduce complexity in the tax law. Mr.
Neal, from Massachusetts and a member of our Committee, has
proposed legislation to substitute a simpler method for the
alternative minimum tax. With several of my colleagues on this
Committee, I have introduced a bill to simplify the capital
gains tax.
I am certain that this Committee can work together to
consider these various proposals. I hope we can work in a
bipartisan manner, which has been the tradition of this
Committee, to pass legislation this year that will further the
goal of reducing complexity in the Tax Code.
Thank you, Mr. Chairman.
Chairman Houghton. Thank you, Mr. Coyne.
Mr. Commissioner?
STATEMENT OF HON. CHARLES O. ROSSOTTI, COMMISSIONER, INTERNAL
REVENUE SERVICE
Commissioner Rossotti. Thank you very much, Mr. Chairman.
It is great to be able to see straight across like this. I
appreciate that very much.
[Laughter.]
Commissioner Rossotti. I appreciate the opportunity to
testify before the Committee on this first annual report on tax
law complexity.
I think you have pointed out many times, Mr. Chairman, that
the Tax Code has continued to grow in complexity. In fact, over
the last 14 years since the 1986 legislation, there have been
about 9,500 changes to the Tax Code. Of course, we know there
are number of factors that contribute to the complexity. These
include a desire to provide tax cuts while limiting revenue
losses, a desire to achieve fairness in the tax system, and
finally a general growth of complexity in the global economy.
Many of the taxpayers, tax practitioners, and other people
that we spoke to when writing and compiling this report have
emphasized that sometimes even seemingly small changes to the
Code can have serious consequences for taxpayers and the IRS,
especially if there are frequent changes and if there is short
lead time to implement these changes due to the effective dates
of the provision.
Whenever a tax law changes, the IRS must ensure that our
systems, training, and employee tools are current and reflect
the most current legislation. We must also issue guidance and
tax forms covering the changes in time for the taxpayers to
file in the next filing season. It is especially problematic
when these changes come late in the calendar year when forms
and publications for the next filing season may have already
been designed.
So I think, Mr. Chairman, before we get to specific
provisions, it is worth noting that one of the most helpful
things the Congress can do is to provide the IRS with adequate
time prior to the statutory effective dates when changes go
into effect. I do want to say that the taxwriting Committees
over the last year have been really receptive to many of our
recommendations in this regard. This was particularly true when
we were going through the Y2K Program. In fact, I doubt that we
would have been successful with the Y2K Program had we not had
a good relationship in working out these effective dates.
I just want to put that on the agenda as a general problem
and a general issue that we need to work with the taxwriting
Committees on in the future.
With respect our report, which you have seen, it really had
three objectives, one replying specifically to the request in
RRA 98. We have tried to provide information on such things
such as frequently asked taxpayer questions, areas where
taxpayers have difficulty in complying with the Tax Code, and
missing or incomplete guidance.
Second, the report does describe how we selected and
analyzed certain specific areas of the Code for further
scrutiny in this particular report. With no pun intended, Mr.
Chairman, analyzing the entire Code would have been too complex
to do the first time. So instead, we tried to look at the
complexity from a taxpayer's point of view. After consulting
with numerous experts and others who have looked at this and
analyzing our own data, we chose to focus on three particular
areas of the Code that in particular affect a large number of
taxpayers.
For each of the three areas we selected--filing and
dependent definitions, alternative minimum tax for individuals,
and estimated taxes--we tried to analyze why those provisions
are considered very complex. And then we provided a number of
options the Congress might want to consider that would reduce
complexity.
I do need to stress, Mr. Chairman, that the options in our
report are not recommendations in the full sense as they do not
take into account revenue impact or the distribution of
revenue, which would have to be considered in any legislation.
But just to note the first one of these--and the one that
really affects the most taxpayers--can be seen on this chart
over here on the left. This one deals with the first set of
provisions of the Code that have to do with definitions of
filing status, dependent exemptions, and various tax credits.
These tend to go together.
As you can see, there are six different kinds of elections
or credits the taxpayers have the option to elect, such as head
of household, or filing status, dependent exemptions, and
various credits, including the earned income credit and the
child credit. These are six different areas. And then across
the top there are five different kinds of tests that are
applied in the Tax Code to determine eligibility or the status
of these elections.
As you can see, some apply in some cases and some apply in
other cases. But in addition to that, of course, there are
different definitions under these tests. Even where it appears
to be the same, such as the age limit, there are different
definitions. For example, there is no general age test for
dependents or for the education credit. However, for the
dependent child care credit, it is limited to qualifying
individuals under the age of 13. The child tax credit is
limited to those under 17. The EITC applies to qualifying
children under 19. And the kiddie tax is under 14. And
actually, there are more complications than that.
This illustrates some of the confusing aspects of the
varying definitions.
Based on our analysis, we developed a number of options to
be considered that would reduce the complexity associated with
these inconsistent definitions, such as adopting one definition
of the relationship test for dependents and qualifying
individuals for tax credits, including the EIC.
The second area that we covered was the alternative minimum
tax. This, of course, was created to see that no taxpayer who
had substantial economic income avoids a tax liability through
the use of exclusions, deductions, and credits. This is a
complex provision that has not been indexed for inflation. We
estimate that about 27 percent of the taxpayers who now pay the
AMT have less than $100,000 in adjusted gross income. If it is
not changed by 2005, we would have about 6.3 million AMT payers
compared to a little over 1 million today.
Based on our analysis, we developed a number of options
that could alleviate AMT complexity. These include calculating
the AMT using information that is already on the tax return and
possibly repealing the provisions related to married filing
separate taxpayers.
The third area, briefly, is the complexity of the taxpayer
encountering meeting their estimated tax obligations. Mr.
Chairman, as you know, this provision particularly affects
self-employed and small business taxpayers, a rapidly growing
segment. Some of the options that could be considered here for
simplifying would be to make the estimated tax periods
standardized and would in each case equal to one-quarter, and
perhaps make the filing data 15 days after the end of each
calendar quarter. Another possibility would be to keep the safe
harbor provisions constant. They have been changing quite
rapidly.
I know that is a very brief summary, but I just wanted to
mention the three areas that we have covered. We recognize that
this does not cover all the areas of complexity by any means,
but we hope it is a start in covering some of the more
troublesome areas related to Tax Code complexity and providing
some options that could be used to reduce undue and unnecessary
complexity.
Thank you very much, Mr. Chairman. I would be glad to
answer questions.
[The prepared statement follows:]
Statement of Hon. Charles O. Rossotti, Commissioner, Internal Revenue
Service
Introduction
Mr. Chairman, I welcome this opportunity to testify before
the Subcommittee on Oversight on the Internal Revenue Service's
first annual report to Congress on tax law complexity. The IRS
Restructuring and Reform Act of 1998 (RRA 98) requires the
Commissioner of Internal Revenue to report annually to the
House Ways and Means Committee and Senate Finance Committee on
areas of complexity in the Internal Revenue Code (Code). My
testimony will summarize the report's major findings.
Background
Few issues have generated as much discussion in recent
years as Tax Code complexity. Executive and legislative branch
policymakers, as well as taxpayers, have been vocal about the
burden that complexity places on taxpayers as they seek to meet
their tax obligations, and on the Internal Revenue Service as
it works to administer the Code.
Mr. Chairman, many circumstances contribute to the Code's
complexity. Complexity is added both knowingly and
inadvertently as (1) tax laws are changed, (2) legislative
tradeoffs among different policy objectives are made, and (3)
the economy and society as a whole become more complex.
The Code's complexity becomes even more burdensome to
taxpayers and the IRS when the Code changes frequently or when
changes are made effective shortly in the future or
retroactively. One of the largest problems that the IRS
encounters is short or retroactive effective dates for changes
in the tax law. Mr. Chairman, the single most helpful thing
Congress can do in this regard is to provide the IRS with
adequate time prior to the date statutory changes go into
effect. I am pleased to say that the tax writing committees
have been receptive to our recommendation in this regard,
particularly with respect to provisions that might have
jeopardized our Y2K program.
Reducing complexity can alleviate taxpayer burden by
cutting the time and costs taxpayers face in meeting their tax
obligations, and increase compliance by making those same
obligations easier to understand and meet. Reducing complexity
will also make it easier for IRS' employees to do their jobs of
providing services to taxpayers and enforcing the law.
The IRS tax law complexity report has three objectives.
First, to the extent available, the report provides the
specific information requested in RRA 98, including frequently-
asked taxpayer questions, areas where taxpayers have difficulty
in complying with the Code, and missing or incomplete guidance.
Second, it describes how these specific areas of the Code
that were analyzed for inclusion in this report were selected.
Third, the report analyzes where complexity occurs, and
possible options for reducing complexity in filing definitions,
the non-corporate or individual Alternative Minimum Tax (AMT),
and estimated taxes.
The short-term goal is to respond to the immediate issues
suggested in the legislation; the long-term goal is to provide
a systematic examination of complexity in tax administration
that correlates with both taxpayer burden and taxpayer
compliance issues.
Tax Law Complexity: Best Seen Through Both Burden and
Compliance
While complexity, burden and compliance are key integrated
concepts in tax administration, each is also a stand-alone
issue. Burden results from taxpayers spending time and money
trying to understand and meet their filing, reporting and
payment responsibilities. Complexity adds to that burden when
these taxpayers must also determine if and how specific Code
provisions apply to them. On the other end of the spectrum,
significant reductions in burden, as well as increases in
compliance may be driven by a simplification change that
affects many taxpayers.
By the same token, noncompliance can result from taxpayers'
frustrations with the complexity encountered when trying to
obey the law. Individual taxpayers cope with complexity as best
they can. Some struggle with it by themselves, while others
rely on tax preparation software or paid preparers.
Approximately 50 percent of all individual taxpayers use paid
preparers to complete their tax returns. At least 33 percent
use software.
Complexity also creates opportunities for ``gray areas''
where taxpayers can take aggressive positions that may or may
not be legitimate. For example, this could include the use of
conflicting definitions for the same terms or concepts, such as
the definition of a child. Taxpayers with children may be
eligible for a number of different tax benefits. However the
definition of a child may vary among these provisions, and as a
result, taxpayers may find that they are not able to claim the
same child for dependent exemptions, head-of-household, filing
status, child tax credits, the Earned Income Tax Credit (EITC),
and other child-related benefits. These same considerations
make it all the more difficult for the IRS to enforce the Code
consistently and fairly.
This complexity also requires providing additional
government resources to carry out all of the IRS' programs,
from providing taxpayers telephone and walk-in assistance, as
well as easy-to-understand forms and publications, to auditing
potentially non-compliant returns. For example, for calendar
year 1999, the IRS responded to almost two million taxpayer
inquiries related to filing season definitions, yet over three
million returns were filed with errors involving filing
definitions.
Complexity is also introduced through a variety of sources,
including the Code, other federal statutes, regulations, forms,
publications, and procedures. In addition, changes in
individuals' circumstances can introduce complexity. For
example, when two people marry, they must decide which filing
status to use to minimize their taxes. They are now dealing
with tax system complexity. Divorce creates its own set of
complexity considerations.
Complexity is rooted even deeper in the national landscape.
In a complex economy and social structure, such as those in the
United States, many tax goals can be achieved only through tax
provisions that reflect the underlying complexity of the
financial transaction or goal. Complexity is frequently
introduced as policymakers make trade-offs between simple tax
designs and the desire to make the tax system fair and
equitable in a fashion that supports social and economic as
well as tax policy goals.
The Impact of Statutory Change
At one time or another, legislative changes to the Code
have had an impact on all taxpayer segments. When tax laws
change, individuals often face uncertainty as to how to comply
with the changes. In addition, the inability to stay current
with tax law changes has been cited by small business owners
and individuals as a primary reason for their use of paid
preparers.
Many of the taxpayers, tax practitioners, scholars, and
other stakeholders with whom the IRS spoke when researching and
writing the tax complexity report, emphasized that even the
simplest changes to the Code can have complex and serious
consequences for taxpayers and the IRS if the change is
frequent and/or has a retroactive or short lead time for the
effective date.
Mr. Chairman, let me provide some historical context for
this discussion. Since 1986, seventy-eight tax laws have been
enacted. The EITC has been changed almost yearly for the past
decade. One of the 78 new laws, the Tax and Trade Relief
Extension Act of 1998, contained 25 sections of tax changes. Of
these changes, 11 were effective retroactively and four were
effective within 90 days of the end of the calendar year.
The enactment of provisions with retroactive or short
effective lead times also increases complexity. Both the IRS
and taxpayers are challenged and frustrated by this situation
and both must act quickly to accommodate these changes.
The IRS must ensure that its systems, training, and other
employee tools are current and reflect the most recent
legislation. The IRS must also issue clear guidance and tax
forms covering the changes in time for the next filing season.
Especially problematic are changes that come late in the
calendar year when the forms and publications for the next
filing season are ready to go, or have already been sent to the
printers.
Beyond the logistical challenges and the additional costs
the IRS may incur, short time frames frequently do not allow
the IRS to consult with taxpayers and other stakeholders when
developing new forms. This can result in the forms being more
difficult for taxpayers to understand or complete than they
would be under normal circumstances.
Taxpayers also face the uncertainty that late changes
introduce around their current and future tax obligations. With
short lead times, both the IRS and taxpayers have little time
or opportunity to become knowledgeable about the changes to the
Code. This creates additional opportunities for error as well
as heightened frustration and conflict.
In addition, because the time between when a tax return is
filed and when it could be audited could be from one to two
years, taxpayers and IRS employees must also accommodate
circumstances where the Tax Code has changed in the intervening
time period.
Obviously, time limitations affect our ability to make the
systems changes necessary to support the statutory changes I
have described. The Taxpayer Relief Act of 1997 and RRA 98 are
good examples of statutes with many challenging tax-related
changes and short effective date lead times. The following
table provides in greater details the extensive changes and
effective dates set by recent statutes.
----------------------------------------------------------------------------------------------------------------
Total Number Effective
Number of Retro- of Sections Date Between
Bill Title and Public Law Number Date Passed Sections active Over that are Oct. 1 and
1 Year Retroactive Dec. 31
----------------------------------------------------------------------------------------------------------------
Small Business Job Protection Act 8/20/96 111 12 28 44
of 1996 P. L. 104-188
Taxpayer Bill of Rights 2 P. L. 7/30/96 47 0 3 2
104-168
Balanced Budget Act of 1997 P. L. 8/5/97 218 10 24 77
105-33
Taxpayer Relief Act of 1997 P. L.
105-34
Tax Provisions of the 6/9/98 13 1 2 0
Transportation Equity Act for the
21st Century P. L. 105-178
IRS Reform and Restructuring Act 7/22/98 113 2 12 2
of 1998 P. L. 105-206
Tax and Trade Relief Extension Act 10/21/98 25 2 11 4
of 1998 P. L. 105-277
----------------------------------------------------------------------------------------------------------------
Source: IRS Legislative Affairs
Mr. Chairman, as I mentioned at the beginning of my
testimony, I also want to commend the House Ways and Means and
Senate Finance Committees for their enormous help,
understanding and cooperation on effective dates related to the
IRS' Century Date Change project. I seriously doubt that we
would have had such a successful Y2K conversion without this
excellent working relationship.
Report's Objectives and Scope
For this report, the IRS limited its analysis to provisions
of the Code that impact individual taxpayers--both Wage and
Investment, and Small Business/Self-Employed taxpayers. The
three specific provisions in the Code that we selected for our
in-depth review were filing definitions, individual Alternative
Minimum Tax (AMT), and estimated taxes.
Filing Definitions
The IRS focused its analysis on inconsistencies in filing
definitions because they clearly illustrate how complexity is
introduced into the Federal tax return preparation and filing
processes.
Numerous definitions are used to determine a taxpayer's
filing status and eligibility to claim the dependency
exemptions and credits for qualifying individuals. The
complexity associated with filing status definitions is
reflected in the high volume of contacts IRS receives from
taxpayers through customer service calls, TeleTax, and the
Internet. Frontline IRS employees also identified definitions
for eligibility of credits as a major contributor to taxpayer
complexity. Of special interest to the IRS was how relationship
tests and income tests, which are used to determine eligibility
for credits, can have an impact on complexity.
Based on our analysis, we developed the following options
for Congress to consider that would reduce complexity
associated with inconsistent filing definitions:
Adopt one definition of relationship for
dependents and qualifying individuals for tax credits including
the EITC;
Use Adjusted Gross Income rather than the modified
Adjusted Gross Income for determining eligibility under the
Child Tax Credit and Education credits;
Use one set of income thresholds for the Child Tax
Credit and Education credits; and
Adopt one age criterion for defining a qualifying
child.
It is important to note that we have not analyzed the
budgetary effects of these options or the others presented in
the complexity report or their effects on other policy goals,
such as fairness and promoting economic growth. Accordingly,
the options should not be considered as policy recommendations.
However, we hope that they will at least other ways to simplify
the tax system.
Individual Alternative Minimum Tax
The AMT was created by the Revenue Act of 1978 and was
intended to ensure that no taxpayer with substantial economic
income avoids a tax liability through the use of exclusions,
deductions, and credits. The AMT is a complex provision that is
not indexed for inflation. As such, the number of taxpayers
experiencing the complexity of computing Alternative Minimum
Tax Income (AMTI) and paying AMT is projected to increase
substantially in the years to come.
Our analysis of AMT included a review of many elements that
contribute to the provision's complexity, including the various
thresholds and phase-outs that must be considered, the complex
mathematical calculations that must be performed, and the
linkages that must be made between forms and schedules.
Based on our analysis of the complexity within AMT and a
review of proposals made by stakeholders, both inside and
outside of government, the IRS developed the following options
for enacting or amending legislation that would alleviate AMT
complexity. Once again, these options should not be considered
as policy recommendations:
Calculate AMTI using information already on the
tax return;
Repeal the excess AMTI provisions for married
filing separately taxpayers;
Repeal the requirement for recalculation of
depreciation; and
Index exemption amounts and phase-out thresholds
for inflation.
Estimated Taxes
Taxpayers face several areas of complexity in meeting their
estimated tax obligations. These include complexity in the Code
and regulations regarding inconsistent time periods for
calculating and remitting the tax and the safe-harbor
provisions for high-income taxpayers. These are the areas we
focused on in our analysis for this report.
Some of the options that Congress may wish to consider for
alleviating the complexity associated with preparing and filing
estimated tax returns are:
Standardize the installment payment schedule with
payments due 15 days after the end of the quarter;
Standardize the payment periods under the
annualized method; and
Keep the high-income safe harbor percentage
constant.
Conclusion
Mr. Chairman, in conclusion, I believe that this first
report represents an important initial step in identifying,
analyzing and explaining some of the most fundamental problems
related to tax law complexity and providing options for
reducing undue and unnecessary complexity. Although these
options should not be considered policy recommendations, we
look forward to working with the Administration and Congress to
help reduce taxpayer burden related to tax law complexity.
Chairman Houghton. Thank you very much, Mr. Commissioner.
Mr. Coyne?
Mr. Coyne. Thank you, Mr. Chairman.
Commissioner Rossotti, in your testimony--as you alluded
to--the chart that shows that since 1995 there have been 527
tax law changes and you are required to implement those changes
as quickly and as fairly as possible.
What are the most complex of those 527 changes, from your
estimation?
Commissioner Rossotti. I don't know that I could answer
that off the top of my head, Mr. Coyne. I would have to go back
and analyze those changes and get back to you on that.
I think one point to be made is the sheer numbers. It is
not just one change, but the sheer combination of them that
really causes probably the most difficulty. But if you would
like, I can get back to you with an answer.
Mr. Coyne. Just maybe the top three or four most complex.
Commissioner Rossotti. Sure.
[The information follows:]
Because the tax code does not affect all taxpayers in the
same way, it is difficult to quantity exactly which of the 527
tax law changes since 1995 qualifies as the ``most complex.''
Generally speaking, for individuals the most complex tax
provision is the 1997 capital gains tax reduction which
requires taxpayers to apply up to four separate rates to the
different components of the taxpayer's net long-term capital
gain to calculate their capital gain tax. Part IV of the 1999
Schedule D, which is used for this computation, contains 35
lines entries. Compare this to the pre-1987 capital gains tax
which simply excluded a percentage of the taxpayer's long-term
capital gain (60% in 1986) and applied the regular tax rates
tot he remainder. (Between 1987 and 1996, the tax on long-term
capital gains was limited to 28%.)
Another notable area of complexity is the multiple benefits
provided for education. These benefits include education IRAs,
two different credits for college expenses, exemption from tax
for qualified stat tuition programs, and the deduction for
interest on education loans. While none of these provisions in
and of itself is that complicated, the total of these benefits
and the rules for coordination between benefits can be
overwhelming. Pub. 970, Tax Benefits for Higher Education,
which attempts to provide an oversimplified explanation of
these benefits, contains more than 15 pages of text.
Mr. Coyne. How does your report recommend, for instance,
that the capital gains be simplified? Do you have any
recommendation?
Commissioner Rossotti. In this particular report, we did
not address the capital gains provisions--not that that isn't
one that could be subject to analysis--and I would hope that in
future years we could perhaps include capital gains as one of
the provisions. Because of the limitations of time and the
enormity of the tax code, we thought it would be more effective
to pick certain areas this year and try to provide some
analysis for those. We are not claiming those are the only
complex areas.
We did not analyze capital gains, although certainly that
is a complex area.
Mr. Coyne. Do you hold out hope that there might be some
salvation for being able to simplify capital gains filing?
Commissioner Rossotti. I really don't know, Mr. Coyne. I
think what we can do, as we go on each year, is add additional
analyses for different provisions. I certainly have heard from
many people that capital gains is one that we ought to analyze.
So we can certainly put that high on our priority list for next
year.
Mr. Coyne. Has the statutory requirement for tax complexity
analysis, as required by the Reform Act of 2 years ago--has
that been effective?
Commissioner Rossotti. Of course, there haven't been too
many major tax changes since that was put in, so I think we
will have to wait and see. I know we have worked with the Joint
Committee on every significant tax provision and have provided
information through the Joint Committee to the taxwriting
Committees on the impact of proposed changes. I hope that those
have been helpful to the members as they have considered these
provisions.
We have conformed to the requirements of the law and have
provided that analysis in working closely with the Joint
Committee. But of course, there hasn't been too much in the way
of tax legislation yet, so we will have to wait and see how
effective that is.
Mr. Coyne. Thank you.
Chairman Houghton. Ms. Dunn?
Ms. Dunn. Good morning, Mr. Rossotti. It is nice to see you
again.
I have been trying to simplify the Tax Code for you by
eliminating a whole class of taxes, the estate tax. We
succeeded in passing that in the House of Representatives,
which is now before the Senate.
Some of the alternatives are based on an effort to increase
the exemption for family held businesses and farms and estates.
I don't mean to shanghai you on this--and maybe it is something
you would like to answer in writing--but I have great concerns
about that way to approach the relief of the death tax because
it seems to me that the work that we did in 1997 to define a
family held estate created such a narrow spectrum of
possibilities that only between about 3 and 5 percent of family
held businesses were even able to take advantage of it.
So I believe it is deceptive for some to say now we are
going to increase the exemption based on that same description.
I was wondering if you had any thoughts on this, if you
know about that.
Commissioner Rossotti. I would have to say I would have to
get back to you. Not because it isn't complex, but only because
we had limited resources, we did not cover any estate tax
provisions in this report. So I don't have any data right now
to really answer your question. But I would be happy to get
back and try to get with your staff.
Ms. Dunn. Perhaps I can put it in writing.
Commissioner Rossotti. Sure. We will attempt to do that.
Chairman Houghton. I have a couple of questions here. The
first is pretty broad, and that is really the working
relationship between the IRS and Congress. Where do you see
Congress really helping--within the next year--us make a dent
in this complexity issue? Where do you see us working with you
on this?
Commissioner Rossotti. In my statement, I made a couple of
points. On any provisions that the Congress chooses to change--
hopefully in the direction of simplification, but for perhaps
other reasons as well--I think the kind of relationship we had
as we were going through the Y2K change, where we really had
good conversation as these provisions were being considered is
important.
There are two points, really. One is as required by the
law, and through the Joint Committee we do provide an analysis
of the complexity and the impact on tax forms and things like
that. That would be our opportunity to provide that input to
the Congress. Then the other extremely important one is just
the timing of these things, which I mentioned in my statement.
Those are two very practical things. I think we have a
channel to work with and if we can maintain that and improve
it, I think it would be extremely good for everyone.
Of course, the other one is that we do have this report and
we have laid out some possibilities there. We will again have a
report next year in the early part of the year that will build
on this. Based on the comments we get in this hearing and from
other stakeholders, we will expand into other areas of the
Code--as you suggest in your opening statement--to analyze
additional areas of complexity. We hope that those would be
helpful to the taxwriting Committees in considering ways that
the Committee could reduce complexity in the Code.
Those would be my two major suggestions.
Chairman Houghton. Moving more toward the administrative
rather than the legislative route, and picking up on something
Mrs. Dunn was talking about, small businesses.
I understand that there are upward of 200 requirements,
forms, and reports for small businesses. It seems like an awful
lot. I can't put a figure on it, but it is just sort of a gut
feeling that it is wrong. I wonder whether there are things you
can do administratively, rather than having to go through the
legislative process, to help with that.
Commissioner Rossotti. I think there is. This is one of our
real priorities. As you know, part of our whole modernization
plan is to set up a whole division that will be dedicated to
small businesses and self-employed individuals. A major part of
their mission is just going to be focusing on working with
small business taxpayers, identify what we need to do to make
life simpler for them, and to also educate them because there
is a minimum that has to be done to comply with the Code.
Some of the things we have done already--and there is more
we can do--we took about 2 million taxpayers out of the need to
provide what are called tax deposits. These are usually monthly
forms that you fill out with employment taxes. It used to be
that if you had more than $500 per quarter--which is a very
small number in today's economy--you had to file these. We were
able to administratively, with the help of Treasury, to
increase that to $1,000 a quarter. That doesn't sound like
much, but it took 2 million businesses out of that whole thing
entirely.
So we are looking at those kinds of options. That is
already done and there are other possibilities like that.
Another approach that we are trying to take is to package
things. As you mentioned, the 200 plus--and if you take a big
book like this and hand it to somebody it is hard to figure out
what applies to you and what doesn't. A lot of things don't
really apply, but you don't know which ones apply. So we are
trying to package them to make them easier.
One of the things we have done, working with the Small
Business Administration, is to come up with a CD-Rom that has
been quite positively received. It has all the information on
it looked at from a small business point of view. First of all,
it is all there in one place and you can search it and it
points you down to what is really applicable to you.
Your question is very, very much on target and is really a
whole strategy that we have. There is no one solution that I am
aware of that magically solves it. But I believe if we keep
working on it and working with the small business community and
the self-employed individuals we can definitely reduce that
burden.
One of the areas that we covered in our report has to do
with estimated taxes. One of the reasons we picked that one out
is because that one does affect self-employed individuals and
small business owners in particular. It is important for people
to pay taxes as you go, but we think that is an area that
potentially could be simplified in terms of how it is
implemented to make it easier for people. That is one of the
most common places that self-employed individuals go wrong and
get into penalty situations.
I am just summarizing some of the areas, but I certainly
agree with your point and I think it is something, if we keep
working on it, we can over time make a dramatic difference in
the ease with which small businesses and self-employed people
can comply with the Code.
Chairman Houghton. Thank you very much.
Mr. Coyne?
Mr. Coyne. Thank you, Mr. Chairman.
Commissioner, I commend you in taking on the problem of the
complexity of the earned income tax credit through
standardizing criteria for a qualifying child and adopting one
definition of relationship for dependents and qualifying
individuals.
Can you tell us to what extent this could serve to reduce
errors in the EITC Program?
Commissioner Rossotti. I don't have any way to quantify it
precisely, but I can tell you that the whole area of people
putting down an individual as a qualifying child and having it
be incorrect is the most common error that occurs. As you can
tell from the complexity of the definitions and the fact that
those definitions are different from what you need to qualify
for an exemption, there is certainly an understandable reason
why there would be errors in that.
And by the way, people also make errors without the EIC in
terms of their dependents. It seems to the average person that
these are all the same thing. But according to the Tax Code,
they are not the same thing.
It is a complex area to figure out how to solve, but I
would certainly say if you had to pick out one area that
affects the largest number of taxpayers, these things that are
on this chart--to the extent they could be simplified, it would
make a big difference.
To give you an example, here is a booklet that we put out
that is pretty popular, a common thing that people use, similar
to what is in their tax forms. The first part explains how to
fill out your 1040 return. If you look at this, there are about
13 pages here just in the beginning that cover just the first
two rows on there, which is the filing status and the dependent
exemption.
There is a flow chart. This is to determine if you can take
someone who lives in your house--your son or your daughter or
anyone who lives in your house--as a dependent. This is pretty
complicated for the average person to do, and it is the average
person that is doing this.
This is why we highlight this area in our analysis.
Certainly from the point of view of our employees, from the
point of view of our hot line, and from the point of view of
the phone service, this is the area we get the most questions
on, and that we get the most errors on. It is perfectly
understandable if you just leaf through the first 13 pages here
to tell someone what seems like a simple question.
Can I take my niece that lives with me as a dependent? That
sounds like a simple question, but you have to wade through
quite a bit of information to try to find the answer to that
question.
I think that if we could find a way over time to combine
these things and simplify them to make a standard definition,
it would without question reduce the burden on individual
taxpayers and reduce the number of errors that we have to work
with taxpayers on.
Mr. Coyne. You have a report that is due relative to the
earned income tax credit. I think you told us at one time that
it might be due out by the end of the year.
Commissioner Rossotti. Yes. I hope that will be the case.
We are working on that now.
Mr. Coyne. You are still hoping that it could come out
before the end of this year?
Commissioner Rossotti. Yes.
Chairman Houghton. Ms. Dunn?
Ms. Dunn. No questions, Mr. Chairman.
Chairman Houghton. Mr. McDermott?
Mr. McDermott. I have no questions, Mr. Chairman.
Chairman Houghton. Commissioner, you may or may not know
this, but I introduced a bill in Congress that seeks to reduce
the burden on taxpayers, the same recurring theme. As your
report did, my bill focused on tax provisions affecting
individuals and small businesses. The bill addresses ways to
simplify AMT, estimated taxes, and things like that. It also
proposed replacing the current capital gains tax regime of the
50 percent, exclusion from income, raising the gross receipts
exemption, broaden the exemption so that more small businesses
could avoid the burdensome uniform capitalization, and reducing
recordkeeping requirements.
I wonder if your agency had any response to that. Did they
develop any other options?
Commissioner Rossotti. We have not specifically analyzed
both provisions, Mr. Chairman. I think that certainly we could
look at them, as with the legislation we are required to do,
and provide tax estimates of what it would do to reduce
complexity.
As I mentioned in answer to Mr. Coyne's question, capital
gains, in particular, is one area that we know has complexity.
I think it would be high on our agenda for next year to
analyze. We just didn't get to it for this particular year.
Some of the things, such as reducing recordkeeping
requirements and getting rid of records--those kinds of things
are practical issues that would probably be very helpful.
I will mention one thing. On July 17th, next month, as a
follow-up to this and in preparation for next year, we are
actually sponsoring with OMB a Tax Complexity Forum in
Washington. We have asked a lot of stakeholders who represent
small businesses and practitioners to come in and, having
looked at our reports the first time, give us additional input
as to what we could do next year.
At that meeting on the 17th--and we would be glad to
provide you more information about it--it would be an
opportunity to get some input on a variety of additional
proposals and ideas that haven't yet been considered in our
report.
Chairman Houghton. I have another question for you. We have
talked about this before, but I am still fascinated with the
whole concept of training.
There are so many changes in the tax laws and regulations.
How do you keep abreast of this in training your people?
Commissioner Rossotti. As I mentioned in my statement, this
is probably our number one issue. It is interesting. It isn't
even the complexity of the Code that is the hardest problem, it
is the change in the Code. Many of our practitioner friends and
colleagues tell us this over and over again, that even when
there are simple changes--people do adjust to the Tax Code over
time because they take last year's return. I figured it out
last year and my situation doesn't change that much from year
to year. They kind of get used to it.
When you interject significant changes--or sometimes even
insignificant changes--the education process, both for our own
employees and for taxpayers, is a major challenge. Then, of
course, you have all the computer software and computer things
like that that have to be done.
So the rate of change is without a doubt one of the
greatest challenges in tax administration. We have a whole
process in our organization, because we know that there will be
changes. But the faster they come and the shorter the lead
time, the more difficult it is.
Chairman Houghton. Well, that's not a bad record for a
hearing, is it?
Commissioner, just one final point. You obviously have
nothing to do with the writing of the Tax Code, but obviously
the IRS can play a very important role in alleviating some of
the Tax Code complexities. We look forward to working with you.
Commissioner Rossotti. Thank you.
Chairman Houghton. We thank you very much for being with us
here.
[Whereupon, at 10:37 a.m., the hearing was adjourned.]
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