[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]



 
HEARING ON IRS LATEST ENFORCEMENT: IS THE BULLS-EYE ON SMALL BUSINESS?
=======================================================================

                                HEARING

                               before the

                      COMMITTEE ON SMALL BUSINESS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                               __________

                     WASHINGTON, DC, APRIL 5, 2006

                               __________

                           Serial No. 109-46

                               __________

         Printed for the use of the Committee on Small Business


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 house


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                      COMMITTEE ON SMALL BUSINESS

                 DONALD A. MANZULLO, Illinois, Chairman

ROSCOE BARTLETT, Maryland, Vice      NYDIA VELAZQUEZ, New York
Chairman                             JUANITA MILLENDER-McDONALD,
SUE KELLY, New York                    California
STEVE CHABOT, Ohio                   TOM UDALL, New Mexico
SAM GRAVES, Missouri                 DANIEL LIPINSKI, Illinois
TODD AKIN, Missouri                  ENI FALEOMAVAEGA, American Samoa
BILL SHUSTER, Pennsylvania           DONNA CHRISTENSEN, Virgin Islands
MARILYN MUSGRAVE, Colorado           DANNY DAVIS, Illinois
JEB BRADLEY, New Hampshire           ED CASE, Hawaii
STEVE KING, Iowa                     MADELEINE BORDALLO, Guam
THADDEUS McCOTTER, Michigan          RAUL GRIJALVA, Arizona
RIC KELLER, Florida                  MICHAEL MICHAUD, Maine
TED POE, Texas                       LINDA SANCHEZ, California
MICHAEL SODREL, Indiana              JOHN BARROW, Georgia
JEFF FORTENBERRY, Nebraska           MELISSA BEAN, Illinois
MICHAEL FITZPATRICK, Pennsylvania    GWEN MOORE, Wisconsin
LYNN WESTMORELAND, Georgia
LOUIE GOHMERT, Texas

                  J. Matthew Szymanski, Chief of Staff

          Phil Eskeland, Deputy Chief of Staff/Policy Director

                  Michael Day, Minority Staff Director

                                  (ii)


                            C O N T E N T S

                              ----------                              

                               Witnesses

                                                                   Page
Everson, The Honorable Mark W., Commissioner, Internal Revenue 
  Service........................................................     4
Sullivan, The Honorable Thomas M., Chief Counsel for Advocacy, 
  U.S. Small Business Administration.............................     6
Brown, Mr. Kevin, Commissioner, Small Business/Self-Employed 
  Division, Internal Revenue Service.............................    26
Olson, Ms. Nina, National Taxpayer Advocate, Internal Revenue 
  Service........................................................    28
Satagaj, Mr. John, President and General Counsel, Small Business 
  Legislative Council............................................    31
Hall, Mr. Keith, CPA, Partner, Hall and Hughes, PLLC.............    32
Fredrich, Mr. Michael, President, Manitowoc Custom Molding, LLC..    35
Sawicky, Dr. Matt, Economic Policy Institute.....................    37

                                Appendix

Opening statements:
    Manzullo, Hon. Donald A......................................    57
    Velazquez, Hon. Nydia........................................    60
Prepared statements:
    Everson, The Honorable Mark W., Commissioner, Internal 
      Revenue Service............................................    62
    Sullivan, The Honorable Thomas M., Chief Counsel for 
      Advocacy, U.S. Small Business Administration...............    72
    Brown, Mr. Kevin, Commissioner, Small Business/Self-Employed 
      Division, Internal Revenue Service.........................    78
    Olson, Ms. Nina, National Taxpayer Advocate, Internal Revenue 
      Service....................................................    84
    Satagaj, Mr. John, President and General Counsel, Small 
      Business Legislative Council...............................    99
    Hall, Mr. Keith, CPA, Partner, Hall and Hughes, PLLC.........   104
    Fredrich, Mr. Michael, President, Manitowoc Custom Molding, 
      LLC........................................................   113
    Sawicky, Dr. Matt, Economic Policy Institute.................   118
Additional material:
    Brown, Alvin S., Alvin Brown and Associates, LLC.............   124
    Stoner, Floyd E., American Bankers Association...............   146

                                 (iii)


 HEARING ON IRS LATEST ENFORCEMENT: IS THE BULLS-EYE ON SMALL BUSINESS?

                              ----------                              


                        WEDNESDAY, APRIL 5, 2006

                   House of Representatives
                                Committee on Small Business
                                                     Washington, DC
    The Committee met, pursuant to call, at 10:00 a.m., in Room 
2360 House Office Building, Hon. Donald Manzullo [Chairman of 
the Committee] presiding.
    Present: Representatives Manzullo, Kelly, Akin, Sodrel, 
Velazquez, Bordallo, Barrow.
    Chairman Manzullo. Good morning.
    Before receiving testimony from the panel, I want to remind 
everybody that we would like to keep the second panel witnesses 
to their oral testimony to five minutes. In front of you on the 
table, you will see a box that will let you know when your time 
is up. When the light is yellow, you have one minute remaining. 
When five minutes have expired, a red light will appear. Once 
the red light goes on please wrap up your testimony as soon as 
you are comfortable.
    This is the second hearing we have been having on the so 
called tax gap, which the IRS defines as the difference between 
what is paid and what should be paid. And everybody agrees that 
people should be paying taxes legally owed.
    The purpose of this hearing really is twofold. The first 
part is whether or not small businesses have been unfairly 
targeted by the IRS to the exclusion of others that may not be 
paying their taxes correctly. The second part has to do with 
what types of remedies are available to the IRS. But I want you 
to notice that the IRS' efforts are targeted at mom and pop 
small businesses.
    I read over the GAO's report on the IRS last night while 
watching the tremendous game with the University of Maryland. I 
do not know if I was more excited over that basketball game or 
over GAO's report on the IRS. This is a report you have to read 
yourself. It is dated July 2005. Page 11 makes it explicitly 
clear because the IRS has no way of knowing whether or not 
corporations pay their taxes correctly, they do not even 
discuss going after corporations, instead the IRS goes after 
the little guys, the most vulnerable, the ones without the big 
lobbying firms in Washington, the ones represented by trade 
associations and the little guys who always get the crap kicked 
out of them on Capitol Hill. This GAO report is nothing less 
than condemning over what the IRS is doing. It should make the 
IRS hang its head in shame.
    I want to read from it on page 11. Estimates for some 
components of the tax gap are based on old data. The data is 
used by the IRS to determine which persons to pursue to reduce 
the tax gap. The report explains that ``The IRS has difficulty 
estimating the tax gap because of different interpretations 
that complicate determination as to whether or not taxes are 
paid fairly by corporations. Further the report states that the 
IRS also ``explained that due to these complexities and the 
costs and burdens of collecting complete and accurate data for 
corporation, IRS has not systematically measured large 
corporate tax compliance through statistically valid studies, 
even though the officials acknowledged that such studies would 
be useful in estimating the related tax gap.''
    If I were a professor and you turned in the report the IRS 
is using to go after the small people, you would get nothing 
less than a F or an F minus.
    I find it incomprehensible that the IRS is coming out with 
these new and fiscal schemes going after small businessmen when 
the data they rely upon is not worthy of a first grader. It's a 
disgrace that the IRS should rely upon virtually no 
information. But the word is out. Last year, audits were up 100 
percent. If you're a small businessman, they were up 140 
percent.
    The remedies that the IRS is proposing only attach to the 
little guys, the moms and pops and not to the C corporations. 
And the incredibility of these proposals means that if a small 
businessman is the sole shareholder in a C corporation, he's 
exempt. But, if he can't afford the attorney to go into a C 
corporation he's not exempt from the wrath of the IRS. I'm 
really upset about this. And I'm upset about it because of the 
poor scholarship that's gone into the study, as much respect as 
I have for Mark Everson and I know that he inherited this. This 
study was in place even before he came into office. Mark is 
still using this information for the purpose of going after the 
most vulnerable.
    Our job here in the Small Business Committee is to look 
after people that no one else cares about in this place, the 
forgotten ones, the 7 billion small business people that always 
get shuffled, the ones that pay health and accident insurance 
premiums after 15 percent FICA and FUTA taxes. They're the only 
business people that have to pay for their insurance with after 
tax money.
    And the frustration level of this Chairman is running 
extremely high at this point because of the number of small 
business people that are being hit. But in spite of that, we 
look forward to the testimony of Mark Everson, who I think has 
done an exemplary job at the IRS. He's got a job that Congress 
has mandated to go after these people, and he's going after 
them on the best information that he has and the only methods 
that he knows. We disagree with the quality of his information 
and disagree with the remedies he's proposed but agree with the 
fact that you cannot have a nicer person than somebody like 
him.
    And I yield to the minority, Ms. Velazquez.
    [Chairman Manzullo opening statement may be found in the 
appendix.]
    Ms. Velazquez. Thank you, Mr. Chairman.
    With April 15 right around the corner, taxes are 
undoubtedly on everyone's mind. Today's hearing will focus on 
the tax gap; the difference between what the IRS is supposed to 
collect and what is actually collected. According to the IRS, 
the tax gap is estimated to be $345 billion per year and 
growing.
    As the budget deficit mounts, around $400 billion, the 
administration is looking for ways to recover lost revenue that 
was supposed to come flowing in as a result of their fiscal 
policy. But it has not. Unfortunately, it appears the 
administration is trying to make up for these shortfalls and 
balance the budget by unfairly targeting small businesses. 
Today, we will hear from the IRS about a plan in the 
President's FY 2007 budget to crack down on small firms by 
granting the IRS even greater authority for enforcement.
    This proposal, while having a significant impact on 
entrepreneurs will only reduce the tax gap by one tenth of 1 
percent. This is a large price to pay for a solution that will 
not even fix the problem. However, any attempt to solely blame 
the IRS is wrong. What seems to be lost in this discussion is 
the impact wrong policy choices, specifically tax policy made 
by congressional Republicans and the administration, have had 
on this nation's small businesses.
    While providing minimal relief for entrepreneurs, the bulk 
of the reform passed has only further complicated the process. 
It has added thousands of pages to the tax code, which will 
only exasperate the growing tax gap problem.
    For proof, one only has to look at the 2004 tax bill. Even 
the Chairman of the Ways and Means Committee testified that 
this legislation set back efforts to simplify the tax code. 
Small businesses are being hit twice; once with the ever-
increasing complexities of the tax code and again with the 
rising possibility of an audit.
    Given the growing complexity, tax assistance is needed now 
more than ever for small businesses. Unfortunately, rather than 
providing assistance, the Administration is closing taxpayer 
assistance centers. It simply does not make sense for the IRS 
to shift these resources when the complexity of the tax code is 
increasing.
    Congress will be voting on the budget this week and we will 
see just how much commitment there is to fairness for small 
businesses. The question at hand is: Will Members support the 
Administration's budget proposal to further reduce tax 
compliance assistance efforts and impose strict enforcement 
efforts? Or will they reject these proposals?
    While many in the President's party are more than happy to 
vote for his tax cuts and trump all the supposed good they are 
doing, when it comes to the consequences, increased compliance 
costs and a growing tax gap, they are vehemently opposed. 
Unfortunately, you simply can't have it both ways.
    As has been the case with tax, energy and health care 
policy, the Administration continually favors large 
corporations. It is no surprise that while the tax gap is not 
only made up of small business taxpayers, this Administration 
lets the big corporations off the hook and instead focuses on 
entrepreneurs. At the same time, many small firms have little 
or no resources to defend themselves.
    Small businesses are the drivers of this nation's economy, 
and they deserve every effort possible to decrease the burdens 
they face. If the goal today is to reduce the costs to small 
business, Congress should first look to reduce the complexity 
of the tax code.
    Most entrepreneurs are doing everything they can to pay the 
taxes they owe. They should not be blamed for the tax gap. This 
Administration needs to come to terms with the role their 
policies have had in furthering the tax gap. They need to admit 
the problem, then work to reduce the effects rather than point 
the finger, which is exactly what is happening with this 
current debate.
    Thank you, Mr. Chairman.
    Chairman Manzullo. Thank you.
    The first panel we here from, Mark Everson, who has served 
as Commissioner of the IRS since 2003.
    Next, the Committee will hear from Tom Sullivan who is 
Chief Counsel of the U.S. Small Business Administration Office 
of Advocacy.
    Both have been before this Committee on several occasions. 
We look forward their testimony.
    I am going to set this clock at about ten minutes for the 
first panel. And if you do not use it up, that is fine. But 
because your testimonies are so complex, I want to give you 
plenty of time to do that.
    And Commissioner Everson, thank you for coming and we look 
forward to your testimony.
    And I also want to state to the folks here that you will be 
leaving after your testimony, but the taxpayer advocate plus 
somebody else from the IRS will be sitting on the second panel. 
Kevin Brown will be on the second panel, plus I understand you 
are going to have people from the agency in the audience that 
will be monitoring all the testimony. We appreciate that.

     STATEMENT OF MARK W. EVERSON, INTERNAL REVENUE SERVICE

    Mr. Everson. Thank you. I do not think I will use the whole 
ten minutes. But we already covered a lot in the opening 
statements, so I think we will get to plenty in the questions.
    Good morning Mr. Chairman, Ranking Member Velazquez and the 
members of the Committee on Small Business.
    I am pleased to be here again to update you on our efforts 
to reduce the tax gap. As you know, the tax gap is the 
difference between the amount of tax taxpayers should pay for a 
given year and the amount that is actually paid on a timely 
basis. The tax gap represents in dollar terms the annual amount 
of noncompliance with our tax laws.
    We now estimate that for the year 2001, the overall gross 
tax gap for all types of tax was approximately $345 billion, or 
a noncompliance rate of 16.3 percent. Our estimate of the net 
tax gap or what remains after enforcement and other late 
payments is $290 billion.
    To reduce the tax gap we seek to improve service to 
taxpayers, we also enforce the law against those who do not 
comply. Our working equation at the IRS is service plus 
enforcement equals compliance. We strive to pursue to a 
balanced approach for all taxpayers, not just small businesses.
    For service, our outreach and education programs help small 
businesses deal with the complexities of the tax code. And we 
are reducing wherever possible the paperwork and reporting 
burden small businesses face. Electronic filing, which is 
growing rapidly across the nation, sharply reduces taxpayer 
errors on their returns. Our award winning website, IRS.gov, is 
one of the most widely used websites in the world during tax 
seasons.
    On the next panel, you will hear from Kevin Brown, the head 
of our Small Business/Self Employed Division. Kevin will talk 
more about our efforts to decrease the amount of time and money 
taxpayers must spend to meet IRS requirements.
    We will continue to work to improve services. But as you 
know, we are also boosting enforcement. The typical small 
business already has enough challenges without having to deal 
with a competitor who does not pay his or her fair share in 
taxes. We need to make sure that all are playing by the same 
rules. We want a level playing field.
    No businessman or businesswoman should gain an unfair 
competitive advantage because he or she decides to underreport 
income, overstate deductions or fail to properly remit payroll 
taxes.
    In recent years we have restored the credibility of our 
overall enforcement programs. In fiscal year 2005 individual 
audits were up 20 percent from 2004 to 1.2 million. They're up 
97 percent since 2000.
    High income audits were also up and have increased a 120 
percent since 2000.
    Corporate audits bottomed out in 2003, but by 2005 had 
recovered by over 50 percent.
    Collections are more robust. Last year we had 2.7 million 
levies versus 200,000 in the year 2000.
    All told, enforcement revenues have increased from $43.1 
billion in 2004 to $47.3 billion last year.
    In the President's fiscal year 2007 request we seek to 
build on this progress. We are asking for an additional $137 
million in enforcement. This increase will allow us to maximize 
the return on the investment made in enforcement last year when 
Congress provided $42 million in additional enforcement 
funding.
    Our research on the tax gap clearly indicates that where 
there is third party reporting, there is better compliance. In 
this regard I would draw to your attention a number of 
proposals in the President's 2007 budget aimed to address 
administrative and reporting issues. The most important of 
these is the proposal to mandate reporting to the IRS of gross 
receipts by credit card issuers for their business customers.
    I believe the five legislative proposals that accompanied 
the Administration's funding request can make a significant 
contribution to reducing the tax gap. I hope they will enjoy 
your support.
    In addition to these specific legislative proposals, I 
would also note that we plan to study the distinction between 
independent contractors and employees under current law.
    Let me make one final point. The extraordinary complexity 
of our tax system contributes to the tax gap. I continue to be 
a strong advocate of tax reform and simplification.
    Thank you.
    [The Honorable Mark Everson's testimony may be found in the 
appendix.]
    Chairman Manzullo. Thank you.
    Mr. Sullivan?

     STATEMENT OF THOMAS M. SULLIVAN, U.S. SMALL BUSINESS 
                         ADMINISTRATION

    Mr. Sullivan. Good morning Chairman Manzullo, Congresswoman 
Velazquez, Congressman Kelly. I am Tom Sullivan, the Chief 
Counsel for Advocacy at SBA. Congress established my office to 
independently represent the views of small business before 
Congress and federal agencies. So the comments expressed here 
don't necessarily reflect the Administration or the SBA.
    My written statement was not circulated to OMB for comment. 
I'd like to submit my written statement for the record and 
briefly summarize.
    Chairman Manzullo. All the written statements of the 
witnesses will be inserted into the record without objection.
    Mr. Sullivan. Thank you, Mr. Chair.
    The small business industry groups who come to my office to 
try to appeal to us to bring their views into other government 
agencies have expressed concern that IRS is focused on small 
entities as a primary means of improving tax compliance. News 
articles illustrate the reasons why these trade groups view 
IRS' focus to be trained on their members. A March 20th ``Tax 
Notes Today'' article reported that IRS increased its number of 
audits primarily through a spike in small business audits.
    In recent testimony the Commissioner highlighted the return 
on investment for resources spent on enforcement each dollar, 
the Commissioner said, spent generated $4 in additional taxes 
collected.
    Small business groups who have appealed to my office are 
insistent that a similar analysis of how the service function 
of IRS realizes a return on investment would go far to 
demonstrate the balance of service plus enforcement.
    Nina Olson, the National Taxpayer Advocate who is on the 
second panel this morning, has on numerous occasions and 
recently at a hearing over in the Senate encouraged the IRS to 
``recognize the central role taxpayer service plays in 
achieving compliance and do more to study the optimal ways to 
deliver taxpayer service and the magnitude of the impact.''
    Also you mentioned, Mr. Chairman, in your opening statement 
the GAO. GAO has encouraged the IRS to conduct research on the 
reasons for taxpayer noncompliance. And in 1996 GAO made 
similar recommendations.
    Small business groups feel that this type of research on 
the service components of IRS can guide the IRS' education in 
taxpayer compliance programs.
    Now let me turn my attention to some of the specific 
proposals that were mentioned by the Commissioners and will be 
mentioned in the second panel by the National Taxpayer 
Advocate.
    The Treasury proposals and the Taxpayer Advocate's 
proposals that I will address require third party reporting and 
withholding. The Administration has proposed information 
reporting and backup withholding on credit card payments, 
payment card issuers, which are credit and debit cards. They 
would report reimbursements made to merchants and withhold 
taxes in certain circumstances.
    Second, the Administration has proposed to require 
information reporting and backup withholding on all non-wage 
payments made to government contracts.
    Small business groups who have come to my office have 
expressed that an unintended consequence of the increased 
withholding will be its harm to the cash flow of small 
businesses. In general, cash flow or liquidity is one of the 
most significant constraints small entities face in managing 
their business. According to a recent NFIB survey cash flow 
issues ranked in the top ten of important problems faced by 
small businesses. Small entities have a more difficult time 
paying their bills when their cash flow is interrupted. And 
small businesses must either borrow additional capital or 
forego early payment discounts to manage cash flow shortfalls.
    Another unintended consequence of increased withholding is 
that tax deductible expenses of small entities may 
unnecessarily be taxed. Payments received by small entities for 
the services and products they provide include both their 
expenses and profits. Small business groups are concerned that 
another unintended consequence does not enter into the 
equations of withholding because expenses are generally tax 
deductible while profits are subject to tax.
    Before Treasury and IRS impose new reporting and 
withholding requirements, small business believe it is 
important to determine the impact that small card issuers and 
small local governments will need to absorb as a consequence of 
these reporting and withholding strategies.
    The National Taxpayer Advocate has proposed other reporting 
and withholding regimes. The third party proposals detailed in 
my written statement, while presented as voluntary really 
impose additional administrative burdens on small businesses 
that contract with self-employed taxpayers. Small businesses 
currently shoulder exceedingly high tax compliance costs. A 
study that was recently updated by my office shows that the 
cost of compliance costs employers with less than 20 employees 
a total of $1304 per employee. Additionally, requiring the 
payors of self-employed taxpayers to withhold may distort the 
line between being an employee and being an independent 
contractor.
    Payors of self-employed taxpayers may become vulnerable to 
employer liability issues in that blurry line of independent 
contractor versus employee. Those issues include workman's 
compensation and unemployment tax issues.
    Research sponsored by my office continues to show that the 
cost of tax compliance is 67 percent higher in small firms than 
in large firms. What can the IRS do to limit this 
disproportionate burden or unlevel playing field? Small 
businesses believe that IRS can evaluate the service they 
provide taxpayers so the importance of taxpayer service is not 
lost as they attempt to improve tax compliance.
    And certainly this hearing is an opportunity for IRS to 
consider some alternatives that may minimize the unintended 
impact of some proposals on small business.
    Thank you for allowing me to appear this morning.
    [The Honorable Thomas Sullivan's testimony may be found in 
the appendix.]
    Chairman Manzullo. Thank you.
    Ms. Kelly, why don't you go first?
    Ms. Kelly. Thank you. I appreciate it. I have a markup in 
another Committee I have to get to.
    I am very pleased to have the two of you here. There is no 
one that knows who really likes to dip in their pocket on April 
15th and pay taxes. They would rather keep the money. Quite 
frankly, as a Republican in this Congress, I would like to have 
them keep the money. But that being said, when you talk about 
small business as a small business owner, former small business 
owner I know that the tax system is very complicated, but I 
also know that there is an attitudinal problem. Many times when 
someone comes into your office and says ``I am here from the 
IRS for an audit,'' the attitude is ah-ha got you.
    At point in the past in my husband's office there was an 
auditor who came and said ``I have not found anything, but I 
have to find something because I have to cover the cost of my 
salary for being here.'' I know that that is not the first time 
that I have heard that. I have heard that in testimony in this 
Committee from other people, other small business owners.
    Our problem as small business owners is several. The basic 
problem is clarity. We do not get enough education at the small 
business level to truly understand the tax codes. So you wind 
up holding on to every tiny little slip of paper because you do 
not know what the tax man is going to want when he comes in. It 
is everything from whether or not your business has donated to 
charity, paid for an ad in a high school book, all kinds of 
things that effect us as small business owners.
    And I would encourage you, Mr. Everson and your group, your 
staff; Mr. Sullivan, I know you are out trying to help with 
clarity, but I know that both of you know that we have got to 
work through chambers of commerce, the NFIB, the groups that 
are out there to get more education on this tax code to the 
small business owners. It makes it easier for them. And without 
their full knowledge of all the little tiny tangential laws 
that may effect their particular business, then they do not 
save or have necessarily what is there.
    Because my husband and I own several different small 
business we at one point in our lives for a period of about 15 
years were audited on every single year by the IRS because the 
IRS did not know enough about the businesses that we were 
running to understand what we were filing as our tax code. And 
I see heads in the audience shaking. Sure, other people have 
been through that. I am not the only person.
    Well, what concerns me is that we have some evidence here 
in this study that Chairman Manzullo was talking about that 
nothing really has changed over the course of the last ten 
years. We need to have a change.
    So I would like an open commitment from you to try to help 
us teach small businesses better than you have been to approach 
a clarity with the type of business that people are in. Someone 
who shoes horses for a living has a totally different business 
than someone who is making small pieces of equipment for the 
Intel industry. All these different businesses have different 
approaches to their business.
    You have got a one size fits all approach to the filing of 
things, and that is very difficult and it makes it very 
complicated. I would like to see you work toward clarity. Can 
you give me some assurance that you are going to do that?
    Mr. Everson. Well, you have covered a lot of ground there, 
and I agree with a great deal of it. We are committed to 
outreach and education and I think Kevin will get into some 
more of the details on that. But we have active programs 
working with the NFIB, which you mentioned, and all the 
different groups and get involved in their newspapers. And I 
think that is an area where I would suggest to you that that 
has been a success story of recent years.
    Can we do more? Absolutely, we need to do more.
    Two other points on this. Again, simplification of the 
Code. As you keep handing us the Jobs Act. The Jobs Act was 
this thick.
    We've talked about the proposals. The Chairman and I talked 
yesterday about one of the things we want to look at is the 
definition of employee versus independent contractor. This is 
our training manual to apply the 20 part test on whether 
somebody is an employee or an independent contractor. We can 
only educate our people so well with the law that you have 
given us, if you will. So this is a joint discussion.
    But, yes, we will continue to focus on the education and 
the outreach.
    The last point I would say is I do not agree with the idea 
that somebody has to find something. Our no change rate on 
audits that you are talking about runs something like 16 or 17 
percent. This research that we have undertaken the Chairman 
does not have much faith in it but we think it is pretty good, 
we believe will help us better figure out where we want to look 
so that we are not in that situation that you are discussing; 
that somebody is in there saying ``gee, there is nothing 
here.'' This is something where we believe if we use the 
research properly, we will be able to risk adjust where we 
look.
    Ms. Kelly. Well, just a follow-up on that, Mr. Everson. Are 
you in fact investigating more small businesses in this nation, 
is that a fact?
    Mr. Everson. Yes, that is fact. If the Chair will indulge 
me for just a minute I would like to show several charts that 
will sort of frame this issue.
    Selected coverage rates 2005. Companies with assets of $250 
million, 44 percent. That is why we did not bother to do the 
research. We did the 46,000 audits on individuals, the coverage 
is so much lower. I would not use any more money on the 
corporations based on even if I knew that the tax gap was 
understated by half, because it is a relatively small piece. We 
are in there all the time auditing the biggest companies.
    Estate tax, gross estates with over $5 million, 28 percent 
audit rate.
    Corporations $10 to $50 million assets, 14 percent audit 
rate.
    Individuals with income over a million dollars, that's 5 
percent. This is still too low. We are bring this up.
    What we are talking about here is individual businesses, 
individuals with the Schedule C, that is at 3 percent audit 
rate. That is in contrast to the fact that if we go to the tax 
gap map you will see that the problem.
    Time filing that's most the individuals, that's about 8 or 
9 percent, underpayment. You say you what you owe us but then 
you just do not pay us, that is another 8 or 9 percent. Eighty 
percent of it is under reporting. Most of that is in the 
individual income tax.
    The biggest piece is in the under reported business income 
and that has an effect on the self-employment taxes. So it is 
really a bigger number than the $109 billion that effects the 
$39 billion?
    The areas where we don't get much reporting, third party 
reporting come up to $110 billion of the tax gap. The biggest 
piece there is Schedule C income, that is $68 billion. That $68 
billion has different components. The biggest single piece of 
that is gross income, that is $39 billion. There are other 
pieces in here.
    And I agree. Look, education of what depreciation could be 
or car and truck expenses, we can do better there. But I don't 
think that gross income is--that most of this education will do 
it on this $39 billion. The question here is whether the income 
is being reported.
    Why is this important? Because if you look at individual 
returns, this shows the change in individual returns since 
1978. It has gone up 50 percent for all individual returns. We 
are up at over 135 million now. But Schedule C filers have gone 
up by 175 percent. This is no surprise to you. You know what 
has happened; there is a small growth in small businesses. But 
that issue that I just showed there, that is going to get 
bigger as time goes on.
    So the basic rule here, we want to increase the audits, and 
we are increasing them everywhere, it is not just small 
businesses. But when we get the legislative proposals this is 
what you--this breaks out the compliance relatively speaking.
    Wages, we have 150 million Americans, we are not talking 
about them here, but there are 150 million American employees. 
They are used to reporting and withholding, by the way. We are 
not proposing withholding. We are proposing backup withholding. 
But the average America, 150 million of us including everybody 
on this panel, is used to reporting on your wages. There is no 
cheating on wages, a one percent noncompliance rate. Where you 
have no reporting. no reporting like the income for the 
Schedule C filer, the noncompliance rate is over 50 percent. 
That is the problem. That is the problem.
    Ms. Kelly. That is possibly, sir, because of confusion.
    Mr. Everson. I would agree on things like depreciation of 
car expenses, but not on gross receipts. Not that complicated 
when somebody pays you, when somebody pays you in cash or with 
a credit card, it is not that complicated.
    Ms. Kelly. Mr. Everson, what is your basis for all of this? 
Have you hypothesized a number?
    Mr. Everson. No. Forty-six thousand audits were done as a 
part of the national research program that has been reviewed by 
GAO and others. What the Chairman was talking about earlier 
was, with which I agree, he stated accurately what happened. We 
did not do the research on the C-Corps and the reason we didn't 
do the research on the C-Corps was because, as I said, we are 
already auditing those big firms by over 40 percent a year. So 
that this was a very intensive effort, cost of tens of millions 
of dollars to do this research. Looked at by GAO and others, a 
lot of academics participated in it.
    Ms. Kelly. Let me just say that I notice here the reason I 
am saying, all these yellow boxes have a little code down here 
saying ``dependent on older estimates.''
    Mr. Everson. Yes. Yes.
    Ms. Kelly. So I wonder about the metrics you are using on 
these charts.
    Mr. Everson. What I would say to you is all of what we have 
been talking about is over here. I concede freely to you that 
these are the big corporations right here. Even if this number 
is doubled because it is off by a factor of 100, what I am 
suggesting to you is we already have plans in place to attack 
that. So that where we spend our research effort, our initial--
    Chairman Manzullo. With withholding plans in place, your 
remedies are aimed solely at small businesses. You want to have 
backup withholding on credit card companies and on independent 
contractors solely as small businessman, completely excluding 
the C corporations.
    I am sorry. Ms. Velazquez?
    Mr. Everson. I'm sorry, Congresswoman. I am happy to come 
see you and continue to talk about this.
     Ms. Velazquez. Mr. Emerson, thank you for your testimony. 
Everson, I am sorry.
    Mr. Everson. Actually, I hate to correct the Chairman, but 
it is Everson. So if you will give me that opportunity.
    Ms. Velazquez. Everson. Okay.
    How much did you say that you spent on this study?
     Commissioner Everson. I think that study cost us something 
like $100 million. I could be wrong. Is that? This is the head 
of our research program, Mark Mazur. He says that is about 
right.
    Ms. Velazquez. Okay. So you spent all that money to figure 
out the tax gap?
    Mr. Everson. Yes.
    Ms. Velazquez. And did you figure out why people were under 
reporting? Do you have that data, complete data?
    Mr. Everson. We do not have that. The problem--
    Ms. Velazquez. So is it because they are cheaters or the 
tax code complexity? What is it? Because let me tell you, if 
you go to any university and you are going to do a research on 
a problem and then you make a conclusion without really trying 
to figure out why these people are not paying or are under 
reporting so that you can then develop a public policy to 
tackle the real issue, so why do you think that enforcement is 
the answer?
    Mr. Everson. Well, I think that there are a number of 
studies that have certainly substantiated the impact of the 
enforcement in terms of both the direct impact if you look at 
what we have brought in, we have increased the direct monies 
that have come back to us in the last three or four years, plus 
the indirect impact that if I am audited and I mention it to my 
neighbor, they will perhaps file differently. So that is 
clearly there.
    The debate that you are talking about is, which I agree, is 
on trying to quantify the service impact which we have been 
looking at. It is very difficult to do that. The statisticians 
who have looked at that have had a great deal of difficulty 
trying to find that.
    Now when we did the research, to answer your question, our 
people tried to determine but were not successful because if we 
go to you, if we find a problem in your return, if we ask you 
did you intentionally cheat, what are you going to say? You are 
going to say no. I mean, that is the normal response. Nobody is 
going to admit, or very few anyway, that they were 
intentionally violating the law. So it is very hard to 
determine with the precision that you or I might want when you 
do the audit the exact reason.
    Ms. Velazquez. But your response and your answer is based 
on a prejudged finding that they are under reporting because 
they do not want to pay. In no way you are doing any effort to 
find out whether or not the tax code complexity is the one 
preventing these people from paying?
    Mr. Everson. No. I would not agree entirely with that. I 
have stated--
    Ms. Velazquez. But let me ask you so enforcement is the 
sole answer?
    Mr. Everson. No, not at all. I think--
    Ms. Velazquez. So let me ask you another question.
    Mr. Everson. Yes.
    Ms. Velazquez. I just want to hear yes or no.
    Mr. Everson. Yes.
    Ms. Velazquez. So enforcement coupled with what?
    Mr. Everson. With service. As I said at the beginning, we 
believe in service and enforcement.
    Ms. Velazquez. Okay.
    Mr. Everson. You need to do both. And if I can say again 
what I said in the oral statement, I believe simplification is 
essential to get after this, particularly for small businesses 
and people--
    Ms. Velazquez. In terms of reducing the taxpayer assistance 
programs and the reduce of staffing at your office that have 
been the trend in the last three to five years?
    Mr. Everson. You made reference to this in your opening 
statement. Last year the Administration had a proposal to 
shutter 68 walk-in centers. We have not done that. The '07 
request that is pending before the Congress right now maintains 
services at a steady state. We are not contemplating any 
reductions in the services in the request, ma'am, that is 
before the Congress right now. So I think we got the lesson 
from last year's difficult discussions.
    Ms. Velazquez. Okay.
    Mr. Everson. So we are not proposing that again.
    Ms. Velazquez. Okay. So we will hear a lot about what the 
IRS is doing towards enforcement. But I want to look at 
Congress' record on the issue. According to a report published 
by the Democratic staff of the House Ways and Means Committee 
there were 900 changes to the tax code in the 108th Congress. 
The FSC/ETI legislation passed--
    Mr. Everson. Yes.
    Ms. Velazquez. --in 2004 provided for 561 changes and added 
250 pages of tax law changes. This does not even include the 
2001 and 2002 tax cut that added complexity and thousands of 
burden of hours on small businesses. How would you assess 
Congress' record on helping reduce the tax guide?
    Mr. Everson. Well I take my own self interest seriously and 
I am not going to take a particular shot at Congress, other 
than to say that that record that you are talking about adding 
complexity, it gets us nowhere. What I have said repeatedly 
is--
    Ms. Velazquez. Give me a grade, A, B, C?
    Mr. Everson. I've got to say that over time Congress fails 
in the effort to get a simple understandable tax code.
    Ms. Velazquez. So that is an F? You know, I used to be a 
college professor and I love--
    Mr. Everson. I think we can agree on that.
    Ms. Velazquez. Mr. Sullivan and then Mr. Everson--
    Mr. Everson. Thank you.
    Ms. Velazquez. --would you agree that the tax codes has in 
2001 have increased complexity?
    Mr. Everson. I would agree that the tax code since 1986 
over a period of years of control of Congress by both parties 
has grown in complexity. This is an inevitable process. And 
what happens is you have got these cycles where people 
eventually get feed up with all the complexity and there is a 
real call for reform. I am an advocate of that reform.
    Ms. Velazquez. But five years ago we heard a lot about, you 
know, this is going to be the Congress and this is going to be 
the Administration's--
    Mr. Everson. I am not wading into--
    Ms. Velazquez. Of course.
    Mr. Everson. Let me make one thing clear. I am not wading 
into a partisan debate on this. I am giving you the simple fact 
that over decades this code has continued to grow; that's all.
    Ms. Velazquez. Mr. Sullivan, Advocacy has done numerous 
reports on the issue of taxes and small businesses. For 
example, I know that the Office of Advocacy studied the impact 
of marginal rates on small businesses. That was quite a timely 
report considering Congress was voting on marginal rates in 
2003.
    Given the huge impact of this $2 trillion in tax cuts, why 
have you not done any work to study whether these changes have 
increased complexity for small businesses.
    Mr. Sullivan. Congresswoman, actually we have done some 
studies on the overall complexity. We have not narrowed in on 
whether specific year tax cuts contribute.
    Ms. Velazquez. Okay.
    Mr. Sullivan. But I would point the Congresswoman and this 
Committee to a working paper by an economist in my office, Dr. 
Saade Radwan that documents what Commissioner Everson was 
saying, that however well intentioned each different change may 
be, and this echoes your concerns, Congresswoman Velazquez, the 
overall complexity actually is harmful to small business.
    Ms. Velazquez. So are you telling me that are you going to 
commission a study on this? This is huge for small business.
    Mr. Sullivan. Well as the Congresswoman pointed out, 
sometimes our timing of studies does not exactly comport with 
congressional action. Actually, this is not on purpose, but our 
studies take anywhere from one year to two years.
    Ms. Velazquez. I know. It was coincidental 2003. But can I 
get a--
    Mr. Sullivan. But we tried to get that study done as 
quickly as we could, and we hope that it benefits the debate.
    What we will try to do is continue to focus in on what 
parts of the tax code or the over all complexity of the tax 
code benefit small business. And as far as focusing in on 
specific year tax changes, I would direct the Committee's 
attention to a March report by the Department of Treasury that 
is peer reviewed that documents a number of different pros and 
cons of recent tax changes.
    Ms. Velazquez. Thank you, Mr. Sullivan.
    Mr. Everson, does Small Business Self-Employment Division 
of the IRS has served a critical role by meeting with members 
of the small business community to identify concerns. It has 
also been helpful to small business and tax practitioners who 
need a system making determinations about tax code questions.
    I am concerned that there have been efforts by the IRS to 
shift resources in this division from compliance towards more 
enforcement. Can you talk about the staffing level at your 
department?
    Mr. Everson. Sure. And I'll let Kevin talk about it 
afterwards in more detail. But what we did in the last year was 
we had people who were on the enforcement side within this 
division, SB/SE, and we were doing part time work on outreach. 
And what we did was we consolidated this to make this a year 
around full time responsibility. Because what was happening was 
when you get into this busy season that we are in now, they 
were being taken off of that outreach. We did not think that 
was particularly effective. So we have made some changes in the 
last year or two to try and have a more dedicated full time 
work force on this.
    Ms. Velazquez. So, Mr. Everson, we constantly hear how 
small businesses are paying less taxes under this 
Administration and they saw enormous benefit from the tax cuts. 
If that is the case and rates are lower, it seems there will be 
less incentive to intentionally taxes by under reporting 
income. However, the IRS is cracking down on small businesses. 
Do this not seem kind of backward? Do you disagree with the 
theory that lower tax rates should lower tax avoidance?
    Mr. Everson. I think that the debate, I do not want to wade 
into the policy debate because my job is to administer the 
code, good or bad, as written. Obviously policy decision are 
taken to provide incentives for economic activity. There are 
compliance issues, though. Complexity is one, also stability is 
another. We have not talked about stability.
    The constant changing of the rules is an issue on top of 
just how complex they are.
    If you look at our research, which is for 2001, you are 
right that each year the revenue stream of the government 
changes. It changes for rates, it changes for increases in 
corporate receipts versus individual receipts. So there is a 
mix effect that takes place over time. But what we would 
suggest is we're concerned about going after the gap in all the 
areas, but we do prioritize.
    If we go back to the bar chart, one of the things that's 
very clear from the research is is that, again, where there's 
no reporting like there is for employees, that the gap is 
largest. So we want to get after that through not just some 
more audits, but also through some additional reporting.
    Ms. Velazquez. I would have more questions later, Mr. 
Chairman.
    Chairman Manzullo. Thank you.
    Could you put up that chart, selected IRS coverage rates FY 
2005? Sometimes these charts remind me of that guy on Johnny 
Carson giving the directions to the used car lot. Do you 
remember that with the freeways, wore the big hat and 
everything?
    Mr. Everson. This?
    Chairman Manzullo. How many corporations are there with 
assets above 250 million? Do you know the figure for that?
    Mr. Everson. I don't have the figure. I can certainly get 
it for you. But the number of the largest corporate audits that 
we did last year were--I guess this would be all of our 
companies over 10 million in assets. See, Kevin's group has 
companies with assets up to 10 million; it has got the C-Corps 
and the individuals filing the Schedule C. Our large and mid-
sized business unit is anything over 10 million assets. We did 
about 13,000 audits last year.
    Chairman Manzullo. Well, how many companies are there? Does 
anybody know? The gentleman just handed you a--
    Mr. Everson. Yes. This is the number of audits. It doesn't 
say with--the number of returns. Okay. I am told it is about 
11,000.
    Chairman Manzullo. For corporations with assets over 250 
million?
    Mr. Everson. Yes. Yes. That is correct. I guess we got 
11,000 returns filed in calendar 2004, 11,000 had assets over 
250 million.
    Chairman Manzullo. Not the estate, but the next one, 
corporations between 10 and 250 million?
    Mr. Everson. That would be--
    Chairman Manzullo. You guys can help your boss out. Don't 
let him guess here.
    Mr. Everson. Oh, he's got it right here.
    Chairman Manzullo. Okay.
    Mr. Everson. It's all right here. He is just making me add 
up the numbers.
    Chairman Manzullo. All right.
    Mr. Everson. It is about 43,000.
    Chairman Manzullo. But where are the number of corporations 
that are under 10 million?
    Mr. Everson. That is a different category. I think that 
that audit rate is less than 1 percent. For C-Corps assets of 
10 million, it is about seven-tenths of one percent, Mr. 
Chairman, that audit rate.
     Chairman Manzullo. Do you know how many there are?
    Mr. Everson. Oh, a couple million, I guess.
    Chairman Manzullo. Well--
    Mr. Everson. Let's see. Yes. Now let me show you one 
additional--
    Chairman Manzullo. Let me back up. There are 2 million 
firms that have 10 million--
    Mr. Everson. Two million C-Corps.
    Chairman Manzullo. Two million C-Corps that have under 10 
million in assets?
    Mr. Everson. C-Corps. Let me show you what is happening 
with the C-Corps, Mr. Chairman, and why this is not as big an 
area of emphasis.
    Chairman Manzullo. And the audit rate on that group is 
about .3 percent.
    Mr. Everson. Point seven.
    Chairman Manzullo. Point seven. All right. Go ahead.
    Mr. Everson. Mr. Chairman, this lays this out. Because you 
have talked to me before about S-Corps what has happened over 
the years, again, starting at the same point.
    1978 we had about 2 million C-Corps and a half a million of 
the S-Corps. Look at what has happened here, and this line is 
crossed now. Far more businesses are operating as S-Corps. The 
C-Corp number--
    Chairman Manzullo. Now let me stop you. What is the audit 
rate for S-Corps?
    Mr. Everson. The audit rate for S-Corps, go back to that 
chart, .3 percent; it is next to nothing.
    Chairman Manzullo. All right.
    Mr. Everson. That is why--
    Chairman Manzullo. Then how many S-Corps are there?
    Mr. Everson. Well, it is right here.
    Chairman Manzullo. Okay. Wait a minute. So it is about 
three and a half million? Okay. All right.
    Mr. Everson. So what we are doing, this is an area where we 
were doing nothing. Nothing at all. I am not saying we missed 
this, but take a look at this. S-Corps, .3 percent. So one of 
these we have corresponded is about is your concern that the 
next stage of the research we are putting here. Now we may 
conclude that there are not problems with the S-Corps, but with 
an audit rate like that we just do not know.
    Chairman Manzullo. Well, that is the whole point.
    Mr. Everson. That is why we are doing the research.
    Chairman Manzullo. No. You see, you just do not know and 
yet you go full ahead pell-mell after the mom and pops?
    Mr. Everson. Well the S-Corps we're doing the research 
program with 5,000 returns--
    Chairman Manzullo. I mean you spent $100 million. How much 
more money and more time do you need to do this? And why do you 
advocate such draconian withholding measures when your research 
is not done?
    Mr. Everson. Let me make sure that I clarify the--I would 
not agree with the characterization of draconian. We are 
proposing--
    Chairman Manzullo. Well, how about plutonian then?
    Mr. Everson. We are proposing reporting and backup of 
withholding. If you look at backup withholding which is in 
place for all Americans now for let's say dividends and 
interest. Let year we got something like 330 million reports on 
dividends and interest. Only a little over one in a thousand 
didn't come in with the proper taxpayer identification number. 
That is what would trigger potentially the backup withholding. 
So it is a very de minimis number of people.
    Chairman Manzullo. Let me finish with this before we get 
into that, because I want you to explain the withholding on it. 
Well, how many individual businesses are there that fild 
Schedule C?
    Mr. Everson. It is now up to about 16 percent of all the 
returns. So what would that be? About 18, 20 million? Twenty 
million let us say.
    Chairman Manzullo. So you got 20 million people. So there 
would be substantially a lot more people would be audited--
    Mr. Everson. Well, as I indicated, our priority has been 
to--
    Chairman Manzullo. No. Let me finish. Let me finish. A lot 
more people would be audited. You have a better chance of being 
audited if you are a small business person in terms of the 
personnel that the IRS is dispatching for that?
    Mr. Everson. Well, those are the rates right there. And we 
have a high rate. A lot of controversy. I get a lot of comments 
from Madam Velazquez side of the aisle on EITC audit rates, 
because look at that. That is 2.4 percent and some people think 
that is too high. That program has a lot of concern because of 
the high error rate stemming sometimes from fraud, but largely 
from the complexity of all the definitions. There are a lot of 
issues in there.
    We try to run a balanced program, but what we have worked 
on in the last several years has been particularly in the high 
income area, take a look at that five percent audit rate and 
also on the corporate areas where we brought that back up and 
progressively worked on the shelters.
    So I would not agree with the characterization that we have 
focused particularly on small business. I would not agree with 
that at all.
    Chairman Manzullo. Well, you said that yourself.
    Mr. Everson. No. I said we are, we need to do more and we 
need keep forward.
    Chairman Manzullo. You are focusing on small business. What 
you do not understand here, do you know who comprise a lot of C 
corporations that have under 10 million in assets? These are 
lawyers, accountants; these are all service organizations.
    Mr. Everson. Yes.
    Chairman Manzullo. Service companies. Manufacturing 
companies and other retailers would have more than 10 million. 
And there is a whole group of people in there that are under 10 
million that you are not even touching as long as they are a C 
Corporation.
    Mr. Everson. Well, the thing is, Mr. Chairman, again we 
measure our effectiveness in part by what I mentioned before, 
this no change rate. For the small C-Corps the no change rate, 
that is where we go in and it is Congresswoman's Kelly's issue 
of we do not find anything. When we have done the C audits on 
the smallest businesses, that no change rate is something 
around 40 percent in contrast for individuals that rate is 15 
or 16 percent. So--
    Chairman Manzullo. Well wait a second. Your audit rate on 
two million companies with under 10 million in assets is .7 
percent?
    Mr. Everson. Yes.
    Chairman Manzullo. That is a pretty small number?
    Mr. Everson. Yes.
    Chairman Manzullo. But you have already made the assumption 
based on your study that GAO does not like that you are not 
going to go after these people.
    Mr. Everson. I did not say we are not going to go after 
these people. But what we do is we use the studies to risk 
adjust and also we use our own results. And as I just 
indicated, when we look at the C-Corps, the very smallest of 
them, a no change rate means we do not find anything 40 percent 
of time. There is in our field experience, if you will, we see 
relatively more compliance in that entity.
    Chairman Manzullo. But the only remedies you are proposing 
are against non-C entities, mom and pops, withholding, is that 
correct?
    Mr. Everson. I think that we are working across three 
fronts, if you will, to do more across the board. And what we 
are doing first is we are increasing our enforcement 
activities. We are improving our procedures, which includes a 
whole series of productivity and other improvements and using 
research where we have it. And then we are making, as you 
suggested, some legislative proposals.
    Chairman Manzullo. Right. Now the legislative proposals, 
and by the way I found it very interesting that you want to 
level the playing field. I have never known the IRS that wants 
to level the playing field between two businesses. I am sure 
that businesses would rather have less regulations and the IRS 
trying to make things easier for one and not for the other. I 
just find that astonishing.
    But in terms of the withholding, let me walk you through a 
scenario.
    Mr. Everson. Yes.
     Chairman Manzullo. Let us say that I am a restaurant 
owners, a non-C-Corporation, mom and pop, the way my brother 
was. And I report a million dollars in gross receipts for tax 
year 2006. And, hypothetically, through your research IRS 
estimates that restaurants receive 50 percent of their payments 
from customers using credit cards and 50 percent in cash.
    Then the credit card companies send the IRS information 
which you want from every credit card company for every 
business except C corporations. They send you information that 
my restaurant reports $400,000 in credit card charges. No. I'm 
sorry. Reports $800,000 in credit card charges. The return 
shows a million dollars gross, you have $800,000 in credit card 
charges. What would the IRS do?
    Mr. Everson. Well, I will not give you a specific answer 
because I am not an expert in that area. But what we do is we 
have formulas where we work based on history and research and 
we select our audits based on those formulas.
    Chairman Manzullo. No, I--
    Mr. Everson. No, please, let me finish.
    Chairman Manzullo. No, just a second.
    Mr. Everson. I'm trying to say--
    Chairman Manzullo. I made it easy for you.
    Mr. Everson. I can't tell you what we would do. It depends 
on resources we have.
    Chairman Manzullo. Well, let us say you decide to audit. So 
you decide to audit.
    Mr. Everson. Right. It comes down to what Congresswoman 
Kelly was asking about before, having a knowledge of the 
business. The pattern of credit versus cash receipts might be 
different in a restaurant than it is in a dry cleaner or a 
small gardening services.
    Chairman Manzullo. Let me go through it one more.
    Mr. Everson. Yes.
    Chairman Manzullo. The return shows a million dollars gross 
receipt.
    Mr. Everson. Yes.
    Chairman Manzullo. This is a restaurant.
    Mr. Everson. Yes.
    Chairman Manzullo. Hypothetically, all right, the IRS says 
50 percent comes from credit cards and 50 percent comes from 
cash. And then the credit card companies send you notice that 
there was $800,000 charged in credit cards which should trigger 
in somebody's mind that it should be 1.6 million reported as 
opposed 1 million reported. My question is if the IRS has that 
information, which is what you want, is that not correct?
    Mr. Everson. Yes, that is correct. That is what we want.
    Chairman Manzullo. What would you do with it?
    Mr. Everson. If someone sticks out, if a business sticks 
and is different from others--
    Chairman Manzullo. And this one would.
    Mr. Everson. Yes. If it would, it might trigger an audit.
    Chairman Manzullo. All right. And then what would you do? I 
mean not talking about the audit. Would you ask the credit card 
company to withhold?
    Mr. Everson. No.
    Chairman Manzullo. You would not?
    Mr. Everson. No. Because the backup withholding attaches if 
you as--let us say you are the credit card issuer.
    Chairman Manzullo. Okay.
    Mr. Everson. If you forward it to us the wrong number, a 
number that matched up Everson and you reported that I had a 
taxpayer identification number, but when we went to match up it 
didn't match up to what we showed for Everson, that is what 
would trigger backup withholding.
    Chairman Manzullo. So in the hypothetical that I gave you 
that would not trigger any backup withholding?
    Mr. Everson. No, sir. Not at all.
    Chairman Manzullo. Okay. So that is why the documents that 
you put out are--
    Mr. Everson. They are unclear.
    Chairman Manzullo. They are unclear.
    Mr. Everson. Okay.
    Chairman Manzullo. So it is only if there is something 
wrong with the taxpayer identification number?
    Mr. Everson. That is it. And that is the same way it works 
on dividends and interest right now, which people are used to 
doing.
    Chairman Manzullo. Okay. Let me take you to another 
scenario. The restaurant owner, not everybody who has a credit 
card has a TIN number, is that correct? We used to call it an 
SS-4 when I practiced law. Has a taxpayer identification number 
or Social Security number?
    Mr. Everson. Well if you don't have a Social Security 
number, you have got a bigger problem than that, because you 
got to file a tax return with us, you got to have a number that 
identifies you. So you got to have a number.
    Chairman Manzullo. Okay. Do you need a Social Security 
number to get a Visa or MasterCard, anybody? Is it normally 
required? I think it is, would that be correct?
    Mr. Everson. I think it's a pretty standard piece of 
information.
    Chairman Manzullo. Am I correct in assuming that?
    Mr. Everson. Yes.
    Chairman Manzullo. Now there are a lot of small businesses 
that do not get a taxpayer identification number but report 
their income on a Schedule C through their own Social Security 
numbers?
    Mr. Everson. Absolutely. That is correct.
    Chairman Manzullo. You don't have a problem with that??
    Mr. Everson. No. No. We are not suggesting we change that.
    Chairman Manzullo. Okay. Well then explain to me, 
Commissioner Everson, where there's a faulty taxpayer 
identification number, give me the scenario in that restaurant 
thing if you could?
    Mr. Everson. Yes. They haven't been square with you as the 
credit card issuer. They put down my Social Security number 
because they don't want the IRS to get the right number. And 
this is no different than, again, dividends and interest.
    Chairman Manzullo. So this is really actual fraud?
    Mr. Everson. Yes, or--well, look, what we do is we send out 
notices. We do not impose backup withholding. Let me be clear 
here. There can be confusion. A credit card issuer, somebody 
could have made a mistake just like Merrill Lynch might. We 
send out notices. Again, let me give you the numbers for last 
year total returns filed in 2003 for dividends and interest. We 
got almost 320 million reports. The number where the TINs did 
not mention up was 334,000. That is a little over one in a 
thousand. That is what triggers notices and ultimately backup 
withholding.
    Chairman Manzullo. But notwithstanding, you still would 
require every credit card issuer or clearinghouse give the IRS 
information on how much every single small business in the 
nation was generating in credit card receipts?
    Mr. Everson. That is the gist of the proposal, that is it, 
sir. And--
    Chairman Manzullo. No, let me stop you right there.
    Mr. Everson. Yes.
    Chairman Manzullo. Do you have any idea what that would 
cost in terms of regulation?
    Mr. Everson. We are working with the industry. We have the 
banking--
    Chairman Manzullo. The answer is you do not know?
    Mr. Everson. We do not know a precise number at this stage.
    Chairman Manzullo. But notwithstanding the fact that you do 
not know, you are still asking Congress this year for those 
legislative proposals?
    Mr. Everson. We have made a broad proposal. We are going to 
work with the Congress and we will try to minimize the burden, 
but you are correct?
    Chairman Manzullo. All right. Now let me give you a 
scenario where I got involved and Ms. Velazquez also got 
involved. When the HOPE Scholarship for the $1500 tax credit 
for middle and lower income taxpayers was instituted, Secretary 
Rubin testified before the Senate and he was asked a question: 
How much would it cost the 7,000 universities, colleges and 
community colleges and trade schools across the nation to send 
out a form showing the source of the payment for the tuition? 
He said the cost would be the cost of the stamp.
    I got involved as Chairman of the Small Business Committee 
because actually, believe it or not, we have jurisdiction over 
colleges that have less than 500 employees. The annual cost was 
$100 million. And I worked with Chairman Rossotti for five 
years, changed the law and changed the regulations. And, of 
course the IRS, because the IRS considers itself exempt from 
the Regulatory Flexibility Act and continually refuses to do 
any research or reporting or compliance with that Act as to 
what it would cost the small business people, IRS was off by 
$100 million. Now I would say with these fine research fellows 
that you hire for $100 million a year, before the IRS even 
comes out with any notion of any change in reporting, I would 
suggest that you figure out exactly how much it is going to 
cost and you do that before you even come up with a proposal. 
And that is where this is deficient because Secretary Rubin was 
so wrong. In fact, I was fighting the software manufacturers 
and you were in the middle of that also. Remember that?
    And it is a good thing that Commissioner Rossotti was a 
systems person. I mean his background was in computers and 
analysis. And he recognized the problem right away. And we 
worked with 7,000 schools across the nation. They could not 
believe that this burden had been imposed.
    Now Congress had imposed that burden. And that is what can 
happen when legislation is proposed and there is no research 
done on it.
    Ms. Velazquez? Okay. Well then I have just got one other 
question to conclude.
    And that would be I understand fully now the withholding on 
credit cards would only be triggered in the event that there is 
some fraud going on.
    Mr. Everson. Well there could be confusion, sir, and we 
send notices out.
    Chairman Manzullo. But there's confusion and it is 
corrected right away and there's no withholding?
    Mr. Everson. That would be right. We send out notices.
    Chairman Manzullo. Let us say that I have got the 
restaurant and Mr. Sullivan is a plumber. I do not like to use 
the words plumber around Congress. But let us say he is a 
plumber and he does work in my restaurant from time-to-time. 
And then you notice that Mr. Sullivan is not, maybe he has been 
late in filing the quarterly estimate from time-to-time and you 
think that perhaps he is not reporting all the income that 
comes in. Are you proposing any remedy that would have me as 
the payor withhold or report to you on the money that I owe him 
as the plumber?
    Mr. Everson. No, sir. We are not changing those. Our 
proposals do not run to increased reporting from business. I 
know you do not believe this, Mr. Chairman, but I tried to be 
sensitive to your concerns. And what we proposed is the more 
reporting by the credit card issuers, and here ten of those 
businesses do 84 percent of the $2.2 trillion in credit card 
issuances around the country or dollars that come in through 
credit cards, and also governmental entities do some more 
reporting, not a business doing it; what you are talking about. 
That is--
    Chairman Manzullo. So under your proposals I, as the 
restaurant owner would not have to do anything more?
    Mr. Everson. No, sir.
    Chairman Manzullo. Is that correct? And you would never ask 
me to withhold on any payments that I would owe to him?
    Mr. Everson. No, sir.
    Chairman Manzullo. And I understand that there is a present 
law passed by Congress and for which you are not responsible, 
that says even in that scenario I am supposed to report any 
independent contractor payments in excess of $600 a year?
    Mr. Everson. That is correct.
    Chairman Manzullo. That is the existing law?
    Mr. Everson. The existing law, I think you are correct in 
stating--
    Chairman Manzullo. And that is not followed. That is not 
followed?
    Mr. Everson. I would not say that it is not followed. I 
think we could do better on that.
    Chairman Manzullo. The more sophisticated the business, the 
more that is done?
    Mr. Everson. Well, yes, that would probably be right. I 
mean, it gets to some of the issues we were talking about 
before as to what gets reported. People may if they get the 
1099s, they may be reporting the 1099s they get as income, but 
not the ones they do not get.
    Chairman Manzullo. So let me make sure this is very clear.
    Mr. Everson. Yes.
    Chairman Manzullo. This helps both you and me. The only 
additional reporting that, yes I guess I will use the word 
``only'', that you are requesting would be to have the credit 
card companies issue to the IRS at the end of the year all the 
transactions--
    Mr. Everson. No, gross receipts. Just one number.
    Chairman Manzullo. I'm sorry. Gross receipts for 
unincorporated businesses.
    Mr. Everson. For all the businesses, yes. That is right.
    Chairman Manzullo. For incorporated businesses also or just 
unincorporated businesses? It's just unincorporated.
    Mr. Everson. I think it's just unincorporated. Yes.
    Chairman Manzullo. It is just the little guys?
    Mr. Everson. Well--
    Chairman Manzullo. Yes.
    Mr. Everson. --we have not been that specific, sir.
    Chairman Manzullo. Well--
    Mr. Everson. We said it by general language so you have got 
an opportunity to weigh in. Do you want to put the companies in 
there, too.
    Chairman Manzullo. No, I understand. But it is targeted at 
small businesses? That is your target--
    Mr. Everson. It is targeted where I showed.
    Chairman Manzullo. I have got your paper here.
    Mr. Everson. Yes. It showed--I think we have been pretty 
clear as to where we think we can get the money.
    Chairman Manzullo. No, I want to clear this up before I let 
you go here.
    Mr. Everson. Okay. All right.
    Chairman Manzullo. It is targeted at sole proprietorships, 
the 25 million people out there and the partnerships that are 
not corporations.
    Mr. Everson. I think that is fair enough. Fair enough. That 
is where the biggest under reporting is.
    Chairman Manzullo. Do you think that corporations under 
report?
    Mr. Everson. It goes back down that other road.
    Chairman Manzullo. No, I mean--
    Mr. Everson. Yes.
    Chairman Manzullo. Because if you are doing that much 
auditing--
    Mr. Everson. We are doing the auditing, yes. We set up--
    Chairman Manzullo. And you find out that they do not pay 
the--
    Mr. Everson. We set up billions of dollars in additional 
assets from them.
    Chairman Manzullo. But you only want to impose the 
additional reporting on small unincorporated businesses and not 
on the incorporated business, is that correct?
    Mr. Everson. Well, we have not been that specific. If you 
want to add the big C-Corps, you know, Blockbuster Video to it, 
I do not know.
    Chairman Manzullo. No, it is here.
    Mr. Everson. We can certainly put that in there. It is a 
general proposal. We did not submit language. We have said we 
want to work with the Congress on the contours of the proposal.
    Chairman Manzullo. Well--
    Mr. Everson. We have got the American Bankers Association 
coming in this week to talk to people about this. So we clearly 
want to talk about this.
    Chairman Manzullo. It says payment cards are a growing form 
of payment for retail business transactions. And it goes on 
here. I mean, it is obvious that the additional reporting that 
you want to have the credit card companies do is only for the 
little guys because you consider them to be the biggest 
cheaters.
    Mr. Everson. ``Biggest cheaters,'' I have not use that 
word.
    Chairman Manzullo. But it is true. It is true.
    Mr. Everson. I have showed you where the biggest piece of 
the tax gap is.
    Chairman Manzullo. No, I understand. People cheat, people 
cheat.
    Mr. Everson. What we are trying to do here again is level 
the playing field so that: (1) The Government gets what it is 
due. And also so that the small businesses playing by the rules 
does not get disadvantaged.
    Chairman Manzullo. Let me read your writing here, your 
proposal. ``It is expected that as under current information 
reporting regulations certain categories of merchant payees 
such as corporations will be excluded from the reporting and 
backup withholding requirements.'' These are your own words.
    Mr. Everson. If you have a problem with that, we will work 
with you on that.
    Chairman Manzullo. You think I am sitting here because I 
enjoy reading this?
    Mr. Everson. Okay.
    Chairman Manzullo. I mean the reason for this hearing is 
the fact that in your own words the only people that you think 
of significance who are not paying their income taxes are these 
little guys.
    Mr. Everson. I do not think that. I am not suggesting that, 
sir. But we do not see--I do not think the revenue line is 
where we see problems with C-Corps.
    Chairman Manzullo. Well, you know, I think--
    Mr. Everson. That is what we are talking about here, is the 
revenue line.
    Chairman Manzullo. What is the revenue line?
    Mr. Everson. Gross receipts. They have more sophisticated 
accounting systems and I believe you would find that--
    Chairman Manzullo. You mean like Enron and those clowns?
    Mr. Everson. I do not think that--
    Chairman Manzullo. How much did those clowns take from the 
American people? How many corporations out there are the 
Enrons, the small Enrons?
    Mr. Everson. Look--
    Chairman Manzullo. Ms. Velazquez, do you have any idea? 
Would you not like to know?
    Ms. Velazquez. But let me just say that you sound like a 
Democrat today.
    Chairman Manzullo. Oh, no, no. We are in there with the 
little people.
    Mr. Everson. Mr. Chairman, if you talk to your colleagues 
at Ways and Means and, Ms. Velazquez, nobody would tell you 
that we have done anything except work on high income and 
corporate people. You can look at the KPMG matters, the 
aggressive shelter work we have done with Son of Boss 
increasing all this.
    Chairman Manzullo. Well, no, I--
    Mr. Everson. We are not going after just the little guy.
    Chairman Manzullo. No. I am just saying that in your own 
words you have already said you are going after the little 
guys.
    Mr. Everson. No. On revenues the bigger problem is clearly 
where we have indicated.
    Chairman Manzullo. All right. You know this page 117, this 
is your document.
    Mr. Everson. Okay.
    Chairman Manzullo. And I just read from your document.
    Mr. Everson. Fair enough.
    Chairman Manzullo. Mr. Sullivan, am I correct that this is 
targeted at little people?
    Mr. Sullivan. I think the Chairman and Commissioner Everson 
are actually expressing the same concern, although a little bit 
differently. The small businesses that come to my office have 
said that there is reporting in the proposal and they are 
terrified that the next step after reporting is withholding. 
That is what they are terrified about. And I think you will 
hear more about that from the next panel.
    Chairman Manzullo. Okay.
    Mr. Sullivan. Because that is certainly something that the 
Taxpayer Advocate has talked about. And I think Commissioner 
Everson has said he is sensitive to those concerns, which I 
think--
    Chairman Manzullo. Okay.
    Mr. Sullivan. But they are fearful of what comes after 
reporting.
    Mr. Everson. I understand that concern and I am making no 
proposal and do not support the withholding. As you know, I 
have said to you privately to you in the past.
    Chairman Manzullo. Yes. Because my question is, and I will 
let you go on this finally--
    Mr. Everson. Okay.
    Chairman Manzullo. Treasury has different compliance 
suggestions than the Taxpayer Advocate, is that correct?
    Mr. Everson. Yes. The Taxpayer Advocate is set up to look 
at issues of problems of dealing with the service and gives us 
internally as a part of the IRS to try and help us improve our 
administrative procedures.
    Chairman Manzullo. Right.
    Mr. Everson. But she also makes an annual report to 
Congress highlighting 20 areas where her office has concluded 
that there are particular problems navigating the code or 
enforcement procedures.
    Chairman Manzullo. But her suggestions for enforcement 
compliance are separate from yours?
    Mr. Everson. Absolutely. They are not Administration 
proposals.
    Chairman Manzullo. All right. And hers are even more 
pervasive, and we will have fun with her shortly.
    Mr. Everson. Let her characterize her own thoughts.
    Chairman Manzullo. All right.
    Mr. Everson. I never try to speak for Nina. I have learned 
that in my three years on the job.
    Chairman Manzullo. I want to thank both of you for coming. 
I know we have taken a lot of time, but I wanted to get 
explicitly clear what the Treasury has proposed in terms of 
withholding. And I know we have taken a lot of time to do that, 
but it has been worthwhile to do that.
    Again, Commissioner Everson, every time we have called you 
have come to the office, you have been available. You have been 
very transparent with us. And I really appreciate the efforts 
that you are doing at the IRS.
    And, Mr. Sullivan also, we did not ask you a lot of 
questions but we did not have to. I appreciate the work that 
you do on behalf of the small businesses.
    And the first panel is excused.
    Mr. Everson. If I can say one last thing, Mr. Chairman.
    Chairman Manzullo. Yes.
    Mr. Everson. I am happy to be here. I appreciate the vigor 
with which you and your Committee members represent your 
interest. And I think this is the way that tax policy ought to 
be reached. Because it should not be done in the dark of night 
in some appropriations rider where people are doing things that 
have impact. This is a full debate. We want to work with the 
Congress on these issues.
    Chairman Manzullo. Thank you, Commissioner. I appreciate it 
very much.
    Let us get the second panel ready.
    [Recess.]
    Chairman Manzullo. I'm surprised you guys stuck around 
after the first panel. We are going to go from left to right. 
If you could keep it to five minutes, I would appreciate it. 
Obviously your full statements will be a part of the record.
    Our first witness on the second panel is Kevin Brown, who 
also has been a frequent visitor to the office. And he is the 
Commissioner of the Small Business/Self-Employed Division at 
the IRS. We look forward to your testimony. Thank you very 
much.

    STATEMENT OF KEVIN BROWN, SMALL BUSINESS/SELF-EMPLOYED 
               DIVISION, INTERNAL REVENUE SERVICE

    Mr. Brown. Good morning, Chairman Manzullo, and Ranking 
Member Velazquez, and distinguished members of the Committee. I 
appreciate the opportunity to talk with you today about the 
work of the Small Business/Self-Employed Division of the 
Internal Revenue Service.
    The SB/SE organization is made up of 28,000 employees who 
serve about 45 million taxpayers, roughly one-third of the 
taxpaying population. Our taxpayer base consists of seven 
million small businesses, including corporations and 
partnerships with assets of $10 million or less; 33 million 
self-employed and supplemental income earners; and five million 
other taxpayers who file employment, excise, estate, gift, 
fiduciary and international tax returns.
    As I begin, I want to echo a couple of the themes you have 
just heard from Commissioner Everson. First, whether we are 
providing service through education, outreach or burden 
reduction, or we are seeking out noncompliance through our 
enforcement efforts, our intent is to help all taxpayers, 
including small businesses, comply with the tax laws and to 
ensure that these laws are applied fairly to all. Secondly, it 
takes a balance between service and enforcement to achieve 
compliance, and SB/SE strives daily to maintain this balance 
for its taxpayer community.
    Today I am going to focus primarily on the service side of 
the equation by highlighting some of our recent efforts.
    We know that the vast majority of small business taxpayers 
rely on their practitioners to handle their tax returns. Given 
this situation, it is vitally important that we reach out to 
the practitioner community so that they can, in turn, support 
their small business clients. We have built a robust outreach 
and education program to do just that, to touch thousands of 
stakeholders and through them reach millions of small business 
taxpayers. The result is more than 15,000 relationships with 
national and local partners including practitioner 
organizations, small business and industry associations and 
federal and state agencies and governments. One of the more 
well-known services we provide is the Small Business Forums 
which we co-host with the United States Chamber of Commerce, 
the National Federation of Independent Business and the Small 
Business Legislative Council. Through these forums small 
business organizations receive the latest small business 
information from the IRS and in turn are able to share their 
members' concerns and issues with us.
    Due to the success of the national forums, we are launching 
local small business forums at the state level this spring.
    SB/SE also devotes resources to identifying major sources 
of taxpayer burden and to developing and implementing ways to 
reduce this burden. Since 2002 our Office of Taxpayer Burden 
Reduction has been instrumental in reducing taxpayer burden by 
over 200 million hours. Here are some highlights.
    In January 2006, we implemented the Annual Forum 944 for 
employers who have a total annual employment tax liability of 
$1000 or less. Most of the estimated 950,000 eligible Form 944 
filers also will be able to pay annually with their form 944.
    This year we implemented a new automatic six-month 
extension period reducing burden by 11 million hours.
    Simplification of the office in the home deduction for the 
small business taxpayer is high in our priority list for tax 
year 2006. We are looking into several ways to address the 
burden caused by Form 8829, which is completed annually by 
about 2.4 million Schedule C filers as well as Schedule A 
filers.
    I also want to mention our SB/SE Disaster Coordination 
Office. In the aftermath of the recent hurricanes this office 
played a key role in the IRS' success in providing on the 
ground assistance to individuals and businesses in dealing with 
the myriad of related tax issues.
    Most recently the IRS has been partnering with the 
Department of Housing and Urban Development and Mayor Ray Nagin 
of New Orleans to help make businesses in the hardest hit areas 
of New Orleans and Louisiana aware of Federal incentive relief 
that is available to them.
    In summary, Mr. Chairman, I believe that the SB/SE Division 
of the IRS is providing much-needed support to the small 
businesses of America. We have demonstrated our commitment to 
service through the outreach and education we are providing, 
the partnerships we have developed and our numerous efforts to 
reduce taxpayer burden. At the same time, by using our 
enforcement resources to detect noncompliance, we are helping 
compliant businesses by eliminating the unfair advantage 
created when their competitors fail to comply with the tax 
laws.
    Thank you, Mr. Chairman. I will be happy to answer any 
questions you and the other Members of the Committee may have.
    [Commissioner Brown's testimony may be found in the 
appendix.]
    Chairman Manzullo. Thank you.
    Our next witness is Nina Olson. She is the National 
Taxpayer Advocate serving as advocate for taxpayers to the IRS 
and the Congress. We look forward to your testimony.

       STATEMENT OF NINA OLSON, TAXPAYER ADVOCATE SERVICE

    Ms. Olson. Thank you. I believe you.
    Mr. Chairman, Congresswoman Velazquez and Members of the 
Committee, as you know, my organization, the Taxpayer Advocate 
Service devotes a substantial portion of its efforts to 
assisting small businesses and self-employed individuals who 
experience problems with the IRS. Through February of this 
fiscal year, small business cases accounted for about 44 
percent of Taxpayer Advocate Service case closures, around 
90,000 cases a year. And we have been able to provide relief to 
small business taxpayers in nearly 75 percent of those cases.
    In addition to our case work, the Taxpayer Advocate Service 
is actively involved in identifying areas of the tax system 
that impose burdens on small business taxpayers. When we 
identify systemic problems we make administrative and 
legislative recommendations to help mitigate these burdens. I 
discussed several of the recommendations I have made in my 
written testimony, including recommendations from my 2004 
annual report to reduce burdens on small businesses. I am 
please that Chairman Manzullo included many of these proposals 
in the Small Employer Tax Relief Act of 2005 that he introduced 
last fall.
    In my annual reports to Congress I have also made 
administrative and legislative recommendations to reduce the 
tax gap. The IRS estimates that the net tax gap runs at about 
290 billion a year. The IRS expects to receive about 135 
million individual income tax returns this year. Therefore, the 
average individual tax filer is effectively paying a surtax of 
more than $2100 a year to subsidize noncompliance. As the 
statutory voice for all taxpayers, I find that to be an 
unacceptable state of affairs. It is unfair to the millions of 
taxpayers who pay their taxes in full and it erodes public tax 
confidence in our tax system. After all, if my neighbor is not 
paying his taxes, why should I.
    When you drill down a level the IRS data show that the cash 
economy is the largest single contributor to the tax gap. And 
while 99 percent of wage income earned by employees shows up on 
tax returns, the IRS estimates that only about 43 percent of 
self-employment income reportable on a Schedule C shows up.
    The low rate at which taxpayers report cash economy income 
creates two sets of problems. First, it places honest 
businesses at a competitive disadvantage. If one taxpayer is 
paying his taxes but a competitor is not, the honest business 
person will lose out on sales because the noncompliant 
competitor can use its tax savings to undercut the price of 
goods and services. Second, taxpayers operating in the cash 
economy have greater opportunities to be noncompliant because 
they know the payments they receive are not being reported to 
the IRS and therefore will be difficult for the IRS to detect.
    And as I know from 27 years I spent working with small 
business taxpayers professionally and as a self-employed person 
myself for those years, many small businesses operate on tight 
margins and plow every cent they can save back into their 
business. They have enormous difficulty saving money and since 
there is no mechanism to withhold taxes from their income, they 
often find they have spent their funds by the time tax payments 
are due. Then the IRS may come calling and these people would 
often come to me for help. Unfortunately, the most I could do 
in some of these cases was to help them request collection 
alternatives and in other cases it was simply too late. The 
sheer weight of the tax debt caused the business to go under.
    In light of the concerns I've expressed about the high rate 
of noncompliance in the cash economy and the extreme pressures 
small businesses face if they are audited, I have tried to 
offer proposals that strike a reasonable balance between 
reducing the high rate of noncompliance in the cash economy and 
avoiding excessive burdens on small businesses. There is no one 
size fits all solution and my proposals are just that; 
proposals that I and others may be able to improve on. But I 
think they represent a useful starting point.
    My written statement discusses some of my proposals in 
greater detail, but I would like to briefly highlight our 
proposal to amend the Internal Revenue Code to require the IRS 
to promote making estimated tax payments through its electronic 
funds transfer payment system and to establish a goal of 
collecting at least 75 percent of all estimated tax payment 
dollars through EFTPS by fiscal year 2012.
    One key feature of EFTPS that many taxpayers may find 
attractive is the ability to voluntarily schedule more frequent 
automatic estimated tax payments up to--
    Chairman Manzullo. Ms. Olson, could you talk about the most 
controversial, the backup withholding?
    Ms. Olson. Certainly.
    Chairman Manzullo. I think it starts on about page 11, 11 
and 12. You can tell that's where our concern is.
    Ms. Olson. All right.
    Chairman Manzullo. We appreciate the other information and 
agree with it, but we want you to address the proposal we 
disagree with.
    Ms. Olson. Okay. But I would like to say about that 
proposal--
    Chairman Manzullo. Go ahead.
    Ms. Olson. That it is the third in a tiered approach. That 
my goal is to get people to be able to stay out of trouble by 
being able to make estimated tax payments as easily as they 
would make automatic debits from their accounts for a car or a 
mortgage payment.
    And then I also have a proposal about companies that want 
to do withholding for their independent contractors, that they 
could come into the IRS, and this would not be the IRS 
contacting them, but that they would come into the IRS and say 
we want to treat our people as independent contractors but they 
are having a hard time saving and we want to do this voluntary 
withholding. And they would be considered independent 
contractors for all purposes such as deducting expenses and 
everything like that, except for the fact that the payor would 
be withholding.
    And I believe that those two proposals will eliminate a 
large amount of noncompliance and help companies, small 
businesses stay out of trouble in the first place.
    But for those individuals, those persons, those entities 
that are substantially noncompliant and repetitively 
noncompliant, and I believe that that is something Congress 
could determine or you could allow the Secretary to determine, 
but where there is a repetition of nonpayment of taxes year 
after year, then I propose that the IRS be able to use backup 
withholding in order to get the attention of those taxpayers 
and get them to call us. And once they call us, then we can 
channel them and say, folks, we will release backup withholding 
if you will schedule a year's worth of estimated taxes a year 
in advance so we know that you are not getting into trouble 
again. We will help you resolve your arrears, but we want to 
put you in a going forward basis with your estimated taxes.
    And so that is the withholding proposal. I am saying that 
you have to have a demonstrated history of noncompliance, in 
your words these might be the cheaters, they are cheating other 
taxpayers.
    Chairman Manzullo. And that would--I have got to get this 
out in your testimony in chief here. And that backup 
withholding would be on money coming from?
    Ms. Olson. Payors.
    Chairman Manzullo. Such as a credit card company?
    Ms. Olson. Well, I did not propose the credit card company.
    Chairman Manzullo. Or?
    Ms. Olson. It would be from, for example, if you were in 
construction and you were working for a large contractor and 
you were on the framing crew, then you would have the 
contractor do the backup withholding.
    Chairman Manzullo. But that is done now because of 
withholding for?
    Ms. Olson. For interest and dividends, that is right.
    Chairman Manzullo. No, no, no. For worker's compensation 
insurance to make sure it is--
    Ms. Olson. That is correct.
    Chairman Manzullo. But your proposal would also apply in 
the hypothetical that I gave the Commissioner about the 
restaurant owner that would owe money to the plumber if you 
found that the plumber was substantially noncompliant, is that 
not correct?
    Ms. Olson. That might happen in that instance. Now, I would 
imagine that the IRS would not be taking it down to that level. 
That they are going to be looking at persons who are repeatedly 
noncompliant and that it is worth them implementing--
    Chairman Manzullo. We always look at the worse possible 
scenario.
    Ms. Olson. I agree. I think that that is a legitimate 
concern.
    Chairman Manzullo. I interrupted your testimony. Did you 
get out everything that you had wanted to?
    Ms. Olson. I think so.
    Chairman Manzullo. Okay. Thank you.
    Ms. Olson. Yes. Thank you, sir.
    [Ms. Olson's testimony may be found in the appendix.]
    Chairman Manzullo. Our next witness is John Satagaj. And, 
John, we look forward to your testimony.

 STATEMENT OF JOHN SATAGAJ, SMALL BUSINESS LEGISLATIVE COUNCIL

    Mr. Satagaj. Thank you, Mr. Chairman, Ms, Velazquez, 
Members of the Committee. It is always a pleasure to be here.
    I think I noted last time I was here it was just a year ago 
for the same subject, it was a historic moment because I 
completed Commissioner Brown for the great work he is doing. So 
I am going to double it up. He is two-for-two, he continues to 
do a marvelous job. If we clone Commissioner Brown, we would 
have a much better situation and maybe not as combative and we 
have to be with the IRS sometimes. So I compliment--
    Chairman Manzullo. That was combative. The Commissioner is 
very smart because there's a Proverb that says that a soft 
answer turns away wrath. And he succeeded in doing that with 
his great smile and his personality, and also his candor.
    Go ahead.
    Mr. Satagaj. There is always going to be a tax gap; we all 
know that. And you alluded to the GAO study earlier in your 
testimony and opening statement. I believe the IRS has been 
doing tax gap studies since the studies. I think the first one 
was 1977. The first GAO report was in 1988. It looked at the 
'77, '82 and '87 tax gap ones And I guarantee if you take that 
'88 study and put it up against the one you referenced, it 
would say all of the same things. You know the data is old, we 
do not know what it is, we are not asking. We have been talking 
about the same issues about how you analyze the tax gap and how 
you find it. Nothing has changed between the 1977 tax gap 
estimate and the one today in terms of understanding what it is 
really about. And I think you illustrated that very well in 
your opening statement.
    The next point I want to make is about the blue book that 
you referenced, the five proposals and the one I call it the 
phantom six, the one on the independent contractors. And with 
all due respect, I think whoever wrote that did a disservice to 
the President of United States. Because the words are there and 
I've heard for the two or three weeks or four weeks since that 
has been out is ``Well, it is a general proposal and we need to 
figure out what it really means.'' And your conversation with 
the Commissioner about the corporations and the credit cards 
illustrates perfectly how little we know about those proposals 
and the potential impact. Does it cover C corporations? Is it 
excluding C corporations and S-Corporations? If it is, and I 
think for a while there I heard the Commissioner say that, then 
we are looking at all sole proprietors. How many sole 
proprietors take credit cards?
    And when you exclude all the brick and mortar that our S-
Corporations and C corporations, who are you going after? You 
have got 25 million of them maybe, but how many of them take 
the credit cards? And if it was not meant for that universe, 
why did we propose it? But it illustrates that that proposal, 
those words means things to us in the small business community 
and we get upset about them.
    I was talking to Advocate Olson, Nina, about that sentence, 
the phantom six. Well, I guarantee every one of us, and I told 
her this, it was a disservice to her. Because all of us who 
worked that independent contractor issue read that sentence, 
the first reaction is, ah ha, the Advocate is getting her 
proposal through in a different way through that proposal. And 
you have heard what she has talked about, and it is not that. 
And so we have a disservice to the President and to all of us 
if we are not careful how we choose our words. Because it means 
something to those of us in the small business community, and 
we did not see that there.
    So with those points, one last point. The IRS every year 
puts out a--they give bunk frivolous myths about filing your 
return. You know, things that you should not do that people 
claim, like the 16th Amendment is invalid so I do not have to 
file my return or if I put all zeros, I do not have to pay a 
tax.
    There was one that was interesting in there, and I pulled 
it out because I think it's really relevant to today. Filing a 
tax return is voluntary. A lot of people say I do not have to 
do it. And this is the IRS' words. Some people mistake the word 
voluntary for optional. But filing a tax return is not optional 
for those who meet the law's minimum gross income requirement. 
The word ``voluntary'' as used in the IRS publications, court 
decisions and elsewhere refers to the fact that the U.S. tax 
system is a voluntary compliance system. Now here is the 
important sentence in my mind and everything we are talking 
about here today about whether it is information report, it is 
backup withholding or it is anything. This is the sentence that 
we talk about our system. ``This means only that taxpayers 
themselves determine the correct amount of tax pursuant to law 
and complete the appropriate returns rather than have the 
government do this for them as done in other countries.''
    This is what America is about. This is what about being a 
small business is American is about. And we had better be darn 
careful if we are taking away any one element of that voluntary 
system.
    Thank you, Mr. Chairman.
    [Mr. Satagaj's testimony may be found in the appendix.]
    Chairman Manzullo. Thank you.
    I forgot to state that you are testifying on behalf of the 
Small Business Legislative Counsel.
    Thank you for your testimony.
    Next witness is Keith Hall, CPA speaking on behalf of the 
National Association for the Self-Employed. We look forward to 
your testimony.

         STATEMENT OF KEITH HALL, HALL AND HUGHES, PLLC

    Mr. Hall. Thank you.
    Chairman Manzullo, Ranking Member Velazquez, I thank you so 
much for the opportunity to be here today as a small business 
owner.
    To a small business guy like me any number that ends in 
billions is a touch concept to grasp. The tax gap that we are 
talking about today is one of those touch concepts.
    Through the National Association for the Self-Employed I 
visit with thousands of small business people each year. Based 
on that experience, I hope to shed a little light on some of 
the proposals and how they effect people like me. I 
specifically would like to talk about three things.
    First, and perhaps the most concern for me, is a proposal 
to initiate required withholding on non-employee payments. The 
withholding proposals would be based on gross payments as 
opposed to taxable income. This would require the same amount 
of cash withholding from all independent contractors regardless 
of the nature of their business. The business owner with the 
lowest profit margin would be hurt the worst, since they would 
be hit with the same amount of cash withholding even though 
they have less money to work with.
    Tracy Boulware, who is an NASE member from Houston, told us 
and I quote, ``I own a small company. I pay my taxes. Sometimes 
my profit margin is only 3.5 to 5 percent. This type of 
legislation could put me out of business. It is that simple.''
    The small business that has only a 3 to 5 percent profit 
margin would be devastated and probably could not continue to 
operate. But that is not the only bad stories that would be out 
there.
    I personally have a client in Garland, Texas that has a 
business cutting grass at retail strip centers. His total gross 
income for last year was about $240,000, which seems like a lot 
of money. But he has two full time crew chiefs and employees a 
number of college students during the summer. So at the end of 
the day he has about $40,000 of net income and pays about six 
grand in taxes. But under a withholding rule he would have 
$12,000 of his money withheld. That translates into about $500 
per month less to manage his family and manage his business.
    When I asked him if he could manage on $500 less a month, 
he also gave me a quote, but I thought I probably should leave 
it out here.
     We talk a lot about creating jobs and we talk about a 
stronger America, but this guy is actually out there doing it. 
And because he chooses to put a lot of his money back into the 
community he is going to be hurt the worst. The key point is 
that withholding based solely on gross payments would be 
greatly unfair to many taxpayers and for some it would mean the 
difference between surviving and not surviving.
    A second is the credit card reporting. Almost everyone has 
some type of information that is reported to the IRS either by 
their employer, by their bank or by their clients. This 
proposal would expand that type of reporting to credit and 
debit card transactions. Now capturing information can only 
have a positive impact, in my opinion, particularly in light of 
those taxpayers who consciously choose to avoid reporting 
income. If requiring the credit card companies to report these 
payments will help identify those that abuse the system, I am 
all for it. If reporting is used to match credit card receipts 
to the tax returns similar to the way 1099s are done today, I 
think it is a great idea. If, on the other hand, the reporting 
is used to make judgments regarding other items on the item, I 
think problems could arise.
    Discussions have included taking the total credit card 
receipts reported for a particular business and then 
extrapolating that total to total income, thereby making 
assumptions on amounts that are not reported. Making 
assumptions on information that is not reported will, again, 
paint all small businesses with the same paint brush which can 
only end up causing more problems then it solves.
    Perhaps the most critical problem with this proposal is an 
estimated return on investment. The Treasury estimated that it 
would save $225 million compared to 335 billion, which is 
nominal, especially compared to the burden it is going to place 
on both the IRS and on business taxpayers.
    The bottom line here is I am in favor of increased 
reporting, I am just afraid that this proposal will provide a 
lot more numbers but won't really have a big impact on fixing 
the tax gap.
    Lastly is education versus enforcement. Most issues faced 
by small businesses deal directly with the complexities of the 
tax code. The IRS' commitment to education over the last five 
years has made a tremendous difference. Anyone who thinks that 
the IRS has not been a friendly and more helpful entity has not 
had a chance to review their website. The commitment to that 
website changes in the Form 941, 940, the new Form 944; all 
prove that they have been listening and that they want to help. 
I am afraid, however, that the commitment to education might be 
fading. It seems clear that the proposed budget is moving away 
from education and toward enforcement. Point blank, more 
education means more compliance. My belief is that $1 in 
education is worth much more than $1 in enforcement.
    When I graduated from college, and I will not say how long 
that was, my goal was to make a lot of money, to conquer the 
business world and to be the man. But as I have gotten older I 
recognize that all we really have a chance to do is make a 
difference. Today you guys are called on to make a difference, 
not only for me, but for millions of small business owners just 
like me in evaluating each one of these proposals. It is my 
wish that the difference you strive to make is based on 
reducing overall tax code complexity and maintaining a 
commitment to education.
    Thanks again for the opportunity to be here, and thanks for 
making a difference.
    [Mr. Hall's testimony may be found in the appendix.]
    Chairman Manzullo. I appreciate that.
    Our next witness is Michael J. Fredrich. And I am going to 
touch upon his biography because first of all, I forgive you 
for graduating from the University of Wisconsin because I went 
to Marquette.
    Mr. Fredrich. It was a rough time and I forgive you, too.
    Chairman Manzullo. That is all right. It says personal, 
married 31 years to the same woman, no children, 13 dogs, 10 
cats, six horses and no mice. And with that introduction--
    Mr. Fredrich. That is right.
    Chairman Manzullo. But BS degree in nuclear engineering, 
MBA in finance, corporate turnaround specialist. Industries 
include manufacturing. You know the time I spend in 
manufacturing. I really do look forward to your testimony.

  STATEMENT OF MICHAEL FREDRICH, MANITOWOC CUSTOM MOLDING, LLC

    Mr. Fredrich. Well, thank you, Mr. Chairman. And thank you 
Ms. Velazquez.
    Chairman Manzullo. I'm sorry. On behalf of the Small 
Business and Entrepreneurial Council.
    Go ahead.
    Mr. Fredrich. Yes. Thank you.
    Well, I am happy to be here today.
    And I read the testimony of Mr. Brown and I would have to 
say, I would not want your job. I think you are trying to do 
the right thing and you are dealing with really an impossible 
situation. I mean our tax code is so complex it crosses 
people's eyes. I mean, I do not know how many people in here 
actually do their own taxes, but I mean it is just impossible 
to do.
    And I know this is not a debate, but Ms. Olson, I read 
yours, too. And if you are helping the small business, do not 
help so much. We do not need that kind of help.
    I view this proposal as one more straw on our back of small 
business. We are, you know, a professional tax collector. We 
collect federal tax, state tax, Social Security tax, Medicare, 
unemployment tax, state and federal. We file W2s. We do 1099s. 
And we do not get paid for any of this service. And on top of 
this now we are going to become immigration police, which is 
not the topic of this.
    There was competition mentioned that we want to make 
everybody pay their taxes so we have a level playing field. I 
would offer this to anybody that thinks adding more burden on 
small business creates a level playing field and improves 
competition. I would say this: You are looking at the wrong 
competitors. Our competitors are not other small businesses in 
this country. Our competitors are small businesses and 
companies around the world. And I offer this as an example.
     One of our customers, Kohler Engine--we make parts that's 
Kohler Plumbing, but they also make engines. Most people 
probably do not know that.
    They have a group of people that go around and assess your 
cost structure and they compare you not just to other people in 
this country, they compare you to other of your competitors in 
the world. So we have competitors in China and we have 
competitors in India. And they look at our cost structure and 
they say well your costs are too high. So here is your choice. 
You can lower your price or you can lose the business. And that 
is fact. And they are not the only company that has it, lots of 
companies have that. So that is the cost reality that we are 
dealing with.
    In my testimony I have a thing here called the Anthony 
factor. Small businesses do not and cannot have a high 
overhead. We cannot employ more people than we absolutely need 
to. So in situations like our computer system, we cannot have 
an IT person on staff so we use Anthony. We pay Anthony the way 
we pay everybody else. We pay him by check an we issue him a 
1099. And the thought of having to start now messing around 
withholding on Anthony is just silly. I mean, it is just one 
more straw. And at the increment it does not seam like it is a 
lot, but it is. I mean, you have to look at the whole thing in 
its total.
    Another example. We do not have a direct salesman, we have 
a guy that we have been trying to leave his current employment 
where he makes $120,000. He has a salary of $120,000. And we 
said to him, look it, why do you not start your own company. Be 
your own boss. We think you would flourish and you could 
represent our company in selling our products and we would 
benefit and you would benefit and it would be good for us.
    So now here is a guy, he is going to leave, walk away from 
$120,000 salary into a situation here he makes zero on day one. 
Absolute zero. So now you are going to enact some legislation 
that is going to require us to withhold 28 percent of what we 
are going to pay him. Well, he cannot afford that. I mean, he 
is already walking away from $120,000. So, you know, that is 
how this kind of thinking, I mean you would think you would 
want to encourage people to start their own business, and that 
is how businesses start. I mean, they start with people going 
out on their own and saying, hey, you know, I can do this for 
myself. And this legislation or this proposal it really dampens 
that.
    One other thing I would like to say. I heard this with 
regard to audit activity $1 yields $4. That is just bunk.
    When you make a calculation like that in a free market 
transaction where you have a willing buyer and a willing seller 
and the IRS does not come to you and say hey, we would like to 
do an audit, what do you think. No. They say we are going to do 
an audit. Okay. So then you have to go and hire your support, 
your tax accountant, you have to go hire Kevin here and say hey 
I need representation that pulls you away. And they do not 
factor those costs in there. They do not factor the focus that 
is taken away from the business.
    Can you imagine? We do not run on a big staff. I mean, I am 
not there today. My partner is there today. But we are there 
everyday that we can be. And to take our focus away to have an 
audit where somebody thinks they make $4 for every dollar of 
audit cost ignores the other half of the equation. What is our 
cost? I mean, that has to be your true yield on what an audit 
costs.
    So I mean they go through this plan of we are going to 
expand--my time is up. I am sorry. I will summarize quickly.
    I think you need to be simpler. You need Hagelian logic; 
less is more. Our tax structure is too, too complicated.
    That is my testimony.
    [Mr. Fredrich's testimony may be found in the appendix.]
    Chairman Manzullo. Now I am convinced that you were at the 
University of Wisconsin. Hagel is the author of Communism.
    Mr. Fredrich. The solution. In business if you want to make 
something better--
    Chairman Manzullo. You do not get it. Everybody accuses the 
University of Washington of being very liberal and said--
    Mr. Fredrich. I was in engineering school there.
    Chairman Manzullo. All right. Sorry about that.
    Appreciate your testimony.
    Mr. Fredrich. Thank you.
    Chairman Manzullo. The next witness is Dr. Max Sawicky, an 
economist with the Economic Policy Institute, who has worked at 
the State and U.S. Treasury Department.
    We look forward to your testimony, Dr. Sawicky.

      STATEMENT OF MATT SAWICKY, ECONOMIC POLICY INSTITUTE

    Mr. Sawicky. Thank you.
    I would like to thank you, Mr. Chairman and Ranking Member 
for inviting me.
    If Ms. Olson does not supply enough disagreement, maybe I 
can fill in the gap.
    The United States has enjoyed a tax holiday for years now. 
We are, as you know, spending much more than we are taking in, 
both in terms of the Federal Government in the U.S. relative to 
the rest of the world. Very few economists think these 
imbalances can be sustained indefinitely. And because of that 
the need for revenue, I think, is going to become inescapable. 
Tax increases are not fun and I think that fact is going to 
compel renewed and expanded interest in the tax gap, which is 
another source of solution.
    Now, I would take exception to some of my friends. Tax 
increases, in and of themselves, do not fix this because in the 
long run we have health care spending increases in both the 
public and private sector which will need to be paid for one 
way or another. If they are not paid for by the government, 
they are paid for by someone else. If they are not paid for, 
then somebody loses health care. So the problem is much bigger 
then revenues, but revenues I think are going to be impossible 
to avoid. And that means the tax gap, among the other things.
    Now the elephant in the room here which nobody has really 
touched upon which pertains to a number of the issues that have 
come up is resources for the IRS. If there is a lack of service 
and education of taxpayers, that is amenable to remedy with 
more resources. If there is a lack of research or an unevenness 
in the focus of research, that is amenable to more resources. 
If there is a shortfall in technology, which I think is a 
particular problem with the IRS, that is a crying need.
    Proposals to flat fund the agency or even reduce funding in 
real terms after adjusting inflation mean that when we talk 
about more service, it is going to come from somewhere else. 
The agency absolutely has to process returns; that is an 
unavoidable expense. If we do more education, it is going to 
mean less enforcement with all the problems that have come up.
    And unlike other issues in the budget, this is not a trade 
off issue. The research, contrary to my college here, I think 
is pretty decisive and emphatic that more spending on a variety 
of measures, not only the ones that have been mentioned here, 
bring in much more money than they cost. There is very high 
payoff ratios that have resulted from very elaborate and 
sophisticated research on this question.
    So then of course the question remains what is the right 
focus. And people are concerned here that small business is 
being singled out. As the Commissioner said, the IRS uses 
formulas to determine audit. These are confidential; they have 
to be. I think nobody from the outside is supposed to know what 
those are. I think the confidence in terms of what the agency 
is likely to do with better financing, although it cannot be 
simply given away without any oversight, is that they are going 
to go where the money is. And that is not particularly to small 
business, it is to businesses with lot of employees and/or high 
net income. It is not to very short with very high income.
    So in terms of small business within that dreaded blue box 
in the tax gap map there is a lot of differentiation between 
really small and small compared to Chrysler but not small 
compared to most Americans. And I think the agency can be 
relied upon if their mandate is to get the best bang for the 
buck in terms of revenue to go to where the money is and not to 
the really small people.
    In that final vein, one small business category that has 
not been mentioned here is, let us say a woman taking in sewing 
making $13,000 a year, somebody mowing lawns. People receiving 
the earned income tax credit have been the target, the real 
target of inordinate attention by the IRS I think at the behest 
of the Congress in a gross misfocus of priorities from the 
standpoint of revenues as well as justice. And if there is 
unfairness there, we cannot be surprised if it bleeds over into 
other places.
    Two more thoughts. One, I think the advance in the computer 
technology and the economy, the reduction of the cost of 
transactions which we already see burgeoning ahead is going to 
make a lot of these discussions obsolete. It is going to be 
easier and easier to collect and report information, the 
process, and without necessarily the need for draconian 
withholding rules, which I am impressed by some of the 
testimony in terms of the problems in that vein. But reporting, 
I think, is much less of an issue, will become decreasingly so 
in the future.
    And finally, I cannot disagree with all the commentary 
about the importance of the simplicity of the tax code and the 
fact that it has gone radically in the wrong direction really 
since 1997, I would say. And this complexity for good, bad and 
different reasons has increased costs all the way around. And 
everybody in Congress is concerned about this but nobody has 
roused themselves to really deal with it seriously. And again I 
come back to the fundamental imbalances in our economy and in 
the budget which get much worse in the long run, which I 
believe will compel the political system, Congress and the 
President, to approach the revenue including the tax gap with 
high seriousness. And part of that solution will be, I think, 
significant simplification of the tax code.
    Thank you very much.
    [Dr. Sawicky's testimony may be found in the appendix.]
    Chairman Manzullo. Thank you. You must have been rejoicing 
last night with that marvelous basketball game. Was that not 
something?
    Mr. Sawicky. I have a 6:30 school bus to catch in the 
morning, so I miss a lot of that late night stuff on TV.
    Chairman Manzullo. You're alma mater.
    Mr. Sawicky. My alma mater is--oh, yes. Yes. Right.
    Chairman Manzullo. Okay.
    Mr. Sawicky. I read about it in the paper. I missed it.
    Chairman Manzullo. It's obvious you do not like basketball, 
so I will go on to something else here.
    Ms. Olson, on withholding, your proposals do not even touch 
credit card withholding, is that correct?
    Ms. Olson. Well, I did not propose the credit card 
withholding, the Administration--
    Chairman Manzullo. That comes from Treasury.
    Ms. Olson. The Administration proposed it.
    Chairman Manzullo. So I guess unless you want to talk 
about, let us go on to--
    Ms. Olson. Right.
    Chairman Manzullo. --what your proposal for withholding is. 
Could you walk us through a scenario?
    Ms. Olson. Yes. First, when you and I had talked earlier 
you asked me to get numbers, so now I have numbers.
    Chairman Manzullo. Is it not great to come into the office 
first?
    Ms. Olson. Yes, it was very helpful.
    Chairman Manzullo. Good.
    Ms. Olson. And it crystallized the mind.
    There are for tax year 2004, which would be last year's 
filing season and are the most recent data that we have since 
this year's filing season is not finished, there were balance 
due returns overall, there were approximately 4 million balance 
due returns. Individual returns they reported tax dollars, they 
made some payment and here is the dollars that are owed.
    Chairman Manzullo. These are individual returns?
    Ms. Olson. These are individual returns.
    Chairman Manzullo. Okay. Go ahead.
    Ms. Olson. So that will include Schedule C.
    Chairman Manzullo. Okay. Go ahead.
    Ms. Olson. Of those returns 1.45 million were Schedule C 
returns. So that is first the universe that we are talking 
about. Out of the 128, 133 million returns that we get every 
year, to even begin to look at my withholding proposal, we are 
talking about 1.45 million returns. That is just the starting 
point.
    Now of the dollars that are balance due for 2004. Okay. Let 
me just say one thing. That Schedule C balance due returns then 
constituted 35 percent of all balance due returns we got in tax 
year 2004.
    Chairman Manzullo. Can I stop you right there? What 
percentage of the total returns do the Schedule C returns 
comprise, do you know that?
    Ms. Olson. Maybe 18 percent my research guy says.
    Chairman Manzullo. About 18 percent. Go ahead.
    Ms. Olson. Okay.
    Chairman Manzullo. Thank you.
    Ms. Olson. And then when you look at the dollars that are 
due on these balance due returns, we had about $12 billion on 
all individual income tax returns due. Okay. A balance due. And 
I am not talking here about under reported income. I am saying 
people said this is how much we owed, we were not able to pay.
    Chairman Manzullo. Right. Okay.
    Ms. Olson. So on those 4 million returns for all individual 
taxpayers, it was about $12 billion due.
    And for Schedule C returns what we had was about $6 billion 
due.
    So the Schedule C balance dues were about 50 percent of the 
dollars, although they were 35 percent of the balance due 
returns and 18 percent of the overall taxpaying population.
    So that is not the end of the equation, though, before you 
get to backup withholding. I mean, some of those people may be 
one time people, of those 1.4 million taxpayers that were 
Schedule C that filed a balance due return. They may just have 
had a bad year, you know, and they are going to contact us and 
get into an installment agreement. They may never repeat that 
problem again.
    So what my universe is to even begin to look at backup 
withholding are people who have had recurring balance due 
returns where they are getting so far behind, where they are 
showing a balance due of $5,000 a year and you have three years 
in a row and you are getting to $15,000 with penalty and 
interest accruing and you are never going to dig yourself out 
of that debt. And that goes back to what I was trying to say in 
my oral testimony. You never dig yourself out of that debt.
    And so what we were trying to say there is we have got a 
repeater, we have got a problem, we have got a trend starting 
with this taxpayer. And the next thing that is going to happen 
is that taxpayer is going to go out of business.
    So what I want to do because all of our notices that have 
been sent out to that taxpayers are not bringing him in and we 
are not getting an arrangement. He is not coming in and he is 
not scheduling his self-employment, his estimated tax payments 
on a monthly basis is to institute backup withholding, just 
like we do with the individual with the interest and the divide 
where people are not responding.
    Chairman Manzullo. On whom?
    Ms. Olson. On repeaters who are showing a trend on Schedule 
C.
    Chairman Manzullo. No, I am sorry. The people that would 
have to withhold?
    Ms. Olson. Okay. If they have 1099s, we would go out to 
their payors. And I would imagine if you just got a 1099 for 
$600 or $650 the IRS would not be contacting that person. But 
if you had someone that it looked like there was one payor, you 
know you were really working for one person, we would go out to 
that person and say we want you to withhold.
    Chairman Manzullo. So that could be a corporation?
    Ms. Olson. It could be a corporation.
    Chairman Manzullo. It could be a sole proprietor?
    Ms. Olson. It could be another sole proprietor, that is 
right.
    Chairman Manzullo. So you would be asking a sole 
proprietor, a small business person, to withhold?
    Ms. Olson. Yes.
    Chairman Manzullo. And then to send that money to the IRS?
    Ms. Olson. Yes.
    Chairman Manzullo. John Satagaj has something to say about 
that, is that the segue?
    Mr. Satagaj. It is hard to believe, I guess is the only 
words I can use.
    Chairman Manzullo. I am astonished. I am astonished. This 
is the Taxpayer Advocate.
    Mr. Satagaj. Yes. I mean, actually, I do not want to get 
into too--
    Chairman Manzullo. Go ahead. You can argue with her.
    Mr. Satagaj. I am struggling with the repeat, how many of 
them are repeaters even.
    Ms. Olson. Actually, we were supposed to have that number 
this morning and we did not receive that number. But it would 
obviously be less than 1.45 million because that is the total 
balance due that we have.
    Chairman Manzullo. So then you would be asking businesses 
that hire this repeater who is an independent contractor to 
withhold because this independent contractor is not paying his 
tax, is that correct?
    Ms. Olson. On a repeated basis, yes.
    Chairman Manzullo. Okay. So then unless that independent 
contractor comes in with this magic certificate of compliance--
    Ms. Olson. No, we have not gotten to that yet. No.
    Chairman Manzullo. But in any case, but it is correct--
    Ms. Olson. Well, what I would like is that what you would 
have is that essentially one backup withholding payment would 
make that taxpayer call the IRS and then part of my proposal is 
that when the taxpayer calls the IRS, we will release 
withholding, backup withholding if they will get into this 
monthly payment plan--
    Chairman Manzullo. That is correct. But now what you are 
saying now is that the creditors of the guy who--
    Ms. Olson. Right. I am asking this small business employer, 
right.
    Chairman Manzullo. --is continuously--not the employer. It 
is not employer. It is the payor.
    Ms. Olson. Right. Okay. The payor. You are right.
    Chairman Manzullo. The payor, that is correct.
    Ms. Olson. The payor. That is correct.
    Chairman Manzullo. You would be asking that person--
    Ms. Olson. Yes.
    Chairman Manzullo. --let us say it is the plumber. Let us 
say the plumber does, I do not know, 300 jobs a year, whatever 
it is. So you would be going after all those people--
    Ms. Olson. Well, not necessarily. I mean, those are the 
questions that the IRS has to decide whether you were going to 
get money from them or not.
    Chairman Manzullo. The problem is this--
    Ms. Olson. Yes.
    Chairman Manzullo. -- is you make a general recommendation. 
You are smart enough to say general recommendation, a little 
bit smarter than Treasury that comes right out and says let us 
do this. You make this general recommendation, but you have 
done nothing to show the cost of implementing it in terms of 
the burden that is on the innocent business, like my brother 
with the restaurant. I mean, he is supposed to be placed in a 
position to determine whether or not his plumber is paying his 
taxes?
    Ms. Olson. Well, see that is a valid point. But with all of 
my recommendations, they are recommendations. The IRS now has a 
small business burden reduction model. And we will feed this 
proposal in and look at what it should be.
    Chairman Manzullo. Well, can I help you feed it right now? 
I think--
    Ms. Olson. So I mean I have been listening to the panel.
    Chairman Manzullo. --it is stupid and it stinks. And may we 
go on to something else on behalf of all the Frank Manzullo 
Juniors who went out of business after 41 years. I am sorry. 
There is no way Frankie ever would have known about a 
certificate of compliance if you asked him to withhold. He 
would look at that thing and say well what does this mean? I 
mean, he has a high school education, actually a business 
school education, and he is a veteran. And he is a very smart 
guy.
    Ms. Olson. Well, many of these--
    Chairman Manzullo. But he would have no idea what that 
means.
    Chairman Manzullo. He already--
    Ms. Olson. Well, many of these small business people have 
employees in additional to independent contractors.
    Chairman Manzullo. Of course. I understand that.
    Ms. Olson. And they are handling withholding in the 
context, too.
    Chairman Manzullo. Right. But I mean--
    Ms. Olson. So it is the same mechanism.
    Chairman Manzullo. But look at the different small business 
groups out there, NFIB members went from the average of three 
employees to I think it is now about five, and the other groups 
are somewhere in that particular area. I mean what happens if 
not only it is his plumber but also the electrician? You know, 
these small business people hire small business people because 
it is good for business. That is the culture; it is just the 
way it is. I mean, there could be a half of dozen people that 
you would send a notice to, especially if it is an area like 
Rockford, Illinois that led the nation in unemployment at 25 
percent. And now it is still at seven percent where people are 
struggling to make their payments, taxes are going up and the 
average wage for the people in the biggest county in my 
District has gone down because of the loss of manufacturing 
jobs. And they are struggling. They are hurting.
    Ms. Olson. I understand this.
    Chairman Manzullo. So you would be asking the small 
businesses that are left to do backup withholding--
    Ms. Olson. No, I would not, sir.
    Chairman Manzullo. --in the event that you find these 
characters that are not fully compliant with the IRS?
    Ms. Olson. Right. Now so the other point that I want to 
make is that the IRS in its current levy program, for example, 
what it has the authority to do under law right--
    Chairman Manzullo. Right.
    Ms. Olson. --now if someone is behind in their taxes and we 
can tell that someone is working for one individual person or 
we can see from the 1099s or that they are working for 25 
individual people, we can go out to those payors and levy on 
the payments that they are making on that person right now.
    Chairman Manzullo. Only if they owe money.
    Ms. Olson. Well, that is what I am talking about here.
    Chairman Manzullo. That is correct.
    Ms. Olson. The IRS has tolerances. We do not go out if 
there are 25 people and they are paying X amount of dollars and 
it is below our tolerances, we do not go out to absolutely 
everybody who shows up on a 1099 when we go out and do our 
levies.
    You know, and the same procedures would occur here. We 
would be making those tolerance decisions.
    Chairman Manzullo. I mean whenever you have decisions, you 
are talking about bureaucrats. You talk about bureaucrats, you 
are talking about forms, you are talking about the forms--you 
know what my brother would do if you said any future work this 
plumber does you have to withhold? Do you know what he would 
do?
    Mr. Satagaj. New plumber.
    Chairman Manzullo. New plumber.
    Ms. Olson. Well, what is he doing in the current situation 
when we go out and say to him we're going to levy on--
    Chairman Manzullo. Well, no, that is the whole point. Then 
you end up putting this guy out of business.
    Ms. Olson. That is happening today in the levy context.
    Chairman Manzullo. Well, no, but it is different in the 
levy. The levy is where the creditor is actually holding money 
that is owed. You can't levy on zero.
    Ms. Olson. You can put it on accounts receivables. And if 
the plumber is working and there is a payment that is due to 
him, then we can levy on that. And that is--
    Chairman Manzullo. Well you know what he would do as a 
small businessman?
    Ms. Olson. --precisely what we are doing now.
    Chairman Manzullo. He would just go on to get somebody 
else. Why should the small--
    Ms. Olson. But I am saying that that is what is happening 
here and it is happening today.
    Chairman Manzullo. No, I understand it. But I mean you have 
got so much research you have to do and of course the IRS 
considers itself exempt from the Regulatory Flexibility Act on 
any regulation. So you come out with these regulations and you 
have absolutely no way of knowing what the cost will be.
    Ms. Olson. Well, actually, to that point part of the reason 
why we have said that these were proposals is because I am 
making them publicly and I am sitting here willing to discuss 
them with you.
    Chairman Manzullo. But that's--
    Ms. Olson. And I have stood before 22 small business groups 
and listened to their concerns, and I have incorporated many of 
their concerns.
    Chairman Manzullo. John?
    Mr. Satagaj. I mean to there is the issue of, you have 
raised the issue. You are going to get rid of that plumber and 
go to another one. You have got the fact that you are going to 
have a lag time here between the years involved and when you 
are getting out the notices. It presumes they keep going back 
to the same people all the time for the same business. I mean, 
there are a lot of presumptions in this to get to the point 
where you're actually going to be able to match up the person 
that you want to withhold from the person.
    Ms. Olson. Yes.
    Mr. Satagaj. I mean, you got too many--
    Chairman Manzullo. All right. Michael, how many subs do you 
have in any given year in your business, in your plastics 
industry, subcontractors?
    Mr. Fredrich. Oh, I would say five to ten.
    Chairman Manzullo. Okay. What about sub-subs? Of course, 
you would not be dealing directly with them, would you?
    Mr. Fredrich. We would not. But--
    Chairman Manzullo. How many people do you buy materials 
from?
    Mr. Fredrich. The materials are all larger customers, 
people that we use as subcontractors. For example, we have a 
guy that comes in and runs a machine that measures the 
tolerance on parts. And we do not have to do that that often 
because it is just for new parts that are getting approved by 
the customer. So, you know, he would come in maybe seven/eight 
times a year and we pay him as an independent contractor.
    But I would say this: You know, they are talking about 
withholding. If you withhold 28 percent of somebody's gross 
revenue, nobody has a 28 percent profit margin. It is just not 
there. I mean if you are talking about withholding, maybe you 
would have to figure out what their profit margin is.
    Ms. Olson. We did do that.
    Mr. Fredrich. And then the percentage of tax. But 28 
percent is--
    Chairman Manzullo. It is a lot of money.
    Mr. Fredrich. It is off the wall. I mean you put--
    Chairman Manzullo. Congresswoman Velazquez?

    Ms. Velazquez. Thank you.
    Ms. Olson, what will be a liability issue for the payor
    Ms. Olson. It would be the same rules under backup 
withholding today, which is that if you have the obligation to 
do backup withholding, then you would be liable just like a 
bank would today.
    If I could make two points. One is my proposal is not to go 
to anything but payments that are currently subject to 1099 
reporting.
    Ms. Velazquez. Okay. In your recommendations would you ask 
the IRS to put more resources into education?
    Ms. Olson. I have made--
    Ms. Velazquez. Personnel?
    Ms. Olson. --at my number one most serious problem for 
taxpayers in this past year's annual report the trend in 
taxpayer service, which includes the outreach and education to 
taxpayers. And I have criticized some of the changes that have 
been made in the Small Business Self-Employed Operating 
Division--
    Ms. Velazquez. And do you hear that more staff people have 
been shifted around--
    Ms. Olson. I state that in my testimony.
    Ms. Velazquez. --and that the resources will be put into 
outreach and education?
    Ms. Olson. I am very concerned about that.
    Ms. Velazquez. So how do you expect then for business to 
understand when they will be in violation or noncompliance?
    Ms. Olson. If I am not satisfied that the IRS is adequately 
staffing this, then I would not be supporting this. I would not 
be putting forward this proposal.
    Ms. Velazquez. Right.
    Ms. Olson. This cannot be separated out from just 
compliance. I mean enforcement.
    Mr. Brown. Excuse me. We do take the service component of 
our mission very seriously. And there has not been a reduction 
in the number of resources devoted to it. I mean, there has 
been a recasting of who performs some of those services. And 
some have migrated to other divisions. But in terms of sheer 
number of people and sheer number of hours devoted to the 
service side of the equation, that has been constant. And we 
take that very seriously. We have tax forums around the country 
and they are very important in terms of educating taxpayers.
    Ms. Velazquez. Let me ask: Have you shifted resources from 
assistance to enforcement?
    Mr. Brown. We are devoting the same amount of resources to 
service as we did before. We had an organization called 
Taxpayer Education and Communication and there was an error--
    Ms. Velazquez. But then you are defeating the purpose 
because if you are going to implement this new proposal and go 
after all these people now, if you are going to have and devote 
the same type of resources, that means--
    Mr. Brown. You are suggesting we would devote more 
resources to it?
    Ms. Velazquez. Correct.
    Mr. Brown. I agree with you that we need to do more in this 
department. That we need to devote both more research and 
become--
    Ms. Velazquez. But I understand your funding, your budget 
will be flat funded.
    Mr. Brown. Our budget will be adequate for what we need to 
do here. Obviously--
    Ms. Velazquez. That is what I hear from the Administrator 
of SBA when he comes here and you see the mess that as a nation 
we have been witness in regarding the victims of Katrina. Why? 
Because the budget of SBA has been cut by 50 percent in the 
last years.
    Mr. Brown. We believe we have the resources necessary to do 
the work here.
    Ms. Velazquez. Okay. Thank you.
    Mr. Satagaj, in your testimony you seem to focus on the 
problem of complexity as a driver of noncompliance. 
Unfortunately, the President's Commission Tax Reform Panel that 
put together a report on simplifying the tax code and nearly 
all of their recommendations have simply been put aside. Why do 
you believe that efforts to simplify the tax code have failed 
and this problem only continues to get worse?
    Mr. Satagaj. A real question. I do not know that I know the 
answer to that one, and I am honest to say that. It is 
frustrating that we have not done it. You allude to that 
report. Former Commissioner Rossotti sat on that panel and I 
would say that he has been one of the very effective spokesman 
for small business and he had some very intriguing proposals in 
there, and some of them lead to actually the very systems we 
are talking about here ironically about reporting. Because he 
talked about checkbooks and he talked about credit card. But 
the payback to get that was you would have a simpler system.
    Ms. Velazquez. Sure.
    Mr. Satagaj. And there is something there to make an 
incentive for the businesses to be part of that system, whereas 
these proposals there is no incentive to it.
    I do not have an answer to why, to be honest with you.
    Ms. Velazquez. Okay. Well would you agree that if our tax 
bills focus on simplifying the tax code, that concerns about 
the tax gap will be reduced?
    Mr. Satagaj. I think so. I think that certainly is a part 
of it. There are several things that fall in there, but that is 
one part.
    Ms. Velazquez. Mr. Sawicky, would you like to comment.
    Mr. Sawicky. Sawicky.
    Ms. Velazquez. Yes. Would you like to comment on my 
questions to Mr. Satagaj?
    Mr. Sawicky. Well, a broader simplification if it broadens 
the tax base makes lower rates possible. And I think the 
research and common sense is universal that lower rates reduces 
the incentives to evade taxes and also reduces the incentives 
to look for legal ways to reduce one's tax payments. So you 
cannot have too much base broadening from my standpoint. Why do 
we not get more? Well, I think it is because half the people in 
this room are involved in activities to get concessions in the 
tax code for one or another interest. And as the Commissioner I 
think said, as these things pile up to the breaking point, at 
some point I think probably with a financial crises resulting 
from our trade and budget deficits, they will be compelled to 
do something serious about simplification for the purpose of 
gaining revenue. The alternative would be problems in financial 
markets that cause serious damage to the economy.
    Ms. Velazquez. But in your view both Congress and the 
Administration bear some responsibility for increasing 
complexity of the code?
    Mr. Sawicky. Well, the people that write the code are 
responsible for the complexity of it. And from my standpoint 
and including the legislation in '97 as well as what came 
after, we have had increasing complexity in the tax code. And 
also that entails all kinds of swiss cheese holes that take 
parts of the base away from taxes.
    Ms. Velazquez. Mr. Brown, in terms of the area of 
enforcement do you believe that by focusing on corporate tax 
shelters will be a more efficient use of the IRS resources as 
opposed to the current efforts to go after small businesses?
    Mr. Brown. I think both are necessary, as the KPMG 
situation the Commissioner alluded to earlier, many of those 
taxpayers are involved in a deal called Son of Boss that 
involved about 1300 individual taxpayers who ended up paying us 
more than $3.7 billion. And this is not money we hope to 
collect. This is money that we have received.
    Ms. Velazquez. So would you say that these larger 
businesses over $250 million or more are better equipped to 
deal with an audit in terms of manpower and costs? Would you 
agree that the relatives costs are much higher for these 
Schedule C filers?
    Mr. Brown. Yes.
    Ms. Velazquez. And with this measure let us talk about the 
cost to the honest taxpayer who is subject to an audit?
    Mr. Brown. Well, the credit--
    Ms. Velazquez. Does that represent a win/win for our 
economy?
    Mr. Brown. Well, I think that is why we really wanted third 
party reporting. The intent here was to not place the burden 
directly on the small business. And I realize, of course, that 
there are some pass-through costs when you are talking about 
credit card companies having to report this type of 
information. But that was the genesis of the idea for increased 
third party reporting as opposed to withholding or going some 
other way which would put the cost directly on the small 
business.
    Ms. Velazquez. But you do not think that that will 
represent a financial burden on small businesses?
    Mr. Brown. I do think it will represent somewhat of a 
financial burden on small businesses, yes I do.
    Ms. Velazquez. Do you really think so, because you have not 
done any impact analysis?
    Mr. Brown. Well, we obviously have to meet with the 
industry. When you are talking about third party reporting, 
there are always going to be costs that we might not be able to 
know, but that is exactly why we are meeting with the industry.
    Ms. Velazquez. Mr. Brown, the IRS suggests five initiatives 
to close the tax gap. And according to your figures the 
cumulative impact of these changes will reduce the tax gap by 
one-tenth of one percent. Even that, would not the time of the 
Administration, the IRS, the Treasury and Congress be better 
spent on taxing simplification rather than trying to go after 
such a small amount given the huge administrative burdens that 
they seem to create?
    Mr. Brown. The proposals we believe do not create huge 
administrative burdens. I guess I would take issue with that 
word.
    Ms. Velazquez. Well, we would start $100 million that you 
pay for a study.
    Mr. Brown. I think Senator Baucus asked the Commissioner at 
a hearing recently the same question and he said is this 
enough? This does not represent enough in terms of efforts. So 
I think the point is valid that this is a minor piece.
    As to tax simplification, I applaud any efforts to simplify 
the code. It is very difficult for our revenue agents to 
enforce the laws when even they sometimes are not certain about 
the laws, let alone the small business they're intending to 
audit.
    Ms. Velazquez. So you agree with me that since 1997 the tax 
code are more complex?
    Mr. Brown. I have been in this business since 1987 and 
every year it has gotten more complex.
    Ms. Velazquez. More so after 1997.
    Mr. Brown. 1987 is when I got into this business, and it is 
been much more complex every year.
    Ms. Velazquez. Thank you, Mr. Chairman.
    Chairman Manzullo. Thank you.
    Now, what side of these proposals do you come down on, with 
Ms. Olson or with the Commissioner?
    Mr. Brown. Oh, with the Commissioner, obviously.
    Ms. Olson. The Advocate speaks for herself.
    Chairman Manzullo. Are you not glad that the Commissioner 
went first?
    Mr. Brown. Yes.
    Chairman Manzullo. Right.
    Mr. Brown, I guess this was the so called ``blue book''?
    Mr. Brown. Yes.
    Chairman Manzullo. On page 117. Do you have it there?
    Mr. Brown. I do somewhere in this rule book, yes.
    Chairman Manzullo. Could you flip to it? This is when it 
talks about increased information reporting on payment card 
transactions. Do you see that?
    Mr. Brown. If you will give me a second, I will find that 
for you. Thank you.
    Chairman Manzullo. Does that say on top increased 
information at page 117?
    Mr. Brown. It sure does.
    Chairman Manzullo. Okay. Would you go down to where it says 
``reasons for change'' And read the last sentence in there 
where it says ``in addition.''
    Now this is only, as the Commissioner said, with regard to 
people that give somebody else's wrong tax number.
    Mr. Brown. That is correct.
    Chairman Manzullo. You want to read it out loud for us?
    Mr. Brown. Sure. ``In addition, implementing a backup 
withholding system for payment card reimbursements to 
businesses would lead to material improvements in the 
compliance rates of these taxpayers without imposing a 
significant burden on card issuers.''
    Chairman Manzullo. Who came up with the last portion of 
that sentence?
    Mr. Brown. This was a combined effort between the Treasury 
Department, the IRS and other parts of the Administration.
    Chairman Manzullo. And I would note that, first, this is 
put out and then come the meetings with the industry. Is that 
order correct?
    Mr. Brown. There were some preliminary discussions with 
people who are familiar with the industry and who worked in the 
industry before we did this. And there are ongoing discussions 
as we speak with members of the Credit Card Association, the 
American Bankers Association.
    Chairman Manzullo. But why would you put this out? I mean, 
this is a statement of fact. This is a sales piece that you 
give to Congress. I mean you have made a factual determination 
that there would be no significant burden on card issuers. I 
mean, this is not--
    Mr. Brown. Well, this refers to just the backup 
withholding, this particular sentence.
    Chairman Manzullo. Well, you have to start with that.
    Mr. Brown. But this is--
    Chairman Manzullo. I mean how could you come to that 
conclusion?
    Mr. Brown. By talking to people who are familiar with the 
industry. I have worked in the industry. And this is the way 
the budget process works. We obviously want to work with the 
Congress to make sure and to work with the industries to make 
sure that we do this--
    Chairman Manzullo. First of all, I do not believe this. I 
mean this is factually incorrect because every time you do 
something else to withhold, it is going to be new software. I 
mean, the software people must love you. You would have to 
change programs here.
    Mr. Brown. No. We have backup withholding regimes in place 
now. This really is designed to mirror the current backup--
    Chairman Manzullo. No, no, no. This is something new. This 
is credit cards. And what I don't understand is if somebody 
gives you a bad TIN number, what kind of people are these? Are 
these crooks? What are they? Who is doing that and why do you 
not put them in jail or charge them with a crime if they are 
using somebody else's instead of going after the credit card 
issuer and saying this guy who was using a bogus TIN number, we 
want you to withhold on the money you give him? Why do you not 
just put him out of business or arrest him or something? That 
sounds like credit card fraud to me.
    Mr. Brown. Well, some of these are just made in error. 
People transpose number. So we do not jump right to back--
    Chairman Manzullo. Well, I realize that goes on all the 
time.
    Mr. Brown. That is correct.
    Chairman Manzullo. That proposal does not even address 
that. Because once the error is brought to their attention, you 
know somebody could have interposed a number or transposed a 
number.
    Mr. Brown. The vast majority of them, correct once we 
notify.
    Chairman Manzullo. Right. But I do not understand this. I 
mean, if somebody gives a wrong TIN number and it is not an 
error, what kind of a person is that? Is that a thief?
    Mr. Brown. Well, it can be.
    Chairman Manzullo. Or what?
    Mr. Brown. It can be someone who is generally trying to 
avoid the information going to the Internal Revenue Service. 
And there are other reasons that you would--
    Chairman Manzullo. Well, that is pretty serious, is it not?
    Mr. Brown. It can be. And there are also all sorts of Bank 
Secrecy Act provisions that would be run afoul of here, too, as 
well. I mean often times you are dealing with banks with 
taxpayer identification numbers and they want to launder money. 
There are a lot of reasons why people want to avoid that kind 
of scrutiny.
    Chairman Manzullo. But I mean you are really not in the 
business here of going after the money launders.
    Mr. Brown. Unfortunately I am.
    Chairman Manzullo. Well, not with this proposal?
    Mr. Brown. Not with this proposal. But I unfortunately own 
the Bank Secrecy Act program for the Internal Revenue Service, 
it is in my division.
    Chairman Manzullo. Okay. Well, that is another part of your 
portfolio.
    And again, this is aimed at the small business people, as 
finally we got the Commissioner to agree that this particular 
provision was. I still do not understand how you can make this 
statement. Because what you are talking about is that for every 
small business person you are going to make, and I think you 
said 25 million people, the credit card companies give all that 
information to the IRS so they can filter through all of that 
to see who is giving a wrong number, is that not correct?
    Mr. Brown. What we are looking for is an aggregate number 
on gross receipts, payments made to if you are a restaurant. 
That is the number we are looking for. And also we are looking 
to make sure that when the information comes in that there is a 
proper taxpayer identification number.
    Chairman Manzullo. Well, that it is interesting because now 
you are talking about withholding on credit cards on an 
aggregate number and your boss just testified to the fact that 
the only time that credit cards would be involved is because of 
a false TIN number.
    Mr. Brown. That is correct. No--
    Chairman Manzullo. Well, why did you mention aggregate 
number? Because that could be something that you might be 
looking for, is it not? It could give reason for an audit, 
could it not?
    Mr. Brown. The third party reporting is specifically 
designed to give us an aggregate number for credit card 
receipts--
    Chairman Manzullo. You have it back there? Yes. This stinks 
because now I know what you are doing. You want to have all the 
credit card companies report to you so then you can take that 
information and then compare it against their income tax 
return. So this is more than the people with the false TIN 
numbers, is that not correct, on credit cards?
    Mr. Brown. The false TIN numbers only applies to the backup 
withholding. The TIN numbers do not come into play other than 
for the backup withholding.
    Chairman Manzullo. Well, yes, but then what would you do? 
This is just a big net. Just a fishing net out here so you can 
get more information. Because you know what? Let me share what 
occurs on page 41 of this report that you guys just love. Page 
34. This says, but unfortunately these are not your own words 
so I can't cross examine you like I did your boss, ``Appendix 3 
IRS key efforts to reduce the tax gap. The IRS strategic plan 
outlines, it does not prioritize service and enforcments to 
improve compliance.'' That is not good. ``Therefore, we asked 
IRS officials to identify IRS' key efforts to reduce the tax 
gap. IRS divisions provided lists that totaled 47 efforts which 
are described in the following examples. The Small Business/
Self-Employed Division,'' that is you?
    Mr. Brown. Yes.
    Chairman Manzullo. Okay. ``Identified 15 efforts such as 
models to identify higher priority collection cases to 
pursue.'' Another word for modeling is profiling, is that not 
correct?
    Mr. Brown. I will agree with that.
    Chairman Manzullo. Good. And another one is a computer 
matching program to identify under reported income. That is 
what you want?
    Mr. Brown. Well, what that is referring to is, I mean, it 
is somewhat like Max explained before. We have a formula we use 
to assess returns. We do not just audit randomly. We view 
random audits as a waste of time. I do not want to hassle 
taxpayer where there is not a high probability of there being 
something wrong. You know, we do not have the resources to do 
that and, frankly, neither do the taxpayers. So the idea of the 
National Research Project was to get us better formulas that 
would allow us--
    Chairman Manzullo. No. But you want that information from 
the credit card companies because then you could match that 
information with what appears on income tax returns. See, that 
is what you want.
    Ms. Olson. But that is what we do today with the 1099 
information.
    Chairman Manzullo. Oh, I understand that. But this would be 
a 25 million small businesses, we are not talking about 
corporations. This is just little guys, small businesses. All 
that information would be going from their credit card company 
to you so you could take that information and you could measure 
it against what they are reporting?
    Mr. Brown. Yes.
    Chairman Manzullo. What is that going to cost the IRS to 
manage all that information?
    Mr. Brown. We do not know right now.
    Chairman Manzullo. You do not know? Do you not think it is 
important?
    Yes, we talked to the credit card people. We did that. We 
have in our office. Do you want to know the figure? Eight 
million transactions per second; that is the entire credit card 
industry.
    Ms. Olson. But I do not think that--I mean, this is not my 
proposal, but the proposal is a total for the year on a 
calendar year.
    Mr. Brown. That is right.
    Chairman Manzullo. Wow, goodness gracious. Eight million 
per second. I cannot even figure that out as a Congressman 
times 60 what that is. I mean, can you not see why we are 
excited here? Can you not see why we want to know what is this 
thing going to cost the taxpayers?
    I mean, the first thing that I would do is the guy behind 
with the $100 million study, all right, and you are with the 
IRS, right? Okay. Mark. Okay.
    The first thing I would do is say before I get Congressman 
Manzullo all excited, I am going to sit down with Mark and say 
``Mark, what is this going to cost? Give me a guesstimate. Give 
me a ballpark figure so that when I come up with efforts to do 
things, I do not come up with a statement that says without 
imposing significant burden on cad issuers.''
    You have no idea what this is going to cost, do you, That 8 
million transactions per second?
    Mr. Brown. We do not precise numbers. That is why we are 
working with the industry right now.
    Chairman Manzullo. Well, you do not have anything. You have 
got nothing.
    Mr. Brown. That is not true. We did have meetings with 
people who are familiar with the--
    Chairman Manzullo. No. You can have all the meetings you 
want. They do not know. They are in the business of issuing 
credit to consumers, not giving background information to the 
IRS. That is not their mission.
    Mr. Brown. But we have ready reference point with banks 
which do report the information to us now.
    Chairman Manzullo. Oh. I mean, sure you got your 1099s. I 
can understand. But can you not see as the Chairman of the 
Small Business Committee why we see this as angst? Because one 
thing that you could never realize is you come up with formulas 
and you will say well if it is a restaurant, it has got to have 
this amount and that it has got to be 42 percent has to be 
credit cards and we are going to set up our computers so that 
at 42 percent, whatever it is, it is not on credit cards that 
is going to trigger an audit. Somebody has to come up with all 
those figures and that is another study and you already have 
those secret formula that you cannot show the public. Maybe if 
we shared the formula with the public, then the public would 
know better than to cheat if they know what you are looking 
for.
    Ms. Olson. Sir, would you rather us not do those studies 
and go out and randomly audit taxpayers? Because the point of 
the studies is that if we do do an audit--I mean, I am 
supporter of the studies because I do not want us going out and 
just randomly auditing people. I want the IRS to focus its 
audit resources on the people who have the highest amount of 
noncompliance.
    Chairman Manzullo. No, I understand. But the problem is 
this: You have already spent $100 million of the taxpayer's 
money on a study that is lousy. If I may, if I may and I went 
through this last night as I was watching the basketball game. 
And every time I saw something, I would underline it. Every 
time I saw a basket made for your old alma mater, which you do 
not watch, I saw--
    Mr. Sawicky. I was working on my testimony then.
    Chairman Manzullo. That probably put you to sleep.
    But I mean where you do not even have provisions to track 
your data. In other words, you do not even know what you are 
capturing before you are making conclusions. Let me read this 
to you.
    ``Several factors concern IRS about its data on the reasons 
for noncompliance which could be unintentional or intentional, 
though IRS is developing the system to capture better 
examination data.'' Yes, right. ``IRS does not have firm or 
specific plans to develop better data on the reasons for 
noncompliance even though lack of such data makes it harder to 
decide whether it should address specific areas of 
noncompliance through nonenforcement efforts such as designing 
clear forms of publications on enforcement efforts.''
    You do not have the data for that and yet in your testimony 
you went after your boss where you said I am concerned because 
when the IRS Small Business/Self-Employed Division, that is 
you, Kevin, Taxpayer Education and Communication Division was 
merged with its Communication Liaison or Disclosure Division, 
education staffing was reduced from 699 in fiscal year 2003 to 
I believe there is a typo error in the testimony, is that 
correct?
    Mr. Brown. We might want to confirm that.
    Chairman Manzullo. But this says ``Is reduced from 699 to 
184.'' And I think someone from the IRS contacted us and said 
the real number is 480.
    Ms. Olson. They disagree with us, but we got this off of 
the time keeping records. So I do not know what to tell you 
about that.
    Chairman Manzullo. Okay. Is she right?
    Ms. Olson. But I mean I have no numbers.
    Mr. Brown. No.
    Chairman Manzullo. She is wrong?
    Ms. Olson. It is all numbers from the IRS.
    Mr. Brown. I think the number is incorrect.
    Chairman Manzullo. What is the number?
    Mr. Brown. The number is approximately 500. But it is not 
accurate--
    Chairman Manzullo. You went from 699 to 500?
    Mr. Brown. No, it is not apples-to-apples. That is what 
annoys me about this. The 699--
    Chairman Manzullo. This is your fruit you are looking at.
    Mr. Brown. Yes. The 699 were people who did not work full 
time on education and outreach. They went off for half the year 
to do other duties. Now we have 500 people working full time on 
this. So--
    Chairman Manzullo. But you are going to have to hire 
another 5,000 if you are going to have somebody 8 million 
transactions per second.
    Ms. Olson. If I might, sir, I think that your point about 
needing to know the reasons for noncompliance is very 
important. And I have written a lot about that in my annual 
reports. And I think that that actually was what was motivating 
to make the proposals about the voluntary estimated tax 
payments. Because you do not want to use an audit--
    Chairman Manzullo. You mean such as salons?
    Ms. Olson. Well, the salons, exactly, but also to 
scheduling a year in advance, that you do not--
    Chairman Manzullo. Yes. I do not think that there is much 
angst in the small business community--
    Ms. Olson. About that?
    Chairman Manzullo. --over a system set up like that to make 
it easier for people to be in compliance like that, and if it 
is truly voluntary--
    Ms. Olson. Well, the way that I looked at this was, and 
this really was me on relying on my own personal experience 
because I have prepared returns for 27 years for these folks 
and saw these things happening, that I believe that the vast 
majority of people who are behind on their payments are self-
employed, it really is just a matter that they just cannot 
save. And I do not think that we should be using all the clubs 
and all the enforcements actions that the IRS has for those 
kinds of people. You need to think about--
    Chairman Manzullo. Put them on a budget?
    Ms. Olson. Exactly.
    Chairman Manzullo. Good. Good for you.
    Ms. Olson. And so then what you need to reserve your 
enforcement resources for are those people who are the most 
recalcitrant, who are tending in a direction where they will 
never get themselves out.
    Chairman Manzullo. True offenders.
    Ms. Olson. Yes.
    Chairman Manzullo. Let me read something else here. This 
says, this is on page 4, I mean this is some pretty interesting 
reading. ``IRS approach for reducing the tax gap includes 
improving taxpayer service to increase voluntary compliance and 
enhance an enforcement of tax laws by detecting and addressing 
noncompliance, but does not incorporate some steps consistent 
with results oriented management. To support this approach IRS 
has established two broad strategic goals and identified over 
40 related key efforts which includes using direct enforcement 
actions to address high income non-filers and using analytical 
models to pursue higher priority collection cases. However, IRS 
has not established long term quantitative compliance goals and 
regularly collected data to track progress is reducing the tax 
gap which would compliment its current important compliance 
efforts.''
    I mean, so you have no way to determine if what you are 
doing is the right way to go, but you are on your way. And now 
you are off into a whole area, you with your own proposal, to 
have individuals withhold and the credit card companies to have 
them withhold on people that are not paying their taxes. More 
government, more rules, more regulations, more compliance.
    Ms. Olson. Well, I can only tell you that in my proposal I 
would insist on those controls. And I think that--
    Chairman Manzullo. Yes, but you will not be there forever.
    Ms. Olson. Well, that is true. But one would hope that you 
all, someone will be in your chair and we will hope is honest.
    Chairman Manzullo. And it does not work that way. Because 
unless you have been raised in small business, you have no 
idea. No idea what is going on.
    What this is saying here is that the IRS goes off in new 
directions in enforcement but does not look where you have 
been. It does not seem to care because you have no way of 
measuring it.
    I mean you were there so long you dropped off your sleeping 
bag in the office last night, you stop by and see us so 
frequently.
    Ms. Everson said that the tax gap was reduced from 43.1 to 
47.3 billion. Evidently, an extra 6 billion came in 
approximately, or 4 billion came in.
    Mr. Brown. That is referring to enforcement revenues.
    Chairman Manzullo. Enforcement revenues from one year to 
the next?
    Mr. Brown. Yes.
    Chairman Manzullo. How much of that came from the small 
businesses that we're talking about? Do you have any idea?
    Mr. Brown. The increase?
    Chairman Manzullo. Yes.
    Mr. Brown. I do not know.
    Chairman Manzullo. I will bet you do not. That is what they 
are talking about.
    Mr. Brown. No, I can get--no, I can get--
    Chairman Manzullo. See, you have no way to determine it 
because you do not have the procedures set up for that.
    Mr. Brown. Oh, I can get you the number. We can get you 
that number.
    Chairman Manzullo. You have got it there?
    Mr. Brown. I just do not have it now.
    Chairman Manzullo. It is not there? Obviously, you cannot 
bring everything with you. The point is is that that is 
important to determine whether or not you are spending your 
resources in the same area. Do you not agree?
    Mr. Brown. Yes, but--
    Chairman Manzullo. I mean you have to know if you are 
successful.
    Mr. Brown. Yes, but we have a number of measures that do 
tell us whether or not we are successful. We look at no change 
rates; when you have a high no change rate as the Commissioner 
described in the C-Corporation, area--
    Chairman Manzullo. Right.
    Mr. Brown. -- you realize that those are not a fruitful way 
to spend your audit time.
    Chairman Manzullo. Right. So you go after the little guys?
    Mr. Brown. You have other measures about average 
adjustment, things like that. I mean, there are a number of 
measures there that tell you are you auditing in the right 
areas and are you getting anything out of the audits.
    Chairman Manzullo. Well then if that is the case, then why 
is this report so damning?
    Mr. Brown. Because they are talking about closing the 
overall tax gap, which at the time they wrote the report we did 
not even have a precise estimate for.
    Chairman Manzullo. I mean they said, GAO actually 
complimented IRS on having the right figure on what the tax gap 
was, which I thought was quite interesting.
    Mr. Brown. And we are also now in the process of 
developing. We have gotten a number of the same sorts of 
questions from the Senate Finance Committee.
    Chairman Manzullo. Why do you not develop all this stuff? 
Why do you not get all your facts before you come out with 
these proposals? I mean you know how this Congress is. I mean 
this could be slipped in. I think Commissioner Everson said 
himself that he appreciates a hearing like this because he's 
afraid stuff like this would get slipped in in the middle of 
the night into something and then everybody's scared.
    I know I have prolonged this beyond it. But what happened 
with the HOPE Scholarship thing, I mean that was $100 million a 
year that was imposed on higher education that would have been 
passed on to the students. And that got put into law. President 
Clinton insisted that the colleges report that. That was his 
language that was added to it before he signed the bill. And no 
one had ever done that estimate on the compliance of it.
    I mean you guys have got to find out what this stuff is 
going to cost--
    Mr. Brown. We agree.
    Chairman Manzullo. --before you do it. And then look at the 
second thing is how much more of the underground economy are 
you going to create? Word gets out on the streets, IRS is going 
after credit card transactions, if you pay me in cash, I will 
give you 20 percent discount. Do not take any credit cards. How 
much are you going to push underground with this?
    Mr. Brown. Well, I can tell you unfortunately that is 
already going on.
    Chairman Manzullo. Well, of course. It is going to go on 
even more.
    Now do you really think that the sophisticated cheater who 
gets his money from Visa is going to encourage his consumers to 
say this transaction is priceless. He is going to say pay me in 
cash. And what you are proposing is going to have even more of 
an underground economy. It will be counter productive and then 
we lose on both ends.
    Mr. Brown. Ultimately I think time is on our side. When I 
can go to the Wendy's drive-through window now and use a credit 
card, I mean we are moving into--
    Chairman Manzullo. That's Wendy's. They're big.
    Mr. Brown. Yes, but I can--
    Chairman Manzullo. I mean, you know, what about the Shady 
Grove Drive-In that my dad ran from 1954. No, that was the name 
of it. 1954 to 1970?
    Mr. Brown. Even taxicab drivers are now frequently taking 
credit cards.
    Chairman Manzullo. Well, you know what? My brother never 
took credit cards in his restaurant. You know why?
    Mr. Brown. Probably the fee.
    Chairman Manzullo. No. That is right. His margin was so 
small that he was not about to pay 3 percent. And he told his 
customers if they came there, they wanted to give him a Visa, 
he said give me a personal check. The guy said I left my 
checkbook at home. And my brother would give him a 3 by 5 card 
with his name, address and the amount of the bill and the guy 
would send him a check in the mail.
    You know, our goal is to keep things simple. But you are 
off on a terrible road there. And as long as I sit in this 
chair, and unfortunately that is only until the end of this 
year, this will get slipped in in the middle of the night. I 
understand the guys over in the Senate, the millionaires over 
there, most of them are millionaires that do not know what it 
is like to meet a payroll to be raised in small business, are 
trying to come up with a proposal to slip this in somewhere. 
Okay. Well thank you guys for coming. I appreciate what a 
diverse background we have.
    Did you have fun, Michael?
    Mr. Fredrich. I had a thrilling time today.
    Chairman Manzullo. Have you ever testified before Congress 
before?
    Mr. Fredrich. I did one time on minimum wage.
    Chairman Manzullo. Well, to each of you thank you so much 
for coming, especially those that traveled a long distance.
    And this hearing is adjourned.
    [Whereupon, at 12:59 p.m., the Committee was adjourned.]

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