April 17, 1997
On behalf of the members of the American Payroll Association, I would like to congratulate you on the interesting and important work you are doing to investigate the need for improvement at the Internal Revenue Service.
As you may know, the APA represents more than 14,000 U.S. businesses on issues relating to payroll tax reporting, withholding and depositing. According to the Service's own calculations, more than 70 percent of all federal revenue is collected through income tax withholding. As such, APA's members are the nation's tax collectors. Moreover, payroll departments are responsible for submitting hundreds of millions of the more than 1.1 billion information returns received annually by the IRS and all of the 350 million received by the Social Security Administration (SSA). These include wage reporting forms (Form W-2, "Wage and Tax Statement" and Form W-3, "Transmittal of Wage and Tax Statements"), Forms 1099-MISC, "Miscellaneous Income," for reporting payments made to independent contractors, and employment tax returns, including quarterly Forms 941, "Employerís Quarterly Federal Tax Return", (covering income tax withholding and FICA taxes), and Form 940, "Employerís Annual Federal Unemployment Tax Return," (reporting unemployment taxes).
Thus, not only do U.S. businesses collect and deposit over 70 percent of the gross federal revenues of the United States, they also provide most of the documents used by the tax administration agencies for their own record keeping, balancing and compliance endeavors.
We are pleased that the Commission is taking a hard look at the employment tax collection system. Our members have a tremendous stake in these improvement efforts. Payroll tax processing is a large cost to businesses. Minimizing this burden on U.S. businesses should be a top priority of Congress, Treasury, and IRS. APA believes that improving tax processes and relieving burden on taxpayers require examining more than just the IRS, however. We suggest that the Commission consider the following in preparing its recommendations to Congress.
I. The Role Congress and the Treasury Play in Increasing Tax (and Payroll Tax) Complexity.
II. APA's Specific Recommendations for IRS Improvements.
I. The Role Congress and the Treasury Play in Increasing Tax (and Payroll Tax) Complexity.
APA thinks that IRS-bashing is unfair and unproductive. Many of the current "IRS problems" being addressed by the Commission were not created by the IRS. Various administrations, Congress and the Treasury are also responsible for creating problems at IRS. Their role needs to be examined as well if IRS processes are to be improved and taxpayers better served.
A. Too many tax bills.
The IRS is drowning in regulations projects required by wave after wave of major tax law changes -- more than one a year since 1981. Each new tax law includes hundreds of major changes, and some legislation, with their accompanying committee reports, cover thousands of pages. The "technical corrections" laws alone, which fix mistakes in existing statutes, in some cases cover thousands of different items. The IRS simply cannot issue guidance fast enough to catch up, and U.S. businesses are left to ponder what compliance requires. If they guess wrong, penalties can be assessed. There are currently almost 350 outstanding IRS regulations projects.
Recommendation: Congress should either provide for an increase in the IRS's budget for regulation-writing or pass fewer tax law changes requiring complex implementing regulations.
B. Too little thought given to the impact of tax changes on U.S. businesses as Congress uses the payroll tax system to raise revenue.
Most of the legislative changes in recent years that have created major payroll system changes, plan amendments, and the acceleration of tax deposits have been enacted as revenue raisers. This has created additional burdens for U.S. businesses. Additionally, these revenue raisers and revenue savers often are enacted without the benefit of adequate hearings or opportunities for public comment. We also suspect that the cost to the economy in taxpayer burden is often greater than the money brought into the Treasury. Here are some recent examples:
ē IRC Section 127 educational assistance exclusion. Tax-free educational assistance is a popular and useful fringe benefits that employers offer to their employees. Yet, Congress has let the exclusion expire eight times since 1978, with two of the expirations occurring during the middle of a tax year. Several of the eight extensions of this exclusion have been enacted retroactively. Retroactive tax changes always overburden payroll departments. These kinds of changes result in many administrative and record keeping burdens, including the need to issue Forms W-2c "Statement of Corrected Income and Tax Amounts" to employees and the government. This is extremely costly for both the public and private sector. This popular exclusion will expire again (in the middle of a tax year) for classes beginning after June 30, 1997. Congress should pass a permanent extender and stop the legislative bickering and associated problems over what is a very small amount of revenue.
ē Moving and travel expense deductions. Six times in four years, Congress has radically changed the tax treatment of different types of relocation and travel expenses: Moving expense deductions were limited, spousal travel expense deductions were disallowed, meals and entertainment deductions were cut from 80% to 50% of the expense; travel expenses were disallowed for jobs lasting over a year; some parking was taxed; and some van pooling and transit expense reimbursements were exempted. All of these changes have payroll department repercussions -- requiring detailed and expensive tracking of costs and benefits; more reporting; higher payroll taxes; smaller deductions; changes in plans and benefit booklets -- and in some cases, all of the above! In none of these cases were payroll people consulted at any congressional hearing to discuss how to design these changes to minimize taxpayer confusion, or to avoid the need for corrective IRS guidance.
ē Increase in supplemental wage withholding and backup withholding rates. The tax withholding rate for "supplemental wages" (any bonuses, stock options, fringe benefits, or any other one-time payments) was increased from 20 percent to 28 percent in 1994. The withholding rate for "backup withholding" on certain payments reported on Forms 1099 was raised to 31 percent (from 20 percent) in 1993. In many cases, these high withholding rates apply to workers in the 15 percent income tax bracket, so they result in burdensome tax increases for lower-paid employees, which are not remedied in many cases until an employee files his tax return in the next year. Also, in cases where the company has failed to withhold, these 28 percent and 31 percent rates are used to calculate the taxes and penalties assessed to the company -- even if the worker involved paid tax at only a 15 percent rate! Congress should not allow such overly punitive penalties.
ē IRC Section 137 adoption assistance. In 1996, when Congress adopted an income exclusion for employer-provided adoption expenses, it failed to exclude the benefit from FICA and federal unemployment taxes, and left it unclear as to whether employers are required to monitor employees' incomes in order to determine the tax treatment of the benefit. Thus Congress created a procedural hurdles that discourage employers from even offering the benefit.
· Current proposals to accelerate state and federal unemployment insurance tax deposits. This provision is currently in the Administrationís budget proposal. Treasury officials have no stated policy basis for the provision, which produces a one-time revenue spike by accelerating federal and state unemployment insurance deposits from quarterly to monthly. The proposal indicates that the Administration and Treasury are willing to burden U.S. employers and the entire state and federal unemployment system with system changes for a one-time revenue raiser. We would hope Congress isnít.
· Including the Electronic Federal Tax Payment System (EFTPS) in the funding provisions of the North American Free Trade Agreement (NAFTA) without a public comment process. (See below.)
Each of these all-too-common problems outlined above could have been avoided if Congressís budget, appropriations, and tax committees had paid more attention to the payroll tax collection process, and had worked with their tax collectors and adopted written procedures that work for U.S. businesses without the need for future corrections or complex IRS regulations.
Recommendation: Stop using the payroll tax deposit system to raise revenues without analyzing the burdens on taxpayers and the economy. APA hopes the Committee will devise recommendations to avoid repeating these mistakes. We recommend these procedures include working with the U.S. businesses who actually collect the taxes and using that expertise to design legislation that is clean and clear. It can be done. If Congress is serious about relieving taxpayer burden, it must.
C. Too little concern for the impact of the non-tax use of the payroll withholding and reporting system.
Each time lawmakers assume in legislative requirements that U.S. businesses need merely to "push a button" to collect and report information on their employees for the government, they impose high costs on businesses. Payroll tax systems are built to serve one purpose: compliance with the myriad of federal, state, and local tax and employment legislation and regulation with which employers are faced. They thus contain only the specific data elements needed for this purpose. Any collection and reporting of information not related to this purpose, or, which requires new data elements, forces U.S. businesses to reconfigure existing systems or to build and maintain new ones. These are very costly endeavors. It is even costlier if required deadlines are unrealistic. Some recent examples are:
ē The Omnibus Budget Reconciliation Act of 1993's (OBRA Ď93) provision which required U.S. businesses to collect and report unrelated data on worker health care benefits: the Medicare/Medicaid Data Bank. In 1993, Congress required the reporting of all workers' tax-free health benefits, in an attempt to discover possible Medicare fraud by elderly or disabled people whose employers should have been paying their hospital bills. Although the number of cases of possible abuses involved much less than 1 percent of workers, the provision required reporting on 100 percent of workers. This "Medicare/Medicaid Data Bank" would have forced U.S. businesses to build new systems to collect and report data that did not exist in any payroll system. The cost? Hundreds of millions of dollars. Further, the information collected and reported could not have been used to set up the Data Bank, as the Health Care Financing Administration was not funded to process the information.
The expense of gathering the information and completing the reports was far more than the amount of fraudulent payments that could ever have been detected. This legislation was so wrongly focused, and so hard to implement, that it first was frozen, and ultimately repealed -- but not without thousands of wasted hours of time of congressional staffers, agency employees, and concerned payroll department and health benefit plan lobbyists. The provision should never have been considered, and wouldnít have been enacted if Congress had allowed a public comment process.
· Collecting overdue student loans and other federal agency loans through the payroll withholding process. These collection practices (expanded in the Debt Collection Improvement Act of 1996) force U.S. businesses into funding and carrying out the enforcement operations for various federal agencies. U.S. businesses should not be used this way, nor should the payroll tax withholding system.
· Proposals during the national debate on health care reform. During the 1993 Congressional hearings on the health care reform proposals put forth by the administration, one member of the House declared that collecting the employee contribution for the proposed system was "as simple as another line on Form W-2." In fact, U.S. businesses would have had to build and maintain very costly systems, and so would the government. This kind of thinking and inaccurate public pronouncements on the part of members of Congress do nothing to relieve burden on U.S. businesses. In fact, they ensure even more burden to come. The proposals would have required legislation mandating huge and costly data processing systems for U.S. businesses.
Recommendation: Stop using payroll returns to report non-tax information. The Form W-2 already contains 27 information boxes, some with nearly 20 different special alphabetical "codes" ("A" through "T") for use in reporting different information. This form is almost three-dimensional, it contains so much information! Congress should not try to use Form W-2, Form W-4, or Form 1099 to report non-tax information. In every case where this has been attempted in the past, these data collection requirements force payroll departments to build "exception systems" and force the IRS to build equivalent "exception systems" to process this non-tax information. Why? Because existing systems can only collect and report data that are pertinent to tax collection, depositing and reporting. This is as it should be. If a non-tax data element is required, a company has to build a new data base. It then must build a system for processing the information and reporting it to the government.
D. Too little care given to allowing reasonable deadlines for U.S. businesses to make systems changes necessary to comply with new requirements.
If Congress is serious about reducing the burden that its tax code creates, it must allow adequate time for systems to be built. U.S. businesses are under threat of large penalties if they do not comply with the tax law. They are not able to simply "push a button" when new laws and regulations are promulgated. In fact, the following time elements exist in building new systems or making changes to existing systems:
· The time it takes the regulatory agencies to provide guidance to businesses regarding the new requirements after the passage of law. As we have seen, this can take years. Often, effective dates arrive before regulations exist. This forces U.S. businesses to build systems based on their best guess regarding the intent of Congress.
· The time it takes the regulatory agencies to educate employers about their obligations, especially in the case of small businesses that may not have access to information and professional expertise available to larger businesses. After regulations, it takes some time before taxpayers are educated about requirements, especially if regulations are complex or require significant changes to existing practices.
· The time it takes to make changes to existing systems. The more complex the regulations, the more time businesses need to prepare for compliance.
· The amount of time it takes to test system changes to ensure compliance and the reporting of clean, accurate information to the government agencies for their enforcement programs.
· The amount of time it takes for software design and testing. Most U.S. businesses buy their tax processing software from outside vendors. If these vendors do not have enough time to develop products, businesses pay with costly systems changes and/or manual or exception systems.
· The amount of time it takes for design of pilot programs to test transactions and transmission among the various users before businesses come under penalty exposure.
It is important to note that these processes must be accomplished in a linear fashion, and cannot be accomplished at the same time. Congress must allow for realistic effective dates, recognizing that each one of these steps takes a finite amount of time for both the public and private sectors. Congress should work with the private and public sectors to design realistic implementation schedules. It should not establish effective dates based solely on revenue needs.
A classic example of what happens when Congress does not allow sufficient time for these steps is the implementation of the new Electronic Federal Tax Payment System (EFTPS), which is proceeding right now. Congress mandated the EFTPS as a funding vehicle for NAFTA in November 1993. Congress amended the tax code to require electronic deposit of employment taxes on a phased-in basis. Congress further required the first wave of taxpayers to come on to the system on January 1, 1995. This phase-in schedule, we believe, was designed purely to bring in revenue, and not with regard to the time needed to build a system that would accommodate the needs of taxpayers. In addition, this funding vehicle was included without any public comment process. The users of the system -- taxpayers, payroll service bureaus and other third-party service providers, software designers, tax practitioners, banking representatives, and their professional associations -- were given no opportunity to comment to Congress. We believe that all of this was very short-sighted of the Congress. These decisions had predictable results.
First, IRS, Treasury, and the banking infrastructure of the United States had only 14 months to build an entirely new, nationwide, electronic system for accepting tax deposits that would eventually affect nearly every business, large and small, in the U.S. Thus, software designers and banks had even less time to provide products and services. Taxpayers, tax practitioners, and payroll service bureaus and other third party service providers had even less time to understand requirements, build the necessary infrastructure to comply, and advise clients about the new system. Indeed, for the first two implementation dates, (1/1/95 and 1/1/96), the system was not operable. The TAXLINK pilot program was substituted. Requirements and systems were still being drafted and built as recently as several months ago. There are still no final regulations regarding use of the EFTPS and taxpayer responsibilities. All of this resulted in a system delay of six months, a great deal of confusion among taxpayers, and another loss of confidence in the Internal Revenue Service.
Recommendation: Congress should involve the users of the tax system in decision making and drafting of legislation. Quality, it is known, starts at the top, with the top management supporting the entire process.
Once Congress has ensured that the legislative language is as clear and as easy to implement as possible, it should oversee a process for tax regulations and/or systems design which involves all users, not just government users. Critically important are the nationís tax collectors - U.S. businesses, payroll service bureaus (who process and deposit a significant percentage of U.S. payroll taxes), the software designers who supply U.S. businesses with the software needed to stay in compliance, tax practitioners, Treasury, IRS, the Social Security Administration (which administers some payroll taxes and performs complex balancing processes with IRS) and the state tax administrators.
This will require a fundamental shift in current philosophy for Congress, Treasury, and IRS. The tax system in the United States is extremely complex. Lawmakers should not write legislation in a vacuum. They should understand how the law impacts the business systems of their tax collectors. A great deal of expertise exists today in the private sector. It should be formally incorporated into the legislative process. Any organization that does not involve the users of processes before building them is setting itself up for predictable, but avoidable, failure.
Only by involving the front-end users in the design process can serious implementation problems be avoided. As Gerard H. Barloco of USAA stated, "governance of systems requires a formal relationship between the business community supported and the information services organization providing that support."
E. Little knowledge of and little attention paid to the impact on the states of tax changes.
Many states follow the federal income tax law in imposing state income taxes on their residents. This is a boon to U.S. businesses, because it allows for standardization in business systems. This is a cost saver. When Congress passes complex legislation that requires complex regulations, states have no choice but to either follow suit or institute different, non-standard requirements.
Recommendation: The effect on states of tax changes and standards development should be considered by Congress. Wherever possible, the federal government and its state counterparts should work together to ensure uniform standards and ease of implementation and administration.
II. APA's Specific Recommendations for IRS Improvements.
A. Congress should examine the feasibility of making IRS an independent agency, thereby separating tax policy and tax administration functions.
APA believes that IRSís mission of administering the tax code is separate and distinct from that of the Treasuryís. APA does not believe oversight should remain with Treasury for the following reasons:
· IRS has no formal way to object to policy decisions which adversely affect either the IRSís systems or U.S. taxpayers.
· IRSís Chief Counsel should be counsel to the IRS, not Treasury. If this were so, IRS would be able to protest decisions which adversely affect the Service, the tax administration system and taxpayers more effectively. In addition, it could negotiate on its own behalf.
· Treasuryís Modernization Management Board (MMB) is comprised solely of federal government executives. Although the MMB is credited with managing several constructive changes at IRS, it falls far short of the kind of oversight needed. (See below)
B. Congress should establish a Board of Directors to manage the IRS. This Board should be comprised of representatives from federal and state tax and employment agencies, U.S. businesses (large and small), third party service providers, tax practitioners, software designers, legal experts, and systems professionals.
Such a governing board would allow for a critically important external review process which does not currently exist. Such a process is needed to ensure the Service does not continue to work in a vacuum and does not continue to exclude systems users from system design decisions. Such a board would also be able to set up a process to quickly evaluate ideas from the private sector and provide for their quick implementation if deemed appropriate.
C. Congress should enact fundamental and immediate reform of IRSís payroll tax penalty system.
Each year, IRS sends out hundreds, if not thousands, of excessive assessments and erroneous penalty notices. These excessive assessments have many different causes. First, the IRS withholding rules are not simple or crystal clear, so mistakes are perilously easy to make. Second, as noted above, a reporting and withholding mistake for a worker in the 15 percent bracket can create a tax liability for the employer of 28 percent of the unreported income. Third, after the tax shortfall is calculated, the reporting and deposit penalties can double the employer's IRS liability, depending upon the type of mistake and the amount of wrongly reported income. Finally, under the current IRS deposit "ordering rules," the penalty for deposit shortfalls can, in some cases, be extended to more than one payroll tax deposit within the same calendar quarter. This occurs, because under a special deposit "ordering rule" contained in IRS guidance, the IRS computers do not automatically credit employment tax deposits to the amount due on the date the deposits are actually made, but back to the date of the earliest outstanding employment tax underdeposit liability during that calendar quarter. This retroactive "deemed deposit" rule has the effect of continually creating new underdeposits with each new deposit following any actual underdeposit. Reflecting the automatic operation of this carry-back and crediting rule, the amount of each new underdeposit equals the lesser of (1) the amount of the pre-existing underdeposit liability that remains outstanding, or (2) the amount of the new deposit that is shifted backwards in time. The resulting underdeposit penalty will mount throughout the calendar quarter. The employer is not notified of the shortfall until the assessment of a substantial penalty after the quarter ends.
APA understands that, in response to hundreds of taxpayers' complaints, the IRS may soon revoke this harsh penalty calculation rule (although we do not yet know the effective date of the announcement, or when the implementing guidance will be issued). Penalties like this should never have been designed, however -- and an employment tax audit system that can put a business out of existence should not be allowed to continue to operate. Payroll tax penalties should never be used either to raise revenue or to punish for punishment's sake. Instead they are intended to promote voluntary compliance. Accordingly, any employer with both a record of deposit compliance and prompt corrective actions to correct deposit errors should not be subjected to overly punitive deposit penalties. This is especially true in cases where the error was made following a careful, comprehensive review of the applicable IRS guidance controlling the employment tax deposit requirements.
D. An "Employment Tax and Payroll Issues" Office should be established in IRSís Chief Counselís Office.
Over 70 percent of the gross federal revenues of the United States are collected, reported and deposited by U.S. businesses through the payroll tax process. Yet there is no specific section in IRS's Chief Counsel's Office called "Employment Taxes." Perhaps this is why important regulations are given low priorities and there is a lack of understanding of regulatory impacts on businesses. These problems might be alleviated if the IRS were to create a single branch within its Chief Counsel's Office that could handle and coordinate such things as the taxation of fringe benefits, information reporting, employment tax deposit rules, and related penalties for making mistakes.
E. Congress should insist on publication of guidance goals, with deadlines and budgets established for those goals as a method to ensure prompt publication of new withholding, depositing, and reporting requirements.
Several years ago, the IRS began publishing a yearly business plan. This plan prioritizes its guidance projects for the year. In too many cases, the items included in the plan are not well-defined, or represent only minor projects, or parts of projects. Meanwhile, more important projects remain on the back burner. This priority development process should be coordinated with the IRS's list of outstanding regulations projects, and the guidance-targeting process should be more open and more receptive to public comments. Finally, after articulating these guidance goals and deadlines, the IRS must provide project budgets -- and assign enough people, and funds, to publish the guidance on time. IRS should be held accountable to such fixed targets and budgets, so that projects that need public guidance, including return filing, tax depositing, information reporting and tax-tracking systems, are produced timely.
F. Congress should ensure that IRSís computer systems and associated processes are reformed and modernized.
It is no secret that IRS's computer systems are in critical condition. In the area of information reporting, Congress and the IRS should:
· Reduce costs for both the public and private sectors by focusing on and articulating a strategy for automating the information reporting process.
IRS does not appear to have a strategy for automating the information reporting process. Rather, its focus is on individual taxpayers and tax returns. The majority of the approximately 1.4 billion documents which are processed by SSA and IRS are information returns received from U.S. businesses. Most of these documents do not have the kind of complicated attachments that make automating tax returns difficult. In order to automate the information reporting process, IRS should take the following steps promptly:
· Work with the private sector in articulating a strategy and invite users of the tax system and software designers to lend their expertise. Work with all users of the system(s), public and private, during all phases of design, implementation and maintenance. Develop and test pilots before implementing programs.
· Remove the electronic signature barriers to electronic, magnetic media and PC filing of information returns and work with the American National Standards Institute (ANSI) and the states to ensure nationwide standards.
· Resolve security issues and remove barriers to electronic filing.
IRS has stated that in no instance has the fate of a tax claim relied on the validity of a signature on an information return. This means that hundreds of millions of these information reporting documents can potentially be transmitted electronically without a paper signature attachment. We thus believe that most, if not all, of the (perceived) security problems surrounding moving information returns electronically to and from the IRS should be resolvable, without adding to the years of delay that have already occurred. APA believes the technological solutions exist today. IRS has to articulate requirements, work with their "stakeholders" and create pilots in order to successfully implement programs.
For example, SSA already has begun receiving Forms W-2 electronically, using a bulletin board for smaller employers and high speed bulk data transfer processes for larger employers. Itís our understanding that the growth of SSAís program has been inhibited by the Serviceís delay in establishing a method for electronic signatures and removing the perceived security barriers.
According to SSA, of the 5.5 million employers filing today, only about 10 percent are filing either returns or information reporting documents electronically. However, 50 percent of the remaining five million are filing on paper created by a personal computer. Because this information is already in an electronic format, it could easily be submitted to the IRS by modem. This is a tremendous opportunity. It should be pursued, not held up by lack of electronic signature methods or by concerns regarding security which may be unnecessary.
APA believes the technology exists to do this with the use of PINs. For example, EFTPS uses PINs. We are concerned that the states are beginning to develop standards for electronic signatures and programs to receive tax and information return documents electronically. IRS should partner immediately with the SSA, the state tax and employment agencies, the private sector and ANSI to develop national procedures and standards.
· Provide businesses with alternative methods and incentives to file information returns electronically.
It is important that the government provide users with alternative methods for automated filing. (See discussion on Social Security Administration above.) For example, Electronic Data Interchange (EDI) equipment is expensive and available for tax use in only a very small number of businesses. Businesses are reluctant to make that kind of investment in payroll departments.
Voluntary programs for electronic filing should be created, leaving modem to modem, magnetic media, and other automated methods available to those who want them.
· Outsource when appropriate expertise is not available within IRS.
Thank you for giving the APA an opportunity to make these comments. We remain willing and able to assist the Commission in its efforts to accomplish some long-needed reforms.
Director of Government Affairs