a chance to appeal after assessment. These penalties may also be appealed on special claims for refund. The taxpayer pays a specified portion of the penalty amount and files a claim. If this special refund claim is denied by IRS, the taxpayer may file suit in the appropriate U.S. District Court or in some cases, the U.S. Claims Court. In these special cases, the full penalty amount does not need to be paid before going to court.

Most penalties are assessed by the service centers. Taxpayers may write the service center to request reconsideration of a penalty based on the circumstances involved. These penalties may also be appealed after assessment if the service center does not accept the taxpayer's explanation. Payment does not have to be made prior to appealing the penalty. During the appeal, IRS may or may not send balance due notices or take collection action on an assessed penalty. Taking collection action during an appeal depends on the particular type of penalty, dollar amount, or the extent to which the Collection function is already involved in the case. If the appeals officr sustains these assessed penalties, the taxpayer must pay them in full before pursuing a judicial appeal. After full payment, the taxpayer may file a claim for refund. If the claim is denied by IRS, the taxpayer may file a suit with the appropriate U.S. District Court or the U.S. Claims Court.

It is important to note that, even if the taxpayer does not request formal administrative appeals consideration the taxpayer could still informally "appeal" later and request abatement of the penalty from a revenue officer or other Collection employee who has responsibility for the taxpayer's case. In appropriate situations, a Problem Resolution Program (PRP) employee could also abate penalties. Thus, there are several informal opportunities to have penalties abated as well as various avenues to a formal administrative appeal.

Mr. BRENNAN. In terms of the figures that have been talked about, the so-called abatement rate being around 50 percent, that is true for the dollars assessed. For the volume assessed, the abatement rate is much lower than that. It runs in the neighborhood of 15 to 20 percent.

Also, I would mention that the volume of penalties, the numbers that have been assessed over the past 4 or 5 years has not really grown dramatically.

In terms of your questions on reviews, yes, there is what we call a notice reviews program. As you mentioned, we do calculations and many things by computers, but before those notices go out, the notices are pulled and reviewed to be sure a quality product is going out. There are a number of operational reviews done in each Service Center, and by our regional offices and the National Office. Mr. THOMAS. How low does the decision go in terms of yes or no? Is it below a director?

Mr. BRENNAN. Yes.

Mr. THOMAS. How low does it go?

Mr. BRENNAN. It is basically at the tax examiner level.

Mr. THOMAS. How many tax examiners do you have?

Mr. BRENNAN. Hundreds in a service center.

Mr. THOMAS. So we are talking about tens of thousands of people who can say yes or no?

Mr. BRENNAN. There are hundreds of people and if you do Nationwide, there are thousands of people who would be involved in this.

Mr. THOMAS. That have the final yes or no, but not just involved? Mr. BRENNAN. Right.

Mr. THOMAS. People who can say yes or no in terms of a penalty, that is what I am looking for. I am looking for the number of people who can say yes or no. What is the lowest level that you can get a definitive decision and how many people?

Mr. BRENNAN. It is at the tax examiner level.

Mr. THOMAS. So it is thousands of people. Is the goal of the IRS to lower that or have you thought of making it higher? That is where you run into the consistency problem. People look at it from different perspectives and they have different emotional levels and they respond to different pitches.

Mr. BRENNAN. I think that is true. We are not looking to move it lower. We are looking for two things. To make sure that our people are consistently and well trained.

And second, we are looking to develop and we are working on it right now-artificial intelligence programs that we could use to insure consistency. I believe down the road that we may raise the level.

Mr. THOMAS. The reason I said pitches is if you are telling me that the number we are dealing with is only a 15- to 20-percent kickback but the volume is a 50-percent kickback then maybe it is additional information or it was not presented in a form to allow you to see the computation. Therefore, the discretionary factor is even more critical in terms of how you make these decisions.

I am willing to go with you on this journey, Mr. Chairman, but it will make the members' jobs harder when you remove the easy fixes in dealing with IRS problems, which appear to be IRS problems, but in fact are not.

Chairman PICKLE. I suppose there is no disagreement that 150 tax penalties is too many. There must be an admission that it is growing larger. It has doubled within the last 10 years. I assume there is no argument about the fact that we ought to change the system. Is anybody in disagreement with that?

I would like to say then that the IRS has a task force at work on this question. So has the American Bar Association, and so has the CPA organization. I understand that all of them hope to have some kind of a general analysis and recommendation by late summer or early fall.

I am going to then ask IRS if you would submit, as a goal at least, to this committee, some specific recommendations, presumably in consonance with the Treasury Department, about how we might make the changes. If we are going to have these analyses in by late summer, then we ought to expect something to us as a committee recommendation by this fall. I hope you keep that in mind as a goal and pass that on to Commissioner Gibbs.

We have many witnesses today, so we will have to submit our questions in writing, since time is short. Thank you very much for your attendance here this morning.

The Chair would ask Johnny Finch, Deputy Director, General Government Division, U.S. General Accounting Office. I understand you have Lynda Willis, Group Director, with you this morning?

STATEMENT OF JOHNNY C. FINCH, DEPUTY DIRECTOR, GENERAL GOVERNMENT DIVISION, U.S. GENERAL ACCOUNTING OFFICE, ACCOMPANIED BY LYNDA WILLIS, GROUP DIRECTOR, TAX POLICY AND TAX ADMINISTRATION AUDIT GROUP

Mr. FINCH. Thank you, Mr. Chairman.

Lynda Willis is with me, sir. She is the group director in our Tax Policy and Tax Administration Audit Group, who will be responsible for managing the work in the penalties area we will be doing for your subcommittee in the coming months.

Chairman PICKLE. We are pleased to have both of you with us. Mr. FINCH. I would like to submit my statement for the record and with your permission, I will summarize.

We are pleased to be here today to assist the subcommittee in its review of the civil penalty provisions in the Internal Revenue Code. My statement today covers four points:

First, the need for a comprehensive review of civil penalties and some of the objectives for such a review.

Second, the methodology of the IRS Commissioner's Study of Civil Penalties.

Third, what we know about problems in IRS' administration of civil penalties.

And fourth, the circumstances in which computers generate penalties.

As the tax system has become more complex, so have the accompanying penalties. Given this and the sweeping impact of the Tax Reform Act of 1986, this subcommittee, other congressional committees, and the Commissioner have expressed concerns over the civil penalty provisions of our tax laws. We share these concerns and support the notion that a comprehensive review of those provisions is in order.

The first step should be to identify and understand the problems with the existing system. To this end, the Commissioner has launched a study of the civil sanctions available to IRS. At your request, we have begun to review the methodology being used in IRS' study.

Our preliminary observations are that it currently draws heavily on expert opinion and advice from IRS management and outside organizations, and that its schedule is ambitious. While expert opinions and advice are valuable in identifying problems and developing recommendations for improvement, the IRS study does not presently provide for sampling of taxpayer returns to validate the experts' concerns and opinions, or to empirically determine how well IRS is administering the various penalties.

Without this information it will be difficult to quantify the nature and extent of the problems or to identify and correct their cause. Our work will fill part of the gap by providing the empirical evidence necessary to evaluate the effectiveness of IRS' administration of a limited number of specific penalties.

IRS' administration of civil penalties is a key issue. We have not yet done sufficient work to be in a position to comment conclusively on IRS' overall effectiveness in administering civil penalties. However, our work related to several specific penalties and recent reports by the IRS Internal Audit Staff identify potential problems that should be considered in any comprehensive review.

These problems include instances where IRS did not assess certain penalties when they were warranted, abated penalties when they were not required to do so, made computational errors, and did not assess certain penalties consistently among IRS district offices.

For example, a 1986 IRS Internal Audit report concludes that IRS overlooked millions of dollars in penalties that should have been assessed against employers who claimed fictitious tax deposits on their employment tax returns. Of the accounts with fictitious deposits that Internal Audit identified, none were assessed the penalty. Internal Audit staff projected that, on a nationwide basis, IRS did not assess $437 million in such penalties in 1986.

In an ongoing tax shelter promoter study, we found that IRS made several computation and oversight errors when assessing abusive tax shelter promoter penalties. IRS made 20 such errors resulting in about $4 million in penalty underassessments in 9 of the 29 total cases at 3 selected district offices.

Similarly, inconsistent enforcement of penalties by IRS district offices has also been identified as a problem. For example, we found in our tax shelter study that one district decided not to administer the tax shelter late registration or nonfiling penalty because of the belief that it was too new. The other two districts were assessing late filing penalties but were using a late filing grace period greater than that established by the national office.

You asked us to determine the extent to which IRS uses computers to assess penalties and, if by doing so, IRS assesses a significant number of inaccurate penalties which are ultimately abated or erroneously paid by taxpayers. We found that IRS does not have data readily available to identify the number of penalty assessments which are computer generated. Neither is information available to abatements of erroneous payments.

Theoretically, computer generated penalties should be more consistently assessed than manually generated penalties. Penalties assessed by the computer involve conditions which are specific, well defined, and do not require the exercise of subjective judgment.

In summary we support the need for a comprehensive review of the civil penalty structure. We also believe that now is a good time to begin.

Several issues would need to be addressed in a truly comprehensive review. These include the purpose, need for, and effectiveness of each penalty provision, and the equity and efficiency of IRS' civil penalty administration. Past work by GAO, IRS, and others provide a starting point. But all the information necessary to respond to these issues is not presently available.

The Commissioner's civil penalties study is an important step in developing the information needed. However, undertaking a review of almost 150 penalty provisions and their interrelationships is a massive task. In our view, the Commissioner's study is an ambitious undertaking for the targeted time frames.

We will continue to monitor the evaluation of the study and will keep both IRS and the subcommittee advised of our thoughts.

That concludes my statement, Mr. Chairman. I would be happy to respond to any questions the subcommittee may have. Thank you.

[The statement of Mr. Finch follows:]