Internal Revenue Service Advisory Council 2015 Public Report Table of Contents GENERAL REPORT ........................................................................................................3 ISSUE ONE: THE IRS NEEDS SUFFICIENT FUNDING TO OPERATE EFFICIENTLY AND EFFECTIVELY, PROVIDE TIMELY AND USEFUL GUIDANCE AND ASSISTANCE TO TAXPAYERS, AND ENFORCE CURRENT LAW, SO THAT THE INTEGRITY OF, AND RESPECT FOR, OUR VOLUNTARY TAX SYSTEM IS MAINTAINED......................................................8 ISSUE TWO: LOOKING FORWARD IN THIS VOLATILE ENVIRONMENT, THE IRS MUST MAINTAIN THE TAXPAYER AND PRACTITIONER PROTECTIONS AFFORDED BY A STRONG, BALANCED, AND INDEPENDENT OFFICE OF PROFESSIONAL RESPONSIBILITY......................28 SMALL BUSINESS/SELF-EMPLOYED AND WAGE & INVESTMENT SUBGROUP REPORT ....................................................................................................31 ISSUE ONE: AUTHENTICATION OF 1040 FORMS ..............................................36 ISSUE TWO: REVIEW OF AUTOMATED ONLINE SELF-SERVICE AND TELETAX TELEPHONE APPLICATION TOOLS ..................................................42 ISSUE THREE: THIRD-PARTY PAYER ARRANGEMENTS FOR EMPLOYMENT TAXES ............................................................................................46 ISSUE FOUR: REDUCING TAXPAYER BURDEN BY IMPROVING THE TAXPAYER EXPERIENCE .......................................................................................51 ISSUE FIVE: REVIEW OF OFFER IN COMPROMISE (OIC) FORM AND BOOKLET 656-B, AND COLLECTION INFORMATION FORMS 433-A, 433-B, AND 433-F TO IMPROVE TAXPAYER COMPLIANCE AND SUCCESSFUL UTILIZATION ............................................................................................................57 OFFICE OF PROFESSIONAL RESPONSIBILITY SUBGROUP REPORT ..........71 ISSUE ONE: CONTINUITY OF INDEPENDENCE, STRENGTH, AND VISIBILITY OF THE OFFICE OF PROFESSIONAL RESPONSIBILITY (OPR) ..74 ISSUE TWO: STATUTORY AUTHORITY OF THE IRS TO REGULATE TAX PRACTICE ..................................................................................................................78 ISSUE THREE: APPLICATION OF APPRAISAL STANDARDS CONSISTENT WITH THE UNIFORM STANDARDS OF PROFESSIONAL APPRAISAL PRACTICE ..................................................................................................................83 APPENDIX: REFERENCES TO THE USPAP IN THE UNITED STATES CODE AND REGULATIONS ................................................................................................87 LARGE BUSINESS AND INTERNATIONAL SUBGROUP REPORT ...................91 ISSUE ONE: IMPROVING PENALTY ADMINISTRATION — GENERAL COMMENTS AND RECOMMENDATIONS............................................................95 1 ISSUE TWO: PENALTY FOR ERRONEOUS CLAIM FOR REFUND OR CREDIT EXECUTIVE SUMMARY .........................................................................99 ISSUE THREE: APPLICATION OF QUALIFIED AMENDED RETURN RULES TO REGULARLY EXAMINED TAXPAYERS IN A POST-CIC ENVIRONMENT ......................................................................................................108 ISSUE FOUR: INTERNATIONAL INFORMATION RETURN PENALTIES .....112 ISSUE FIVE: IMPLEMENTATION OF THE TANGIBLE PROPERTY REGULATIONS........................................................................................................117 IRSAC MEMBER BIOGRAPHIES ............................................................................123 2 INTERNAL REVENUE SERVICE ADVISORY COUNCIL GENERAL REPORT PATRICIA H. ATWOOD RONALD D. AUCUTT F. ROBERT BADER EUNKYONG CHOI THOMAS A. CULLINAN ESTARRE (STAR) FISCHER NEIL H. FISHMAN CHERI H. FREEH MICHELE J. GAINES JENNIFER MACMILLAN, Vice-Chair TIMOTHY J. MCCORMALLY JOHN F. MCDERMOTT MARK S. MESLER, SR. FRED F. MURRAY, Chair WALTER PAGANO LUIS R. PARRA ANDRE’ L. RE DONALD H. READ KAREN SALEMI SHERRILL L. TROVATO NOVEMBER 18, 2015 3 GENERAL REPORT OF THE INTERNAL REVENUE SERVICE ADVISORY COUNCIL The Internal Revenue Service Advisory Council (the IRSAC), the successor to the Commissioner’s Advisory Group established in 1953, serves as an advisory body to the Commissioner of Internal Revenue. As an advisory body designed to focus on broad policy matters, the IRSAC's primary purpose is to provide an organized public forum for senior Internal Revenue Service (the IRS) executives and representatives of the public to discuss relevant tax administration issues. Chartered to convey the public’s perception of the Internal Revenue Service and its activities to the Commissioner, the IRSAC membership is balanced to include representation from the taxpaying public, the tax professional community, small and large businesses, and the payroll community. The IRSAC is currently comprised of 20 members with substantial, disparate experience and diverse backgrounds. Many provide tax advice to clients, others manage their large employer’s tax affairs, and many are active in the volunteer income tax community. In addition to representing different-sized organizations, industries, and geographic regions of the United States, members also represent occupations that interact with the IRS and the tax community in a variety of ways. Each member has a unique perspective on tax administration and is committed to providing meaningful input and feedback to the IRS. The members are volunteers, and receive no compensation for their service. 4 Working with IRS leadership, the IRSAC reviews existing practices and procedures, and makes recommendations on both existing and emerging tax administration issues. In addition, the IRSAC suggests operational improvements, conveys the public’s perception of professional standards and best practices for tax professionals and IRS activities, offers constructive observations regarding current or proposed IRS policies, programs, and procedures, and advises the Commissioner and senior IRS executives on substantive tax administration issues. The IRSAC is currently organized into three subgroups — the Small Business/Self-Employed and Wage and Investment (SBSE/W&I) Subgroup, the Large Business and International (LB&I) Subgroup, and the Office of Professional Responsibility (OPR) Subgroup. The members appreciate the invaluable assistance, dedication, and support provided by personnel from the IRS Office of National Public Liaison (NPL) and the operating divisions — Candice Cromling, Director, NPL; Carl Medley, Chief, Liaison Advisory Groups, NPL; Lorenza Wilds, IRSAC Program Manager, NPL; Anna Millikan, NPL; Maria Jaramillo, NPL; Brian Ward, NPL; Johnnie Beale, W&I; Tonjua Menefee, SB/SE; and Kate Gregg, LB&I. They are also grateful for the invaluable assistance provided by IRS executives and other personnel throughout the year. We thank them for their commitment to the IRS’ and IRSAC’s mission and for engaging in the meaningful discussions and dialogue that each subgroup held on numerous important issues. The IRSAC members were honored and privileged to have the opportunity to work with these dedicated, qualified individuals. Their dedicated service to the IRSAC, IRS, and the public should be recognized as truly exemplary. 5 Issues selected for inclusion in this annual report represent those to which IRSAC members have devoted particular attention during four working sessions and numerous conference calls throughout the year. The issues included in the IRSAC annual report are issues that members consider especially important but also include issues that IRS personnel brought to our attention and for which input was requested. Nearly all issues involved extensive research efforts. We acknowledge the many challenges that the IRS has recently experienced and, knowing the demands on IRS executives and operating division representatives, we also sincerely appreciate and want to recognize the time and effort devoted by them to IRSAC activities during the year. The 2015 SBSE/W&I Subgroup, co-chaired by Andre’ L. Re and Sherrill L. Trovato, prepared recommendations regarding cost-effective ways to improve individual taxpayer authentication to ensure a high level of confidence while minimizing taxpayer burden, to mitigate fraud by payroll service providers, to improve the taxpayer experience by increasing the IRS’ communication with taxpayers, and other suggestions to improve the Offer in Compromise process and the automated online self-service applications. The 2015 LB&I Subgroup, chaired by Mark S. Mesler, Sr., prepared recommendations regarding recommendations regarding penalty administration in light of impending LB&I examination process changes and the IRS’ emphasis on international information reporting. In addition, the Subgroup made recommendations on risk assessment and examinations in relation to recently modified Tangible Property Regulations. 6 The 2015 OPR Subgroup, chaired by Ronald D. Aucutt, prepared recommendations to maintain the independence, strength, and visibility of the IRS Office of Professional Responsibility and provide it with the legislative authority it needs to do its job of protecting taxpayers and our voluntary compliance system. It also prepared a recommendation to reaffirm and strengthen a 2011 IRSAC proposal that OPR consistently use the Uniform Standards of Professional Appraisal Practice in judging appraiser conduct. In addition to the reports and recommendations of the three IRSAC subgroups, the Council as a whole identified two transcendent issues — securing adequate funding for the IRS and preserving a strong, balanced, and independent Office of Professional Responsibility — that merit special attention because of their fundamental importance to enabling the United States to have a system of tax administration that can and will meet the objectives of the stated mission of the Internal Revenue Service: The IRS Mission Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all. This mission statement describes our role and the public’s expectation about how we should perform that role. • In the United States, the Congress passes tax laws and requires taxpayers to comply. • The taxpayer’s role is to understand and meet his or her tax obligations. • The IRS role is to help the large majority of compliant taxpayers with the tax law, while ensuring that the minority who are unwilling to comply pay their fair share. 7 ISSUE ONE: THE IRS NEEDS SUFFICIENT FUNDING TO OPERATE EFFICIENTLY AND EFFECTIVELY, PROVIDE TIMELY AND USEFUL GUIDANCE AND ASSISTANCE TO TAXPAYERS, AND ENFORCE CURRENT LAW, SO THAT THE INTEGRITY OF, AND RESPECT FOR, OUR VOLUNTARY TAX SYSTEM IS MAINTAINED Executive Summary The Internal Revenue Service is a bureau of the Department of the Treasury, one of the world’s most efficient tax administrators,1 and by some measures the largest financial services organization in the world. The financing of the federal government depends largely upon the Internal Revenue Service, which collected 93 percent of federal receipts in FY 2014.2 In FY 2012, the IRS collected more than $2.5 trillion in revenue3 and processed more than 237 million tax returns, and more than 2 billion information returns.4 Including the effects of across-the-board rescissions and reductions required by sequestration and other adjustments, overall funding for the IRS has decreased about 17 1 The IRS spent just 48 cents for each $100 it collected in FY 2012. (Table 29, IRS 2012 Data Book.) The US spends roughly half what the average OECD country spends to collect $1,000. See Organization for Economic Cooperation and Development, “Tax Administration 2015: Comparative Information on OECD and Other Advanced and Emerging Economies,” at http://www.oecd.org/ctp/administration/tax- administration-23077727.htm. According to IRS Budget Division, in 2013 IRS spent less than $5 to collect every $1,000 in net revenue. Today that amount is even lower, below $4, and it is likely that only Switzerland now spends less. IRS also spends under one tenth of one percent — currently about 0.06%— of U.S. GDP on tax administration, far lower than most developed countries, again with only Switzerland lower. Note that most OECD countries generate a substantial portion of their revenue from indirect/consumption taxes with self-enforcing features that require less service/compliance work, making the comparison even more significant. 2 GAO-15-624, “IRS 2016 BUDGET: IRS Is Scaling Back Activities and Using Budget Flexibilities to Absorb Funding Cuts,” June 2015 (“GAO-15-624”), at 1. 3 Id. 4There were 2,109,781,400 information returns of various types filed in 2014. See Publication 6961 (Rev. 7-2014). 8 percent on an inflation-adjusted basis since FY 2010,5 and is now below FY 2009 levels.6 These reductions do not include the effects of the unfunded mandates of significant new program costs, like administration of the Patient Protection and Affordable Care Act (the ACA) and other laws, imposed on the IRS. The IRS has managed these massive downward adjustments in its funding by scaling back activities, freezing hiring, limiting training, and using limited budget flexibility7 to reallocate resources among its four appropriations accounts and the programs they respectively control. As discussed below, these cuts have already had a significant and negative impact on both the taxpayer service and enforcement functions of the IRS, inhibiting its ability to carry on the IRS mission. In our view and in the views of others, the adjustments forced by recent budget reductions have had substantial and widespread negative impacts on the agency, all of its 81,279 personnel,8 federal taxpayers, state taxpayers whose state tax- related obligations are affected by interaction between their state tax system and the IRS, and taxpayer representatives (the attorneys, certified public accountants, enrolled agents, software providers, and others who assist taxpayers in filing their tax returns and dealing with the resulting obligations that flow from them). Thus, the reductions affect all the issues with which IRSAC and taxpayers generally are concerned. 5 National Taxpayer Advocate 2014 Annual Report to Congress 13 (Most Serious Problem: TAXPAYER SERVICE: Taxpayer Service Has Reached Unacceptably Low Levels and Is Getting Worse, Creating Compliance Barriers and Significant Inconvenience for Millions of Taxpayers). 6 GAO-15-624, at 1. 7 See note 16 below for additional discussion of these constraints. 8 Full Time Equivalents (“FTE”) reported for FY 2015. GAO-15-624, at 1. Since FY 2010, IRS’s overall staffing has declined by about 13,000 FTEs (14.1 percent). FTEs units are the computed number of equivalent employees working full-time, or the ratio of the total number of paid hours during a period (part time, full time, contracted) by the number of working hours in that period Mondays through Fridays. 9 Recent deficiencies in funding are eroding the significant investments and substantial progress made in the last two decades in modernizing and streamlining the IRS, and making it more efficient. These investments were made at the behest and with the support of House and Senate Congressional leaders in both parties, the Treasury Department and IRS, and private individuals, all of whom care deeply about both particular issues and the core integrity and effectiveness of our tax system. The funding deficiencies compromise the IRS’ ability to deal with the challenges now before us and those yet to come, and may have even more dramatic and costly future impacts on our system of voluntary compliance and self-assessment. An efficient, well-functioning IRS is absolutely critical to every aspect and program of our federal government. State governments are also adversely affected, as most state tax systems “piggyback” off aspects of the federal tax system. IRSAC does not believe that current levels of funding are adequate to achieve these goals so necessary to each and every one of us as American citizens. We say this as professionals who deal with the tax law, tax system, and tax agency on a daily basis. We say this because, candidly, it needs to be said. We believe our tax system, which is dependent on voluntary compliance, is increasingly at risk. Description of the Problem The financing of the federal government depends largely upon the IRS, which collected 93 percent of federal receipts in FY 2014.9 In FY 2012, the IRS collected more 9 GAO-15-624, at 1. 10