Section 9. Internal Revenue Service Operations and Tax

Compliance

OVERVIEW

The Internal Revenue Service (IRS) was established in accordance with the Internal Revenue Act of 1862 which provided for the first income tax in American history. The first Commissioner of the IRS set up office within the Department of the Treasury with three clerks to collect the tax. In fiscal year 1993, IRS will employ more than 115,000 workers to process more than 200 million primary tax returns and collect more than $1 trillion in revenue.

TABLE 1.-NUMBERS OF RETURNS FILED AND REFUNDS SENT

The recently approved fiscal year 1993 appropriation for IRS is over $7 billion, a 6 percent increase over the fiscal year 1992 level. From fiscal year 1983 through fiscal year 1993, IRS's appropriation has increased on average 8 percent annually.

IRS plans to make fundamental changes in tax administration in the next decade. IRS is installing state-of-the-art computer systems which are expected to correct weaknesses that have been identified in IRS operations by providing one-stop service, eliminating inaccurate and erroneous notices, and providing current and complete account information. IRS has estimated that the acquisitions and installation of hardware and software for its long-term computer and telecommunications systems modernization, Tax Systems Modernization (TSM), will require $8.3 billion in funding. Congressional appropriations for TSM in fiscal years 1988 through 1993 totalled $1.5 billion.

The Internal Revenue Service has various programs available to assist taxpayers in complying with the Federal tax laws. Taxpayers can contact IRS's toll-free telephone assistance program with account questions, and procedural or technical inquiries, or taxpayers can walk into IRS offices to obtain assistance. Further, taxpayers can telephone IRS's Tele-Tax for recorded information on certain tax topics or to check the status of a tax refund.

In addition, taxpayers can seek tax preparation assistance through certain programs staffed by volunteers such as the Volunteer Income Tax Assistance (VITA) program which is particularly designed for low-income, disabled, non-English speaking, or special needs taxpayers, and the Tax Counseling for the Elderly (TCE) program, for taxpayers 60 years of age or older. These programs and services to assist taxpayers are outlined in Part VIII "Your Rights as a Taxpayer."

TABLE 3. NUMBER OF TAXPAYERS ASSISTED

The Problem Resolution Program (PRP) is available within IRS to assist taxpayers with difficulties that have not been resolved through normal IRS channels or to assist taxpayers suffering, or about to suffer, economic hardship due to the manner in which the tax laws are administered. The program is directed by the Taxpayer Ombudsman who serves as an advocate for the taxpayer within the IRS. Taxpayers should contact the problem resolution officer in their area to request assistance with still unresolved problems or hardship situations.

Finally, there are student tax clinics to provide taxpayers experiencing tax difficulties with assistance. As of August 1992 the following schools were IRS tax clinic participants: American University, Washington College of Law, (Washington, DC); University of Bridgeport School of Law (Bridgeport, CT); Boston University School of Law (Boston, MA); Chicago-Kent College of Law, Illinois Institute of Technology, (Chicago, IL); Delaware Law School, Widener University, (Wilmington, DE); University of Denver College of Law, Graduate Tax Program, (Denver, CO); Georgia State University, College of Law, (Atlanta, GA); Loyola University of Chicago, School of Law, (Chicago, IL); Loyola University School of Law (New Orleans, LA); University of Minnesota Law School (Minneapolis, MN); University of Nebraska-Lincoln, College of Law, (Lincoln, NE); University of New Mexico School of Law (Albuquerque, NM); University of North Texas, College of Business Administration (Denton, TX); San Jose State University, School of Business-Accounting and Finance, (San Jose, CA); Southern Methodist University School of Law (Dallas, TX); Villanova University School of Law (Villanova, PA); William Mitchell College of Law (St. Paul, MN); University of Wisconsin-Milwaukee, School of Business Administration, (Milwaukee, WI); and, Yeshiva University, Benjamin N. Cardozo School of Law, (New York, NY).

THE TAX GAP

The United States income tax system has one of the highest voluntary compliance levels in the world. Approximately 84 percent of the tax owed on income from legitimate economic activities was voluntarily reported and paid. However, the "tax gap"-an estimate of the difference between the amount of taxes voluntarily paid in a taxable year and the amount of taxes that would have been paid if all taxpayers had filed complete and accurate returns-exceeded $127 billion in 1992 and continues to grow.

For the past several years, the Subcommittee on Oversight of the Committee on Ways and Means has been investigating certain specific areas of potential noncompliance. The Subcommittee continually studies the nature and causes of taxpayer noncompliance with the objective of developing specific recommendations for improving compliance with the tax laws. A compliance rate increase of 1 percentage point will narrow the tax gap by approximately $7 billion per year.

a. Compliance by Foreign-Controlled Corporations

Concern has been expressed that foreign-controlled companies may be paying lower U.S. taxes overall than American-owned companies with similar total sales.

In 1990, the Subcommittee on Oversight investigated 36 foreigncontrolled distributors of automobiles, motorcycles, and electronic equipment. The Subcommittee found that more than half of the 36 companies investigated paid little or no Federal income tax. The subcommittee concluded that inflated pricing of goods purchased from the foreign parents and the performance of functions not properly compensated for by the foreign parent may be partly responsible for the low level of U.S. profits and corporate tax pay

ments.

In the Omnibus Budget Reconciliation Act of 1990, Congress took legislative action to strengthen the IRS's international tax enforcement program. Specifically, (1) the reporting and recordkeeping requirements for multinationals doing business in the United States were expanded to provide IRS with the information necessary to audit intercompany transactions; (2) the statute of limitations in which to assess tax can now be suspended for a corporation during the period of time that the corporation and the IRS are in court litigating the issue of whether the corporation must comply with a specially designated summons issued by the IRS for the production of documents; and, (3) the 20-percent overvaluation penalty was expanded to cover valuation understatements (as well as large valuation overstatements) resulting from section 482 adjustments in excess of $10 million.

To evaluate the effectiveness of recently enacted compliance measures and to address the tax policy questions, the Secretary of the Treasury was required by law to conduct further study of the application and administration of section 482 and to make recommendations. Specifically, Treasury was required to report on the effect of the recent tax law changes on compliance, the use of the "advance determination process" (currently underway to assist corporations and IRS with agreed to pricing methods early in the