This is the accessible text file for GAO report number GAO-04-126 
entitled 'Financial Audit: IRS's Fiscal Years 2003 and 2002 Financial 
Statements' which was released on November 13, 2003.

This text file was formatted by the U.S. General Accounting Office 
(GAO) to be accessible to users with visual impairments, as part of a 
longer term project to improve GAO products' accessibility. Every 
attempt has been made to maintain the structural and data integrity of 
the original printed product. Accessibility features, such as text 
descriptions of tables, consecutively numbered footnotes placed at the 
end of the file, and the text of agency comment letters, are provided 
but may not exactly duplicate the presentation or format of the printed 
version. The portable document format (PDF) file is an exact electronic 
replica of the printed version. We welcome your feedback. Please E-mail 
your comments regarding the contents or accessibility features of this 
document to Webmaster@gao.gov.

This is a work of the U.S. government and is not subject to copyright 
protection in the United States. It may be reproduced and distributed 
in its entirety without further permission from GAO. Because this work 
may contain copyrighted images or other material, permission from the 
copyright holder may be necessary if you wish to reproduce this 
material separately.

Report to the Secretary of the Treasury:

November 2003:

FINANCIAL AUDIT:

IRS's Fiscal Years 2003 and 2002 Financial Statements:

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-126] GAO-04-126:

GAO Highlights:

Highlights of GAO-04-126, a report to the Secretary of the Treasury 

Why GAO Did This Study:

Because of the significance of Internal Revenue Service (IRS) 
collections to federal receipts and, in turn, to the consolidated 
financial statements of the U.S. government, which GAO is required to 
audit, and Congress’s interest in financial management at IRS, GAO 
audits IRS’s financial statements annually to determine whether (1) 
the financial statements IRS prepares are reliable, (2) IRS management 
maintained effective internal controls, and (3) IRS complies with 
selected provisions of significant laws and regulations and its 
financial systems comply with the Federal Financial Management 
Improvement Act of 1996 (FFMIA).

What GAO Found:

In GAO’s opinion, IRS’s fiscal year 2003 financial statements were 
fairly presented in all material respects. Because of serious 
deficiencies in financial systems and internal control weaknesses, 
however, IRS again had to rely extensively on resource-intensive 
compensating processes to prepare its financial statements.

In fiscal year 2003, IRS continued to make great strides in a number 
of areas. IRS improved the accuracy and reliability of its property 
and equipment (P&E) inventory records and implemented a system to 
ensure that software and software licenses were properly controlled 
and used in accordance with license agreements. These and prior years’ 
improvements allowed GAO to conclude that the remaining issues related 
to P&E no longer constitute a material internal control weakness. 
Because of other improvements by IRS, such as timely recording 
obligations and expenditures in its accounting system, GAO no longer 
considers the remaining control issues related to recording certain 
budgetary activity to be a reportable condition. However, IRS 
continues to be challenged by control weaknesses and system 
deficiencies affecting (1) financial reporting, (2) unpaid tax 
assessments, (3) tax revenue and refunds, and (4) computer security. 
IRS was also not always in compliance with laws concerning the 
structure of installment agreements it enters into with taxpayers and 
the timely release of federal tax liens. 

Lack of a financial management system that can produce timely, 
accurate, and useful information needed for day-to-day decisions 
continues to be one of the largest obstacles facing IRS management. 
Through compensating processes, extraordinary efforts, and continued 
improvements to its financial processes and operations, IRS was able 
for the second consecutive year to issue its financial statements 6 
weeks after the end of the fiscal year. Nevertheless, largely because 
its financial management systems do not comply with FFMIA, IRS remains 
unable to produce reliable, timely financial and cost-based 
performance information for decision making or to fully address the 
financial management and operational issues that affect its ability to 
fulfill its responsibilities as the nation’s tax collector.

What GAO Recommends:

In prior audits, GAO made numerous recommendations to IRS to address 
issues raised in this audit. GAO will continue to monitor IRS’s 
progress in implementing the nearly 80 recommendations that remain open as of the date of this report.

IRS agreed with the report's findings and noted that the report fairly 
presented IRS's progress and its remaining challenges. IRS cited a 
number of planned improvements and initiatives to address the matters 
raised in the report. IRS also recognizes that only by implementing 
its new integrated financial management systems will it be able to 
overcome the majority of the material weaknesses cited in the report.

www.gao.gov/cgi-bin/getrpt?GAO-04-126.

To view the full product, including the scope and methodology, click 
on the link above. For more information, contact Steven J. Sebastian 
at (202) 512-3406 or sebastians@gao.gov.

[End of section]

Contents:

Letter: 

Auditor's Report: 

Opinion on IRS's Financial Statements: 

Opinion on Internal Controls: 

Compliance with Laws and Regulations and FFMIA Requirements: 

Consistency of Other Information: 

Objectives, Scope, and Methodology: 

Agency Comments and Our Evaluation: 

Management Discussion and Analysis:

Financial Statements:

Balance Sheets: 

Statements of Net Cost: 

Statements of Changes in Net Position: 

Statements of Budgetary Resources: 

Statements of Financing: 

Statements of Custodial Activity: 

Notes to the Financial Statements: 

Supplemental and Other Accompanying Information:

Appendixes:

Appendix I: Material Weaknesses, Reportable Conditions, and Compliance 
Issues: 

Material Weaknesses: 

Reportable Conditions: 

Compliance Issues: 

Appendix II: Details on Audit Methodology: 

Appendix III: Comments from the Internal Revenue Service: 

Abbreviations:

CADE: Customer Account Data Engine:

CAP: Custodial Accounting Project:

CFO Act: Chief Financial Officers Act of 1990:

EITC: earned income tax credit:

FERS: Federal Employees Retirement System:

FFMIA: Federal Financial Management Improvement Act of 1996:

FFMSR: Federal Financial Management Systems Requirements:

FIA: Federal Managers' Financial Integrity Act of 1982:

FMS: Financial Management Service:

IFS: Integrated Financial System:

IRS: Internal Revenue Service:

IT: information technology:

JFMIP: Joint Financial Management Improvement Program:

NFC: National Finance Center:

OMB: Office of Management and Budget:

P&E: property and equipment:

SGL: U.S. Government Standard General Ledger:

TSP: Thrift Savings Plan:

Letter November 13, 2003:

The Honorable John W. Snow: 
The Secretary of the Treasury:

Dear Mr. Secretary:

The accompanying report presents the results of our audits of the 
financial statements of the Internal Revenue Service (IRS) as of and 
for the fiscal years ending September 30, 2003 and 2002. We performed 
our audits in accordance with the Chief Financial Officers (CFO) Act of 
1990, as expanded by the Government Management Reform Act of 1994. This 
report contains our (1) unqualified opinions on IRS's financial 
statements, (2) opinion that IRS's internal controls were not effective 
as of September 30, 2003, and (3) conclusion regarding IRS's 
noncompliance with two provisions of laws and regulations that we 
tested and IRS's financial management systems' lack of substantial 
compliance with the requirements of the Federal Financial Management 
Improvement Act of 1996.

Our unqualified opinions on IRS's fiscal years 2003 and 2002 financial 
statements were made possible by the continued extraordinary efforts of 
IRS senior management and staff to compensate for serious internal 
control and financial management systems deficiencies. Continuing to 
meet significantly accelerated reporting dates for issuance of the 
financial statements was also a major accomplishment. In 2001, the 
Office of Management and Budget (OMB) announced the executive branch's 
intention to require that agencies accelerate their timeline for 
issuing audited financial statements. For fiscal year 2003, OMB 
requires that agencies issue their audited financial statements by 
January 30, 2004, and for fiscal year 2004 and thereafter, OMB requires 
that agencies issue their audited financial statements by November 15, 
or 6 weeks after the end of the fiscal year. Last year, the Department 
of the Treasury went a step further by establishing, and then 
successfully achieving, a goal of having the audit of its financial 
statements, including those of its component entities such as IRS, 
completed and its departmentwide accountability report issued by 
November 15. IRS continued to successfully meet this challenge in 
fiscal year 2003.

In fiscal year 2003, IRS continued to make great strides in addressing 
its financial management challenges, particularly with respect to its 
administrative accounting operations. For example, IRS implemented 
procedures to improve the accuracy and reliability of its property and 
equipment (P&E) inventory records and implemented an inventory record 
system that captured information essential to ensure that software and 
software licenses were properly controlled and used in accordance with 
license agreements. These improvements, combined with the progress we 
reported last year, enabled us to conclude that the remaining issues 
related to P&E no longer constitute a material internal control 
weakness. Other improvements by IRS, such as more timely recording of 
obligations in its accounting system and implementation of procedures 
to address delays we reported in prior years in IRS's posting of 
expenditures in its accounting system, enabled us to conclude that 
issues related to controls over budgetary activity no longer constitute 
a reportable condition. IRS's actions, coupled with the continued use 
of resource-intensive processes to compensate for the remaining serious 
weaknesses in systems and controls, enabled IRS to again achieve 
Treasury's timeline.

We commend IRS for the improvements it has continued to make in its 
financial processes and operations. Nonetheless, IRS management and 
staff will continue to be challenged to sustain the level of effort 
needed to produce reliable financial statements until the agency is 
able to fully address the underlying systems and internal control 
issues that have made this process so time consuming and resource 
intensive. As we previously reported, IRS continues to lack timely, 
accurate, and useful financial information and sound controls with 
which to make fully informed decisions and to ensure ongoing 
accountability, which is the end goal of the CFO Act. IRS has made 
significant progress in addressing its serious control and systems 
deficiencies and improving financial management during the past 6 
years. It is important that these financial management initiatives 
continue to receive the needed support of the IRS Commissioner to 
achieve comprehensive and lasting financial management reform.

The accompanying report also discusses other significant issues that we 
considered in performing our audit and in forming our conclusions that 
we believe should be brought to the attention of IRS management and 
users of IRS's financial statements.

We are sending copies of this report to the Chairmen and Ranking 
Minority Members of the Senate Committee on Appropriations; Senate 
Committee on Finance; Senate Committee on Governmental Affairs; Senate 
Committee on the Budget; Subcommittee on Transportation, Treasury, and 
General Government, Senate Committee on Appropriations; Subcommittee on 
Taxation and IRS Oversight, Senate Committee on Finance; Subcommittee 
on Oversight of Government Management, the Federal Workforce, and the 
District of Columbia, Senate Committee on Governmental Affairs; House 
Committee on Appropriations; House Committee on Ways and Means; House 
Committee on Government Reform; House Committee on the Budget; 
Subcommittee on Government Efficiency and Financial Management, House 
Committee on Government Reform; and Subcommittee on Oversight, House 
Committee on Ways and Means. In addition, we are sending copies of this 
report to the Chairman and Vice Chairman of the Joint Committee on 
Taxation, the Commissioner of Internal Revenue, the Director of the 
Office of Management and Budget, the Chairman of the IRS Oversight 
Board, and other interested parties. Copies will be made available to 
others upon request. In addition, the report is available at no charge 
on GAO's Web site at [Hyperlink, http://www.gao.gov] http://
www.gao.gov.

This report was prepared under the direction of Steven J. Sebastian, 
Director, Financial Management and Assurance, who can be reached at 
(202) 512-3406. If I can be of further assistance, please call me at 
(202) 512-5500.

Sincerely yours,

David M. Walker: 

Comptroller General of the United States:

Auditor's Report To the Commissioner of Internal Revenue:

In accordance with the Chief Financial Officers (CFO) Act of 1990, as 
expanded by the Government Management Reform Act of 1994, this report 
presents the results of our audits of the financial statements of the 
Internal Revenue Service (IRS) for fiscal years 2003 and 2002. The 
financial statements report the assets, liabilities, net position, net 
costs, changes in net position, budgetary resources, reconciliation of 
net costs to budgetary obligations, and custodial activity related to 
IRS's administration of its responsibilities for implementing federal 
tax legislation. The financial statements do not include an estimate of 
the amount of taxes owed the federal government but which have not been 
identified by IRS, often referred to as the tax gap.[Footnote 1]

In its role as the nation's tax collector, IRS has a demanding 
responsibility in collecting taxes, processing tax returns, and 
enforcing the nation's tax laws. The size and complexity of IRS's 
operations present additional challenges to management. IRS is a large, 
complex organization with tens of thousands of people in 10 service 
center campuses, three computing centers, and numerous other field 
offices throughout the United States. In each of fiscal years 2003 and 
2002, IRS collected about $2 trillion in tax payments, processed 
hundreds of millions of tax and information returns, and paid about 
$300 billion and $281 billion, respectively, in refunds to taxpayers.

One of the largest obstacles facing IRS management today continues to 
be the agency's lack of a financial management system capable of 
producing the reliable and timely information IRS managers need to 
assist in making day-to-day decisions. IRS continued to face many of 
the pervasive internal control weaknesses that we have reported each 
year since we began auditing its financial statements in fiscal year 
1992,[Footnote 2] though it also continued to make significant strides 
in addressing its financial management challenges. In fiscal year 2003, 
for the fourth consecutive year, IRS was able to produce financial 
statements covering its tax custodial and administrative activities 
that are fairly stated in all material respects. Moreover, for the 
second consecutive year, IRS was able to 
produce its financial statements only a month and a half after the end 
of the fiscal year.[Footnote 3]

IRS's success in meeting its accelerated reporting date for the second 
consecutive year was a major accomplishment and represents continued 
improvement over previous years. Nevertheless, many of IRS's 
longstanding systems and internal control weaknesses continued to 
exist, necessitating continued reliance on costly compensating 
processes, statistical projections, external contractors, substantial 
adjustments, and monumental human efforts to prepare a set of reliable 
financial statements. These costly efforts would not have been 
necessary if IRS's systems and controls had operated effectively. Until 
the underlying systemic problems that give rise to this condition are 
resolved, IRS will need to continue making refinements in the way it 
processes transactions, maintains its records, and reports financial 
information.

Strong commitment, hard work, and a continued reassessment of certain 
basic business processes by both IRS senior leadership and staff were 
the key to IRS's success in obtaining an unqualified audit opinion on 
its fiscal year 2003 financial statements. IRS continued to make 
notable progress in a number of areas, particularly with respect to its 
administrative accounting operations. For example, IRS implemented 
procedures to improve the accuracy and reliability of its property and 
equipment (P&E) inventory records, and implemented an inventory record 
system that captured information essential to ensure that software and 
software licenses were properly controlled and used in accordance with 
license agreements. These improvements, combined with improvements made 
in prior years, allowed us to conclude that the remaining issues 
related to P&E no longer constitute a material internal control 
weakness. Also, IRS significantly enhanced its accountability over 
budgetary activity by instituting more timely recording of obligations 
in its accounting system 
and by implementing procedures to address delays in posting 
expenditures in its accounting system. IRS's actions enabled us to 
conclude that issues related to controls over budgetary activity no 
longer constitute a reportable condition. However, despite these 
improvements, we continue to consider issues related to controls over 
financial reporting, management of unpaid assessments, collection of 
revenue and issuance of tax refunds, and computer security to be 
material weaknesses.[Footnote 4]

Producing financial statements within a month and a half after the end 
of the fiscal year while sustaining an unqualified opinion for the 
second year in a row was a significant accomplishment for IRS. At the 
same time, the effort it took continued to place a considerable strain 
on IRS resources and required substantial contractor support. IRS has 
clearly made progress in improving its financial management, and the 
process changes IRS has instituted in the last 2 fiscal years represent 
good financial management practices. Nevertheless, IRS personnel will 
continue to be challenged to sustain the level of effort needed to 
produce reliable financial statements timely until IRS successfully 
addresses the underlying systems and internal control problems that 
cause this process to be time consuming and difficult. Additionally, 
this process does not produce the reliable, useful, and timely 
financial and performance information IRS needs for decision making on 
an ongoing basis, which is a goal of the CFO Act, nor can it fully 
address the underlying financial management and operational issues that 
adversely affect IRS's ability to effectively fulfill its 
responsibilities as the nation's tax collector.

IRS is currently installing a new financial management system intended 
to resolve many of the issues discussed in this report. However, IRS 
has encountered problems that have led to delays in the implementation 
of key elements of its new financial management system. For example, 
IRS had planned to begin implementation of the first release of the 
Integrated Financial System (IFS), its new core accounting system, in 
October 2003, but testing delays during pre-implementation caused IRS 
to defer implementation until the middle of fiscal year 2004. IRS also 
encountered delays in the implementation of the first phase of the 
Customer Account Data Engine (CADE), the new system being designed to 
modernize IRS's taxpayer master files, which caused IRS to defer 
implementation of CADE for about 1 year. Once fully implemented, CADE 
is to provide tax information to IFS for reporting purposes through the 
Custodial Accounting Project (CAP). CAP is a system designed to support 
management needs for information related to tax operations for purposes 
of day-to-day decision making, performance management, and reporting. 
CAP, which has also experienced some delays due to unanticipated data 
volume and data quality problems, is to be integrated with IFS and is 
being designed to support financial management of revenue transactions, 
including reporting of individual receipt and refund activity. IRS does 
not expect that its new financial management systems will be fully 
implemented until at least 2007.

Opinion on IRS's Financial Statements:

IRS's financial statements, including the accompanying notes, present 
fairly, in all material respects, in conformity with U.S. generally 
accepted accounting principles, IRS's assets, liabilities, net 
position, net costs, changes in net position, budgetary resources, 
reconciliation of net costs to budgetary activity, and custodial 
activity as of and for the fiscal years ended September 30, 2003, and 
September 30, 2002.

However, misstatements may nevertheless occur in other financial 
information reported by IRS as a result of the internal control 
weaknesses described in this report.

IRS's financial statements include tax revenues collected during the 
fiscal year as well as the total unpaid taxes for which IRS, the 
taxpayer, or courts agree on the amounts owed. Cumulative unpaid tax 
assessments for which there is no future collection potential or for 
which there is no agreement on the amounts owed are not reported in the 
financial statements. Rather, they are reported as write-offs and 
compliance assessments, respectively, in supplemental information to 
IRS's financial statements. Also, in accordance with U.S. generally 
accepted accounting principles, to the extent that taxes owed in 
accordance with the nation's tax laws are not reported by taxpayers and 
are not identified through IRS's various enforcement programs, they are 
not reported in the financial statements nor in supplemental 
information to the financial statements.

Opinion on Internal Controls:

Because of the material weaknesses in internal controls discussed 
below, IRS did not maintain effective internal controls over financial 
reporting (including safeguarding of assets) or compliance with laws 
and regulations, and thus did not provide reasonable assurance that 
losses, misstatements, and noncompliance with laws material in relation 
to the financial statements would be prevented or detected on a timely 
basis. Our opinion is based on criteria established under 31 U.S.C. § 
3512 (c), (d), commonly referred to as the Federal Managers' Financial 
Integrity Act of 1982 (FIA), and the Office of Management and Budget 
(OMB) Circular A-123, revised June 21, 1995, Management Accountability 
and Control.

Despite its material weaknesses in internal controls and its system 
deficiencies, IRS was able to prepare, primarily through compensating 
processes and approaches, financial statements that were fairly stated 
in all material respects for fiscal years 2003 and 2002. Nonetheless, 
IRS continues to face the following key issues that represent material 
weaknesses in internal controls:

* weaknesses in controls over the financial reporting process, 
resulting in IRS not (1) being able to prepare reliable financial 
statements without extensive compensating procedures and (2) having 
current and reliable ongoing information to support management decision 
making and to prepare cost-based performance measures;

* weaknesses in controls over unpaid tax assessments, resulting in 
IRS's inability to properly manage unpaid assessments and leading to 
increased taxpayer burden;

* weaknesses in controls over the identification and collection of tax 
revenues due the federal government and over the issuance of tax 
refunds, resulting in lost revenue to the federal government and 
potentially billions of dollars in improper payments; and:

* weaknesses in computer security controls, resulting in increased risk 
of unauthorized individuals being allowed to access, alter, or abuse 
proprietary IRS programs and electronic data and taxpayer information.

The material weaknesses in internal controls noted above may adversely 
affect any decision by IRS's management that is based, in whole or in 
part, on information that is inaccurate because of these weaknesses. In 
addition, unaudited financial information reported by IRS, including 
performance information, may also contain misstatements resulting from 
these weaknesses.

In addition to the material weaknesses discussed above, we identified 
two reportable conditions which, although not material weaknesses, 
represent significant deficiencies in the design or operation of 
internal controls that could adversely affect IRS's ability to meet the 
internal control objectives described in this report. These conditions 
concern deficiencies in (1) controls over hard-copy tax receipts and 
taxpayer data, which increase the government's and taxpayers' risk of 
loss or inappropriate disclosure of taxpayer data, and (2) controls 
over P&E, which hamper IRS's ability to have reliable and timely 
information on its balance of P&E throughout the year. We reported 
controls over P&E as a material weakness in our prior audits, but based 
on improvements we found during our fiscal year 2003 audit, we have 
reassessed it as a reportable condition. Similarly, we previously 
reported controls over budgetary activity as a reportable condition, 
but based on improvements we found during our fiscal year 2003 audit, 
we no longer consider the remaining issues related to controls over the 
recording of certain budgetary activity to constitute a reportable 
condition.

We have reported on these material weaknesses and reportable conditions 
in prior audits and have provided IRS recommendations to address these 
issues. Nearly 80 of these recommendations were still open as of the 
date of this report. IRS has made marked strides in resolving these 
matters. We will follow up in future audits to monitor IRS's progress 
in implementing these recommendations. For more details on these 
issues, see appendix I.

Compliance with Laws and Regulations and FFMIA Requirements:

Our tests of compliance with selected provisions of laws and 
regulations disclosed two areas of noncompliance that are reportable 
under U.S. generally accepted government auditing standards and OMB 
guidance. These relate to the release of federal tax liens against 
taxpayers' property and the structure of installment agreements IRS 
enters into with taxpayers to satisfy their outstanding tax 
liabilities.

Except as noted above, our tests for compliance with laws and 
regulations disclosed no other instances of noncompliance that would be 
reportable under U.S. generally accepted government auditing standards 
or OMB audit guidance. However, the objective of our audit was not to 
provide an opinion on overall compliance with laws and regulations. 
Accordingly, we do not express such an opinion.

We also found that IRS's financial management systems did not 
substantially comply with the requirements of the Federal Financial 
Management Improvement Act of 1996 (FFMIA).[Footnote 5] In addition, 
another matter came to our attention, involving some IRS contributions 
to the Thrift Savings Plan that exceed statutory requirements due to an 
automated system-related problem at the National Finance Center.

For more details on these issues, see appendix I.

Consistency of Other Information:

IRS's Management Discussion and Analysis, required supplemental 
information, and other accompanying information contain a wide range of 
data, some of which are not directly related to the financial 
statements. We did not audit and do not express an opinion on this 
information. However, we compared this information for consistency with 
the financial statements and discussed the methods of measurement and 
presentation with IRS officials. Based on this limited work, we found 
no material inconsistencies with the financial statements or 
nonconformance with OMB guidance. Under OMB guidance for the financial 
statements of federal agencies, agencies are asked to strive to develop 
and report objective measures that, to the extent possible, provide 
information about the cost-effectiveness of their programs. We found, 
however, that because of the noted internal control and systems 
limitations, IRS cannot report reliable cost-based performance measures 
relating to its various programs consistent with the Government 
Performance and Results Act of 1993.

Objectives, Scope, and Methodology:

Management is responsible for (1) preparing the annual financial 
statements in conformity with U.S. generally accepted accounting 
principles, (2) establishing, maintaining, and assessing internal 
control to provide reasonable assurance that the broad control 
objectives of 31 U.S.C. § 3512 (c), (d) (FIA) are met, (3) ensuring 
that IRS's financial management systems substantially comply with the 
requirements of FFMIA, and (4) complying with applicable laws and 
regulations.

We are responsible for obtaining reasonable assurance about whether (1) 
the financial statements are presented fairly, in all material 
respects, in conformity with U.S. generally accepted accounting 
principles and (2) management maintained effective internal controls, 
the objectives of which are the following:

* Financial reporting--transactions are properly recorded, processed, 
and summarized to permit the preparation of financial statements in 
conformity with U.S. generally accepted accounting principles and 
assets are safeguarded against loss from unauthorized acquisition, use, 
and disposition.

* Compliance with laws and regulations--transactions are executed in 
accordance with laws governing the use of budget authority and with 
other laws and regulations that could have a direct and material effect 
on the financial statements and any other laws, regulations, and 
governmentwide policies identified by OMB audit guidance.

We are also responsible for (1) testing whether IRS's financial 
management systems substantially comply with the three FFMIA 
requirements, (2) testing compliance with selected provisions of laws 
and regulations that have a direct and material effect on the financial 
statements and laws for which OMB audit guidance requires testing, and 
(3) performing limited procedures with respect to certain other 
information appearing in these annual financial statements. For more 
details on our methodology and the laws and regulations we tested, see 
appendix II.

We did not evaluate all internal controls relevant to operating 
objectives as broadly defined by FIA, such as controls relevant to 
preparing statistical reports and ensuring efficient operations. We 
limited our internal control testing to testing controls over financial 
reporting and compliance with laws and regulations.

We did not test compliance with all laws and regulations applicable to 
IRS. We limited our tests of compliance to those laws and regulations 
that had a direct and material effect on the financial statements or 
that were required to be tested by OMB audit guidance that we deemed 
applicable to the financial statements for the fiscal years ended 
September 30, 2003, and September 30, 2002. We caution that 
noncompliance may occur and not be detected by these tests and that 
such testing may not be sufficient for other purposes.

We performed our work in accordance with U.S. generally accepted 
government auditing standards and OMB audit guidance.

Agency Comments and Our Evaluation:

In responding to this report, IRS noted that the report fairly 
presented IRS's progress and its remaining challenges. IRS noted that 
it had, for the fourth consecutive year, achieved an unqualified audit 
opinion on its financial statements and, for the second consecutive 
year, achieved this under a significantly accelerated reporting 
timetable, issuing the audited financial statements 6 weeks after the 
end of the fiscal year. Additionally, IRS cited a number of financial 
management reforms and improvements during the fiscal year. For 
example, IRS noted that it had implemented improved interim reporting 
processes, implemented a software inventory system to improve 
accountability over software licenses, improved controls to ensure 
better accountability over P&E, implemented a process for developing 
interim accruals for certain specific administrative expenses such as 
rent, and strengthened its oversight of obligating practices. IRS noted 
that these improvements enabled the agency to make progress in 
resolving material weaknesses identified under its annual FIA 
assessment process, including accountability over P&E, 
telecommunications, and administrative financial reporting.

In its response, IRS recognized that it is only through its 
implementation of its new integrated financial management systems that 
it will be able to overcome the majority of the material weaknesses 
cited in the report. IRS noted that, as it continues to work to 
implement its new systems, it will also continue efforts to improve its 
business practices in support of these systems, including implementing 
the core accounting functionality of IFS, streamlining and improving 
business processes for travel, purchase card, and obligations and 
commitments reviews, and implementing policies to more effectively 
collect and report costs associated with trust fund activities. IRS 
noted that the agency was committed to continuous improvement in 
financial management, and that it would continue the 
improvements made in the last few years as it develops and implements 
the fundamental long-term solutions needed to address the internal 
control weaknesses cited in the report.

The complete text of IRS's response is included in appendix III.

Signed by:

David M. Walker: 
Comptroller General of the United States:

October 31, 2003:

Management Discussion and Analysis:

INTERNAL REVENUE SERVICE: 

Management Discussion and Analysis For The Fiscal Year Ended
September 30, 2003:


I. Introduction: 

The first Commissioner of Internal Revenue, George 
Boutwell, made an astute observation of the 1862 revenue law, which 
President Lincoln signed to establish our first income tax. He wrote, 
"It was a remarkable exhibition of legislative wisdom under the 
circumstances, but it was incomplete in part rather than imperfect in 
plan." Even today, that summarizes our progressive system of taxation. 
Certainly, there have been vigorous and difficult debates about 
taxation and tariffs that go back to the creation of the republic. They 
continue to this day at kitchen tables across America and in the halls 
of Congress. But once the dust settles and the law is written, it falls 
to the Internal Revenue Service to fairly and impartially administer 
that law; no matter how complex or controversial it may be.:

Over the last 50 years, the volume and complexity of IRS operations has 
expanded tremendously. Since 1952, the number of returns filed has more 
than doubled, and the number of pages in the tax code has expanded from 
812 to approximately 3,500. The rate of change in the tax 
administration system and in the economy is remarkable. We continue to 
deal directly with more Americans than any other institution, private 
or public.

The IRS has made steady gains in better serving America's taxpayers. 
For the Tax Year (TY) 2002 filing season, the Service processed over 
128.7 million individual returns, and issued over 99.5 million refunds 
totaling $191.2 billion. Web site usage for the same period smashed all 
records with 2.7 billion hits and 336 million files downloaded. IRS 
representatives also answered 25.9 million telephone calls during TY 
2002; the automated telephone system handled about 62.4 million calls. 
The big news is assistor level of service. It is up 20 percent over 
last year. This can be attributed to the implementation of new 
telephone lines, less complicated scripts and lower demand. Time spent 
waiting improved substantially. Average wait time is down 26% from the 
previous year. For TY 2002, more than 46.7 million taxpayers (36 
percent) filed electronically - a 16.4% rise from last year. Much of 
this surge can be attributed to the Free File program that will help 
the IRS to reach the Restructuring & Reform Act of 1998 RRA 98) 
mandated goal of 80% of individual returns filed electronically by 
2007.:

The credibility of the Service's internal financial condition has again 
been validated by the:

* "unqualified" audit opinion from the General Accounting Office's 
(GAO) recently completed audit of our 2002-03 financial statements. 
This is the sixth consecutive year that the IRS has produced combined 
financial statements and the third consecutive year they have been 
issued by November 15th. Taxpayers can be confident that the IRS is 
held to formal accounting standards and is audited in a manner similar 
to those performed in the private sector.:

Mission:

It is a new era for the IRS. The IRS Restructuring and Reform Act of 
1998 (RRA 98) gave us a clear mandate - do a better job in meeting the 
needs of taxpayers and in collecting the taxes. Our mission statement 
expresses that sentiment: Provide America's taxpayers top-quality 
service by helping them understand and meet their tax responsibilities 
and by applying the tax law with integrity and fairness to all.:

This mission statement describes our role, as well as the public's 
expectation regarding how we should perform that role. In the United 
States, the Congress passes tax laws and requires taxpayers to comply 
with them. The taxpayers' role is to understand and meet their tax 
obligations and the majority does, since roughly 98% of the taxes 
collected are paid without active intervention by the IRS. Our role is 
to help the taxpayers who are willing to comply with the tax law, while 
assuring that the minority who are unwilling to voluntarily comply will 
not burden their fellow taxpayers. We recognize that we must meet the 
highest standards in performing this role. All of our services should 
be viewed by the people who receive them as comparable to the best 
service they receive elsewhere. Although we recently marked the fifth 
anniversary of RRA 98, the IRS has not realized all of the benefits of 
this landmark legislation. To fully realize its benefits, the Agency 
must continue its focus on three key areas: (1) The reorganization 
already underway to improve customer service, (2) the information 
technology modernization program, and (3) strengthening the integrity 
of our Nation's tax system through enhanced enforcement activities. To 
this end, we will continue to pursue:

* Top-quality Service to Each Taxpayer in Every Transaction:

* Top-quality Service to All Taxpayers through Fair and Uniform 
Application of the Tax Law:

* Productivity through a Quality Work Environment:

As progress continues to be made on these three fronts, we move closer 
toward achieving our mission and meeting the public's expectations. We 
have developed specific objectives that represent what we are striving 
to achieve and how we will judge our success, both qualitatively and 
quantitatively.:

We succeed only if we achieve a high level of performance on all three 
fronts. We cannot be successful if we collect taxes but do not provide 
top-quality service to each taxpayer or neglect taxpayer rights. 
Equally, we cannot be successful if we provide good service but allow 
compliance to decline and, thereby, fail to collect taxes. Finally, we 
can only achieve these service goals by increasing productivity and 
effectively utilizing the skills of our workforce. Since resources are 
limited, we must use them wisely to productively accomplish our 
mission.:

Organization:

In conformance with the provisions of RRA 98, we designed and made 
substantial progress in implementing a new modernized organizational 
structure. It closely resembles the private sector model of organizing 
around customers with similar needs. The IRS created four customer-
focused operating divisions (ODs) to best serve taxpayers: Wage and 
Investment; Small Business and Self-Employed; Large and Mid-Sized 
Business; and Tax Exempt and Government Entities. There are also a 
number of functional units, including Appeals, the Taxpayer Advocate 
Service, Chief Financial Office, Criminal Investigation, Equal 
Employment Opportunity and Diversity, and Communications and Liaison. 
In addition, Chief Counsel established a senior attorney as the 
Division Counsel for each of the operating divisions.:

Internally, the Modernization and Information Technology Services 
organization and the Agency-Wide Shared Services units provide 
information technology and administrative support, respectively, to all 
divisions.:

The modernized organization focuses on providing services to each set 
of taxpayers in three key program areas: pre-filing, filing and post-
filing. To succeed individually and collectively, all programs and 
organizational units must deliver top-quality services to taxpayers 
through these programs.:

In concert with the provisions of RRA 98, Commissioner Everson, in his 
first message to all employees of the Internal Revenue Service upon 
taking his oath of office, emphasized the need to continue the 
reorganization of the IRS in order to continue to improve customer 
service and increase enforcement. As part of this endeavor, he created 
two new Deputy Commissioner positions. Each Deputy focuses on the needs 
of his respective functions and ultimately their customers. The four 
primary operating divisions and Criminal Investigation report to the 
Deputy Commissioner for Services and Enforcement. The Deputy 
Commissioner for Operations and Support supervises the Chief Financial 
Officer, the Chief Information Officer, the Chief, Mission Assurance, 
the Chief Human Capital Officer and the Chief, Agency-Wide Services.:

IRS Organization Chart:

[See PDF for image]

[End of figure]

The following functional units report directly to the IRS Commissioner: 
National Headquarters (NHQ) includes the Office of the Commissioner, 
Deputy Commissioners, Chief Counsel, Chief Appeals, National Taxpayer 
Advocate, Counselor to the Commissioner, Chief, EEO and Diversity, 
Director, Research & Analysis and Chief, Communications and Liaison. 
Other functions include the Competitive Sourcing Program, Office of Tax 
Administration Coordination, and the Commissioner's Complaint 
Processing and Analysis Group. This organizational unit sets policies 
and goals, provides leadership and direction for the Internal Revenue 
Service, provides Servicewide policy guidance for conducting analysis 
of programs and investments to support strategic decision-making 
required to fulfill the IRS' mission in administering the nation's tax 
laws. The customer base for National Headquarters includes all 
employees, all executives and managers, taxpayers, oversight and 
regulating groups, and Congress and other Government agencies.:

The Chief Counsel's principal customer base consists of the IRS 
Commissioner, the Operating Divisions, and the functional units of the 
IRS, as well as the General Counsel and Tax Legislative Counsel at 
Treasury. Chief Counsel provides impartial interpretation of the 
internal revenue laws and legal advice and representation for the IRS. 
The Chief Counsel has established a senior legal executive as the 
Division Counsel for each operating division to participate fully in 
the plans and activities of the operating division's management and to 
provide legal advice and representation.:

The Appeals organization resolves tax controversies without litigation 
on a basis that is fair and impartial to both the Government and the 
taxpayer. Appeals provides an independent channel for taxpayers who 
have a dispute over a recommended enforcement action.:

The Taxpayer Advocate Service (TAS) exists to help taxpayers resolve 
problems that have not been resolved through normal IRS channels. TAS 
is an independent program headed by the National Taxpayer Advocate. 
Each state and IRS Service Center has at least one local Taxpayer 
Advocate who is independent of the local IRS office and reports 
directly to the National Taxpayer Advocate. Operating Division Taxpayer 
Advocates work directly with operating divisions to identify and 
recommend solutions to systemic problems.

Communication and Liaison (C&L) is a functional business unit which 
partners with the operating and functional divisions to support IRS 
business objectives and communications goals and ensures cross-
divisional coordination. It also partners with their external customers 
to ensure that two-way communications exist between IRS, its employees 
and various stakeholder groups. C&L manages relationships with the 
media, Congress, state and local governments, and other external 
stakeholders.

The following operational/functional units report to the Deputy 
Commissioner for Services and Enforcement:

The Wage and Investment Division (W&I) serves individual and joint 
filers with wage and investment income only, almost all of which is 
reported by third parties. Most of these taxpayers deal with the IRS 
only once a year, when filing their returns, and most receive refunds. 
Compliance issues are limited, concentrated on dependent exemptions, 
credits, filing status, and deductions.

Through its field organization, W&I provides information, support and 
assistance to taxpayers in fulfilling their tax obligations. It also 
conducts processing, account management, and compliance services 
through seven campus locations.

The Small Business and Self-Employed Division (SB/SE) serves fully or 
partially selfemployed individuals and small businesses. Since business 
income and a range of taxes are involved, compliance issues can be 
complex. The possibility for errors in collection and compliance are 
greatest in this group and consequently, this group has considerably 
more frequent dealings with IRS compliance functions. SB/SE has a 
compliance field organization that includes both examination and 
collection. Processing, account management, compliance services, and 
education and outreach are provided at two campuses.

The Large and Mid-Size Business Division (LMSB) serves corporations 
with assets of more than $10 million. While collection issues are rare, 
many complex issues such as tax law interpretation, accounting, and 
regulation, many with international dimensions, frequently arise. LMSB 
is predominantly a field organization that is structured into five 
industry groups: Communications, Technology and Media; Financial 
Services; Heavy Manufacturing and Transportation; Natural Resources and 
Construction; and Retailers, Food, Pharmaceuticals and Healthcare.

The Tax Exempt and Government Entities Division (TE/GE) serves a wide 
range of customers including small local community organizations, 
municipalities, major universities, pension funds, state governments, 
Indian tribal governments and tax exempt bond issuers. TEGE is charged 
with administering detailed and complex provisions of law. Its efforts 
are generally not intended to raise money, but rather to ensure that 
these entities stay within the policy guidelines that enable them to 
maintain their tax-exempt status.

The Criminal Investigation (CI) unit enforces the criminal provisions 
of the Internal Revenue Code. CI operates through a structure of 35 
field offices under the supervision of Special Agents in Charge (SACs). 
The SACs report to Headquarters through six Directors of Field 
Operations located in key cities across the country. CI supports the 
strategies of the four operating divisions to enhance tax 
administration and foster voluntary compliance.

The Office of Professional Responsibility fosters excellence in tax 
professional services to taxpayers by setting, communicating, and 
enforcing standards of competence, integrity, and conduct.

The following functional units report to the Deputy Commissioner for 
Operations Support: The Modernization, Information Technology and 
Security Services (MITS) organization provides leadership in the 
delivery of information technology solutions that anticipate and meet 
enterprise-wide needs by empowering employees to deliver customer-
centered, value-creating systems, products, services, and support. MITS 
is the principal source of advice to the Deputy Commissioner for 
Operations Support on strategic technology planning, data 
administration, technology standards and privacy assurance, and 
telecommunications.

The Agency-Wide Shared Services (AWSS) organization provides the 
expertise and advice necessary to deliver shared services throughout 
the IRS. These services include: space management and acquisition, 
acquisition planning services, labor relations, employee resource 
center and various other aspects of personnel including pre-complaint 
processing & prevention, and alternative dispute resolution.

The Human Capital organization ensures that the IRS workforce is up to 
the challenges of the 21st Century by attracting, motivating, and 
retaining the best possible workers to do the best job possible.

The Chief Financial Officer organization is responsible for the 
acquisition, planning, control and management of all Service financial 
resources, including administrative and revenue accounting. 
Organizational effectiveness is also part of the Chief Financial 
Officer organization.

The Mission Assurance organization is responsible for the continuity of 
tax administration and the safety of IRS personnel in case of any 
emergency.

II. Performance Goals and Results:

The IRS uses performance measures to determine its effectiveness in 
meeting the three IRS strategic goals. The FY 2003 performance 
information that follows is organized by the main objectives within 
each strategic goal.

Strategic Goal 1: Top-quality service to each taxpayer in every 
interaction:

Main Objectives:

* Make filing easier:

* Provide top-quality service to taxpayers needing help with their 
returns or accounts:

* Provide prompt, professional, helpful treatment to taxpayers in cases 
where additional taxes may be due:

Whenever the IRS deals with a taxpayer, we strive to provide prompt 
service. The measure of:

* our success in this goal is whether taxpayers believe we are meeting 
their expectations and how well we help them understand and meet their 
tax obligations.

Major Results and Accomplishments:

Make Filing Easier:

a. Results Summary:

* The economic downturn caused the number of individual tax returns 
filed for calendar year 2003 to drop from prior year levels. This is 
only the third time in the past 30 years that the number of individual 
tax returns dropped in consecutive years. As of August 31, 2003, total 
tax return receipts exceeded 130 million, which is comparable to the 
receipts last year at this time.

* The Electronic Tax Administration (ETA) employed various marketing 
strategies, including the Free File initiative, to target taxpayer and 
preparer segments in an effort to increase the number of electronically 
filed returns. The results of these initiatives are impressive.

More than 400 million information returns were filed electronically.

Receipts of electronically filed (e-filed) returns for the current year 
increased by 12.8% compared to levels received over the same period 
last year. The IRS received nearly 53 million individual (e-filed) 
returns through the end of August 2003.

Receipts of paper 1040 returns for the current year decreased 7.9% 
compared to levels received over the same period last year.

As of September 30, 2003, over 2.79 million e-filed returns were 
received through Free File Alliance members. This figure represents 23% 
of all online returns and 5% of all e-file returns received by the IRS.

On-line filing increased 27% over last year's levels, from 9.4 million 
in 2002 to 11.9 million this year.

Through September 2003, over 5.4 million business returns were filed 
electronically. This represents an increase of 1.3 million for the same 
period last year.

E-filed individual returns with Schedules C, E, F and Form 2106 
increased 1.9 million over the same period last year.

b. Improved Electronic Payment/Filing Options:

* Electronic payments increased by 1.4 million with more than 270,000 
new Electronic Federal Tax Payment System (EFTPS) enrollments.

* Through September 30, 2003, over 66 million Federal Tax:

Deposit payments were received electronically.

* Launched Extensible Markup Language (XML) version of Employment Tax 
e-file.

* Electronic Return Originators (ERO) now have the ability to offer 
employment tax filing for their clients.

* Credit card and debit card options were expanded to include the 
payment of delinquent taxes (individual), installment agreements, and 
extensions.

c. E-Submissions Marketing:

* Launched an e-file advertising campaign including electronic and 
print media. E-file materials were sent to over 30,000 tax 
professionals.

* Tax Specialists contacted the top 20% of tax practitioners (15,446) 
with high volume paper filing to promote e-filing.

d. Pre-Filing Services:

* Created a Media and Publications (M&P) to provide enhanced customer 
service to internal and external customers.

* Coordinated with the Armed Forces Tax Council and individual armed 
service branches to deliver timely information regarding the impact of 
the Earned Income Tax Credit (EITC) law change on military personnel 
and their families. Approximately 400,000 additional enlisted military 
personnel became potentially eligible for claiming EITC.:

* Developed several databases to tailor education and outreach programs 
by identifying specific taxpayer issues, targeting local communities 
for outreach, and measuring program impact at the local level. These 
databases include Tax Years 2000 and 2001 tax return information and 
Tax Years 2001 and 2002 EITC claimant data, including math error 
information. All of these databases drill down to the zip code level.

* Used the U.S. Census data for 1990 - 2000 and the Limited English 
Proficient Study to identify issues, markets, and potential outreach 
areas for increased EITC penetration.

* Publication 15-T, Public Law 108-27, "Jobs Growth Tax Relief 
Reconciliation Act of 2003", which contains reduced Federal tax 
withholding rates, was signed into law on May 28, 2003. Notice 1036, 
"Early Release Copies of New Income Tax Withholding Tables" and 
Publication 15-T were disseminated on May 28th and June 7th, 2003 
respectively, which coincided with the signing of the bill into law.

* Through July 2003, assisted approximately 56.9 million taxpayers with 
filing for the Earned Income Tax Credit (EITC).

* More than 35 million taxpayers received assistance through non-media 
outreach activities (e.g. tax workshops, seminars, assistance centers). 
The number of taxpayers receiving assistance increases to over 140 
million when including media outreach (e.g. newspaper, television, 
etc.).

e. Burden Reduction:

* A "zero-based' accounting approach to forms redesign has been adopted 
and now every line of a form is reviewed to determine its utility. Form 
941 is undergoing a line-by-line analysis to delete unnecessary lines. 
The Form K-1 vision draft and instructions have been revised to become 
more taxpayer-friendly. These revisions also reduced data entry 
keystrokes, resulting in fewer clerical errors and positioning the 
organization for future bar coding.

* The Industry Issue Resolution Program proposal on the "Substantiation 
of the Amount of Expenses for Meals Furnished by Child Care Providers" 
was approved. Family day care providers may now elect to use a 
standardized rate to claim the deductions for meals provided to 
children instead of keeping detailed records and receipts of food 
purchased for use in their business. This change will save day care 
providers approximately 10 million hours a year.

* Media and Publication's Area Distribution Centers netted a 15% 
savings as a result of partnering efforts between Flat Mail Vendors and 
the United States Postal Service that streamlined processing. To date, 
flat mail vendors processed a total of 4.3 million mail pieces for a 
total savings over first class postage of $1.4 million.:

Provide top-quality service to taxpayers needing help with their 
returns or accounts:

a. Results Summary:

* Toll free customer satisfaction was 95 percent.

* The toll free Customer Service Representative (CSR) Level of Service 
(LOS) at 80% has exceeded plan by 8%. Reduced customer wait times and 
handle times contributed to the increased LOS.

* Practitioner Priority Services (PPS) CSR LOS (at 86%) also exceeded 
the fiscal plan through July 2003. Enhanced call routing to the next 
available agent, versus geographic routing, contributed to this 
improved LOS. PPS decreased the wait time to speak to a representative 
by over 150 seconds per call, directly addressing a concern identified 
through recent customer satisfaction surveys.

* Through September 2003, EIN (Employer Identification Number) LOS had 
improved 23 percentage points from the same period last year.

* The cumulative "refund timeliness rate" through June 2003 was 98.8%. 
A proactive approach to inventory management resulted in improvement 
over the previous fiscal year's performance.

* The advanced payment of the child tax credit was successfully 
implemented, which required the issuance of Advance Child Tax Credit 
(ACTC) payments and associated notices to more than 26 million 
taxpayers who claimed the Child Tax Credit on their 2002 income tax 
return. Taxpayers were also provided with easy access on the status of 
their checks through the Internet or by calling the IRS directly.

* Enhanced functionality of IRS Web Site:

As of July 27, 2003, IRS websites had 4.36 billion accesses and 560 
million downloads, which was higher than FY 2002 levels by 40% and 28%, 
respectively.

Through July 26, 2003, 16.8 million taxpayers accessed the new "Where's 
My Refund?" application on the IRS web site. Seventy percent, or 11.8 
million of these taxpayers, successfully completed and received refund 
information.

The new Internet Refund or "Where's My Advance Child Tax Credit 
(ACTC)", on the IRS web site was accessed 3.4 million times with 2.9 
million successful completions for an 84% success rate.

In April 2003, Phase I of the Internet-EIN project (a web based front-
end application process) was implemented.

b. Improvements in Telephone Service:

* More callers got to properly-trained CSRs quicker, as evidenced by 
lower transfer rates, lower Average Speed of Answer (ASA), and lower 
abandon rates. Customers waiting less time to speak to assistors 
resulted in fewer repeat calls, lower total call attempts, and reduced 
demand. as evidenced by unique caller demand decreasing from 53.8 
million for FY 2002 to 50.8 million for 2003.

* Access to toll-free telephone lines in FY 2003 improved over FY 2002 
levels. As of September 30, 2003, the CSRs LOS was 80%, an 18-
percentage point increase over the same period last year. On average, 
taxpayers waited 100 seconds less to speak to an assistor this fiscal 
year as compared to last year. 10:

* Through September 30, 2003, telephone assistors answered nearly 33 
million calls on the Customer Account Services (CAS) toll-free product 
lines.

* Through September 2003, taxpayers made over 6 million call attempts 
on the new Advance Child Tax Credit (ACTC) product line 800-829-0105.

* The "IRS Toll-Free Vision and Marketing Strategy" implemented six new 
dialed numbers designed to improve customer experience and ensure 
callers are directed to the appropriate resource through the use of 
scripts tailored to each dialed number. Each of the new numbers is 
designed for use by a specific segment of callers. These changes are 
part of a new toll-free strategy to improve customer service by 
targeting customer segments and creating more accountability.

* IRS implemented Customer Contact Center Optimization (CCCO), designed 
to support increased site specialization and ensure callers reach an 
assistor with the appropriate skill to assist them. This process 
enhances customer service by readily responding to changing conditions 
in telephone workload as well as improve quality and productivity.

* The "Screener Strategy," which sends tax law calls to a live screener 
for issue identification and transfer to the appropriate application, 
was implemented on October 1, 2002. This replaced screening for Tax Law 
calls at the network level.

* In January 2003, SB/SE and W&I began offering separate division-
specific toll-free telephone lines, significantly reducing caller wait 
time for the SB/SE Business and Specialty Tax, BMF Customer Response 
and IMF Customer Response.

* SB/SE centralized EIN processing to three campus locations and 
implemented EIN tollfree telephone operations.

Provide prompt, professional, helpful treatment to taxpayers in cases 
where additional taxes may be due:

a. Results Summary:

* Through the end FY 2003, Field Collection, Field Examination and 
Service Center Exam customer satisfaction scores exceeded the fiscal 
year targets.

* Through September 2003, the Offer In Compromise (OIC) overage 
indicator (percent of OIC cases disposed of in 6 months or less) has 
improved by nearly 19 percentage points over the same period last year. 
In addition, over 56% of these cases were closed in under 6 months.

* Automated Underreporter implemented additional systems capacity and 
eliminated approximately one million busy and abandoned calls. Exam 
expanded telephone services to more than 500,000 taxpayers through cold 
call units and automated scripts.:

b. Enhanced Customer Service:

* Field and Office Reengineering implemented changes to improve pre-
audit planning, achieve a uniform, structured approach to audits, and 
enhance taxpayer communication.

* Compliance delivered over 740,000 training hours and implemented the 
"My Opinion Counts Council" in ACS, ACS Support, and CSCO.

* Compliance improved its responsiveness to taxpayer needs and timely 
processed 756,000 pre-assessed installment agreements, a 40% increase 
over FY 2002. The "Notice of Intent to Levy" was revised to clarify the 
actions required by taxpayers in order to avoid enforcement actions.

* Revisions were made to simplify and clarify Exam's first notice. 
Beginning January 1, 2003, on refund returns with Earned Income Tax 
Credit EITC, refunds are frozen only to extent of EITC credit, not the 
entire refund.

* Compliance implemented "Decision Installment Agreement" to improve 
quality and completeness of information provided to taxpayers related 
to installment agreements.

Balanced Measures:

A. Employee Plans and Exempt Organization (EP/EO) Determination 
Letters:

Description: Cases established and closed on the Tax Exempt/Government 
Entities Determination System. This measure is an indication of the 
volume of activity in Employee Plans and Exempt Organizations. 
Determinations are taxpayer-initiated requests for specific rulings or 
approvals with respect to an Employee Plan or Exempt Organization 
issue. This measure reports a consolidated total of Employee Plan 
Determination Letters combined with Exempt Organization Determination 
Letters.

FY 2003 Performance: The goal was missed because fewer receipts were 
received in IRS than expected, and were made up primarily of more 
complex cases (individually designed retirement plans) that take longer 
to process. 

EP/EO Determination Letters:

[See PDF for image]



[End of table]



Future Plans: IRS will continue to respond to inventory complexity 
challenges through the following improvement projects: roll out Agent 
Work Center/2002 to Examination agents; migrate the Returns Inventory & 
Classification System (RICS) to a DB2 Platform; redesign the EP/EO 
Determination Letter System; refine controls for Government Entity 
cases; provide access to Form 5500 pension plan returns filed with 
Department of Labor (DOL); and integrate stand-alone information 
systems into the modernized Agent Work center.

B. Total Published Guidance Items Published:

Description: Published Guidance consists of regulations and other 
guidance issued by the IRS and Treasury to interpret and explain the 
Internal Revenue Code. Published Guidance provides taxpayers with 
additional guidance and provides IRS agents guidance in resolving 
difficult technical questions. These items include Actions on 
Decisions; Notices/Announcements; Published Guidance Proposals and 
Studies; Technical Advice Memoranda; Regulations; Revenue Rulings; and 
Revenue Rulings published.

FY 2003 Performance: Counsel's emphasis on issuing Public Guidance over 
private guidance is achieving the desired effect as evidenced by a 36% 
performance increase over FY 2002. Counsel continues to work with IRS 
Operating Divisions and Treasury to identify and address emerging 
issues through published guidance. The number of qualified 
professionals working on Published Guidance increased significantly 
this year, allowing for the production of more published guidance and 
ensuring timely completion of Business Plan projects. 

Total Published Guidance Items Published:

[See PDF for image]

[End of table]

Future Plans: Internal resources will continue to be realigned to 
accommodate increased demand from the IRS and the public for Published 
Guidance in FY 2004. Counsel will continue to work with IRS Operating 
Divisions and Treasury to identify and address emerging issues through 
Published Guidance and integrate efforts directed to the Published 
Guidance program with the IRS Operating Divisions. The Published 
Guidance process will continue to be assessed to ensure efficiency, 
productivity and responsiveness to both clients and taxpayers.

C. Percent Individual Returns Filed Electronically:

Description: The number of electronically filed individual tax returns 
divided by the total number of individual returns filed. Includes all 
returns where electronic filing is permitted (Practitioner e-file, 
TeleFile, VITA [Volunteer Income Tax Assistance], On-line Filing, 
Federal/State returns, etc.):

FY 2003 Performance: The percentage comparison is a ratio of 
electronically filed returns to total filed returns. Since total 
volumes are lower for each category and since paper receipts are closer 
to initial plan than electronically filed returns have been, the 
percentage mathematically is lower than the initial plan.

Percent Individual Returns Filed Electronically:

[See PDF for image]



[End of table]



Future Plans: Electronic Tax Administration (ETA) has developed a 
number of recommendations for the Free File Alliance to consider for 
improving next year's release of the Free File Program. ETA is 
researching the availability of Free File products in Spanish and also 
reviewing opportunities to ensure Section 508 compliance issues 
(accessibility) are met. Targeted marketing programs designed to 
increase the percentage of IMF e-filed returns will continue in FY 
2004, and will include a tiered marketing campaign of direct outreach 
visits, phone calls, and direct mail.

d. Electronic Federal Tax Payments System:

Description: All individual and business tax type payments made 
directly through the Electronic Federal Tax Payment System through IRS 
e-file, directly through payroll service providers, or through credit 
card processors.

FY 2003 Performance: Electronic payments increased by over 1.2 million 
with more than 270,000 new enrollments. Through August 34% of all 
Federal Tax Deposit payments were received electronically. The XML 
version of Employment Tax e-file was launched enabling Electronic 
Return Originators to have the ability to offer employment tax filing 
for their clients. Credit card payment options are now extended to 
payment of delinquent taxes, including installment agreements. A 
nationwide virtual E-Submissions team was established, with 
representatives from IRS headquarters and the field to develop and 
implement a marketing strategy to increase electronic payments. This 
included marketing the benefits of the Electronic Federal Tax Payment 
System (EFTPS) during practitioner contacts. IRS also developed and 
implemented a nationwide marketing strategy toward financial 
institutions, which included cost effective methods to be used by these 
financial institutions in marketing EFTPS to their customers.

IRS partnered with banking associations at the local and national 
levels to educate their members on the benefits of EFTPS. Additional 
guidance on the benefits of EFTPS was provided to employees who have 
customer facing roles. These efforts have been successful, as payments 
have increased by over 1.2 million over FY 2002. 

Electronic Federal Tax Payments (000):

[See PDF for image]



[End of table]



Future Plans: Taxpayer Education and Communication (TEC) will continue 
to influence behavior through practitioner and financial institutions 
contacts throughout FY 2004. The IRS will increase its outreach to 
include marketing EFTPS to individuals filing estimated tax payments 
and continue outreach to practitioners through the nationwide tax 
forums.

E. Toll-Free Customer Satisfaction:

Description: Represents the customers' overall level of satisfaction 
with the services provided by the IRS Toll-Free program. Survey 
recipients are asked to rate IRS performance on a fivepoint scale, 
where a score of 1 or 2 indicates Dissatisfied and 4 or 5 indicates 
Satisfied. Although not affecting the statistical validity of the 
survey, the following are limitations of the survey: only customers 
calling one of the IRS toll-free telephone numbers are included in the 
sample; calls are selected based on a sampling pattern that includes 
variables for the hour of day, day of week, and time of year; and 
customers calling when IRS monitors are not available (Saturday, Sunday 
and some evening hours) are excluded from the survey.

FY 2003 Performance: Customer Satisfaction survey questions were 
enhanced and the survey scale was adjusted from a 4-point to a 5-point 
scale. Prior to FY 2003, satisfaction was defined as the percent of 
customers providing a rating of "4" and dissatisfaction was defined as 
the percent of customers rating a "1". Targets were set using these 
definitions. In FY 2003, with the change to the 5 point scale, the 
definition of satisfaction changed to the percent of 4's and 5's and 
targets were revised to reflect this change. Thus, what appears to be a 
big change in customer satisfaction is primarily a result of the scale 
change and the definition change.

Through July 2003, the toll-free Customer Service Representative Level 
of Service (LOS) at 84% combined with reduced customer wait times and 
handle times contributed to the increased level of customer 
satisfaction.

Toll-Free Customer Satisfaction Percentage Satisfied:

[See PDF for image]

Adjusted plan number for scale change: 93%:

[End of table]

:

Future Plans: The two areas for top-priority improvement efforts are 
the automated answering system and ease of getting through by phone. To 
increase accessibility to assistors, IRS is making changes in the 
routing of calls and scripting of telephone systems. IRS will implement 
recommendations from the Customer Contact Engineering Study group's 
plan to optimize the use of outward facing Toll-Free numbers by 
configuring these numbers to relate directly to taxpayers' inquiries.

F. Toll-Free Customer Service Representative (CSR) Level of Service:

Description: Reported as a percentage, the relative success rate of 
taxpayers calling for assistance and seeking services from a Customer 
Service Representative (CSR). Factors used to arrive at the level of 
service include: callers selecting an automated application; callers 
receiving a busy signal; or callers abandoning while in queue waiting 
for an assistor.

FY 2003 Performance: The increase in level of service is due to a 
variety of factors, including more callers getting to properly trained 
CSRs quicker. Callers waiting less time to speak to assistors resulted 
in fewer repeat callers, lower total call attempts, and reduced demand. 
Many of these improvements can be attributed to Workload Realignment 
and the Tax Law Screener Strategy initiatives focused on delivering the 
call to the appropriate agent group for response. In January 2003, SB/
SE and W&I began offering separate division-specific toll-free 
telephone lines, significantly reducing the menu size that callers 
encounter. These new phone lines included the SB/SE Business & 
Specialty, BMF, Customer Response and IMF Customer Response.

Toll-Free Customer Service Representative (CSR) Level of Service:



[See PDF for image]

[End of table]

Future Plans: The accuracy of the original screening of taxpayer-
initiated calls will be improved by more specific direction and 
training of assistors who staff the phones. In addition, by revising 
the routing structure, transfers to other applications based upon 
secondary issues will be reduced. Anticipated targets for FY 2004 and 
FY 2005 will remain constant at 83%. IRS will implement recommendations 
from the Customer Contact Center Optimization study, including a call 
router to build a pyramid of specialization that will enable routing 
each customer to an employee having the appropriate skill level to 
successfully address the customer's issue. Once implemented, IRS will 
utilize CSR call recording technology quality review, training and 
evaluation.

G. Toll-Free Tax Law Quality:

Description: The percentage of customers receiving accurate responses 
to their tax law inquiries. This evaluates the customer (external), 
administrative (internal) and regulatory accuracy of this service.

FY 2003 Performance: The goals for FY 2003 were set based on FY 2002 
performance and anticipated score increases due to the implementation 
of the new Embedded Quality (EQ) process. The expected improvement from 
EQ was not realized, and IRS is conducting a rootcause analysis to 
determine the reasons why the outcomes were not achieved.

Toll-Free Tax Law Quality:

[See PDF for image]

[End of table]

Future Plans: The following actions will be taken to improve the 
accuracy percentage for FY 2004: delivery of application-specific 
training and subsequent proficiency certification; ongoing research and 
analysis of quality data to identify improvement opportunities and 
initiatives; implementation of Contact Recording to enhance the ability 
of management to gauge and improve individual performance.

H. Toll-Free Account Quality:

[See PDF for image]

[End of table]

Future Plans:

Description: The percentage of customers receiving accurate responses 
to their account inquiries. This evaluates responses posed by internal 
and external customers.

FY 2003 Performance: The goals for FY 2003 were set based on FY 2002 
performance and an anticipated score increases due to the 
implementation of the new Embedded Quality (EQ) process. The expected 
improvements from EQ were not realized, and IRS is conducting a 
rootcause analysis to determine the reasons why the outcomes were not 
achieved.

Toll-Free Account Quality:

[See PDF for image]

[End of table]

Future Plans: The following actions will be taken to improve the 
accuracy percentage for FY 2004: delivery of application-specific 
training and subsequent proficiency certification; ongoing research and 
analysis of quality data to identify improvement opportunities and 
initiatives; implementation of Contact Recording to enhance the ability 
of management to gauge and improve individual performance.:

I. Customer Satisfaction Walk-In:

Description: Represents the customers' overall level of satisfaction 
with the services provided by the IRS at its Taxpayer Assistance 
Centers (TACs). The scores represent the average overall level of 
customer satisfaction ("Keystone" question) from the Customer 
Satisfaction transactional surveys. Survey recipients are asked to rate 
IRS performance on a five-point scale, where a score of 1 or 2 
indicates Dissatisfied and 4 or 5 indicates Satisfied. A limitation 
that may affect the validity of the data is the method in which the 
survey is conducted. The results are based on comment cards that are 
voluntarily completed by customers who have visited a Field Assistance 
office. Traditionally, comment cards are completed by customers who are 
either very satisfied or very dissatisfied with the service received, 
with the majority of comment cards being completed by customers who 
tend to be more satisfied. Therefore, the results should be viewed in 
more of a qualitative, rather than a quantitative, sense.

FY 2003 Performance: Customer satisfaction was below the target because 
the service at the Field Assistance (FA) offices for this period 
remains a key improvement factor in the taxpayer's eyes and survey 
results continue to indicate that customer wait time is highly 
correlated to their overall satisfaction. Survey results are obtained 
through comment cards voluntarily completed by customers, generally 
those who are either very satisfied or very dissatisfied with the 
service received. 

Customer Satisfaction Walk-In Percentage Satisfied:

[See PDF for image]

[End of table]

Future Plans: For 2004, IRS FA offices will continue to implement the 
network of the Queuing Management System (Q-Matic) to screen and 
categorize taxpayer needs.

:

J. EP/EO Customer Satisfaction:

Description: Customers' overall level of satisfaction with the way 
their cases were handled by the IRS Employee Plans and Exempt 
Organizations Examination programs. Scores represent the average 
overall level of customer satisfaction from the Customer Satisfaction 
Transactional Surveys. Survey recipients are asked to rate IRS 
performance on a seven-point scale, where 1 indicates Very Dissatisfied 
and 7 indicates Very Satisfied.

FY 2003 Performance: Overall customer satisfaction in both EP and EO 
continues to improve. In EO, the increased use of limited-scope audits, 
which take less time to complete and are less burdensome for customers, 
has had a positive effect on the two lowest areas of customer 
satisfaction: Length of Process and Time Spent on Audit. EP has 
experienced significant improvements in Fairness of Treatment and is 
actively addressing high-priority customer satisfaction issues like 
Explanation of Process and Time Spent on Audit.

EP/EO Customer Satisfaction:

[See PDF for image]

[End of table]

Future Plans: EO is identifying and addressing potential short-term 
revisions to the Form 990 that can be made to coincide with the 
implementation of electronic filing of this return in 2004. EP is 
revising the initial appointment letter that explains why the taxpayer 
was selected for audit. New enclosures will provide a simplified 
explanation of what to expect from the examination process and of 
taxpayer rights. Other improvements will also reduce the amount of time 
taxpayers spend preparing for audits by eliminating unnecessary 
requests for information.

K. Employee Plans (EP) / Exempt Organizations (EO) Examination Quality:

Description: Level of quality in the Employee Plans and Exempt 
Organizations examination program as measured by the Tax Exempt Quality 
Measurement System (TEQMS). The quality score is the average percentage 
of quality standards rated met (number of standards passed divided by 
the number of standards rated for the reviewed cases).

FY 2003 Performance: TE/GE achieved impressive gains in examination 
quality this year, exceeding its aggressive improvement goals. 
Improvements have been made by providing focused instruction and 
guidance to employees regarding the particular quality standards with 
the lowest pass rates, while maintaining managerial performance 
commitments to TEQMS.

EP/EO Examination Quality:

[See PDF for image]

[End of table]

Future Plans: In FY 2004, the use of dedicated determination groups in 
both EP and EO will promote consistency and quality by removing 
determination work from the responsibilities of both Examination agents 
and managers. In addition, EP and EO will continue to analyze standards 
with lower scores to identify areas in need of further clarification or 
training.

L. Telephone Customer Satisfaction - Automated Collection System (ACS):

Description: Represents the customer's perception of IRS service 
received through contact with employees in the Automated Collection 
System call centers. Limitations on survey respondents not affecting 
the statistical validity are: ACS outgoing calls are not included in 
the survey due to technological limitations, and customers calling when 
IRS monitors are not available (Saturday, Sunday and some evening 
hours) are excluded from the survey. Customer satisfaction is measured 
on a 4-point scale. 1 indicates Unsatisfied and 4 indicates Very 
Satisfied.

FY 2003 Performance: ACS Customer Satisfaction Survey changed from a 4-
point scale to a 5-point scale in January FY 2003. Prior to FY 2003, 
satisfaction was defined as the percent of customers providing a rating 
of "4" and dissatisfaction was defined as percent of customers rating a 
"1". Targets were set using these definitions. In FY 2003, with the 
change to the 5 point scale, IRS also changed the definition of 
satisfaction and dissatisfaction to the percent of 4's and 5's and the 
percent of 1's and 2's and revised the targets to reflect this change. 
Thus, what appears to be a big change in customer satisfaction is 
primarily a result of the scale change and the definition change. 
Through FY 2003, 91% of ACS customers were satisfied (a rating of 4 or 
5 on the 5-point scale). Customers were most satisfied with the 
following survey areas: "Friendliness of the Representative" ; the 
"Representative's Willingness to Help You with Your Issue"; and the 
"Fairness of Treatment." Telephone Customer Satisfaction was negatively 
impacted in the factor, "difficulty in getting through to 
representatives by phone," because of higher than planned incoming call 
demand, which also negatively affected ACS Level of Service (LOS). 
Customers report high degrees of satisfaction in the areas of courtesy, 
attitude and professionalism.

Telephone Customer Satisfaction - ACS (5 pt. Scale):

[See PDF for image]

[End of table]

Future Plans: The ACS Reengineering Team will focus on analyzing the 
high number of callbacks received in ACS, improving interactive 
scripts, balancing staffing to work inventory/cases with telephone 
operations. A new SB/SE Customer Satisfaction Strategy will focus on 
data received from the SB/SE customer base with emphasis on customers' 
prefiling/ filing experiences as well as those customers who have not 
had specific interactions/transactions (i.e. audit or collection 
activity). This information will be utilized to identify improvement 
opportunities with SB/SE taxpayers.

M. Automated Collection System - Telephone Level of Service:

Description: The percentage of calls attempted by taxpayers compared to 
the number of calls answered (calls which abandon while in queue for 
the next available assistor are not included in the count of calls 
answered) in the Automated Collection System (ACS).

FY 2003 Performance: The target was missed due to an increasing number 
of calls not related to a collection matter and therefore, not 
belonging to this specialized area. In addition, during the filing 
season, service was further impacted by the re-assignment of collection 
specialized representatives to assist in the customer service areas of 
tax law and accounts.

ACS - Telephone Level of Service:

[See PDF for image]

[End of table]

Future Plans: In FY 2004, a small increase in resources and 
enhancements to the scheduling process should contribute to an improved 
service level. In addition, a team has been established to look at what 
drives telephone traffic and is expected to develop recommendations 
related to call forecasting and suggest upgrades to the management 
tools designed to match resources to call demand.

N. Customer Satisfaction - Collection Field:

Description: Customers' overall level of satisfaction with the way 
their cases were handled by the IRS Field Collection program. The 
following limitations are placed on the Collection sample: only those 
customers who owe money to the IRS and have been referred to Collection 
are sampled. Samples drawn from the Collection Quality Measurement 
System (CQMS) database only include three types of closures: Currently 
Not Collectible/Hardship, Installment Agreements, and Full Pays. The 
sample does not include: cases with no case history, cases for 
customers the IRS cannot locate, cases where the statute has expired, 
bankruptcy cases, deceased taxpayers, and defunct or insolvent 
corporations. For cases involving an Offer in Compromise, only those 
offers that are accepted by the IRS are currently included. Customer 
satisfaction is measured on a 7-point scale, where 1 indicates Very 
Unsatisfied and 7 indicates Very Satisfied.

FY 2003 Performance: Customer satisfaction continued to improve. 
Results indicate that 60% of collection customers were satisfied with 
the service they have received, exceeding the target. IRS improved 
fairness in collection operations by modifying the Collection Due 
Process program. Managerial involvement is now required before a case 
goes to Appeals, which helps resolve more cases earlier and at lower 
cost to both taxpayers and the IRS. Program reviews focused on 
appropriate case actions and quality reviews included effective case 
actions and protection of taxpayer rights.

Customer Satisfaction - Collection Field:

[See PDF for image]

[End of table]

Future Plans: IRS will continue to evaluate the impact of Collection 
Reengineering initiatives on customer satisfaction. Recommendations 
from the Field Consultation Initiative pilot to improve case quality 
and timeliness will be modified for potential nationwide 
implementation. The new SB/SE Customer Satisfaction Strategy will focus 
on data received from the SB/SE customer base with emphasis on 
customers' pre-filing/filing experiences as well as those customers who 
have not had specific interactions/transactions (i.e., audit or 
collection activity).

O. Field Collection Quality:

Description: Score awarded to reviewed Collection cases by a third-
party reviewer using the Collection Quality Measurement System 
standards. Each standard, if met, has a value. Values are totaled to 
arrive at the score, with deductions in the overall composite score for 
failure to meet a standard designated as critical.

FY 2003 Performance: Quality scores remained at levels below target 
despite improved scores in the following areas: clear action dates, no 
activity lapses over 75 days and timely follow-ups. In addition, FY 
2003 scores improved (over FY 2002 levels) due to increased engagement 
between managers and revenue officers to facilitate timeliness and 
quality of case resolution.

Field Collection Quality:

[See PDF for image]

[End of table]

Future Plans: In FY 2004 and beyond, IRS will continue to develop and 
implement recommendations to improve case quality. P. Automated 
Underreporter Quality:

Description: Quality of all Automated Underreporter (AUR) account 
actions as a result of taxpayer inquiries or internal requests. Quality 
of casework in the underreporter area is measured on paper closed cases 
only.

FY 2003 Performance: Deficiencies include timeliness in meeting interim 
contact requirements and the format of correspondence sent to 
taxpayers. The Embedded Quality initiative will capture new data and 
plans are to replace this measure.

Automated Underreporter Quality:

[SEE PDF FOR IMAGE]

[END OF TABLE]

:

Future Plans: In FY 2004 IRS will continue to refine the process of 
identifying and selecting workload using data analyses and additional 
business rule development with the ultimate goal of removing the screen 
out cases (cases closed without sending notice to the taxpayer.):

Q. Service Center Exam - Customer Satisfaction:

Description: Customer's overall level of satisfaction with the IRS 
Service Center Examination process. The following limitations are 
placed on the service center examination sample: sole proprietors and 
self-employed individuals and farmers, as well as individual 
shareholders and partners examined as a result of a corporate audit are 
included in the sample; the sample excludes businesses that file 
corporate and partnership returns, individuals who did not respond to 
correspondence and audit appointment letters, individuals IRS cannot 
locate and individuals with an international address. Customer 
satisfaction is measured on a 7-point scale, where 1 indicates Very 
Unsatisfied and 7 indicates Very Satisfied.

FY 2003 Performance: Customers are most satisfied with courtesy of IRS 
employees and employees showing the right attitude, which has resulted 
in a 3 percentage point gain over the prior year. Results also indicate 
that taxpayers are primarily dissatisfied with the length of the audit 
process, length of time to get through by phone, and time spent on the 
correspondence exam.

Service Center Exam - Customer Satisfaction Percentage Satisfied:

[SEE PDF FOR IMAGE]

[END OF TABLE]

Future Plans: IRS will coordinate with Wage and Investment on the types 
of EITC audits that will be conducted in the SB/SE centers, improving 
the workload selection, and reducing cycle time. Hiring is also planned 
for FY 2004. The new SB/SE Customer Satisfaction Strategy will focus on 
data received from the SB/SE customer base with emphasis on customers' 
prefiling/ filing experiences as well as those customers who have not 
had specific interactions/ transactions (i.e. audit or collection 
activity). This information will be utilized to identify improvement 
opportunities with SB/SE taxpayers. IRS will embed quality into Service 
Center Compliance programs, providing a higher-quality experience for 
taxpayers and engaging managers in the delivery of services. 
Identifying customer service trends and issues earlier will allow IRS 
to react to customer needs more rapidly, increasing customer 
satisfaction.

R. Service Center Examination Quality:

Description: Correspondence Exam Case Quality measures the case 
accuracy of correspondence exam paper closures. Each site's quality 
reviewer reviews a sample of cases and writes a review record for each 
case.

FY 2003 Performance: The quality score has met the planned target of 
73%. During FY 2003, the Embedded Quality (EQ) initiative was 
implemented in campus operations. The resulting data will be utilized 
as a baseline to establish targets for future fiscal years. The primary 
focus of early quality efforts this year was on implementing the new 
quality review system and establishing consistency between sites and 
managers for the new Data Collection Instrument (DCI). As the focus 
shifted to resolving recurring error, the rates for both the customer 
and the pass/fail measures trended up.

Service Center Examination Quality:

[See PDF for image]

[End of table]

Future Plans: For FY 2004 and beyond, EQ will be implemented in all 
locations and the IRS will evaluate and monitor the results to identify 
improvement opportunities.

S. Examination - Customer Satisfaction:

Description: Represents the level of satisfaction customers receive 
from interactions with IRS Field Examination employees. Scores 
represent the average overall level of customer satisfaction from the 
Customer Satisfaction Transactional Surveys. Survey recipients are 
asked to rate IRS performance on a seven-point scale, where 1 indicates 
Very Dissatisfied and 7 indicates Very Satisfied. A limitation on 
survey data not affecting the statistical validity in the survey 
population is based solely on the audit closures of individual 
taxpayers and does not include Examination contacts with individuals 
that did not result in an audit closure.

FY 2003 Performance: The year ended with results showing that 63% of 
Examination customers were satisfied and 23% were dissatisfied. 
Customer satisfaction scores have steadily improved. Improvement 
opportunities exist in 1) Fairness of Treatment, 2) Explanation of 
Adjustments and Time Spent on the Examination. Field Examination 
Reengineering initiative was piloted to test a uniformed, structured 
approach to conducting audits. Facets of the initiative included a 
revamped pre-audit process and standardized workpapers. Several 
recommendations were made to implement the new audit processes 
nationwide. The highest satisfaction was by taxpayers whose cases were 
handled by a tax professional and/or whose examinations had a 
relatively short cycle time. Further reducing cycle time offers the 
greatest improvement opportunity. The hiring of additional resources in 
FY 2001 and resultant productivity gains, particularly in working 
through the case backlog (reducing overall cycle time), was a 
significant contribution to the improvement in the score over the FY 
2002 level and exceeding the FY 2003 target.:

Examination Customer Satisfaction Percentage Satisfied:

[See PDF for image]

[End of table]

Future Plans: IRS will continue to monitor and evaluate the impact of 
Field Examination Reengineering initiatives on customer satisfaction. 
Recommendations from the pilot are being modified and nationwide 
implementation is scheduled for FY 2004. The new Small Business Self 
Employed Division (SB/SE) Customer Satisfaction Strategy will focus on 
data received from the SB/SE customer base with emphasis on customers' 
pre-filing/filing experiences as well as those customers who have not 
had specific interactions/transactions (i.e. audit or collection 
activity). This information will be utilized to identify improvement 
opportunities with SB/SE taxpayers. IRS will continue to fulfill the 
vision of the Examination Re-engineering project, to make the 
Examination process easier and faster for taxpayers, minimizing the 
accrual of interest on additional assessments, while ensuring 
consistency and fairness.

T. Examination - Case Quality Score:

Description: The score awarded to a reviewed Field Examination case by 
a Quality Reviewer using the Examination Quality Measurement System 
quality standards.

FY 2003 Performance: Despite continued improvements in examination 
quality, year-end performance is slightly below the planned target. 
Areas contributing to shortfall include a lack of embedded quality in 
Field Examination Operations and the need to further monitor the impact 
of Examination Reengineering Initiatives on case quality.

Examination Case Quality Score:

[See PDF for image]

[End of table]

Future Plans: In FY 2004 embedded quality will be implemented for field 
exam, providing the IRS with better tools to manage errors in the 
field.

U. Taxpayer Advocate Casework Quality Index:

Description: Measure of effectiveness in meeting customer expectations 
based on a random sample of cases reviewed and scored against customer 
service standards of timeliness, accuracy, and communication.

FY 2003 Performance: Despite an improvement of 10 percentage points 
over the FY 2001-2002 levels, and the goal was not met due to 
inconsistency in addressing taxpayer issues and customer education.

:

Taxpayer Advocate Casework Quality Index:

[SEE PDF FOR IMAGE]

[END OF TABLE]

Future Plans: FY 2004 activities include validation of TAS' ability to 
take consistent and appropriate efforts to address taxpayer related 
issues and effectively educate its customers, and a re-evaluation of 
quality standards to ensure they match customer service standards 
developed using customer satisfaction survey data. Strategic Goal 2: 
Top-quality service to all taxpayers through fair and uniform 
application of the law.

Main Objectives:

Increase overall compliance.

Increase fairness of compliance.

America's tax system depends on each person who is voluntarily meeting 
his or her tax obligations having confidence that his or her neighbor 
or competitor is also complying. Taxpayers who do not comply cannot be 
allowed to burden those who do.

Major Results and Accomplishments:

Increase Overall Compliance:

a. Results Summary:

* ACS closed more than 1.1 million Taxpayer Delinquent Accounts (TDAs), 
a 22% increase over TDAs closed in FY 2002 and a 10.4% increase over 
the FY 2003 target.:

* ACS closed 197,517 Taxpayer Delinquency Investigations (TDIs), this 
is 4% lower than the previous year.

* ACS dollars collected reached almost $1 billion by September 30, 
2003, a 28% increase over the same period last year.

* Through the use of the predictive dialer, ACS attempted over 1.7 
million outbound calls.

* Automated Substitute For Return (ASFR) closed 67,000 TDIs (universal 
access).

* ACS reduced its priority inventories to be one percent to five 
percent current compared to 11% to 68% current at the end of FY 2002.

* W&I Compliance secured almost 560,000 delinquent returns in FY 2003, 
a 21% increase over FY 2002.

* Compliance Service Collection Operation (CSCO) improved average days 
to close to 18.9 days in FY 2003, a 33% improvement over FY 2002. 25:

* Automated Underreporter (AUR) closures for FY 2003 of 2.89 million is 
slightly lower than the FY 2003 target, despite a prior year reduction 
in Wage and Investment FTE which decreased the number of cases carried 
over to FY 2003. AUR's improved case selection processes in FY 2003 are 
reflected by an increase in the number of notices issued.

* AUR reduced overage correspondence by more than 16%.

* Exam reduced discretionary open cases that are more than 365 days old 
by 79%.

* Compliance exceeded the FY 2003 discretionary exam closure target of 
246,000. In addition this was a 48% increase over FY 2002 closures.

* EITC examination closures were 418,000, exceeding the FY 2003 target 
by 20%, and EITC dollars recommended for proposed deficiencies amounted 
to $541.6 million, almost 20% ahead of FY 2002.

* Field Examination closures exceeded the current year plan for both 
individual and business returns.

* LMSB increased emphasis on abusive tax avoidance transactions by 
examining more returns involving abusive corporate tax shelters, taking 
action to examine and target the promoters of abusive tax avoidance 
strategies, and reaching settlement with taxpayers on substantial tax 
shelter cases.

* LMSB made permanent the Fast Track Settlement Program that reduces 
burden to both the taxpayer and the government. This program increases 
issue resolution at the lowest level, allows for the use of Appeals 
tools during the examination in LMSB, and decreases the overall time 
from the return filing to the ultimate resolution. The length of the 
audit/appeals process is shortened by as much as two years.

* LMSB redirected enforcement resources to address the declining audit 
coverage rates for mid-size corporations in an effort to ensure an 
appropriate compliance presence in all taxpayer segments.

* Field Collection dispositions (Taxpayer Delinquent Accounts-TDA and 
Taxpayer Delinquent Investigations-TDI) and productivity exceeded the 
current year plan and prior year performance.

* OIC closures exceeded the plan levels in both the field and the 
Centralized Offer-In-Compromise Unit. Through September 2003, 56% of 
offers were closed within 6 months compared to 37% for the same period 
in FY 2002.

* Appeals increased the total number of Appeals cases closed from 
68,000 in FY 2002 to 83,000 in FY 2003. This increase in productivity 
is attributable to additional management focus on workload priorities 
(i.e. docketed cases, collection work), increased efficiencies in both 
case management and processing and implementation of process 
improvements, including specialization and segmentation.

* Collection Due Process (CDP) front-end inventory currency and back-
end inventory improved over FY 2002 levels by 25% and 21%, 
respectively.

* CDP case processing productivity has improved with the percentage of 
aged cases dropping from 16.2% in FY 2002 to 5.0% in FY 2003.

* Through September 2003, the Taxpayer Advocate Service (TAS) closed 
196,774 cases.

b. Improved Communications and Service:

* ACS increased direct time delivered on phones by 20% over FY 2002 
levels. ACS answered 1,468,786 calls, a 16% increase over FY 2002, and 
reduced internal telephone transfers by 80% from FY 2002 levels with no 
increase in FTE.

* AUR implemented additional systems capacity and eliminated 
approximately one million busy and abandoned calls.

* Examination expanded telephone services to more than 500,000 
taxpayers through cold call units and automated scripts.

* Field Assistance completed the networking of the Queuing Management 
Project in Area 7, all sites in California.

* Compliance Services Collection Operation (CSCO) timely processed 
756,000 preassessed installment agreements, a 40% increase over FY 
2002.

* The "Notice of Intent to Levy" was revised to clarify the actions 
required by taxpayers in order to avoid enforcement actions.

* Revisions were made to simplify and clarify Exam's first notice.

* Compliance developed and finalized system requirements so that 
beginning January 1, 2003 EITC refunds are frozen only to the extent of 
EITC credit, not the entire refund.

* Compliance implemented "Decision Installment Agreement" to improve 
quality and completeness of information provided to taxpayers related 
to installment agreements.

* Implementation of EQ throughout compliance services led to 
improvements in the EXAM, (CSCO), and ACS service quality; and 20% 
improvement in ACS productivity.

* FY 2003, Field Collection, Field Examination and Service Center Exam 
customer satisfaction scores exceeded the fiscal year targets.

* Field Assistance's Customer Satisfaction Survey results for the 
fiscal year indicated 87% of Field Assistance's customers were 
satisfied, with only 8% being dissatisfied.

* The Appeals function increased the percentage of satisfied customers 
from 44% to 48%. Vehicles used for customer outreach and feedback:

* Developed and implemented quarterly newsletters to disseminate 
current, relevant information to Government Entities customers and 
stakeholders.

* Taxpayer Education and Communication (TEC) in SB/SE utilized a 
variety of distribution channels to reach taxpayers and influence their 
filing and payment behaviors.

* Headliners were distributed to external stakeholders. Topics included 
Money Laundering Schemes, S-Corporation Compensation, Employee 
Leasing, and Electronic Filing for Small Businesses.

* Tax Talk Today, a live Internet program, featured broadcasts with 
lively discussions, real time interaction and the opportunity for 
viewer participation by telephone, e-mail or fax.

* Participation on radio station programs increased significantly and 
the listener base for most segments exceeded 100,000. Presentations 
included information on E-file/EFTPS, Home-Based Businesses, Abusive 
Schemes, and the Offshore Voluntary Compliance Initiative.

* Electronic outreach was enhanced through leveraging stakeholder 
relationships with America On Line (AOL) and Microsoft. Actions include 
IRS links on their tax centers.

* Developed and piloted a customer satisfaction survey for certain 
Government Entities outreach activities.

* Appeals moved to a completely paperless telephone customer survey, 
making it possible to receive results quicker and to react more timely 
to customer concerns.

* Four focus groups were conducted in an effort to obtain additional 
customer feedback on improving face-to-face services on a daily basis. 
Taxpayer Assistance Center (TAC) customers indicated that they visit 
centers because they prefer face-to-face assistance versus telephone 
communications and because they have tax needs that require inperson 
interaction. Their overall satisfaction is dependent upon the 
professionalism of the staff at the TAC locations and the wait time for 
service.

* The SB/SE website was expanded to include information to assist 
taxpayers in determining whether they should submit an offer. The 
website includes explanations on the various types of offers, 
processability criteria, hyperlinks to Form 656 and Collection 
Financial Standards, and Frequently Asked Questions.

* Expanded outreach to small business about retirement plan options, 
including expanding content on irs.gov and widely distributing Choosing 
a Retirement Solution for your Small Business through various channels 
including IRS events, stakeholder groups and online.

* Launched a website to make it easier for political organizations to 
file electronically and greatly improve the public's access to 
information about these organizations.

* LMSB continued to place significant media attention on Abusive Tax 
Schemes to alert taxpayers to the schemes and prevent potential tax 
problems.

* LMSB continued to provide the Tax Shelter Hotline for taxpayers as a 
clearinghouse for information that comes to the attention of the 
Service relating to potentially improper tax shelter activity by 
corporate and non-corporate taxpayers. Publications for the use of 
employees and customers:

* Twenty tax law, self-directed learning modules for use by employees 
were developed and are being expanded to include all tax law topics and 
all probes. These modules are being used for publication method 
training in each tax law category.

* LMSB issued published guidance on four new issues as part of their 
efforts through the Industry Issue Resolution program to resolve 
frequently disputed or burdensome tax issues that affect a significant 
number of business taxpayers.

* Published Revenue Procedures 2003-40 and 2003-41, making both LMSB/
Appeals Fast Track Settlement and SBSE/Appeals Fast Track Mediation 
permanent programs within Appeals. Both programs expand the range of 
dispute resolution options available to taxpayers, promote issue 
resolution at earlier stages and decrease the overall time from return 
filing to ultimate issue resolution.

* Appeals expanded and tailored a number of alternative dispute 
resolution techniques to accommodate the settlements of tax shelters 
and abusive schemes in a timely and consistent manner.:

c. New Initiatives and Program Improvements:

* W & I Compliance implemented the Electronic Levy System (ELS), an 
automated levy review system that systematically verifies the accuracy 
of the levy amounts and levy source addresses prior to mailing, thereby 
reducing hours used on levy review. In FY 2003, ELS produced a 40% 
productivity savings over FY 2002.

* As part of Field Assistance's efforts to improve tax law accuracy, a 
tax law certification initiative was implemented which required that 
each employee be certified to answer technical tax law topics.

* W&I's Tax Forms and Publications made significant progress in 
developing the framework for a state-of-the-art Virtual Translation 
Office (VTO) that will enable the IRS to serve significant segments of 
the Limited English Proficiency population at a minimum cost by 
leveraging existing language resources.

* Embedded Quality was implemented throughout all of Compliance 
Services. Exam improved quality to 65% from 60% in FY 2002. CSCO 
improved quality to 95.3% from 75.9% in FY 2002. ACS sustained quality 
at 90% while improving productivity by 20%.

* The Electronic ACS-Guide (e-ACS G), an interactive research tool for 
ACS Collection Representatives (CRs), was piloted in the Seattle and 
Brookhaven ACS call sites. Through "e-ACS", CRs have user-friendly 
access to key Internal Revenue Manual procedures, the Decision IA took. 
The Collection Statue Expiration Date, W-4 calculators, and other 
research tools.

* Compliance proactively responded to taxpayer issues related to the 
war in Iraq and other designated Combat Zones (CZs). Relief guidelines 
were provided for active duty, reserve duty, and support personnel in 
designated combat zones. The CZ email address was reactivated for 
impacted military taxpayers. Compliance partnered with the Department 
of Defense (DoD) and MITS to implement a systemic identification and 
treatment to protect designated personnel. In addition, Compliance 
delayed the implementation of the DoD Federal Payment Levy Program 
(FPLP) until systemic protections for combat zone personnel could be 
implemented.

* Compliance delivered over 740,000 training hours and implemented "My 
Opinion Counts Council" in ACS, ACS Support, and CSCO.

* TE/GE initiated market-segment based studies to assess levels of 
compliance and identify compliance risks among TE/GE customers.

* TE/GE collaborated with Department of Labor to identify Form 5500 
pension plan non-filers.

* TE/GE worked with IRS Criminal Investigation and Department of 
Treasury to address the diversion of charitable assets to terrorism 
funding.

* TE/GE expanded the use of limited-scope audits and other contacts to 
improve EO's compliance presence within limited resources.

* Appeals continued to play an integral part in the Service's efforts 
to combat tax shelters and abusive tax schemes, bringing its 
independent settlement authority to bear on tax shelter cases as early 
in the process as possible.

* Revised Form 1023, Application for Recognition of Exemption, to be 
implemented for customers next year.

* The Taxpayer Advocate Service (TAS) implemented the TAMIS (Taxpayer 
Advocate Management Information System) Redesign that provides many 
enhancements to improve documentation, timeliness and accuracy of 
casework and to provide significant data to determine reasons why IRS 
did not resolve taxpayers' problems the "first time around.":

* LMSB implemented the Limited Focused Issue Examination (LIFE) process 
to increase the efficient use of examination resources and reduce the 
length of the examination cycle for the taxpayer and the IRS.

LMSB completed the first phase of Form K-1 transcription to support the 
identification of aggressive and abusive transactions at the enterprise 
level.

Increase Fairness of Compliance:

a. Results Summary:

* LMSB increased emphasis on appropriate application of enforcement 
tools such as summons enforcement, penalty administration, and 
coordination with Department of Justice, Counsel, and Criminal 
Investigation.

* Conducted examinations under the National Research Project (NRP) to 
improve workload identification and resource allocation processes, and 
reduce burden on compliant taxpayers.

* Revenue Procedure 2003-11 was issued in January 2003 to announce the 
Offshore Voluntary Compliance Initiative (OVCI), which provided 
taxpayers the opportunity to voluntarily disclose participation in 
unlawful offshore schemes. OVCI was offered until April 15 and received 
approximately 1,300 applications that identified over 400 promoters. 
Applicants reported over $75 million dollars in taxes and approximately 
$55 million has been collected. In June 2003, last chance letters to 
elect OVCI procedures were sent to over 600 taxpayers and verbal offers 
made to over 200 taxpayers with identified offshore issues.

* Several legislative recommendations from the 2001 and 2002 Taxpayer 
Advocate's Annual Reports to Congress ARCs were included in H.R. 1528 
(The Taxpayer Protection and Accountability Act of 2003), passed by the 
House of Representatives on June 19, 2003.:

b. Reengineering:

* Field and Office Examination Reengineering identified ways to improve 
pre-audit planning, achieved a uniform, structured approach to audits, 
and enhance taxpayer communication.

* LMSB used enhanced methodologies for identifying risks in LMSB 
customer base to target returns most deserving of enforcement action.

* LMSB developed and implemented a strategy to identify and address 
compliance issues in the area of executive compensation. These issues 
historically have been addressed through normal guidance and 
examination processes, but increased attention was warranted in light 
of recent significant corporate accounting revelations.

* For appropriate corporate taxpayers, LMSB offered Limited Issue Focus 
Examination (LIFE) procedures to reduce taxpayer burden and to improve 
use of resources.

* Collection Reengineering completed the pilot for the Field 
Consultation Initiative in March 2003 and the results indicated that 
consultations positively impacted business results by moving cases more 
quickly to resolution. A modified process is scheduled for 
implementation in FY 2004.

* Reengineering efforts continue to focus resources on the most 
productive and collectible, high risk cases. Case prioritization using 
the TDA Model began in January 2003 and is having a significant impact. 
The model is continuously monitored and updated.

* Recommendations implemented from the ACS Modeling Team on Risk Based 
criteria are also enabling the right cases to be delivered to ACS at 
the right time.

* Roll out of the Electronic Levy System is allowing ACS to perfect 
levies, initiated by the call site, via a computerized system 
alleviating the paper process. 30:

* SB/SE engaged the Office of Program Evaluation and Risk Analysis in a 
comprehensive study of the Offer-in-Compromise (OIC) program. 
Preliminary results indicate that the processability noncompliance 
screen is effective. A recent Treasury Inspector General for Tax 
Administration audit indicated that we are reaching appropriate case 
decisions in the vast majority of cases. We are pursuing legislative 
proposals that would address frivolous OIC filers as well as remove the 
barriers to granting installment agreements for less than full 
payment.:

c. Focus on Higher Risk Areas:

* LMSB increased its focus on promoters of abusive tax schemes by 
identifying flow-through entities used to mask questionable structured 
transactions; addressing abusive schemes through enforcement; 
implementing the Schedule K-1 matching program; directing research 
efforts to profile promoters and build our understanding of trust 
filing reporting issues; developing skilled employees; and targeting 
educational products and outreach to influence tax compliance 
behaviors.

* LMSB is improving its ability to evaluate book-to-tax differences in 
financial reporting with an eye to discovering compliance risk areas.

* SB/SE Field Examination continued its transition from a traditional 
Discriminate Index Function (DIF) based plan to address the following 
strategic priorities: Promoter Investigations, Offshore Credit Card 
Program, Abusive Schemes, High-Income Taxpayers, High-Income 
Nonfilers, Unreported Income Function, and the National Research 
Program.

* A multi-Operating Division executive steering committee was formed 
with the purpose of developing a coordinated approach for combating 
Abusive Tax-Avoidance Transactions (ATAT). Approximately 900 employees 
were trained to work both domestic and offshore ATATs.

* The Lead Development Center (LDC) was established to centralize the 
receipt and development of leads on promoters of abusive tax schemes. 
The LDC authorizes and monitors IRC Section 6700, 6701 and 7408 
investigations assigned to the field for the entire nation and 
coordinates promoter investigations with the operating divisions.

* Counter-marketing toolkits were developed for selected schemes, as 
well as a Tactical Response Toolkit for ATATs in general.:

d. Improved Communications:

* LMSB is continuing to place significant media attention on actions 
taken to identify and resolve Abusive Corporate Tax Shelters so 
taxpayers are aware the IRS is ensuring fairness of compliance across 
all taxpayer segments.

The ATAT Partnership of IRS and State officials drafted a Memorandum of 
Understanding, providing a framework for individual agreement with 
States allowing joint enforcement, sharing of leads, joint outreach and 
education.

Balanced Measures:

A. Automated Collection System Closures - Taxpayer Delinquent Accounts 
(TDA):

Description: The number of ACS TDA taxpayer closures minus any TDA 
taxpayer cases systemically removed from inventory. Closures include 
full paid accounts, installment agreements, currently not collectible 
accounts, etc.

FY 2003 Performance: The goal was exceeded due to management emphasis 
on training, processing of high priority inventories, case resolution 
activities, levy and lien issuance, and process improvements have 
resulted in increased productivity.

ACS - Taxpayer Delinquent Accounts:

[See PDF for image]

[End of table]

Future Plans: To improve productivity, improvements in scheduling of 
incoming calls staffing and limiting internal programs that cause call 
volume are planned. Additional hires are planned to increase staffing 
available to work inventory and increase productivity. IRS will shift 
the mix of cases for Automated Collection System work. TDA entities are 
traditionally high priority inventory and the emphasis on high priority 
cases will increase the number of TDA closures. Additional factors that 
will contribute to increased TDA dispositions include: an overall 
refocus on ACS mission of collecting delinquent accounts and securing 
delinquent returns, ACS employees hired in FY 2004 should become more 
productive in FY 2005 as they continue to gain experience, and the 
percent of direct time to total time should increase due to reduced 
training.:

b. Automated Collection System Closures - Taxpayer Delinquent 
Investigations (TDI):

Description: Number of entity delinquent investigation closures 
produced in the Automated Collection System. Entities closed using 
codes related to systemic reduction of inventory are not included in 
the actual count.

FY 2003 Performance: There has been a decrease in planned time spent on 
the program, due to primary emphasis being placed on resolving Balance 
Due accounts. Representatives were reassigned to answer telephones 
which decreased their availability to work inventory. The ACS 
Reengineering Team is currently identifying ways to improve performance 
and productivity.

ACS - Taxpayer Delinquent Investigations:

[See PDF for image]

[End of table]

Future Plans: In FY 2004 more emphasis will be placed on working TDIs 
which will be among our high priorities. 32:

C. Field Collection - Number of Cases Closed Taxpayer Delinquent 
Account (TDA):

Description: A count of the number of actual TDA dispositions completed 
by Revenue Officers. A TDA disposition occurs on the Integrated Data 
Retrieval System (IDRS) when the status of an account changes from an 
open status to any closed status.

FY 2003 Performance: As of September 30, 2003, Field Collection closed 
880,939 TDA modules, which exceeds the closures for the same period in 
FY 2002 and the current fiscal year target of 714,256. TDA Productivity 
was 12% above plan. Productivity increased due to a variety of factors 
which included Phase 1 Collection Reengineering efforts that enabled 
more current work to be issued to the Collection Field function. Case 
filters were implemented to help identify cases that are more likely to 
be full paid, and also to identify cases likely to be currently not 
collectible so that they can be removed and permit more productive 
cases to be worked. Full pay and installment agreement disposition 
rates have risen considerably through June of this fiscal year compared 
to a year ago. These dispositions tend to require less direct hours 
than other closing actions. Due to our initiative to centralize and 
consolidate a large portion of OIC inventory, OIC Revenue Officers were 
re-deployed back into the general collection program. These highly 
experienced and skilled Revenue Officers helped increase field 
productivity. 

Field Collection # Cases Closed TDA:

[See PDF for image]

[End of table]

Future Plans: IRS will continue to monitor and evaluate the impact of 
Collection Reengineering Initiatives on productivity and focus on 
priority cases (Abusive Schemes, offer in compromise cases, FTD Alerts, 
Trust Fund TDA/TDI, High-Risk TDA/TDI and High Dollar TDAs > $5 
million).:

d. Field Collection - Number of Cases Closed Taxpayer Delinquent 
Investigation (TDI):

Description: Count of the number of actual TDI dispositions completed 
by Revenue Officers. A TDI disposition occurs on Integrated Data 
Retrieval System (IDRS) when the status of an investigation changes 
from an open status to a closed status.

FY 2003 Performance: The target was exceeded as a result of efforts to 
re-balance inventories and increasing the percentage of time applied to 
TDI cases.

Field Collection # Cases Closed TDI:

[See PDF for image]

[End of table]

Future Plans: Re-engineering initiatives will increase productivity. 
However, due to an emphasis on priority TDA work. IRS expects a 
decrease in the number of TDI closures. Process improvements will 
reduce the amount of direct time spent resolving a TDI.:

e. Automated Underreporter Closures:

Description: Total number of closures of Automated Underreporter Cases.

FY 2003 Performance: The number of AUR cases closed is above target 
even though it falls below the number of cases closed for FY 2002.:

Automated Underreporter Closures:

[See PDF for image]

[End of table]

Future Plans: In FY 2004 IRS plans to further refine the AUR selection 
criteria to close more leads and develop, test and implement a 
centralized AUR case selection model to be available in calendar year 
2005.:

f. Individual Return Examinations Greater Than $100K:

Description: Number of Individual (Form 1040) returns closed by Field 
Examination with a total positive income greater than $100,000.

FY 2003 Performance: The goal was exceeded due to increased focus on 
high-income taxpayers and an increase in Direct Compliance Time. The 
hiring of additional resources in FY 2001 (565 Revenue Agents and 108 
Tax Compliance Officers) and completion of their initial training 
significantly improved the productivity, closing the gap created in 
past years. Increased attention to case management and maintaining 
optimal inventory levels contributed to this improvement.

Individual Return Examinations > $100K:

[See PDF for image]

[End of table]

Future Plans: IRS will continue to evaluate the impact of reengineering 
initiatives on productivity. In FY 2004, closures in this category will 
be reduced slightly to focus on examining more business returns. The 
strategy associated with high income taxpayers will be refined and IRS 
will continue to focus on cases associated with the strategic 
priorities which include Abusive Schemes/Promoters, Offshore 
Activities Credit Cards, High Income Taxpayers, High Income Nonfilers, 
Unreported Income Discriminate Index Function (DIF) and the National 
Research Program. IRS will develop and implement a strategy for high 
income taxpayers. Research of higher income taxpayers has revealed 
potential pockets of non-compliance in income strata of $1 million 
Total Positive Income (TPI) and above. IRS will use new national (UI 
DIF) formulas in conjunction with the new TPI strata to surface 
potential non-compliant returns for audit.

The most experienced field revenue agents will work these cases. IRS 
will redirect to traditional audit program to include taxpayers with 
incomes over $100,000. Since many higher income taxpayers invest in 
various flow-through entities to defer or hide potential taxable 
income, IRS will continue to build its understanding of the filing, 
reporting and payment attributes of Partnerships and Trusts. IRS will 
assess examination coverage across 1040 non-EITC filers and develop a 
strategy for addressing compliance issues in this area. Workload 
identification business rules will be designed and tested to identify 
non-compliant returns. Focus will be on expanded coverage of the higher 
income Wage and Investment population.:

g. Individual Return Examinations Less Than $100K:

Description: Number of Individual (Form 1040) returns closed by Field 
Examination with a total positive income less than $100,000.

FY 2003 Performance: The goal was exceeded due to an increase in Direct 
Compliance Time. The hiring of additional resources in FY 2001 (565 
Revenue Agents and 108 Tax Compliance Officers) and completion of their 
initial training significantly improved the productivity, closing the 
gap created in past years. Increased attention to case management and 
maintaining optimal inventory levels contributed to this improvement.:

Individual Return Examinations < $100K:

[See PDF for image]

[End of table]

Future Plans: IRS will continue to evaluate the impact of reengineering 
initiatives on productivity. In FY 2004, closures in this category will 
be reduced slightly to focus on examining more business returns. IRS 
will assess examination coverage across 1040 non-EITC filers and 
develop a strategy for addressing compliance issues in this area. 
Workload identification business rules will be designed and tested to 
identify non-compliant returns.:

h. Total Returns Examined:

Description: Combined count of the Number of Individual (Form 1040) 
returns closed by Field Examination. This measure is the sum of 
measures F and:

g.

FY 2003 Performance: The goal was exceeded due to increased focus on 
high-income taxpayers and an increase in Direct Compliance Time. The 
hiring of additional resources in FY 2001 (565 Revenue Agents and 108 
Tax Compliance Officers) and completion of their initial training 
significantly improved the productivity, closing the gap created in 
past years. Increased attention to case management and maintaining 
optimal inventory levels contributed to this improvement.:

Total Returns Examined:

[See PDF for image]

[End of table]

Future Plans: IRS will continue to evaluate the impact of reengineering 
initiatives on productivity. In FY 2004, closures in this category will 
be reduced slightly to focus on examining more business returns. The 
strategy associated with high income taxpayers will be refined and IRS 
will continue to focus on cases associated with the strategic 
priorities which include Abusive Schemes/Promoters, Offshore 
Activities Credit Cards, High Income Taxpayers, High Income Nonfilers, 
Unreported Income Discriminate Index Function (DIF) and the National 
Research Program. IRS will develop and implement a strategy for high 
income taxpayers. Research of higher income taxpayers has revealed 
potential pockets of non-compliance in income strata of $1 million 
Total Positive Income (TPI) and above. IRS will use new national (UI 
DIF) formulas in conjunction with the new TPI strata to surface 
potential non-compliant returns for audit. The most experienced field 
revenue agents will work these cases. IRS will redirect to traditional 
audit program to include taxpayers with incomes over $100,000. Since 
many higher income taxpayers invest in various flow-through entities to 
defer or hide potential taxable income, IRS will continue to build its 
understanding of the filing, reporting and payment attributes of 
Partnerships and Trusts. IRS will assess examination coverage across 
1040 non-EITC filers and develop a strategy for addressing compliance 
issues in this area. Workload identification business rules will be 
designed and tested to identify non-compliant returns. Focus will be on 
expanded coverage of the higher income Wage and Investment population.:

i. Number of Business Returns Examined:

Description: Includes LMSB business returns closed outside of the 
coordinated industry program, and SB/SE corporate examinations.

FY 2003 Performance: Initially, the small corporate plan for FY 2003 
was reduced to focus on the Compliance strategic priorities: Abusive 
Schemes/Promoters, Offshore Activities Credit Cards, High Income 
Taxpayers, High Income Nonfilers, Unreported Income DIF and the 
National Research Program. Field Examination made a big push to close 
out open lower priority work prior to assignment of the targeted cases. 
This effort enabled them to beat the planned output goal. 

Number of Business Returns Examined:

[See PDF for image]

[End of table]

Future Plans: IRS will continue to focus on cases associated with the 
strategic priorities which include Abusive Schemes/Promoters, Offshore 
Activities Credit Cards, High Income Taxpayers, High Income Nonfilers, 
Unreported Income DIF and the National Research Program. There will 
also be an increased emphasis on shelters. As part of the strategy to 
address high-income taxpayers, IRS will address flow-through entities.

J. Number of Cases Examined - Large Case:

Description: Number of regular Coordinated Industry cases (CIC) closed 
during the period ("R1" cases;

i.e., not including claim cases, cases returned from Appeals, or non-
examined closures). A Coordinated Industry case consists of one or more 
tax years of the primary taxpayer (usually a large corporate return) 
plus all related returns examined in conjunction with the primary 
taxpayer.

FY 2003 Performance: The achievement against target rate was 97% 
despite case closure delays resulting from the increased complexity of 
issues being worked. The inventory of large cases is made up of 
significant numbers of Tax Shelter and Joint Committee cases that have 
complex issues that take longer for the agent to research and address. 

Cases Examined - Large Case:

[See PDF for image]

[End of table]



Future Plans: In FY 2004 plans are to decrease cycle times using new 
recommendations that establish strict guidelines on the actions to be 
taken on cases of this type. K. Number of Returns Closed - Large Case:

Description: Coordinated Industry Corporate (CIC) returns (F1120 and 
associated Partnership and Employment Tax forms) closed with designated 
activity codes.

FY 2003 Performance: LMSB met its target goal. These types of cases are 
very complex and take longer to close, as a result, a large number of 
closures occur in the final months of the fiscal year. 

Number of Returns Closed - Large Case:

[See PDF for image]

[End of table]

Future Plans: CIC returns are a function of a work product (CIC Cases) 
rather than a planned output. In contrast to Industry returns, where 
goals and targets are established, these returns are a result of 
examination of a key taxpayer. For Coordinated Industry, IRS plans an 
examination for a key taxpayer case, but the related returns (e.g., 
Partnership, Excise Tax, Employment Tax, etc.) are more a byproduct 
than an intended outcome.:

L. Employee Plans / Exempt Organizations Examinations Closed:

Description: Number of Employee Plans plus Exempt Organizations return 
examinations closed in all categories.

FY 2003 Performance: The target was missed in the Employee Plan 
component with the redirection of large numbers of employees to work 
incoming determination receipts instead of their planned examinations, 
necessary due to an unanticipated number of receipts.

EP/EO Examinations Closed:

[See PDF for image]

[End of table]

Future Plans: In FY2004 IRS will continue to address examination 
challenges with improvements in the Exempt Organization determination 
process and implementation of electronic filing of Form 990 returns. M. 
Criminal Investigations Completed:

Description: Cumulative count of the number of all subject criminal 
investigations completed by IRS Criminal Investigation Division (CI) 
during the fiscal year. This includes investigations that resulted in a 
criminal prosecution recommendation to the Department of Justice as 
well as investigations that were discontinued due to a lack of evidence 
or to a finding that the original allegation was false.

FY 2003 Performance: IRS achieved approximately 16 percent above its 
year-end plan for total investigations completed. The increase is due 
to the natural workflow continuation brought on by the rise in 
investigations initiated in FY 2002. The CI workforce, spurred on by 
management's oversight to prevent an excessive amount of overage items 
as well as efforts to continue to apply more direct investigative time, 
is currently in the process of working through that increased level of 
investigative inventory brought on by the higher than normal FY 2002 
initiations. IRS also shifted criminal investigation inventory mix, 
reducing the time spent on narcotics related investigations, and 
increasing the resources dedicated to income tax related investigations 
and to other areas such as anti-terrorism.

Criminal Investigations Completed:

[See PDF for image]

[End of table]

Future Plans: IRS will increase emphasis on promoters of abusive 
foreign and domestic trusts, and schemes based on frivolous legal 
arguments. The Criminal Investigation Division will partner with the 
SB/SE and LMSB Divisions in their efforts to identify abusive tax 
schemes, promoters, and abusive tax shelter activities.

N. Appeals Cases Closed:

Description: Total Appeals Cases Closed equals the total number of 
cases closed by Appeals during the fiscal year, including both non-
docketed and docketed cases. A docketed case is one in which a taxpayer 
has filed a petition in the Tax Court. While this measure is expressed 
in terms of "cases," a case generally includes multiple tax periods.

FY 2003 Performance: Appeals closed a total of 84,677 cases through 
September 2003, exceeding our original plan to close 77,265 cases by 
about 10%. Increased managerial focus on workload priorities, 
maintaining optimal inventory levels, process improvements (including 
specialization and segmentation) and increased case processing 
efficiencies contributed to our success in exceeding the target.

Appeals Cases Closed:

[See PDF for image]

[End of table]

Future Plans: Appeals is committed to providing premier dispute 
resolution services that meet customer needs and expectations. Fast 
Track Settlement, Fast Track Mediation, and other Alternative Dispute 
Resolution programs will continue to be an integral part of the Appeals 
process, geared toward timely, high quality resolution of disputes. 
Appeals will also continue to play a pivotal role in the Service's 
efforts to effectively deal with current tax shelter promotions by 
independently establishing settlement guidelines to facilitate the 
early resolution of these cases. Other plans include implementing 
campus operations which will help mitigate the significant impact on 
workload shifts and the ability to manage them. By centralizing and 
reengineering certain workstream segments at campus locations, Appeals 
will reduce inventories and facilitate a more efficient processing of 
work and improve inventory currency.

O. Taxpayer Advocate Service (TAS) Closure to Receipt Ratio:

Description: Measure of effectiveness in resolving at least the number 
of cases received in order to decrease TAS' open inventory. The result 
is a division of the number of closed cases by the number of receipts.

FY 2003 Performance: TAS has maintained a closure to receipt ratio at 
or above its FY 2003 goal. TAS has accomplished this by monitoring 
receipts and closures by issue, criteria, and office on a weekly basis. 
By doing this, TAS is able to balance inventories and address training 
needs at the earliest time possible. TAS continues to review case 
processing procedures to identify areas where it may improve timeliness 
of case resolution and closure.

TAS Closure to Receipt Ratio:

[See PDF for image]

[End of table]

Future Plans: TAS will continue to work toward the closure to receipt 
ratio of 100%. To achieve this goal, TAS will continue to closely 
monitor receipts and closures and to review case processing procedures. 
TAS plans to partner with the operating divisions and functional units 
to reduce the number of systemic hardship cases received. TAS will also 
maintain and improve service level agreements in anticipation of 
increases in receipts due to economic fluctuations, changes in tax 
laws, and the expected increases in compliance and enforcement 
activities.

Strategic Goal 3: Productivity Through a Quality Work Environment:

Main Objectives:



*Increase employee satisfaction.:



Increase productivity by effectively addressing human resource and work 
environment issues.:

Employee Satisfaction is one measure of management effectiveness and, 
as such, is viewed as an early indicator of the ability to succeed in 
meeting the mission and providing quality products and services to the 
public. By striving to maximize employee satisfaction, IRS is able to 
provide services more efficiently and get the greatest value for every 
dollar spent. There is a linkage between productivity and employee 
satisfaction and engagement. This means employees must have the 
management support, tools and equipment they need to provide effective 
service to customers. The Employee Satisfaction Survey meeting process 
serves to help break down barriers and facilitate effective 
communication among all levels of the organization.

Major Results and Accomplishments:

Increase employee satisfaction:

Results Summary:

* The IRS continued its steady improvement in employee satisfaction, 
with overall "job satisfaction" for IRS as a whole rising to 60% (% of 
4 and 5 responses combined). This compares to 55% in 2002 and 51% in 
2001. (Job Satisfaction is measured by Survey Item Q 17, "Considering 
everything, how satisfied are you with your job?"):

* A record 83,674 employees, or 72.5% of the workforce, responded to 
the annual census survey.

* Several individual IRS organizations made noteworthy gains or 
undertook new employee satisfaction initiatives. For example, Appeals 
employees reached 58% satisfaction in FY 2003, exceeding FY 2002 by 15% 
and the FY 2002 target by 11%. Appeals had the greatest gain in 
employee satisfaction of any IRS business unit since the inception of 
the survey process.

* Employee Satisfaction (ES) Tracker has now been mandated for use by 
all IRS organizations in the post survey 2003 process to ensure that 
survey results and issues raised by the workgroups are addressed in a 
timely manner. 40:

* In W&I, employee participation in the Gallup Survey 2003 increased 
dramatically, from 68% last year to 80% this year---a 17% improvement. 
The W&I Campus response rate increased from 71% in 2002 to 79% in 2003. 
W&I Field and HQ response rate increased from 56% in 2002 to 82% in 
2003.

* In W&I, employee job satisfaction (Q17) improved from 52% in 2001, to 
55% in 2002, and to 60% in 2003. At the same time, dissatisfaction 
(%1's & 2's) decreased from 18% in 2001 to 14% in 2003. Most 
importantly, employee satisfaction did not decrease in any function and 
increased dramatically in most functions.

* The SB/SE results of the annual employee satisfaction survey reports 
overall satisfaction at 56.11%, which exceeds the FY 2002 census score 
by more than 4 percentage points.

* SB/SE response rates (% of employees who chose to take the voluntary 
survey) increased significantly for field and Headquarters from 59% in 
FY 2002 to 65% in FY 2003. Campus response rates remained slightly 
above the national average at 73%. Overall, SB/SE's response rate 
increased from 67% in FY 2002 to 69% in FY 2003.

* SB/SE has begun the process of analyzing specific SB/SE employee 
satisfaction data and employee verbatim (narrative) comments to 
identify the factors that have the most influence on overall 
satisfaction. The top issues identified from the ES Tracker workgroup 
data will be used to identify national trends for future preemptive 
actions.

The most significant increases in survey results for SB/SE were shown 
in Item 2 (Materials), Item 4 (Recognition) and Item 11 (Progress).

Increase productivity by effectively addressing human resource and work 
environment issues. Results Summary:

* SB/SE developed the Employee Satisfaction Strategy/Framework to bring 
focus to key areas affecting employee satisfaction. In December 2002, 
each Operating Unit (OU) Director in SB/SE received an ES scorecard 
that contained OU specific results detailed analysis of ES data. Each 
OU established teams to address ES issues on a corporate/operating unit 
level.

* SB/SE developed a Non-Monetary Recognition System (NMRS) to recognize 
employees who contribute to improving performance and help to achieve 
the goals of the SB/SE operating division and the Internal Revenue 
Service. Implementation in SB/SE of NMRS is scheduled for FY 2004.

* Developed a Recruitment Information Tracking System (RITS) to assist 
with collecting measurable results of recruitment efforts.

* Began the administration of an Exit Survey to capture data that 
impacts employee retention (December 2002). The employee clearance 
process was automated in July 2003.

* Revamped training program to a technologically enabled learning 
environment (on-line, selfstudy, blended learning and "just in time" 
training).

* Revised basic Revenue Agent training to maximize efficiencies and 
minimize costs. The new competency based curriculum reduces training 
time (classroom and on the job) by 10 weeks.

* Established a Workforce Planning Council and began development of a 
Workforce Plan for SB/SE. Components of the Workforce Plan include 
succession planning and the development of improved processes for 
hiring, selecting and retaining employees.

* Approximately one in four W&I workgroups (26%) have been deemed "best 
practice" workgroups as defined by Gallup's Grand Mean score >= 3.96--
-a marked improvement over 12% in 2001. 41:

* Appeals refined its structure by removing internal barriers between 
its operations, providing greater flexibility in moving resources and 
enhancing promotional opportunities at all grade levels.

* Appeals formed several working groups of managers and employees to 
address specific employee concerns and resolve elevated issues. 
Balanced Measures:

a. Agency Wide Employee Satisfaction:

Description: Measure of employee's satisfaction with their job at the 
IRS. At the Service-wide level, the results of Survey Item 17 
(Considering everything, how satisfied are you with your job?) are used 
as the sole determining factor in the externally reported results. 
Additionally, survey questions regarding employees' perception of 
management practices, organizational barriers, and overall work 
environment that impact an employee's efforts to do a good job are used 
in the internally reported results.

FY 2003 Performance: Improvement from the past two years continued in 
2003. IRS' greatest improvement was on the survey items addressing: 
receiving recognition (Q4); receiving feedback on progress (Q11); and 
having necessary materials and equipment (Q2). IRS provided results of 
"SURVEY2003" to employees for discussions in workgroups this summer, 
with subsequent action plans developed to ensure continued improved 
working conditions.:

IRS expanded the paperless survey administration Servicewide, based on 
the success of the paperless pilot conducted in the FY 2002. This 
allowed IRS to maximize the cost benefits, time savings, and user-
friendliness of an electronic mode of survey administration. Both web-
based and telephone-based administration modes were available in 2003. 
In FY 2002, 20% of all surveys were received on paper; that number 
dropped to 7% in 2003.

Responses to questions about training and development continue to 
improve. The addition of the employee scholarship program targeted at 
key staffing needs will reinforce our commitment to employee 
development. The Human Resources Investment Fund, established in 
response to earlier employee feedback about training needs, is 
continuing as a complement to the scholarship program.

Agency Wide Employee Satisfaction:

[See PDF for image]

[End of table]

Future Plans: Each IRS Business Unit will be encouraged to identify one 
or two specific areas of the survey that will be the focus of 
concentrated improvement actions. In the past year, this approach 
proved to be very beneficial for the Wage and Investment organization. 
IRS also plans to expand the use of Employee Satisfaction Tracker, an 
automated system that will facilitate its ability to monitor and hold 
managers accountable for actions taken in response to Employee 
Satisfaction survey data.

The most notable changes to the survey itself will involve further 
expansion of the paperless survey and the addition of new questions. In 
FY 2004, IRS plans to receive all surveys on the web or by phone. New 
survey questions will be added to provide information on the topic of 
safety and security.:

b. Lost Work Day Case Rate:

Description: The Lost Work Day Case Rate is the number of Federal 
Employee Compensation Act claim cases with lost time filed in the 
current fiscal year per 100 full-time equivalent employees. Each 
division is analyzing their specific data to determine the drivers of 
new claim cases and will prepare action plans addressing them once the 
analysis is complete.

FY 2003 Performance: Resource constraints prevented IRS from meeting 
the target despite the 20% improvement over 2002 levels. The 
improvements can be tracked to increased employee awareness of safety 
and health issues, improved employee training, and enhanced data 
capture of accidents and workplace hazards.

Lost Work Day Case Rate:

[See PDF for image]

[End of table]

Future Plans: In FY2004 IRS will enhance the data available from the 
Safety and Health Information Management System (SHIMS) to better 
detect safety hazards, reduce the impact of employee injuries and 
provide greater reporting capability.

III. System Controls and Legal Compliance:

Federal Managers' Financial Integrity Act (FMFIA) In accordance with 
the requirements of the Federal Managers' Financial Integrity Act, the 
Service evaluated its systems of internal controls for the fiscal year 
ending September 30, 2003. Our systems of management controls are 
designed to ensure that:



* Programs achieve their intended results:

* Resources are used consistent with the overall mission:

* Programs and resources are free from waste, fraud, and mismanagement:

* Law and regulations are followed:

* Controls are sufficient to minimize any improper or erroneous 
payments. The Service provides qualified assurance that the objectives 
of the FMFIA are being achieved. This qualified assurance is based on 
the existence of remaining material weaknesses and reportable 
conditions, all of which are being addressed by corrective action 
plans. The Service recommends closing the Financial Statements - 
Administrative material weakness and downgrading the material 
weaknesses, Internal Controls over Telecommunications Costs and 
Property Management to reportable conditions. With these 
recommendations the number of open material weaknesses for IRS is 
reduced from nine to six. The remaining weaknesses would be:

* Collection of Unpaid Taxes (scheduled to close April 2007):

* Demonstrate Capability to Manage Replacement of Tax Processing & 
Business Systems (Plan pending final approval):

* Financial Accounting of Revenue (May 2007 scheduled closing date 
under review):

* Earned Income Tax Credit Non Compliance (scheduled to close September 
2006):

* Computer Security (scheduled to close March 2004):

Measuring Taxpayer Compliance (scheduled to close March 2005) Federal 
Financial Management Improvement Act (FFMIA) As of September 30, 2003, 
the Service's financial management systems did not substantially comply 
with the FFMIA. Remediation Plans for Custodial and Administrative 
Financial Systems are in place to resolve this condition. Due to 
unanticipated data volumes and data quality problems related to the 
Custodial Accounting Project, the current February 2007 due date for 
the Remediation Plan for Custodial Financial Systems is under review 
and subject to change. The January 2006 proposed implementation date 
for Remediation Plan for Administrative Financial Systems is also under 
review due design and configuration issues and their impact on the 
testing process for the Integrated Financial System. These Plans are 
reviewed quarterly by the Office of Management and Budget as a 
stipulation for a waiver of the three year requirement for 
implementation of a FFMIA Remediation Plan.

Laws and Regulations:

As of September 30, 2003, the IRS did not always comply with section 
6325 of the Internal Revenue Code regarding the release of federal tax 
liens or with section 6159 of the code regarding the structuring of 
installment agreements. Reports Consolidation Act of 2000 The IRS FY 
2003 Performance and Accountability Report was prepared to comply with 
the Reports Consolidation Act of 2000. This act authorizes the 
consolidation of Federal financial and performance management reports 
while also satisfying the requirements of the Government Performance 
and Results Act. Limitations of the Financial Statements The principal 
financial statements have been prepared to report the financial 
position and results of operations of the entity, pursuant to the 
requirements of 31 U.S.C. 3515(b). While the statements have been 
prepared from the books and records of the entity in accordance with 
generally accepted accounting principles (GAAP) for Federal entities 
and the format prescribed by OMB, the statements are in addition to the 
financial reports used to monitor and control budgetary resources which 
are prepared from the same books and records. The statements should be 
read with the realization that they are for a component of the U.S. 
Government, a sovereign entity.

IV. Future Challenges:

IRS is influenced by two groups of external auditors (the General 
Accounting Office and the Treasury Inspector General for Tax 
Administration) who, through their reviews, identify Management 
Challenges and High Risk Areas that the IRS will face over the next 
several years (discussed in the next sub-section). As the IRS begins 
FY2004, it is faced with challenges, both from within and outside of 
its organization. The following discussion will identify some of the 
challenges, briefly discuss their nature, as well as the activities 
surrounding them.

Abusive Tax Shelters - By their nature, abusive tax shelters are 
varied, complex, and difficult to detect and measure. Abusive shelters 
may manipulate parts of the tax code or regulations and may involve 
steps to hide the transaction within a tax return. For example, 
preliminary profiling efforts by the IRS using data to determine 
characteristics of noncompliant taxpayer populations have identified 
over 227,000 business entities with almost $64 billion in income for 
tax year 2000 that potentially did not file tax returns. The IRS is 
using a broad-based strategy for addressing abusive tax shelters 
including: targeting promoters to head off the proliferation of 
shelters; making efforts to deter, detect, and resolve abuse; and 
offering inducements to individuals and businesses to disclose their 
use of questionable tax practices.

Technology Modernization Projects - After careful consideration and 
expert input from such prestigious groups as Carnegie Mellon, 
Acquisition Solutions, Bain & Co., and the Gardner Group, the IRS has 
determined the need to realign its priorities - that is, to select the 
key projects it must implement and focus on getting those up and 
running. To this end, the IRS is expected to announce before the end of 
2003 that it will reorganize the structure for managing its massive $8 
billion modernization effort.:

Private Collection Agencies - The IRS faces a significant and growing 
backlog of cases involving individual taxpayers who are aware of their 
tax liabilities but have not paid them. The IRS believes that many of 
these taxpayers have simply chosen not to pay, even though they have 
the means to do so. The Administration's FY 2004 budget proposes to 
support the IRS collection efforts with private collection agencies 
(PCAs) that will engage in carefully defined and limited collection 
activities.

PCAs can be an effective supplement to the IRS's collection efforts but 
cannot totally replace IRS collection resources. IRS employees have 
expanded knowledge and possess a number of enforcement powers and 
tools, such as the ability to levy and file liens on property, which 
could not properly be given to a PCA.

Taxpayer Attitudes - The IRS Oversight Board annually commissions an 
independent survey (Roper) to assess taxpayers' attitudes. The results 
of this latest survey show overall tax compliance levels are still high 
but have declined slightly, taxpayers are showing some softening in 
attitudinal support for compliance, fewer taxpayers agree that it is 
everyone's duty to pay their fair share of taxes, and feel that 
everyone who cheats should be held accountable. Other results from the 
Roper Survey disclosed that taxpayers continue to want the IRS to focus 
on America's rich when going after tax evaders, but compliance is 
increasingly expected of all. Personal integrity remains the strongest 
deterrent to noncompliance; however, fear of being audited is on the 
rise. Taxpayers also feel that most IRS customer service offerings are 
important, but receptivity to these offerings varies. And finally, the 
majority of the public is satisfied with their interaction with the 
IRS.

Major Management Challenges and High-Risk Areas:

Over the last several years the General Accounting Office (GAO) and the 
Treasury Inspector General for Tax Administration (TIGTA) have 
identified several Management Challenges and High-Risk Areas facing 
IRS. IRS has identified specific steps and actions to address these 
issues through its existing program activities. Measures of these 
program activities serve to show progress in addressing the management 
challenges and high-risk areas. A crosswalk showing the relationship 
between management challenges and IRS program activities is shown 
below.

[See PDF for image]

[End of table]

The following pages summarize each Management Challenge and High-Risk 
issue, FY 2003 accomplishments, and actions identified for completion 
in FY 2004 and beyond 47:

Systems Modernization of the IRS:

Successful completion of the modernization efforts will enable the IRS 
to balance the goals of helping taxpayers meet their tax responsibility 
and improving overall compliance with tax laws. Modernization of 
technology is crucial to implementing the new business vision of 
providing world-class service to taxpayers. While the development of 
new technology evolves, existing operations must continue, and 
improvements must be made to meet the needs of tax administration and 
demonstrate IRS' commitment to improve service to taxpayers. The IRS 
continues to make significant progress in improving its systems 
modernization and have demonstrated capability to manage replacement of 
Tax Processing and Business Systems but work remains before expected 
results are achieved.

FY 2003 Accomplishments:

* IRS continued to improve efforts in Business System and Tax 
Processing by modifying the Internet Refund/Fact of Filing (IRFoF) 
application to include the Advance Child Tax Credit,

* Initiated application for Internet Employer Identification Number 
(IEIN) which permits a new small business to apply for and receive an 
Employer Identification Number over the Internet.

* Conducted a study to benchmark IRS application development efforts 
allowing comparison of IRS performance to private industry systems 
modernization efforts. Achieved Software Acquisition Capability 
Maturity Model (SACMM) Level 2 for Business System Modernization Office 
(BSMO) --the first civilian agency of the U.S. Federal Government and 
the first multiproject organization to achieve that rating.

* Our prime support contractor consortium achieved SACMM Level 3, the 
first organization in the world to achieve that rating (The prime 
contractor's role is to design, build, and implement the program's 
information technology systems).

* Deployed Human Resources (HR) Connect.

* Established a new Deputy Commissioner for Operations to give 
attention to human capital practices, continued strong governance and 
rigid adherence to Enterprise Life Cycle (incorporates aspects of 
realizing a new business vision, from strategy development through 
system deployment and operation). FY 2004 Planned Actions:

* IRS will continue to respond to this challenge through 
institutionalizing configuration management procedures for BSMO, 
delivering electronic account resolution transcript delivery, secure e-
mail, disclosure authorization, and bulk Tax ID Number matching 
functionality via the e-Services project.

* Releasing the first segment of the Customer Account Data Engine 
(CADE) by providing key information supporting individual taxpayer 
account and return data.

* Deploying the first release of the Integrated Financial System to 
replace multiple IRS "Core" financial systems (including expenditure 
controls, accounts payable, accounts receivable, general ledger, budget 
formulation, and purchasing controls) with a single comprehensive 
modernized system.

* Implementing the first release of the Custodial Accounting Project 
that will provide detailed tracking information on tax receipts from 
individual filers.

Deploying the Modernized e-File system.

* Implementing effective procedures for validating contractor-
developed cost and schedule estimates by working with the prime 
contractor to develop and deploy best practice estimating capabilities 
consistent with Carnegie Mellon University's Software Engineering 
Institute (SEI).

* Initiating a review of the CADE project by SEI to improve project 
management and delivery.

* Continuing benchmarking efforts allowing comparison of IRS 
performance to that of similar efforts in private industry and:

Implementing analysis of program management by an independent 
contractor.

Processing Returns & Implementing Tax Law Changes during the Filing 
Season:

The filing season impacts every American taxpayer. Many programs, 
activities and resources have to be planned and managed effectively for 
the filing season to be successful. Critical programming changes for 
the filing season must receive priority over other programming 
requests. Although the FY 2003 filing season was a great success, the 
IRS still needs to address some problems in processing tax returns, 
specifically in the areas of the Rate Reduction Credit, Additional 
Child Tax Credit, undelivered refund checks and processing of small 
business corporate returns.

FY 2003 Accomplishments:

IRS continued the transition of its Campus locations into specialized 
processing sites for Business Master File (BMF) and Individual Master 
File (IMF) returns. This transition allows the IRS to focus BMF and IMF 
processing expertise and will result in greater consistency in taxpayer 
treatment. With the growth in electronic filing, Submission Processing 
sites are being reduced and efforts to place the impacted employees are 
being coordinated among the remaining operations at the site. Efforts 
were made to ensure that the required number of employees are available 
for each telephone tax law and account area based on forecasted 
workload Emphasis was also placed on continuing to improve the IRS web 
site usability and managing the web site throughout the filing season.

Actions Planned or Underway:

* Expand e-filing options by adding additional business forms 1120, 
1120s, 943, and 945, converting existing business forms to Extensible 
Markup Language and eliminating other barriers to BMF e-file.

* Implement initiatives to revise BMF forms including simplifying the 
Form 941 to reduce taxpayer burden and bar-coding Forms 1065 and 1120 
to improve processing accuracy and quality.

* Continue to enhance the functionality of the web site by providing 
new features such as enhanced search capabilities and presentation of 
results, tax applications and/or calculators of various types, and 
enhanced globalization to present web content in various languages.

* Develop secure access for taxpayers who file electronically to enable 
them to review their account electronically as required by the IRS 
Restructuring and Reform Act of 1998 (RRA98).

* Identify the appropriate configuration of states to Submission 
Processing sites for future IMF paper processing. (Multi-Year 
Initiative):

* Conduct a pilot of the Remittance Transaction Research system to 
enhance payment processing and provide payment information on-line.

* Ensure specialized procedures related to Disaster Relief,

i.e. Killed In Terrorist Action are used in processing identified 
returns. (Ongoing) Providing Quality Customer Service Operations: 
Improving Taxpayer Service Providing top quality service to every 
taxpayer in every transaction is an integral part of IRS' modernization 
plans. IRS provides customer service in many ways, including toll-free 
telephone service, electronic customer service, written communication 
to taxpayers, walk-in service, and accurate and timely tax refunds. 
Each of these services affects taxpayers' ability and desire to 
voluntarily comply with the tax laws.

FY 2003 Accomplishments:

The EZ Tax Filing initiative was implemented to meet the e-government 
objective of enabling on-line tax return entry and submission at no 
cost to the taxpayer. In addition, IRS provides multilingual services 
to Limited English Proficient taxpayers through increased bilingual 
employees and continued use of Over-the-Phone Interpreter service that 
provides interpreter services in over 150 languages. IRS has expanded 
pre-filing efforts for corporate taxpayers to assist taxpayers in 
filing correct, complete and compliant returns through pre-filing 
agreements and Industry Issue Resolutions. IRS has emphasized increased 
use of published guidance through the Published Guidance Program and is 
moving away from the more limited Private Letter Ruling program. An 
expedited clearance process, recently agreed to by IRS and Treasury, 
has increased the timeliness of published guidance. In addition, an 
Abusive Tax Shelter Hot Line is being used to provide interactive 
outreach for taxpayers who have pre-filing concerns regarding tax 
shelter promotions. IRS continued to improve the availability of on-
line services such as Internet Employer Identification Number, 
Centralized Authorization File, and Practitioner Priority Services as 
well as e-services for practitioners. Electronic interactions such as 
e-filing and e-paying were enhanced, communication with taxpayers was 
augmented through the development of e-government operations and 
employers were provided with access to online employment tax and wage 
information.

Actions Planned or Underway:

* IRS will continue redesigning and simplifying notices, forms and 
publications. Expansion of electronic payment options will continue 
with the development of a TeleFile/Internet electronic funds withdrawal 
application for notice payments and an electronic funds withdrawal 
(Direct Debit) application for installment agreements.

* IRS will continue working with private industry to expand low-cost 
Internet filing options.

* IRS will expand the work done on e-Services to include additional 
customer access to electronic transcript delivery, disclosure 
authorization, and electronic account resolution. 50:

Complexity of the Tax Law According to the FY 2002 National Taxpayer 
Advocate's (NTA) Annual Report to the Congress, the biggest problem 
that individual and business taxpayers had with IRS was tax law 
complexity. The problems caused by this complexity range from 
individual to corporate and international tax issues. It is unlikely 
that the Internal Revenue Code will be simplified at one time. 
Therefore, IRS has the challenge to remove as much complexity as 
possible as a service to taxpayers. The effect of tax law complexity is 
compounded as IRS modernizes. Since complexity can be a major factor in 
the cost of operations, IRS must devote resources to simplifying taxes 
while at the same time modernizing its systems and processes.

FY 2003 Accomplishments:

h.R 1528, the Taxpayer Protection and IRS Accountability Act of 2003 
passed by the House of representatives on June 19, 2003 contained 
several legislative recommendations from the 2001/02 National Taxpayer 
Advocate Annual Report to Congress. Highlights of this Act include the 
reform of penalty and interest provisions; improvement to the fairness 
of IRS collection procedures; improvement to the efficiency of tax 
administration; a temporary adjustment to The Trade Adjustment Act 
Health Insurance Tax Credit; enhancements to taxpayer information 
confidentiality; and authorization of low-income taxpayer clinics. The 
National Taxpayer Advocate will also continue to work with members of 
Congress and their staff to increase understanding and support of 
future legislative recommendations. April 15, 2002, Senator Jeff 
Bingamen (New Mexico) introduced three bills that have been referred to 
the Senate Finance Committee:

* S. 2129 - a bill to amend the Internal Revenue Code (IRC) to clarify 
that any home-based service worker is an employee of the administrator 
of home-based service worker program funding (one of the NTA's key 
legislative proposals):

* S. 2130 - a bill to amend the IRC to allow self-employed individuals 
to deduct health insurance costs in computing self-employment taxes:

* S. 2131 - a bill to amend the IRC to adjust the dollar amounts used 
to calculate the credit for the elderly and the permanently disabled. 
April 18, 2002, the House of Representatives passed HR 586, the Tax 
Relief Guarantee Act of 2002. This act contains provisions that were 
discussed in the 2001 annual report: interest abatement on erroneous 
refunds; Federal tax avoidance penalty; first-time penalty waiver; 
partial pay installment agreements; disclosure provisions regarding 
suicide threats; and return of levy or sales proceeds. In addition, the 
bill contains other provisions the NTA has discussed with members of 
Congress. They are:

* Individuals held harmless on wrongful levy, etc., on individual 
retirement plans;

* Seven-day threshold on tolling of statute of limitations during tax 
review; and:

* Authorization of appropriations for low-income taxpayer clinics. 51:

Actions Planned or Underway:

The following actions will enhance IRS' ability to reduce the 
complexity of the tax law: The NTA has identified potential legislative 
issues to be developed for the 2003 Annual Report to Congress and 
continues to work with members of Congress and their staff to increase 
understanding and support of the key legislative recommendations 
contained in the 2002 report. These legislative recommendations taken 
as a whole represent proposals that the NTA believes will either reduce 
complexity of the Code, reduce taxpayer burden in complying with the 
tax requirements, and protect taxpayer rights.

Tax Compliance Initiatives:

IRS' goal of providing world-class service to taxpayers hinges on the 
theory that if IRS provides the right mix of education, support, and 
up-front problem solving to taxpayers, the overall rate of voluntary 
compliance with the tax laws will increase. The compliance program 
(examining tax returns and collecting tax liabilities) addresses 
taxpayers who do not voluntarily comply. During the last decade, the 
number of tax returns selected for examination by IRS has decreased 
while the number of tax returns filed has increased. The challenge to 
IRS management is to establish a tax compliance program that identifies 
those citizens who do not meet their tax obligation, either by not 
paying the correct amount of tax or not filing proper tax returns, and 
effectively bring them into compliance.

FY 2003 Accomplishments:

Efforts in FY 2003 addressed compliance areas through better education 
of the public; systematic identification of promoters of Tax Shelters 
and participants; improvement in the efficiency of exam and collection 
efforts through reengineering; and reinvigoration of enforcement 
actions such as summons enforcement, injunctions and criminal 
investigation of promoters. IRS developed a comprehensive strategy that 
includes the Offshore Credit Card Project and Offshore Voluntary 
Compliance Initiative, which allows the IRS to identify and refocus our 
resources on the areas that offer the greatest compliance risk to the 
tax system. IRS continued to make significant progress in collecting 
better compliance and non-compliance data.

Actions Planned or Underway:

The following activities will allow IRS to implement a balanced 
compliance program:

* Continue to develop and refine methodologies to identify, prioritize 
and monitor Reporting Compliance Risks, specifically addressing key 
areas of noncompliance with the tax laws including the promotion of 
abusive tax schemes, the misuse of devices such as offshore accounts to 
hide or improperly reduce income, Special Purpose Entities, the use of 
abusive corporate tax avoidance transactions, the non-filing and 
underreporting of income by higherincome individuals, flow-through 
entities and other strategies used to mask questionable structured 
transactions by high-income taxpayers. Address those engaging in 
abusive tax practices through enforcement, full implementation of K-1 
matching, education and research.

* Enhance Published Guidance regarding Abusive Tax Transactions (ATAT) 
by developing and implementing a process for early identification of 
ATAT transactions. 52:

* Expand the use of limited issue focused examination processes; 
explore remote audit alternatives and audit team composition /placement 
practices.

* Improve issue management process including resolution and settlement 
strategies by applying alternative dispute resolution procedures and 
other issue resolution programs such as Pre-filing Agreements, Industry 
Issue Resolutions and Fast Track to resolve tax shelter issues in 
timely and consistent manner.

* Focus pre-filing efforts on abusive trusts, e-commerce, flow-through 
entities, voluntary agreements and burden reduction.

* Implement the Curb Egregious Noncompliance initiative to balance 
compliance efforts, support tax law enforcement, and provide the 
necessary increase in resources across all major compliance programs 
while leveraging new workload selection systems and case building 
approaches developed through re-engineering.

* Develop Potentially Collectible Inventory performance measures that 
give insight into new causes of growth in accounts receivable.

* Focus on reducing pyramiding of trust fund taxes among in-business 
taxpayers to address employment tax noncompliance to decrease the 
accounts receivable inventory.

Develop and implement a multifunctional non-filer strategy that will 
target outreach and compliance efforts. Based upon research results, 
develop alternative treatments to influence non-filing taxpayer 
behavior and promote compliance.

Erroneous Payments; Earned Income Credit Noncompliance:

Both the President and the Congress have expressed concerns with the 
large amount of erroneous payments made by Federal agencies each year. 
The risk of improper payments increases in programs with complex 
criteria for computing payments, a significant volume of transactions 
or emphasis on expediting payments. Although many IRS programs are 
susceptible to erroneous payments, the Earned Income Tax Credit (EITC) 
Program is particularly vulnerable. Each year the IRS spends over $100 
million to help ensure that eligible taxpayers claim the EITC and to 
reduce over-claims and fraud, waste and abuse. However, IRS does not 
have a process to identify and stop refunds on many tax returns using 
tax processing identification numbers, such as Individual Tax 
Identification numbers (ITIN) and erroneously claiming the EITC. IRS 
also faces erroneous payment issues in other program areas such as 
vendor over payments and specious tax claims.

IRS will use compliance study data and risk analysis to determine which 
EITC filers claiming children are most likely to meet the residency 
requirements. We are addressing potentially erroneous claims before 
they are accepted for processing and before any EITC benefits are paid.

FY 2003 Accomplishments:

IRS closed more than 262,000 examinations, exceeding the FY 2003 target 
by 3.3%, and as a result, EITC dollars recovered were almost 20% ahead 
of FY 2002. Processing year 2002 audit results were analyzed to refine 
existing Dependent Data base (DDb) business rules.

Actions Planned or Underway:

IRS will continue to respond to this challenge through the following 
planned actions:

* Commence EITC research efforts to identify ways to reduce EITC 
erroneous payments as well as identify trends in the diverse EITC 
taxpayer population. Use the results of these studies for strategic 
planning of the EITC program.

* Continue participation in a government-wide task force on erroneous 
payments.

* Finalize work on the EITC preparer cases already being actively 
investigated and prepared for prosecution.

* Develop a procedure that will allow IRS to obtain the National 
Directory of New Hires from Health and Human Services to provide 
quarterly employee wage information by employer and information on 
newly hired employees.

* Pilot a qualifying child residency certification program.

* Develop cross-divisional examination strategies that quickly react to 
changing EITC compliance trends.

* Establish a specific EITC threshold in the Underreporter Program.

* Explore new data sources to enhance Dependent Database usability.

* Evaluate public comments from Announcement 2003-40 regarding EITC 
pre-certification activities and determine follow-up actions for Tax 
Year 2004.

* Identify states with EITC Programs and explore partnership 
opportunities. Collect Unpaid Taxes Collecting taxes due the government 
has always been a challenge for IRS, but in recent years the challenge 
has grown. Between 1996 and 2001, the compliance and collection 
programs experienced larger workloads, less staffing, and fewer numbers 
of cases closed per employee. By the end of fiscal year 2001, IRS was 
deferring collection action on about one out of every three tax 
delinquencies assigned to the collection program. To counter this 
trend, the IRS intends to improve the productivity of IRS's existing 
compliance and collections staff and better target noncompliance. IRS' 
new effort to review compliance, the National Research Program (NRP), 
will provide IRS with information on compliance rates and sources of 
noncompliance.

FY 2003 Accomplishments:

IRS developed a comprehensive strategy and approach to modernize 
technology and collection processes. Included are efforts to develop 
and analyze payment and compliance data for both strategic and 
operational purposes, establish baseline measures for payment 
compliance, facilitate better decision making and gauge program 
effectiveness, and to develop support tools that allow IRS to improve 
its resource allocation processes. The NRP is currently implementing a 
reporting compliance study for individual income tax filers. In 
addition, a Strategic Compliance Planning Model (SCPM) has been 
developed to study the effect of optimizing the Service's expected 
budgets for compliance activities across Operating Divisions, programs, 
activities, and geographic locations. This model is intended for use as 
part of the strategic planning process to perform "what-if" analyses of 
different budget allocations and other key assumptions.

Actions Planned or Underway:

IRS will continue to respond to this challenge through the following 
planned actions:

* Provide ACS Collection Representatives with better tools to improve 
efficiency, effectiveness, and quality and case resolution.

* Pursue using Private Collection Agencies (PCAs) to support IRS 
collection efforts and allow IRS to focus limited resources on more 
complex cases and issues.

* Implement Collection Tax Delinquent Account (TDA) Reengineering to 
better identify cases with a high or low propensity to pay or to be 
unproductive in order to optimize efforts.

* Develop and analyze payment and compliance data to set baselines, 
targets and develop strategies annually.

* Develop and implement the filing and payment compliance modernization 
project.

* Develop risk-based compliance approaches for both collection and 
examination activities, including Installment Agreements with 
taxpayers. Ensure that proposed long term-solutions are aligned and 
technically compatible. Develop and implement multiple treatment 
alternatives with the tone, treatment and timing of interaction 
proportional to the risk of the taxpayer.

* Analyze results of the National Research Program to identify pockets 
of noncompliance and to develop pre-filing, filing and post-filing 
strategies to address the findings.

* Develop a TeleFile/Internet electronic funds withdrawal application 
for notice payments and Direct Debit application for Installment 
Agreements to facilitate payments:

* Develop a comprehensive strategy to address the growing inventory of 
accounts receivable and maximize the effectiveness of resources 
targeted to identifying and collecting unpaid tax liabilities.

* Develop a legislative proposal and initiative for collection contract 
support.

Develop proof-of-concept applications using advanced technologies to 
improve workload selection processes, including tax shelter activity, 
high-income taxpayer noncompliance, and detection of tax shelters using 
relational data mining techniques. Integrating Performance and 
Financial Management - Financial Management; Compliance with Federal 
Financial Management Improvement Act (FFMIA) of 1996:

The IRS' financial management systems remain a challenge to the IRS 
management, despite producing, for the third consecutive year, combined 
financial statements covering the IRS' tax custodial and administrative 
activities, and achieving an unqualified audit opinion from the General 
Accounting Office (GAO). IRS' current financial systems alone cannot 
produce reliable information necessary to prepare financial statements 
in accordance with federal accounting standards. The data produced from 
the current financial system has to be reconciled with other subsidiary 
systems to produce reliable financial statements. The IRS lacks the 
timely, accurate, and useful information needed to make informed 
management decisions on an ongoing basis.

FY 2003 Accomplishments:

To improve overall financial management, IRS is implementing two major 
systems: the Custodial Accounting Project (CAP) and the Integrated 
Financial System (IFS). The CAP project will improve IRS' compliance 
with FFMIA and other financial management laws and standard, as well as 
support GAO financial audits. 55:

CAP will be built in a series of incremental releases with release 1 
including Individual Master File data, Financial Management Service 
goals, General Ledger Data and an interface with IFS. The Systems 
Development phase was completed and development of the project began 
with progress being made towards achieving a February 2004, 
implementation date of Release 1. The IFS project will deploy a new 
management system to the IRS that will give the IRS timely and easier 
access to accurate and consistent financial data resulting in improved 
decisionmaking and management of the organization. Significant progress 
was made on IFS in FY 2003, including identifying key process flows, 
systems configuration, system functionality testing, performance and 
technical testing, data conversion from current financial system 
historical data, coordination and creation of interfaces and user 
training.

Actions Planned or Underway:

IRS will continue to respond to this challenge through the following 
actions:

* CAP Release 1 will provide detailed tracking information on tax 
receipts from individual filers based on IMF data, FMS goals, General 
Ledger Data and IFS Interfaces.

The first release of IFS is scheduled for deployment and will include 
the Core Financial System as defined by the Joint Financial Management 
Improvement Program including, General Ledger, Accounts Payable, 
Accounts Receivable, Funds and Cost Management, and Financial 
Reporting.

Integrating Performance and Financial Management - Performance 
Management; Performance Measures and Cost-Based Performance 
Information:

The IRS Strategic Planning and Budget process, which includes the 
Annual Performance Plan and Annual Performance Report, satisfies a 
major requirement of the GPRA. However, IRS' critical performance 
measures do not address all of the strategies listed in the IRS 
Strategic Plan and do not support a significant portion of the IRS' 
budget request. The General Accounting Office (GAO) cited that IRS 
could do a better job of designing and implementing performance 
measures and program evaluations practices that support its on-going 
business operations, modernization efforts and budget requests. 
Further, IRS could make additional progress in linking its budget 
request to intended results so that Congress could make more informed 
budget decisions and better assess IRS' use of resources. GAO also 
noted that IRS still lacks a centralized and integrated cost accounting 
system capable of providing timely and reliable cost information 
related to its activities and programs. Without such a system, managers 
may lack ready information to manage costs and make decisions.

FY 2003 Accomplishments:

All business units have approved balanced measures composed of business 
results quantity and quality, customer satisfaction and employee 
satisfaction. Divisions used balanced measures to report to the 
Commissioner on executing their workplans, and also as the cornerstones 
for building their strategic plans. Divisions are still in the process 
of deploying and setting targets for their balanced measures down to 
the Area office (or equivalent) level. IRS is continuing to implement 
Embedded Quality (EQ), which revamps the way quality is measured, 
calculated, and reported in the sites. EQ creates accountability by 
connecting employee evaluations directly to the corporate balanced 
measures in a fair and meaningful way.

IRS began updating its strategic plan for FY 2003-2008. The new plan 
will link the strategic goals and objectives to the performance goals 
in the Annual Performance Plan and to the Budget. Performance data is 
collected, collated and reported through the Data, Mart and Business 
Performance Management System (BPMS) for most of the IRS critical 
measures. IRS is also continuing to expand use of OMB's Program 
Assessment Rating Tool (PART). A five year-PART plan has been developed 
with new programs being added each year to reach the goal of 100% of 
IRS programs being reviewed in five years.

Actions Planned or Underway:

IRS will continue to respond to this challenge through the following 
actions:

* Review current performance measures to transition from a largely 
output based system, to one focusing on evaluating the outcomes for all 
major processes.

* Complete update and publish IRS strategic Plan for FY 2003-2008, 
linking strategic goals and objectives to performance goals in the 
Annual Performance Plan and the Budget.

* Continue to automate data collection and reporting through Data Mart 
and BPMS.

* Develop the linkage between IRS' operational critical measures and 
its relevant strategic measures to better align resource decisions to 
achieving strategic outcomes.

* Develop strategic measures for all major operating divisions.

* Deploy the Integrated Financial System (IFS) provide the IRS timely 
and easier access to accurate and consistent financial data resulting 
in improved decision-making and management of the organization. IFS is 
being designed to be compliant with JFMIP, with a goal of eventually 
being FFMIA compliant. Once the Integrated Financial System (IFS) is 
implemented in 2004, IRS will continue to respond to this challenge 
through the following actions:

* Begin capturing the full cost of IRS's resources in FY 2004.:

* Allocate overhead costs based on proven business methodologies, that 
are consistently applied, easy to maintain and will support internal 
and external audits.:

* Track the receipt and distribution status of funds by appropriation 
in compliance with federal appropriation laws through the IFS Funds 
Management module.:

* Track and control resources to a specific organizational unit and 
level of responsibility.:

* Provide both direct and indirect cost data, this will help the move 
the Service forward in transitioning to a Performanced-Based 
Organization through the Cost module.:

Produce integrated and reliable financial statements and reports with 
minimal reliance on data from legacy systems.

Security of the IRS - Information Security:

IRS has made considerable progress toward improving computer security 
controls. Despite this progress, more work remains to achieve an 
acceptable level of assurance that automated systems and taxpayer data 
are not placed at risk from both internal and external threats. As the 
primary revenue collector for the United States, IRS is a target for 
both terrorists and hackers. This threat has increased over the last 
few years as a result of both internal factors (such as increased 
connectivity of systems) and external factors (such as the volatile 
threat environment resulting from increased terrorist activity). While 
many steps have been taken to limit risk, IRS systems and taxpayer 
information remain vulnerable to threats impacting the confidentiality, 
integrity, and availability of data and information systems. 57:

FY 2003 Accomplishments:

In FY 2003, development and documentation of improved IRS wide security 
policies, guidelines, standards and procedures for access controls, 
configuration management, and audit trails was completed. 
Implementation, assessment and analysis of security controls was 
completed for border, domain and other routers and switches. Day-to-day 
guidelines, rollout schedules, and training programs relating to the 
implementation of access controls, configuration management, and audit 
trails controls throughout the IRS computing environment were 
developed. Rollout schedules and training program relating to security 
roles and responsibilities were deployed, including implementing 
Federal Information Security Management Act (FISMA) related training. 
Development, implementation, and monitoring of the security curriculum 
for key IT security personnel was completed. substantial progress was 
made toward certification of IRS sensitive systems. Improved disaster 
recovery capability was implemented for IRS critical information 
systems. Continuity exercises were expanded to include larger 
enterprise functions and all response capabilities. Incident Command 
System training was provided to key personnel. Annual security control 
reviews of IRS systems were conducted in compliance with the Federal 
Information Security Management Act of 2002, using NIST Special 
Publication 800-26. IRS intrusion detection and response capability was 
refined and further integrated with emergency preparedness plans and 
procedures. Backup capability for IRS Computer Systems Incident 
Response Center was initiated, providing improved assurance for IRS 
networks. Final phase of physical security upgrades was started to 
increase the control level of critical IRS information processing 
facilities to Department of Justice Level V.

Actions Planned or Underway:

IRS will continue to respond to this challenge through the following 
planned actions:

* Conduct independent compliance assessments to verify and validate 
that security policies, procedures, guidelines and change control 
processes implemented during FY 2003 operate as planned, and are 
consistently meeting compliance requirements throughout the computing 
environment. (09/2004):

* Work with GAO and TIGTA to verify that IRS' disaster recovery 
capability for Masterfile is in place and in compliance with all 
requirements for that capability. (09/2004):

* Complete full certification of IRS sensitive information systems. 
(09/2004):

* Further expand training, testing and exercise activities for business 
continuity. (09/2004):

* Complete Level V physical security enhancements at critical 
information processing facilities. (09/2004):

* Implement a more robust day-to-day execution and monitoring of 
security controls to ensure that key security controls are consistently 
implemented and in place. (09/2004):

* Conduct annual security control reviews of information and 
information systems in compliance with the Federal Information Security 
Management Act of 2002, using NIST Special Publication 800-26. (09/
2004):

* Implement more robust compliance and oversight methodologies to 
ensure that taxpayer information and IRS information and information 
system assets are safeguarded. (09/2004):

* Conduct annual security reviews of information and information 
systems as required by the Federal Information Security Management Act, 
supplementing these reviews with in-depth assessments of security 
controls over critical information assets. (09/2005):

Continue to track and mitigate identified security weaknesses, 
identifying and implementing adjustments to policies procedures and 
guidelines as necessary to maintain consistent controls throughout the 
computing environment. (09/2005):

* Update business continuity plans and programs in response to changes 
in threat conditions. (09/2005):

* Complete backup capability and processes for IRS Computer Systems 
Incident Response Center. (09/2005):

Maintain currency of intrusion detection technologies and practices in 
order to maintain a low level of risk of damage from hacker and 
terrorist activities targeting IRS networks. (09/2005):

Security of the IRS - Employees and Facilities Recent terrorist attacks 
highlighted vulnerabilities in many businesses and government agencies. 
This terrorist activity within the United States demonstrated very 
graphically that the physical security of IRS employees, equipment, and 
structures should be of utmost concern to IRS management. The IRS must 
remain vigilant to all opportunities to enhance the safety of 
employees.

FY 2003 Accomplishments:

National Physical Security Standards were developed to establish 
security enhancements for areas such as guard services, blast 
mitigation, and the infrastructure of all IRS offices. IRS conducted an 
assessment of all IRS buildings and facilities based upon current and 
proposed security standards and began a security risk assessments of 
all Level 1, 2, and 3 buildings. IRS participated in government-wide 
programs that plan for and minimize the risk of catastrophic events on 
mission achievement. Headquarters' continuity of operations (COOP) 
capabilities and enterprise situation awareness management 
capabilities (SAMC) were enhanced.

Actions Planned or Underway:

IRS will continue to respond to this challenge through the following 
planned actions:

* Continue to work with GSA and law enforcement agencies to safeguard 
personnel and assets.

* Closely monitor procedures regarding the inspection of incoming mail 
and packages.

* Continue implementation of security enhancements.

* Continue to participate in government-wide programs that plan for 
disaster response.

* Continue to enhance and maintain COOP and SAMC initiatives.

* Complete security risk assessments of Level 1, 2, and 3 buildings. 
Implement appropriate corrective measures and/or upgrades, subject to 
funds availability and consistent with comparable GSA scheduling for 
Level 4 buildings.

* Develop and incident command structure, using the Senior Commissioner 
Representatives as the Command Manager.

* Identify appropriate protective measures for all IRS facilities in 
accordance with the National Physical Security Standards. 59:

Human Capital:

Like many other government agencies, IRS continues to face a range of 
serious personnel management issues, ranging from recruiting, training, 
and retaining employees to problems associated with IRS' recent 
reorganization and modernization efforts. Although IRS initiated 
actions to incorporate a workforce planning process into its strategic 
planning process, IRS management has not established a project plan 
that assigns responsibilities and includes milestones for each step in 
the process.

FY 2003 Accomplishments:

The IRS is implementing a comprehensive Human Capital Strategy that is 
based upon six human capital standards for success: strategic 
alignment, workforce planning and deployment, leadership and knowledge 
management, performance culture, talent, accountability. IRS developed 
a phased retirement program for potential use as incentives for 
employees in critical job series to extend their association with the 
IRS. IRS also received the authority for waivers to annuity offsets in 
order to benefit from the vast experience of annuitants. A robust 
succession planning model was developed and the use of executive search 
assistance in filling critical executive positions has been 
implemented. A new, competency-based, transformational leadership 
development program was introduced to equip current and future leaders 
for increased service to both IRS employees and taxpayers. All 70,000 
front-line employees were trained on customer satisfaction strategies, 
to reinforce IRS' mission and improve performance. Balanced measures 
training was provided for all managers to reinforce the importance of 
individual accountability for organizational performance. Training has 
been decentralized to give the operating divisions responsibility for 
technical training so it can be tailored to meet the needs of their 
specific taxpayers.

Actions Planned or Underway:

IRS will continue to respond to this challenge through the following 
planned actions:

* Evaluate each human capital initiative for workforce impact and 
determine effective and appropriate mitigation strategies to address 
the results.

* Determine and approve bargaining strategies for each human capital 
initiative to reach agreement with NTEU.

* Build managerial capacity to implement complex organizational change 
with minimal productivity loss during the transition to the new and 
more efficient structure.

* Implement a multi-year recruitment/marketing strategy that includes 
the expansion of the internet employment website, a complete print 
media advertising campaign, market research, and an extensive internet 
media advertising campaign.

* Develop a Competency Models/Occupational Analysis for all positions 
within the IRS to identify competencies necessary for successful 
performance in all of our frontline occupations, target recruitment 
based on skill gaps, and to target individual/employee training 
opportunities based on skill gaps.

* Develop a Career-Pathing process that focuses on training, 
application, assessment and feedback to provide opportunities to 
develop technical expertise needed for senior professional (SP) 
positions.

* Extend partnerships with key colleges and universities. 60:

* Improve recruiting performance through such initiatives as expansion 
of category ratings and the increased use of simulations in assessing 
job applicants--particularly in the areas of Customer Service 
Representatives and Revenue Agents.

* Expand use of the internet for recruiting.

* Implement QuickHire, an Internet-based tool that automates the hiring 
process and allows for web-based submission of job applications.

* Use the personnel flexibilities granted under Restructuring and 
Reform Act of 1998:

* (RRA '98) and will push for new flexibilities that help with 
workforce renewal.

* Ensure that the IT infrastructure is robust enough to handle 
comprehensive e-learning systems.

Design refresher training for managers to use tailored case studies and 
simulations in training, providing hands on experience to realize the 
"stepping stone" approach.

Taxpayer Protection and Rights IRS effected an independent review to 
determine its compliance with the Restructuring and Reform Act of 1998 
(RRA 98) Section 1204, which prohibits the use of enforcement 
statistics to evaluate IRS employees or to impose or suggest production 
quotas or goals. In addition, all IRS Appropriate Supervisors certify 
each quarter that they have not improperly used enforcement statistics 
in evaluating employees. Separately, the National Taxpayer Advocate 
began several national initiatives to identify areas for improving 
Taxpayer Advocate Services processes and procedures to improve 
performance in offices with low scores. A study was also performed of 
the Federal Case Registry of Child Support Orders (FCR) to evaluate the 
accuracy and timeliness of the data contained in the FCR/Dependent 
Database. Correspondence audits were conducted for the sample of Earned 
Income Tax Credit taxpayers selected in the study.

Actions Planned or Underway:

In FY 2004, IRS will focus on taxpayer groups that are at higher risk 
of non-compliance to maintain confidence in the integrity of our tax 
administration program; fully implement the K-1 matching program, 
reconciling partnership income reporting documents to the beneficiaries 
of this income on federal income tax returns; partner with state taxing 
agencies to implement programs that compare state tax information with 
federal income and/or employment tax return information; and, refine 
procedures to certify compliance with the requirements of Title VI of 
the Civil Rights Act of 1964 to provide equal access and non-
discriminatory services to all eligible taxpayers.:

V. Financial Highlights Stewardship Information Analysis:

Overview of Revenue and Administrative Accounts The IRS' financial 
statements and footnotes received an unqualified audit opinion for the 
fourth consecutive year for administrative accounts and the seventh 
consecutive year for revenue accounts. Administrative accounts reflect 
resources used and expenses incurred in administering the tax laws. 
Revenue accounts reflect net taxes receivable and taxes collected to 
support the federal government. The Balance Sheet reflects total assets 
of $ 24.80 billion. Of these assets, almost 81 percent are Federal 
Taxes Receivable. These receivables are the amounts expected to be 
collected from past due accounts. The increase in assets of $ 0.09 
billion is primarily attributable to increased capital investment in 
software. The majority of the liabilities, almost 87 percent, consist 
of amounts due to Treasury related to Federal Taxes Receivable. The 
Statement of Custodial Activity shows that IRS programs resulted in $ 
1.952 trillion in Federal receipts. IRS collections constitute 96 
percent of the Federal Government receipts, as shown in the following 
chart.

Total Federal Receipts - (Percent):

[See PDF for image]

[End of figure]

b. Financing Sources The IRS receives the majority of its funding 
through annual, multiyear appropriations which are available for use 
within certain specified statutory limits. There are three major and 
several minor operating appropriations. The Processing, Assistance and 
Management appropriation funds the processing of tax returns and 
related documents, assistance for taxpayers in the filing of their 
returns and paying taxes due, matching information with returns,

Budget Fiscal Year 2003 Appropriations - (Percent):

[See PDF for image]

[End of figure]

conducting internal audit reviews and security investigations, and 
managing financial resources. The Tax Law Enforcement appropriation 
provides funds for the examination of tax returns and the 
administrative and judicial settlement of taxpayer appeals of 
examination findings. The Information Services appropriation funds 
costs for data processing and information and telecommunications 
support for the Service's activities. The Business Systems 
Modernization Account and the tax credit program appropriations are the 
most significant of the minor operating appropriations. The former 
funds capital asset acquisitions of information technology systems. The 
latter provides resources for expanded customer service and outreach, 
strengthened enforcement, customer education, and enhanced research to 
reduce valid claims and erroneous filings associated with Earned Income 
Tax (EITC) and Child Care Tax (CCTC) Credits and to administer the 
Health Care Tax Credit (HCTC). Besides appropriations, the Service 
utilizes other financing sources. These include net transfers from 
other federal agencies, receipts of penalty and interest payments 
related to assessed taxes, User Fees for direct services provided to 
customers (for example, installment fees, photo copy fees, and letter 
rulings and determinations fees), and imputed financing (subsidies from 
other federal funds that cover specific expenses such as retirement 
benefits).:

c. Use of Resources The Statement of Net Cost reflects the use of 
resources in carrying out the agency's major programs. The major 
programs are Pre-filing, Filing and Account Services, Compliance, and 
Administration of Tax Credit Programs (EITC and CCTC and HCTC). Pre-
filing activities include taxpayer education and outreach, pre-filing 
agreements, and tax publication issuance and distribution. Filing and 
account services activities include the filing of tax returns, current 
account status, and processing of taxpayer information. Compliance 
activities include document matching, audits, and criminal 
investigation activities. Administration of the tax credit programs 
includes EITC and CCTC pre-filing, filing and account services, and 
compliance activities, and HCTC health insurance tax credit program 
activities.

How the Service Used Its Resources - (Percent):

[See PDF for image]

[End of figure]

Revenue and Refund Trend Information:

Federal tax revenues are collected through six major classifications: 
individual income, corporate income, excise taxes, estate and gift 
taxes, railroad retirement, and Federal unemployment taxes. Overall 
revenue receipts (approximately $1.952 trillion) for FY 2003 decreased 
by approximately 3 percent. Individual income taxes, which include both 
FICA and SECA taxes, decreased by more than 2 percent. Corporate income 
taxes decreased by 8 percent. Collections from all other tax sources 
decreased 4 percent from 2002 to 2003. The decline in receipts reflects 
lower marginal tax rates enacted as part of the Economic Growth and Tax 
Relief Reconciliation Act of 2001 (EGTRRA) which impacted withholding 
tables in January 2002. Decreases in equity valuations during 2002, as 
evidenced by a decrease in the S&P 500 Index, are believed to have led 
to a significant decrease in capital gains realizations and income from 
the exercising of stock options, contributing to the decrease in net 
individual income tax collections. The decrease in net corporate tax 
receipts can be attributed to two onetime deposit rule provisions: 
EGTRRA allowed corporate taxpayers to shift the estimated payment 
normally due on September 17, 2001 (FY01) to October 1, 2001 (FY02) and 
IRS relief for those affected by the events of September 11th allowed 
taxpayers to further shift these payments to January 2002. FY02 
receipts were inflated by these one-time shifts allowed for FY01 which 
did not occur in FY03. The entire amount of Federal revenue received in 
2003 was distributed to Treasury.

Collections of Federal Tax Revenue:

[See PDF for image]

[End of figure]

Federal tax refund activity, which includes tax, interest, the special 
tax rebate authorization, payments for Earned Income Tax Credits, and 
Child Care Tax Credits in excess of the tax liability was $300 billion. 
In fiscal year 2003, the Service issued $14 billion in advance payments 
of the child care tax credit in accordance with the Jobs and Growth Tax 
Relief Reconciliation Act of 2003 (Public Law 108-27). Overall refund 
disbursements increased by 7 percent. The table below shows that all 
tax class refunds remained consistent year to year with the exception 
of the Individual income, FICA/SECA and other refunds class, which 
reflects the advanced child care tax credit payments made pursuant to 
Public Law 108-27.

Federal Tax Refund Activity:

[See PDF for image]

[End of figure]

Analysis of Unpaid Assessments:

Most Unpaid Assessments Are Not Receivables and Are Largely 
Uncollectible As reflected in the supplemental information to IRS' 
fiscal year 2003 Financial Statements, the unpaid assessment balance 
was about $246 billion as of September 30, 2003. This unpaid assessment 
balance represents assessments resulting from taxpayers filing returns 
without sufficient payment; as well as from the Service's enforcement 
programs such as Examination, Underreporter, Substitute for Return, and 
Combined Annual Wage Reporting. A significant portion of this balance 
is not considered a receivable. In addition, a substantial portion of 
the amounts considered receivables is largely uncollectible. Under 
federal accounting standards, unpaid assessments require taxpayer or 
court agreement to be considered federal taxes receivable. Assessments 
not agreed to by taxpayers or the courts are considered compliance 
assessments and are not considered federal taxes receivable. 
Assessments with unlikely future collection potential are called 
writeoffs. Figure 1 depicts the components of the unpaid assessments 
balance as of September 30, 2003.

Figure 1: Components of IRS' $246 Billion of Unpaid Assessments:

[See PDF for image]

[End of figure]

Of the $246 billion balance of unpaid assessments, $126 billion 
represents write-offs. Writeoffs principally consist of amounts owed by 
defunct taxpayer's and include many failed financial institutions 
resolved by the Federal Deposit Insurance Corporation (FDIC) and the 
former Resolution Trust Corporation (RTC). The remaining amounts are 
owed by taxpayers with extreme economic and/or financial hardships, 
deceased taxpayers, and taxpayers who are insolvent due to bankruptcy.

:

Figure 2 depicts the components of the write off balance as of 
September 30, 2003.

Figure 2: Components of IRS' $126 Billion of Write offs:

[See PDF for image]

[End of figure]

In addition, $31 billion of unpaid assessments represent amounts that 
have not been agreed to by either the taxpayer or a court. These 
assessments result primarily from various Service enforcement programs 
to promote voluntary compliance. Due to the lack of agreement, these 
compliance assessments have less potential for future collection than 
the unpaid assessments that are considered federal taxes receivable. 
The remaining $89 billion of unpaid assessments represent federal taxes 
receivable. About $69 billion (78%) of this balance is estimated to be 
uncollectible due primarily to the taxpayer's economic situation, 
including individual taxpayers who are unemployed, are currently in 
bankruptcy, or have other financial problems. However, under certain 
conditions, IRS may continue collection action for 10 years after the 
assessment. Thus, these accounts may still ultimately have some 
collection potential if the taxpayer's economic condition improves. 
About $20 billion, or about 23%, of federal taxes receivable is 
estimated to be collectible. Components of the collectible balance 
include installment agreements with estates and individuals, confirmed 
payment plans through bankruptcy, and some newer amounts due from 
individuals and businesses with a history of compliance. The taxes 
receivable amount from September 30, 2002, to September 30, 2003, 
increased from $87 billion to $89 billion. The percent estimated to be 
collectible at September 30, 2003 (22%), decreased slightly from 
September 30, 2002 (23%). Figure 3 depicts the taxes receivable balance 
that is considered collectible and uncollectible as of September 30, 
2003.

Figure 3: Components of IRS' $89 Billion of Taxes Receivable:

[See PDF for image]

[End of figure]

It is also important to note that the unpaid assessment balance 
contains unpaid assessed tax, penalty, and interest, and accrued 
penalty and interest computed through September 30, 2003.

About $154 billion (63%) of the unpaid assessment balance as of 
September 30, 2003, contains interest and penalties, as depicted in 
figure 4, and are largely uncollectible. Figure 4 depicts the Unpaid 
Taxes and Interest and Penalty Components as of September 30, 2003.

Figure 4: Unpaid Taxes and Interest and Penalty Components of $246 
Billion in Unpaid Assessments:

[See PDF for image]

[End of figure]

Interest and penalties are such a high percentage of the balance 
because IRS must continue to accrue them through the 10-year statutory 
collection date, regardless of whether an account meets the criteria 
for financial statement recognition or has any collection potential. 
For example, interest and penalties continue to accrue on write-offs, 
such as FDIC and RTC cases, and on exam assessments where taxpayers 
have not agreed to the amount assessed. The overall growth in unpaid 
assessments during fiscal year 2003 was mostly attributable to the 
accrual of interest and penalties.

ADDENDUM: President's Management Agenda:

ADDENDUM: President's Management Agenda:

The IRS made steady progress on the President's Management Agenda this 
year and we still have room for improvement. IRS adjusted its "Getting 
to green plans" to reflect the new "Proud to be" criteria and refined 
its milestones to achieve these goals by July 2004. The table below 
summarizes the Department of the Treasury's self-score of IRS' status 
and progress for all four quarters of FY 2003.

IRS Overall Ratings as of September 30, 2003:

[See PDF for image]

[End of figure]

* Implemented an Integrated Workforce Planning System that forecasts 
multi-year hiring requirements:

* Developed a 5-Year Staffing Plan for critical occupations:

* Implemented a Succession Planning Management System as a key source 
for filling executive positions:

* Implemented a MS/MBA Pilot Program in accounting and taxation:

* Established an E-Training Partnership with OPM to join their Go-Learn 
effort with our new elearning system:

* Introduced a new Department Manager Leadership Curriculum:

* Extended Pay-for-Performance System to Department Managers:

* Enhanced Performance Management System for employees:

* Implemented a new National Performance Awards Agreement:

* Expanded Category Rating usage for determining job applicants' 
qualifications:

* Received OPM's preliminary approval to implement the Senior 
Leadership Demonstration Project that fundamentally changes executive 
human capital management in the IRS:

* Began the roll-out of HR Connect to replace the existing IRS 
automated human resources information management system Planned:

* Introduce new Web-Based Technology (Quick-Hire/Career Connector) to 
reduce hiring time:

* Expand Category Rating and Applicant Simulation Assessments used in 
hiring process:

* Leverage Electronic and Print Advertising for recruiting job 
applicants to include the Internet:

* Develop new performance support tools and training delivery 
technologies to enhance workforce learning and development in a more 
cost-effective manner:

Continue to streamline and innovate hiring and staffing processes:

Competitive Sourcing:

Accomplished:

Appointed Competitive Sourcing Director:

Completed contract negotiations with National Industries for Severely 
Handicapped (NISH) for IRS Mailroom (70 FTE):

Completed studies involving 157 FTE; - Architect/Engineering 
Streamlined (16 FTE) - Retained In-house - Tax Law ADC Telephone Direct 
Conversion (141) - Outsourced:

Scheduled to issue the solicitation during the 9/15-9/19/03 for Campus 
Operations Information Technology (350 FTE):

Planned:

Complete 3 standard competitions (1200 FTE): Building Maintenance (100 
FTE); Area Distribution Centers (500 FTE); Campus Operations (350 FTE):

Complete Files Activities (1250 FTE):

Publication of the 2nd draft of the PWS (Performance Work statement) 
Q2, 2004:

Warehousing and Transportation (160 FTE); Publication of the 2nd draft 
of the PWS (Performance Workstation) Q2, 2004:

Budget & Performance Integration:

Accomplished:

Proposed outcome and output performance measures in the OMB budget 
submission:

Conducted Quarterly Business Performance Reviews and issued monthly 
performance reports to address significant business performance issues:

Proposed new EITC outcome goals; developed and began implementing a 
plan to improve EITC:

Linked 100% of performance appraisal plans to the IRS mission:

Application Qualification Testing (AQT) completed on IFS Cost Module; 
Systems Integration Testing (SIT) begun; Development of implementation 
plan begun:

Planned:

Realign IRS budget structure in FY 2006:

Implement IRS Cost Module:

Issue PART components for FY 2006 budget cycle, and integrate PART 
results in the assessment phase of strategic planning and budget 
process:

Update strategic assessment documents with new/revised budget and 
performance information:

E-Government:

Accomplished:

Submitted all Exhibit 300s to Treasury:

Established IT Governance Board to prioritize, select, and monitor 
major IT projects:

Security Certification:

Certified 72% of the IRS Systems in the Sensitive Systems Database 
(SSDB).

Total number of systems certified in FY 2003 is 100 systems, an 
increase of 15 from FY 2002:

Certification Program Office (CPO) has certified critical systems that 
include EServices, Health Coverage Tax Credit, Detroit Internet 
Gateway, IDRS and STIR 70:

Electronic Tax Products for Business:

Launched E-Services (Registration, on-line Preparer Tax ID number; SSN 
and Name matching feature) Release 1.1 in August on-time and within 
budget:

Reached agreement with OMB and SBA to replace SBA's stand alone FEIN 
application; agreed to link to IRS internet EIN application system:

Began development needed to deliver an integrated state registration 
number/federal Employer Identification Number (EIN) application.

Free File:

Affected over 2,700,000 citizens during FY 03:

Started activities to receive proposals from existing and prospective 
Free File Alliance members for 2004 filing season:

Provided guidance and input to SPEC for final stages of feasibility 
study to include Free File at its volunteer partner sites:

Finalized the 2004 Free File monitoring plan - a plan that will provide 
direction to effectively review online tax software programs offered by 
Free File Alliance members.

Coordinated internally to promote Free File within various 
publications/services available to the public in 2004 (e.g., 1040 
Series Instruction Booklets; tax publications (e.g., Pubs 910 and 17); 
E-file marketing brochures, E-file marketing campaign; TeleTax, etc. 
Planned:

Lead effort to involve states in pursuing an integrated state 
registration/FEIN process:

Make the corporate family of forms (IRS-1120) and 990 family (Return of 
Organization Exempt from Income Tax) available electronically - Q2, FY 
2004.

Financial Performance:

Accomplished:

Achieved a clean audit opinion by November 14, 2003:

Completed all corrective actions and have closure pending on 1 material 
weakness - Financial Statements-Admin.

Downgraded two material weaknesses to reportable condition - 
Telecommunications costs and Property Management.

Progressed in developing definitive corrective action plans for 
remaining material weaknesses.

Planned:

Launch an EITC certification pilot for Tax Year 2003 returns in January 
2004.

Qualifying Child Residency Certification Pilot changed from 8/03 and 
45,000 taxpayers to January 2004 and 25,000 taxpayers;

Filing status initiative will be in January 2004; increase in cases 
from 5,000 to 40,000:

Begin income misreporting initiative in October 2003; cases increased 
from 175,000 to 300,000:

Close additional material weaknesses:

Implement the Integrated Financial System in FY 2004.



[End of section]

Financial Statements:

[See PDF for image]

[End of figure]

[End of section]

Balance Sheets:

[See PDF for image]

[End of figure]

Statements of Net Cost:

[See PDF for image]

[End of figure]

Statements of Changes in Net Position:

[See PDF for image]

[End of figure]

Statements of Budgetary Resources:

[See PDF for image]

[End of figure]

Statements of Financing:

[See PDF for image]

[End of figure]

Statements of Custodial Activity:

[See PDF for image]

[End of figure]

Notes to the Financial Statements:

[See PDF for image]

[End of figure]

[See PDF for image]

[End of figure]

[End of section]

Supplemental and Other Accompanying Information:

[End of section]

[See PDF for image]

[End of figure]

[End of section]

Appendixes :

[End of section]

Appendix I: Material Weaknesses, Reportable Conditions, and Compliance 
Issues:

Material Weaknesses:

During our audits of the Internal Revenue Service's (IRS) fiscal years 
2003 and 2002 financial statements, we identified four material 
weaknesses in internal controls. These material weaknesses have given 
rise to significant management challenges that have (1) impaired 
management's ability to prepare financial statements and other 
financial information without extensive compensating procedures, (2) 
limited the availability of reliable information to assist management 
in effectively managing operations on an ongoing basis, (3) reduced 
IRS's effectiveness in enforcing the Internal Revenue Code, (4) 
resulted in errors in taxpayer accounts, and (5) increased taxpayer 
burden. The issues that we have identified and discuss in this report 
relate to IRS's controls over (1) financial reporting, (2) unpaid 
assessments, (3) federal tax revenue and refunds, and (4) computer 
security. We reported on each of these issues last year.[Footnote 6] We 
highlight these issues in the following sections. Less significant 
matters involving IRS's system of internal controls and its operations 
will be reported to IRS separately.

We also reported a material weakness in controls over IRS's property 
and equipment (P&E) in prior years. However, as a result of continued 
improvements in IRS's controls over its P&E, we have reassessed this as 
a reportable condition that no longer rises to the level of a material 
weakness.

Financial Reporting:

In fiscal year 2003, as in prior years, IRS did not have financial 
management systems adequate to enable it to timely, routinely, and 
reliably generate and report the information needed to both prepare 
financial statements and manage operations on an ongoing basis. To 
overcome these systemic deficiencies, IRS was compelled to rely on 
extensive compensating procedures that were costly, labor intensive, 
and not always effective. During fiscal year 2003, IRS (1) did not have 
an adequate general ledger system for financial reporting purposes, (2) 
did not recognize transactions affecting taxes receivable at interim 
periods or record the balance in its general ledger system, (3) could 
not determine and report on the specific amount of revenue collected 
for each of several of the federal government's largest revenue 
sources, and (4) did not have a cost accounting system capable of 
providing timely and reliable cost information related to IRS's 
activities and programs. In fiscal year 2003, IRS enhanced its 
procedures to more timely record certain types of administrative 
transactions and thereby improved the ongoing reliability of its 
financial information. Nonetheless, significant deficiencies remain. 
To compensate for its weaknesses in the financial reporting process, 
IRS continued to depend extensively on labor-intensive compensating 
procedures to enable it to generate reliable information for the annual 
financial statements. Although this approach culminated in financial 
statements that were fairly stated as of September 30, 2003 and 2002, 
it has not produced the current data needed to assist in managing 
operations on an ongoing basis, such as cost-based performance 
information to assist in making or justifying resource allocation 
decisions.

As in previous years,[Footnote 7] during fiscal year 2003, IRS's 
general ledger system (1) comprised two independent general ledgers 
that were not integrated with each other or with their supporting 
records for material balances and (2) was not supported by adequate 
audit trails for federal tax revenue, federal tax refunds, taxes 
receivable, or P&E. IRS's use of two separate general ledgers to 
account for its tax collection activities and the costs of conducting 
those activities, respectively, greatly complicates efforts to measure 
the cost of IRS's tax collection efforts. In addition, IRS's general 
ledger for its custodial activities does not use the standard federal 
accounting classification structure. Because of these deficiencies, 
IRS's general ledger system does not conform to the U.S. Government 
Standard General Ledger (SGL) as required by the Core Financial System 
Requirements of the Joint Financial Management Improvement Program 
(JFMIP)[Footnote 8] or the requirements of the Federal Financial 
Management Improvement Act of 1996 (FFMIA).

In its Management Discussion and Analysis, IRS discusses its plans to 
implement the Integrated Financial System (IFS), which will incorporate 
a single, integrated general ledger that is expected to be fully 
compliant with FFMIA.[Footnote 9] The initial phase of IFS's 
implementation, which was originally scheduled for October 1, 2003, has 
been rescheduled for the spring of 2004 due to testing problems. IRS's 
efforts to modernize its financial management system have been affected 
by delays in the past, and given the substantial size and complexity of 
this project, further delays are possible. However, even if there are 
no further delays, IRS does not currently expect IFS to be fully 
implemented with an SGL-compliant general ledger supported by detailed 
subsidiary records and audit trails for all custodial and 
administrative accounts until at least 2007.

In prior years, we reported that IRS did not always timely record 
material transactions in its general ledger.[Footnote 10] During fiscal 
year 2003, IRS implemented interim accruals to monthly record material 
administrative activities, such as rent, postage, and telephone 
expenses. This has significantly improved the reliability of related 
balances during the year. However, for taxes receivable and the related 
balances due to Treasury, the balances reported for interim periods are 
not based on the routine recording of transactions. Instead, as 
discussed in the material weakness over unpaid assessments, IRS 
requires months of effort and compensating procedures to produce a 
balance for taxes receivable, the single largest item on its balance 
sheet.

During fiscal year 2003, IRS continued to be unable to determine the 
specific amount of revenue it actually collects for three of the 
federal government's four largest revenue sources--Social Security, 
hospital insurance, and individual income taxes. In addition, IRS 
continued to be unable to determine, at the time payments are received, 
collections for the Highway Trust Fund or other trust funds that 
receive excise tax receipts. This is primarily because the accounting 
information needed to validate the taxpayer's liability and record the 
payment to the proper trust fund is provided on the tax return, which 
is received months after the payment is submitted. Further, the 
information on the tax return pertains only to the amount of the tax 
liability, not to how to distribute the amount previously collected 
among the appropriate trust funds. IRS does not require taxpayers to 
submit information identifying the type of tax at the time of payment 
because it believes that imposing such a requirement would create an 
additional burden to taxpayers. In addition, IRS's systems cannot 
presently capture and report such information routinely. IRS is working 
on systems improvements to accommodate this type of information. IRS 
will continue to be unable to timely report the specific amount of 
revenue it actually collects for these large revenue sources until it 
has the systems capability to record, and requires taxpayers to 
provide, this information. This condition also makes the federal 
government reliant on a complex, multistep process to distribute excise 
taxes to the recipient trust funds that continues to be susceptible to 
error.

With the acceleration of the financial reporting deadline for all 
federal agencies to November 15 beginning in fiscal year 2004, IRS's 
inability to timely report specific amounts of excise tax revenue to 
recipient trust funds becomes even more significant for these funds and 
their administrators. Currently, the annual excise tax receipts 
reported by recipient trust funds include 3 months of estimated 
receipts. The trust funds report 3 months of estimated receipts because 
IRS needs 5 and a half months to complete its certification of excise 
tax receipts and therefore does not complete the certification for the 
fourth quarter of the fiscal year until the following March. Under the 
accelerated deadline of November 15 beginning in fiscal year 2004, 
recipient trust funds will also have to report estimated receipts for 
the third quarter of the fiscal year, since IRS does not complete its 
certification of third-quarter receipts until mid-December. Therefore, 
annual excise tax receipts reported by recipient trust funds will 
include 6 months of estimated receipts beginning in 2004. To the extent 
that these estimates differ from the certified amounts, significantly 
inaccurate distributions to the trust funds could result and, in the 
case of the Highway Trust Fund, incorrect allocations of revenues to 
states.[Footnote 11]

During fiscal year 2003, IRS continued to lack a cost accounting system 
(1) capable of accurately and timely tracking and reporting the costs 
of IRS's programs and projects to assist it in managing its costs and 
(2) meeting the JFMIP Systems Requirements for Managerial Cost 
Accounting.[Footnote 12] This condition also renders IRS unable to 
produce reliable cost-based performance information. IRS officials have 
indicated that IRS's records contain the information necessary to 
enable them to determine the cost of various activities, such as 
conducting investigations. However, this information is widely 
distributed among a variety of information systems, which are not 
linked and therefore cannot share data. This makes the accumulation of 
cost information time consuming, labor intensive, and not readily 
available as a tool to manage costs. For example, IRS has a variety of 
workload management systems that staff in different units use to track 
how their time is spent on specific tasks. However, these systems are 
not integrated with IRS's general ledger or each other to allow IRS to 
readily identify and accumulate the total costs for time spent by all 
units involved in any specific activity. In addition, IRS's workload 
management systems are not designed to track certain material forms of 
nonpersonnel costs by project and subproject, such as equipment 
depreciation, rent, and utilities.

Without a cost accounting system to centrally accumulate, organize, and 
timely report cost data in a format that meets management's current 
needs, such information is not readily available for use by managers to 
aid in routinely managing costs and in decision making. Instead, IRS 
often finds it necessary to conduct special research tailored to 
determine the cost of a specific task or project. For example, IRS's 
fiscal year 2003 appropriation required IRS to spend at least $60 
million combating abusive tax shelters. However, because it does not 
have a cost accounting system, IRS resorted to manually developing cost 
information from a variety of automated systems to measure how much it 
had spent on combating abusive tax shelters and thereby ensure that it 
complied with this requirement. In its Management Discussion and 
Analysis, IRS stated that the new cost management system, which 
includes a cost accounting module, will be a component of IFS, now 
scheduled for deployment during fiscal year 2004. Ultimately, IRS 
expects this system to provide and reliably report cost information 
that it can use to manage its operations. However, when IFS is 
initially deployed in 2004, the cost accounting module will not include 
the underlying cost information. To make the module fully operational, 
IRS will first need to determine the full range of cost information it 
needs to support decision making and develop means to capture and 
accumulate those costs.

As a result of these pervasive financial reporting weaknesses, IRS was 
compelled to expend far more time and effort to maintain its accounting 
records and generate financial management information than would 
otherwise have been necessary, and despite these monumental efforts, 
continued to lack current, reliable financial information available to 
assist in managing operations throughout fiscal year 2003. During 
fiscal year 2003, as part of its strategic planning process, IRS 
conducted a comprehensive assessment of its strategic priorities to 
prioritize IRS's programs relative to the agency's mission in light of 
its available resources. IRS is using the outcome of this process as a 
basis for resource allocation decisions intended to reduce the 
difference between the aggregate amount of taxes assessed by federal 
tax laws in any given year and the amount that is paid voluntarily and 
timely (known as the tax gap). Addressing the financial reporting 
deficiencies discussed above would enhance this process by providing 
sound, reliable, and timely information to assist in evaluating the 
impact of these decisions in terms of both the costs incurred and the 
benefits derived.

Unpaid Tax Assessments:

During fiscal year 2003, we continued to find serious internal control 
issues that affected IRS's management of unpaid assessments. 
Specifically, we found (1) IRS continued to lack a subsidiary ledger 
for unpaid assessments that would allow it to produce timely and useful 
information with which to manage and report externallyand (2) errors 
and delays in recording taxpayer information, payments, and other 
activities that continued to hinder IRS's ability to effectively manage 
its unpaid assessments.[Footnote 13]

IRS's management of unpaid assessments is hindered by a lack of 
effective supporting systems. IRS continues to lack a detailed listing, 
or subsidiary ledger, that tracks and accumulates unpaid assessments 
and their status on an ongoing basis. As a result, IRS must continue to 
rely on a costly, labor-intensive manual compensating process for 
external reporting. Specifically, to report balances for taxes 
receivable and other unpaid assessments in its financial statements and 
supplemental information, IRS must apply statistical sampling and 
projection techniques to data in its master files[Footnote 14] to 
estimate the balances at year-end. While refinements continue to be 
made to this process, it continued to take several months to complete, 
required adjustments totaling tens of billions of dollars, and produced 
amounts that were only reliable as of the last day of the fiscal year. 
Consequently, this information is not useful for ongoing management 
decisions. In addition, the lack of a subsidiary ledger renders IRS 
unable to timely develop reliable financial and management reports and 
promptly identify and focus collection efforts on accounts most likely 
to prove collectible.

IRS's management of unpaid assessments also continued to be hindered by 
inaccurate tax records. We continued to find errors and omissions in 
taxpayer records resulting from IRS's failure to accurately and timely 
record information. Errors in IRS records can cause frustration to 
taxpayers who either do not owe the debt or owe a significantly lower 
amount. In addition, input errors can cost the government money. For 
example, IRS entered a company's 2000 tax deposits into the 2001 tax 
period. In January 2003, IRS issued the company a refund of more than 
$100,000 because--as a result of the input error--IRS records indicated 
that the company had overpaid its 2001 taxes. IRS corrected the error 
in July 2003, but as of September 30, 2003, IRS had not recovered the 
erroneous refund. In another example, when a taxpayer provided 
additional supporting documentation for a credit that IRS had initially 
disallowed, IRS inadvertently abated the entire tax debt rather than 
just the amount of the credit. This error resulted in IRS's issuing a 
refund of nearly $60,000, when only $44,000 should have been issued. 
The refund occurred in December 2002, but IRS personnel did not 
identify the error until they reviewed the case for our audit. As of 
September 30, 2003, IRS had not recovered the amount erroneously 
refunded.

As in prior years, the most prevalent errors we found during fiscal 
year 2003 involved IRS's failure to record payments in all related 
taxpayer accounts associated with unpaid payroll taxes.[Footnote 15] 
IRS's current systems continued to be unable to automatically link each 
of the multiple assessments made for the one tax liability. 
Consequently, if the business or an officer pays some or all of the 
outstanding taxes, IRS's systems are unable to automatically reflect 
the payment as a reduction in the related account or accounts. In 
reviewing unpaid payroll tax cases where one or more individuals were 
assessed a trust fund recovery penalty, we found 24 cases in which 
payments were not properly recorded in all related taxpayer 
accounts.[Footnote 16] IRS has recognized the seriousness of this issue 
and has attempted to compensate for the lack of an automated link 
between related accounts by manually inputting a code in each account 
that manually cross-references it to other related accounts. However, 
our work in fiscal year 2003 continues to show that this compensating 
control has not been fully effective: Of the 24 cases with payments 
that were not properly recorded, 17 had the manual cross-references.

We have reported on issues related to trust fund recovery penalties in 
previous audits.[Footnote 17] IRS has acknowledged the seriousness of 
the failure to post trust fund payments and continues to take remedial 
steps to address the impact. For example, IRS has convened a task group 
to design an automated trust fund recovery penalty system that can 
properly cross-reference payments received and thus eliminate the 
opportunity for errors that plague the current manual process. As a 
first step, the task group identified cases that needed to have a 
cross-reference added and requested corrections in the records. IRS 
officials stated that they hoped to complete this initial step in 
addressing the overall trust fund recovery penalty issues by early in 
fiscal year 2004. However, the ultimate solution to many of these 
issues continues to be the successful modernization of IRS's systems, 
which IRS acknowledges will take several years to complete.

Tax Revenue and Refunds:

During fiscal year 2003, we continued to find that IRS's controls were 
not fully effective in maximizing the government's ability to collect 
what is owed and in minimizing the risk of payment of improper refunds. 
IRS recognized this in its fiscal year 2003 Federal Managers' Financial 
Integrity Act (FIA) assurance statement to the Treasury, in which it 
reported material weaknesses in the collection of unpaid taxes and in 
earned income tax credit (EITC) noncompliance. IRS's taxpayer 
compliance programs identify billions of dollars of potentially 
underreported taxes and invalid EITCs each year. However, due in large 
part to perceived resource constraints, IRS selects only a portion of 
the questionable cases it identifies for follow-up investigation and 
action. In addition, IRS often does not initiate follow-up on the cases 
it selects until months after the related tax returns have been filed 
and any related refunds disbursed, affecting its chances of collecting 
amounts due on these cases. Consequently, the federal government is 
exposed to potentially significant losses from reduced revenue and 
disbursements of improper refunds.

The options available to IRS in its efforts to identify and pursue the 
correct amount of taxes owed and to ensure that only valid refunds are 
disbursed continue to be limited. For example, third-party information, 
such as the data provided on IRS 1099 forms,[Footnote 18] that can 
corroborate the amount of income reported by taxpayers is not required 
to be filed until after the start of the tax filing season.[Footnote 
19] Consequently, comparison of such information with tax return data 
is problematic because IRS does not have time to prepare the third-
party data for matching prior to the receipt of individual tax returns. 
Additionally, while it processes hundreds of millions of tax returns 
each filing season, IRS must issue refunds within statutory time 
constraints or be subject to interest charges.[Footnote 20]

As we previously reported, IRS has some preventive controls that help 
to reduce the magnitude of underreported taxes owed and improper 
refunds issued. For example, IRS's Examination Branch is responsible 
for performing examinations on tax returns with potentially invalid 
EITC claims[Footnote 21] to determine the validity of the claim. When 
performed before refunds are disbursed, these examinations are an 
important control to prevent disbursement of improper refunds. However, 
in some cases these examinations are performed after any related 
refunds are disbursed, which reduces their effectiveness as a 
preventive control. In its most recent study of EITC compliance, IRS 
estimated that of about $31.3 billion in EITC claims filed by taxpayers 
for tax year 1999, at least $8.5 billion (27 percent) should not have 
been paid.[Footnote 22] Of this amount, only $1.2 billion (14 percent) 
was either recovered or expected to be recovered through compliance 
efforts. The dollar amount of improper refunds disbursed related to 
these invalid EITCs is unknown. However, based on the fiscal year 2000 
EITC refund rate, which was about 84 percent,[Footnote 23] IRS may have 
disbursed about $7.1 billion in EITC-related improper refunds in tax 
year 1999, of which about $6.1 billion (86 percent) may never be 
recovered. The full magnitude of improper refunds disbursed annually 
due to invalid EITCs is unknown.

IRS's estimate of $8.5 billion in EITC claims that should not have been 
paid is just one aspect of the larger challenge IRS faces in the area 
of tax compliance. IRS's most current estimate of the annual tax gap is 
between $250 billion and $300 billion.[Footnote 24] Compliance problems 
that contribute to the tax gap include individual and corporate tax 
schemes, misuse of trust and offshore accounts, abusive individual and 
corporate tax shelters, businesses' failure to file and pay employment 
tax, and underreporting of taxes. Another challenge is enforcing an 
increasingly complex tax system that increases the risk of both 
intentional and unintentional noncompliance, which could, in turn, 
further erode taxpayers' confidence in the nation's tax system.

Due to time and other constraints, IRS relies extensively on detective 
controls, such as automated matching of returns with third-party data 
such as W-2s (wage and tax statements) to identify for collection 
underreported taxes and improper refunds. However, these programs are 
not run until months after the returns have been filed. As a result, 
they are used too late to prevent improper refunds from being 
disbursed. In addition, although IRS's matching program for individual 
tax returns identifies billions of dollars of potentially underreported 
taxes each year, IRS only follows up on a portion of these cases to 
determine how much tax is actually due and to pursue collection of 
those amounts. For example, for tax year 2001,[Footnote 25] IRS's 
matching program for individuals identified 15.7 million individual tax 
returns with potential underreported taxes totaling $17.2 billion. 
Because the volume of cases IRS can follow up on depends on resource 
availability, IRS conducts an analysis that identifies case 
characteristics that have historically yielded greater assessments as a 
result of follow-up efforts. For example, for tax year 2001, IRS 
investigated 3 million (19 percent) of these returns, which accounted 
for about $7.7 billion (45 percent) of the total potential 
underreported taxes. There are factors that affect IRS's ability to 
accelerate the timing of its automated matches, such as the limitations 
of its current automated systems and the timing of filing requirements 
for preparers of third-party documents, which are beyond IRS's control. 
Nonetheless, the information from IRS's automated matching program 
suggests that a substantial amount of additional revenue might be 
realized if additional resources were devoted to follow-up efforts. At 
present, billions of dollars in underreported taxes could remain 
uncollected and improper refunds could be disbursed. This, in turn, 
could further erode taxpayer confidence in the equity of the tax system 
and reduce compliance with the tax laws.

Computer Security:

IRS relies extensively on information technology (IT) to perform basic 
functions, such as processing tax returns and payments, maintaining 
sensitive taxpayer data, calculating interest and penalties, and 
generating refunds. Although IRS has corrected or mitigated many of the 
computer security weaknesses identified in our previous reports, much 
remains to be done to resolve the significant control weaknesses that 
continue to exist within IRS's computing environment and to be able to 
promptly address new security threats and risks as they emerge. Such 
weaknesses can impair the agency's ability to perform vital functions, 
and can increase the risk of unauthorized disclosure, modification, or 
destruction of taxpayer data.

IRS has continued to make progress improving computer security 
controls. For example, IRS has developed and is implementing an 
enterprisewide plan of action and milestones that are to address 
vulnerabilities in nine key control areas. Associated with this effort, 
IRS has, among other things, updated security standards for certain 
systems and devices, defined the security roles and responsibilities of 
IT and non-IT personnel, deployed automated tools to assist personnel 
in monitoring the compliance of certain systems with security 
standards, developed system-specific corrective action plans for 
resolving known instances of noncompliance, and installed current 
antivirus software on certain servers reviewed.

However, IRS continued to have serious weaknesses in fiscal year 2003 
with computer controls designed to protect computing resources such as 
networks, computer equipment, software programs, and data from 
unauthorized use, modification, and disclosure. For example, IRS did 
not always effectively configure and implement computer systems and 
network devices in accordance with its computer security guidelines and 
adequately protect system resources from unauthorized access. The 
following examples illustrate the types of computer weaknesses that 
affect IRS's financial and tax processing systems.

* IRS did not consistently implement strong password controls or 
adequately restrict electronic access rights and permissions on certain 
servers and network devices. Inappropriate access to sensitive files 
and directories can enable an intruder or user to gain unauthorized 
access to computing resources.

* IRS did not consistently control network services or configure system 
software to minimize the risk of unauthorized access to and ensure the 
integrity of system programs, files, and data. At two of three 
locations visited, for example, we were able to compromise critical 
network devices used to manage and monitor the network.

* IRS did not consistently examine audit logs of certain servers and 
network devices for unauthorized activities. Key security-related 
events and pertinent data were sometimes not recorded in audit logs, 
and security specialists did not routinely or fully examine logs for 
unauthorized activity or usage trends.

Collectively, these problems indicate material weaknesses in IRS's 
internal controls over information systems and data. These weaknesses 
decreased the reliability and increased the vulnerability of data 
processed by the systems. Until IRS can adequately mitigate these 
weaknesses, unauthorized individuals could gain access to critical 
hardware and software and intentionally or inadvertently access, alter, 
or delete sensitive data or computer programs. Such individuals could 
also obtain personal taxpayer information and use it to commit 
financial crimes in the taxpayers' names (identity fraud), such as 
establishing credit and incurring debt.

Reportable Conditions:

In addition to the material weaknesses discussed above, we identified 
one reportable condition, which concerns weaknesses in IRS's internal 
controls over tax receipts and taxpayer information, which we have 
reported as a reportable condition in prior years, and a second 
reportable condition, which concerns weaknesses in internal controls 
over P&E, which we have reported as a material weakness in prior 
years.[Footnote 26]

In our previous report on the results of our audit of IRS's fiscal year 
2002 financial statements, we discussed the presence of a reportable 
condition with respect to weaknesses in IRS's internal controls over 
budgetary activity. During fiscal year 2003, IRS improved the 
timeliness of recording obligations in its accounting system and 
implemented procedures to address delays in recording expenditures. IRS 
continues to have difficulty recording routine transactions in the 
adjustments to prior year obligations accounts.[Footnote 27] However, 
we do not consider this remaining issue to constitute a reportable 
condition with respect to IRS's controls over budgetary activity.

Hard-Copy Tax Receipts and Taxpayer Information:

IRS manually processes tax receipts and taxpayer information at its 
service center campuses and field offices. In addition, commercial 
lockbox banks, operating under contract with Treasury's Financial 
Management Service (FMS), process tax receipts and taxpayer information 
on behalf of IRS. Recognizing its responsibility to protect taxpayer 
information and receipts, IRS has taken action in the past several 
years to address a number of internal control deficiencies we have 
reported with respect to safeguarding of tax receipts and taxpayer 
information. For example, to improve the safeguarding of taxpayer 
receipts and data, IRS updated many of its policies and procedures, 
began conducting periodic security reviews of receipt processing areas, 
and implemented many of its new hiring and courier standards. 
Additionally, in fiscal year 2003, IRS issued new candling[Footnote 28] 
procedures for lockbox banks and service center campuses, and courier 
service agreements for four service center campuses were renegotiated 
to include more stringent background investigation requirements for 
courier service employees. Nonetheless, during fiscal year 2003, we 
continued to find that IRS's controls over cash, checks, and related 
hard-copy taxpayer data IRS received from taxpayers were inadequate to 
sufficiently limit the risk of theft, loss, or misuse of such funds and 
data, primarily because of inconsistencies in the establishment and 
implementation of, and compliance with, policies at IRS service center 
campuses, field offices, and lockbox banks.

We previously reported on weaknesses in internal controls to deter 
unauthorized access to receipt processing areas.[Footnote 29] While we 
found improvement at lockbox banks in fiscal year 2003, we continued to 
find security access issues at two of the four service center campuses, 
three of the four lockbox banks, and both field offices we visited. 
Examples of issues we found include the following:

* At two service centers and at one lockbox bank, guards failed to 
respond when we activated a perimeter door alarm.

* At one service center, unauthorized access was made possible by (1) 
employees keeping a door to a mailroom processing area open and (2) a 
door to the receipts processing area that repeatedly opened 
automatically.

* At another service center, mail stored in an overflow area was not 
adequately protected from unauthorized access.

* At both field offices, taxpayers delivered receipts and taxpayer data 
to IRS personnel in unsecured areas.

* At one field office, the receipt processing areas were not adequately 
secured, and IRS field office personnel had the ability to access areas 
with tax receipts and taxpayer information, regardless of their need or 
authorization for access.

* At one service center for the second successive year, personal items 
were allowed into the receipt processing area in clear plastic bags of 
various sizes, with many bags containing so many items that not all the 
items could be identified through the bag. Additionally, at this 
location, employees brought books, purses, and newspapers into the 
processing area--all objects in which taxpayer receipts could easily be 
concealed. At the same service center, a number of temporary employees 
had not been issued lockers outside the processing area in which to 
keep their personal belongings, increasing the likelihood that 
unauthorized personal belongings would be brought into the processing 
area.

* At a field office, employees were allowed to store personal 
belongings, such as purses and briefcases, in areas where taxpayer 
receipts were accepted.

We continued to find other weaknesses and inconsistencies in controls 
over processing taxpayer receipts and taxpayer data at three of the 
four service center campuses, all four lockbox banks, and both field 
offices we visited. Examples of these weaknesses and inconsistencies 
include the following:

* At one service center and at one field office, receipts were stored 
in open, unlocked containers, contrary to IRS policy.

* At one service center, three lockbox banks, and two field offices, 
some returned refund checks were not restrictively endorsed as required 
or staff were unaware of the endorsement requirement. As we previously 
reported, returned refund checks are highly susceptible to 
theft.[Footnote 30]

* At two service centers and two lockbox banks, initial candling was 
either not performed or was not performed according to procedure.

* At two service centers, items discovered in final candling had not 
been properly logged.

* At three lockbox banks, candling logs had not been properly 
maintained or there was no evidence that required candling reviews had 
been performed according to procedure.

In previous years, IRS made an effort to address courier security 
weaknesses we cited by adopting more stringent security standards for 
couriers who transport IRS's daily deposits to depository institutions. 
However, at three of the four service centers and all four lockbox 
banks we visited, we found that IRS did not have controls in place to 
ensure that the courier requirements were effectively enforced. For 
example, at one service center campus, despite the requirement that two 
couriers pick up and transport deposits, only one courier picked up the 
deposits for more than 20 days during the fiscal year. Additionally, at 
two service centers and one lockbox bank, immediate family members were 
allowed to meet the two-courier requirement, increasing the risk of 
collusion.

In addition, we learned through inquiry that two couriers at a service 
center other than those we visited were allowed to continue to pick up 
deposits, without being escorted, after their interim access[Footnote 
31] had been denied.

These weaknesses increase IRS's vulnerability to theft or loss and 
expose taxpayers to increased risk of losses from financial crimes 
committed by individuals who inappropriately gain access to taxpayer 
receipts and confidential information entrusted to IRS. Thus, it is 
important that IRS continue to work to effectively address these 
matters because they are critical to IRS's success in meeting its 
customer service goals.

Property and Equipment:

In prior years, we identified serious internal control deficiencies 
that prevented IRS from having (1) current, reliable P&E information 
available on an ongoing basis and (2) reasonable assurance that its 
assets were properly safeguarded and used only in accordance with 
management policy.[Footnote 32] Over the past several years, IRS has 
made substantial progress in addressing internal control deficiencies 
related to its P&E. In fiscal year 2003, we noted further improvements 
in IRS's controls and procedures that enhanced its ability to account 
for P&E. Specifically, IRS implemented (1) procedures to improve the 
accuracy and reliability of its P&E inventory records and (2) an 
inventory record system that captured information essential to ensure 
that software and software licenses were properly controlled and used 
in accordance with license agreements. These further improvements 
allowed us to conclude that the remaining issues related to P&E no 
longer constitute a material internal control weakness. However, 
fundamental deficiencies in IRS's financial management system continued 
to exist, which precluded IRS from having ongoing information on its 
balance of P&E. Through the use of compensating procedures, IRS was 
able to report a balance for P&E on its financial statements at 
September 30, 2003, that was fairly stated in all material respects.

In our fiscal years 2002 and 2001 audits, we reported that IRS had made 
progress in its efforts to properly account for and control P&E, 
including implementing a new inventory system, establishing units with 
specific responsibility for maintaining the accuracy of the inventory 
records, and implementing procedures to improve the accuracy and 
reliability of its P&E inventory records. Our prior year inventory 
testing results reflected the progress that IRS made. For example, the 
number of errors we found in our testing declined from 35 out of 220 
inventory records tested in fiscal year 2000 to 22 out of 220 records 
tested in fiscal year 2002.

In fiscal year 2003, IRS further improved procedures and practices used 
to maintain accurate and reliable inventory records. Specifically, IRS 
(1) developed procedures to obtain and use electronic data from vendors 
to create inventory records, which helped ensure that assets were 
promptly and accurately recorded upon receipt of the assets, (2) 
focused additional effort on ensuring that asset disposals were 
recorded timely, (3) expanded use of network monitoring software to 
track assets, (4) provided additional training to employees responsible 
for maintaining inventory records, and (5) enhanced monitoring and 
quality control over the annual inventory process. As a result of these 
actions and actions taken in prior years, our testing during fiscal 
year 2003 indicated significant improvement in the accuracy and 
reliability of IRS's P&E inventory records. We found eight errors in 
the 220 inventory records we tested during our fiscal year 2003 audit. 
Based on our testing in fiscal year 2003, we estimated that 4 percent 
of the items in IRS's P&E inventory records were erroneously included 
as assets.[Footnote 33] This is a dramatic improvement over the error 
rate in fiscal year 2000, when we estimated that 16 percent of the 
items in IRS's P&E inventory were erroneously included as IRS 
assets.[Footnote 34]

We reported previously that IRS's property management system did not 
capture information, such as licenser, contract period, and number of 
authorized users, essential to ensure that software and software 
licenses were controlled and utilized only in accordance with software 
license contracts. In fiscal year 2003, IRS developed a database of 
software licenses that captured the key information needed to ensure 
that software licenses were controlled and used in accordance with 
terms of the license agreements. For example, this database allows IRS 
to track the number of software installations deployed against the 
number of licenses purchased. In addition, IRS developed and 
implemented policies and procedures to update inventory records to 
reflect software acquisitions as they occur.

Although IRS has made significant progress in its efforts to maintain 
accurate and reliable P&E inventory records, fundamental system 
deficiencies continue to exist. IRS still does not have an integrated 
property management system that appropriately records P&E additions:

and disposals as they occur and links costs on the accounting records 
to property records. Instead, IRS continues to record as expenses 
property purchases as they occur, and then later extracts the costs of 
property acquisitions from operating expenses and records adjustments 
to remove property purchases from expenses and capitalize them as P&E. 
We reported in our prior year audit that IRS improved the timeliness of 
extracting and recording P&E financial information. As a result, IRS is 
now able to analyze transactions monthly and update P&E accounting 
records quarterly. In fiscal year 2003, IRS revised certain accounting 
codes, which further enhanced its ability to analyze and extract the 
cost of developing major software systems. However, IRS still does not 
have reliable P&E data available on an ongoing basis that it can use to 
make operational decisions related to the acquisition and use of P&E, 
and its property management system does not provide timely and reliable 
information to facilitate the preparation of financial statements.

Because IRS did not properly record P&E transactions in P&E accounts as 
they occurred, it was again necessary for IRS to hire a contractor to 
extract, analyze, and compile the data needed to report a reliable P&E 
balance. In addition, IRS must go through a labor-intensive and time-
consuming process to link the property acquisitions eventually recorded 
on IRS's accounting records to assets recorded on IRS's property 
records. These weaknesses in IRS's property and accounting systems will 
continue to exist until IRS has an integrated accounting and property 
system. IRS plans to install an asset management module to the 
integrated financial system by August 2005. According to IRS, the 
integrated system, when fully implemented, will be capable of recording 
P&E as assets when purchased and generating detailed records for P&E 
that reconcile to the financial records.

Compliance Issues:

Our tests of compliance with selected provisions of laws and 
regulations disclosed two areas of noncompliance that are reportable 
under U.S. generally accepted government auditing standards and Office 
of Management and Budget (OMB) guidance. These relate to the release of 
federal tax liens against taxpayers' property and the structure of 
installment agreements IRS enters into with taxpayers to satisfy the 
taxpayer's outstanding tax liability. We also found that IRS's 
financial management systems do not substantially comply with the 
requirements of FFMIA. In addition, our audit disclosed another matter, 
involving IRS contributions to the Thrift Savings Plan (TSP) that 
exceeded statutory requirements.

Release of Federal Tax Liens:

The Internal Revenue Code grants IRS the power to file a lien against 
the property of any taxpayer who neglects or refuses to pay all 
assessed federal taxes. The lien becomes effective when it is filed 
with a designated office, such as a courthouse in the county where the 
taxpayer's property is located. The lien serves to protect the interest 
of the federal government and as a public notice to current and 
potential creditors of the government's interest in the taxpayer's 
property. For example, federal tax liens are disclosed in credit 
reports of individuals. Under section 6325 of the Internal Revenue 
Code, IRS is required to release a federal tax lien within 30 days 
after the date the tax liability is satisfied or has become legally 
unenforceable or the Secretary of the Treasury has accepted a bond for 
the assessed tax.

In previous audits, we found that IRS did not always release the 
applicable federal tax lien within 30 days of the tax liability being 
either paid off or abated as required by the Internal Revenue 
Code.[Footnote 35] We found that this condition continued to exist in 
fiscal year 2003. Specifically, in our testing of 59 statistically 
selected tax cases with liens in which the taxpayers' total outstanding 
tax liabilities were either paid off or abated during fiscal year 2003, 
we found 12 instances in which IRS did not release the applicable 
federal tax lien within the statutorily mandated 30 days. The time 
between satisfaction of the liability and release of the lien ranged 
from 35 to 249 days. Three of the 12 liens were not released timely 
because the taxpayers' accounts contained inaccurate or outdated freeze 
codes, which are codes that prevent certain types of updates and 
closing actions to the taxpayers' accounts.[Footnote 36] The presence 
of these freeze codes prevented IRS's system from automatically 
identifying the liens for release. For example, a freeze code on one 
taxpayer's account prevented the release of the lien for 249 days after 
satisfaction of the debt. IRS identified that it had failed to release 
the lien when reviewing the case after we selected it for testing as 
part of our audit. In two other cases, inappropriate freeze codes 
prevented the accounts from registering as having been paid in full, 
which prevented IRS's systems from automatically releasing the liens. 
These liens still had not been released as of the time of our review in 
August 2003--in one case 7 months and the other case 2 months after the 
tax liability had been satisfied. IRS officials could not explain why 
the freeze codes were not reversed in the three cases with inaccurate 
or erroneous freeze codes that we identified.

On the basis of the results of our work, we estimate that for 20 
percent of unpaid tax assessment cases where IRS had filed a tax lien 
that were resolved in fiscal year 2003, IRS did not release the lien 
within 30 days.[Footnote 37] The failure to promptly release tax liens 
could cause undue hardship and burden to taxpayers who are attempting 
to sell property or apply for commercial credit.

Structuring of Installment Agreements:

Section 6159 of the Internal Revenue Code authorizes IRS to enter into 
installment agreements with taxpayers to fully satisfy the taxpayer's 
tax liability. Audits for prior years showed that IRS had not always 
structured installment agreements to ensure that they would satisfy the 
taxpayer's outstanding tax liability, including future interest 
accruals, before the statutory collection period for the tax liability 
expired.[Footnote 38]

During our fiscal year 2003 financial audit, we again found that 
installment agreements were not always structured to provide for full 
payment of the tax liability. Specifically, in our testing of 59 
statistically selected installment agreements, we found 3 instances in 
which the terms of the installment agreements did not require full 
satisfaction of the tax liability. On the basis of the results of our 
work, we estimate that about 5 percent of new installment agreements 
entered into during fiscal year 2003 had payment terms that would not 
fully satisfy the tax liability within the statutory collection 
period.[Footnote 39] The presence of such cases in fiscal year 2003:

indicates that IRS was not in compliance with section 6159 of the 
Internal Revenue Code. Legislation is currently pending that, if 
enacted, would eliminate the requirement that installment agreements 
provide for full payment of the tax debt.[Footnote 40]

Financial Management Systems' Noncompliance with FFMIA:

In fiscal year 2003, we continued to find that IRS's financial 
management systems did not substantially comply with the requirements 
of FFMIA. Specifically, IRS's systems did not comply with Federal 
Financial Management Systems Requirements (FFMSR), federal accounting 
standards (U.S. generally accepted accounting principles), and the SGL 
at the transaction level. We found that IRS (1) cannot rely solely on 
information from its general ledger to prepare its financial 
statements, (2) does not have a general ledger that conforms to the 
SGL, (3) lacks a subsidiary ledger for its unpaid assessments, and (4) 
lacks an effective audit trail from its general ledger back to 
subsidiary detailed records and transaction source documents for 
material balances. Other material weaknesses we discussed earlier--
controls over unpaid assessments, federal tax revenue and refunds, and 
computer security--are also conditions indicating that IRS's systems do 
not substantially comply with the requirements of FFMIA.

This ties in with our earlier discussions of material weaknesses 
related to the inability of IRS's financial management systems to 
produce auditable financial statements and related disclosures that 
conform with U.S. generally accepted accounting principles without 
substantial compensating processes and significant adjustments. These 
weaknesses also indicate that IRS's systems cannot routinely accumulate 
and report the full cost of its activities. Since IRS's systems do not 
comply with FFMSR, U.S. generally accepted accounting principles, and 
the SGL, they also do not comply with OMB Circular A-127, Financial 
Management Systems. In its FIA assurance statement to Treasury, IRS 
reported that its financial management systems did not substantially 
comply with the requirements of FFMIA in fiscal year 2003.

IRS has established a remediation plan to address the conditions 
affecting its systems' ability to comply with the requirements of 
FFMIA. This plan outlines the actions to be taken to resolve these 
issues, designates resources to be devoted to implementing those 
actions, and specifies time frames for their completion. Due to the 
long-term nature of IRS's systems modernization efforts, which IRS 
expects will resolve many of the most serious issues, many of the 
planned time frames exceed the 3-year resolution period specified in 
FFMIA. However, for these instances IRS has received a waiver from this 
requirement from OMB, as authorized by FFMIA.

Thrift Savings Plan Contributions:

During the course of this year's audit, another matter came to our 
attention, concerning excess contributions to certain employees' TSP 
accounts. TSP was authorized by the Congress under the Federal 
Employees' Retirement System Act of 1986.[Footnote 41] Title 5 U.S.C. § 
8432 requires agencies to contribute to TSP 1 percent of the base pay 
of all employees, regardless of whether the employees make their own 
contributions.[Footnote 42] In testing this requirement as part of our 
testing of IRS's fiscal year 2003 payroll transactions, we found that 
IRS had made contributions to TSP for some FERS employees in excess of 
the statutory 1 percent contribution rate applicable to noncontributing 
employees. In response to our inquiry, IRS contacted the Department of 
Agriculture's National Finance Center (NFC), which processes IRS's 
payroll under a contractual agreement, and requested that it 
investigate the matter. NFC, in turn, has preliminarily traced this 
condition to a problem within its automated systems that caused 
duplicate TSP records to be generated and duplicate mandatory TSP 
contributions to be erroneously made when some IRS employees were 
reassigned from one IRS organizational unit to another. Based on the 
results of our audit work, we determined that the effect of this 
problem on IRS is not material. However, the potential effect on other 
agencies whose payrolls are processed by NFC is unknown. NFC is 
currently conducting an internal investigation to try to determine, 
among other things, the full scope and magnitude of the problem. We 
will discuss this matter in more detail in a separate report.

[End of section]

Appendix II Details on Audit Methodology:

To fulfill our responsibilities as the auditor of the Internal Revenue 
Service's (IRS) financial statements, we did the following:

* Examined, on a test basis, evidence supporting the amounts and 
disclosures in the financial statements. This included testing selected 
statistical samples of unpaid assessment, revenue, refund, accrued 
expenses, payroll, nonpayroll, property and equipment, and undelivered 
order transactions. These statistical samples were selected primarily 
to substantiate balances and activities reported in IRS's financial 
statements. Consequently, dollar errors or amounts can and have been 
statistically projected to the population of transactions from which 
they were selected. In testing these samples, certain attributes were 
identified that indicated either significant deficiencies in the design 
or operation of internal control or compliance with provisions of laws 
and regulations. These attributes, where applicable, can be and have 
been statistically projected to the appropriate populations.

* Assessed the accounting principles used and significant estimates 
made by management.

* Evaluated the overall presentation of the financial statements.

* Obtained an understanding of internal controls related to financial 
reporting (including safeguarding assets), compliance with laws and 
regulations (including the execution of transactions in accordance with 
budget authority), and performance measures reported in the Management 
Discussion and Analysis.

* Tested relevant internal controls over financial reporting (including 
safeguarding assets) and compliance, and evaluated the design and 
operating effectiveness of internal controls.

* Considered the process for evaluating and reporting on internal 
controls and financial management systems under the Federal Managers' 
Financial Integrity Act of 1982.

* Tested compliance with selected provisions of the following laws and 
regulations: Anti-Deficiency Act, as amended (31 U.S.C. § 1341(a)(1) 
and 31 U.S.C. § 1517(a)); Agreements for payment of tax liability in 
installments (26 U.S.C. § 6159); Purpose Statute (31 U.S.C. § 1301); 
Release of lien or discharge of property (26 U.S.C. § 6325); Interest 
on underpayment, nonpayment, or extensions of time for payment of tax 
(26 U.S.C. § 6601); Interest on overpayments (26 U.S.C. § 6611); 
Determination of rate of interest (26 U.S.C. § 6621); Failure to file 
tax return or to pay tax (26 U.S.C. § 6651); Failure by individual to 
pay estimated income tax (26 U.S.C. § 6654); Failure by corporation to 
pay estimated income tax (26 U.S.C. § 6655); Prompt Payment Act (31 
U.S.C. § 3902(a), (b), and (f), and 31 U.S.C. § 3904); Pay and 
Allowance System for Civilian Employees (5 U.S.C. §§ 5332 and 5343, and 
29 U.S.C. § 206); Federal Employees' Retirement System Act of 1986, as 
amended (5 U.S.C. §§ 8422, 8423, and 8432); Social Security Act, as 
amended (26 U.S.C. §§ 3101 and 3121, and 42 U.S.C. § 430); Federal 
Employees Health Benefits Act of 1959, as amended (5 U.S.C. §§ 8905, 
8906, and 8909); and Consolidated Appropriations Resolution, 2003 (Pub. 
L. No. 108-7).

* Tested whether IRS's financial management systems substantially 
comply with the three requirements of the Federal Financial Management 
Improvement Act of 1996.

[End of section]

Appendix III: Comments from the Internal Revenue Service:

DEPUTY COMMISSIONER:

DEPARTMENT OF THE TREASURY INTERNAL REVENUE SERVICE WASHINGTON. D.C. 
20224:

November 6, 2003:

Mr. David M. Walker Comptroller General U.S. General Accounting Office 
441 G Street, NW Washington, D.C. 20548:

Dear Mr. Walker:

We believe your draft report titled, Financial Audit. IRS' Fiscal Years 
2003 and 2002 Financial Statements, fairly presents both our progress 
and our remaining challenges. For the fourth consecutive year, we 
achieved an unqualified audit opinion for the annual financial 
statements. Additionally, we accomplished this milestone for a second 
consecutive year under the accelerated reporting schedule, requiring 
the issuance of our financial statement just six weeks after the end of 
the fiscal year. This clearly demonstrates to the public that we can 
properly and consistently account for approximately $2 trillion in 
revenue receipts, $300 billion in refunds, and $11 billion in 
appropriated funds.

We wish to recognize the GAO's dedication and professionalism 
throughout this year's audit process. We appreciate the excellent 
counsel and support the auditors provided to us. Your willingness to 
work with us to further accelerate the audit schedule and increase 
interim testing allowed us to achieve not only our audit related work 
but also to provide needed staff resources to continue work on critical 
financial systems modernization projects through the audit period.

We appreciate your acknowledgement of the great strides we made in FY 
2003. During the fiscal year, we instituted a number of financial 
management reforms and improvements. Specifically we:

* Implemented improved interim reporting processes to ensure quarterly 
financial statements were both accurate and timely:

* Met or exceeded Treasury's three-day close goal for monthly financial 
reporting:  

* Implemented a software inventory system to improve 
accountability over software licenses:

* Improved controls over Property and Equipment accountability, 
including cleansing inventory accounts and performing interim 
validations of those accounts: 

* Implemented an interim accrual process 
for specific administrative expenses such as rent, postage, and 
telephone services and improved the accuracy of our year end major 
contract accrual:

* Strengthened our oversight of obligating practices and performed a 
mid-year self-assessment of the timeliness of obligations:

Piloted Phase II of the Automated Trust Fund Recovery Penalty 
Compliance Center (ATFR-CC) application designed to cross-reference 
payments and credits on related trust fund recovery penalty (TFRP) 
accounts:

Implemented a new sampling methodology for estimating the balance of 
taxes receivable and other unpaid assessments at year-end:

These improvements contributed significantly to our ability to address 
three of nine outstanding Material Weaknesses during FY 2003. As noted 
in your report, our actions to increase accountability over Property. 
and Equipment, through the implementation of a software inventory 
process and improved procedures, have allowed the Service to downgrade 
this 21 year old Material Weakness to a reportable condition. 
Additionally, we have requested Treasury approve a similar downgrade in 
the Telecommunications Material Weakness and eliminate the Material 
Weakness in Financial Statements Administrative.

The IRS remains committed to completing the FFMIA Remediation Plan to 
implement modernized financial systems. Although these systems are 
taking longer to come on-line than we had hoped, we appreciate your 
understanding of the size and complexity of these projects. It is 
critical that, when implemented, the systems meet our operational needs 
as well as the requirements of the CFO Act. During the next year, as we 
work to bring these systems on-line, we will also undertake actions to 
continue to improve our business practices in support of those systems 
implementations. As examples, we plan to:

* Implement the core accounting functionality of the Integrated 
Financial System; 

* Streamline and improve our business processes for 
travel, purchase card, and reviews of unliquidated obligations and 
commitments:

* Implement policies to more effectively collect and report costs for 
trust fund activities:

In closing, I would like to restate the IRS' commitment to continual 
improvement in financial management. That commitment permeates 
throughout the Service. We will continue the improvements made in the 
last few years as we develop and implement the fundamental long-term 
solutions needed to address the internal control weaknesses cited in 
your report. Both the GAO and the IRS recognize that it is only through 
implementation of new integrated financial management systems that we 
will be able to overcome the majority of the material weaknesses cited 
in your report.

Sincerely,

Signed by: 

John M. Dalrymple:

Deputy Commissioner for Operations Support:

[End of section]

(196000):

FOOTNOTES

[1] IRS includes an estimate of the tax gap in the other accompanying 
information.

[2] U.S. General Accounting Office, Financial Audit: Examination of 
IRS' Fiscal Year 1992 Financial Statements, GAO/AIMD-93-2 (Washington, 
D.C.: June 30, 1993).

[3] In 2001, the Office of Management and Budget announced the 
executive branch's intention to significantly accelerate agencies' 
financial reporting timeline, requiring that for fiscal year 2004 and 
thereafter they issue their financial statements by November 15, or 6 
weeks after the end of the fiscal year. The Department of the Treasury 
established and achieved its own goal of meeting this accelerated 
timeline 2 years early. For fiscal year 2002, the audit of Treasury's 
financial statements, including those of its component entities such as 
IRS, was completed and was issued by November 15. 

[4] A material weakness is a reportable condition that precludes the 
entity's internal controls from providing reasonable assurance that 
material misstatements in the financial statements would be prevented 
or detected on a timely basis. Reportable conditions are matters coming 
to our attention that, in our judgment, should be communicated because 
they represent significant deficiencies in the design or operation of 
internal controls that could adversely affect IRS's ability to meet the 
objectives described in this report.

[5] 31 U.S.C. § 3512 note (2000) (Federal Financial Management 
Improvement).

[6] U.S. General Accounting Office, Financial Audit: IRS's Fiscal Years 
2002 and 2001 Financial Statements, GAO-03-243 (Washington, D.C.: Nov. 
15, 2002).

[7] GAO-03-243.

[8] The Joint Financial Management Improvement Program (JFMIP) is a 
cooperative undertaking of the Office of Management and Budget (OMB), 
the Department of the Treasury, the Office of Personnel Management, and 
GAO working in cooperation with each other and with operating agencies 
to improve financial management practices.

[9] IRS's integrated financial system is planned to include the core 
financial system defined by JFMIP, including an SGL-compliant general 
ledger, accounts payable, accounts receivable, fund and cost 
management, budget formulation, and financial reporting.

[10] GAO-03-243.

[11] The Transportation Equity Act for the 21ST Century, Pub. L. No. 
105-178, 112 Stat. 107 (1998) enhanced the link between the amount of 
funds received by states and the amount of tax receipts credited to the 
Highway Trust Fund by requiring that highway program funds be 
distributed to states on the basis of annual highway account receipts.

[12] Joint Financial Management Improvement Program, Systems 
Requirements for Managerial Cost Accounting (Washington, D.C.: February 
1998).

[13] Unpaid assessments consist of (1) taxes due from taxpayers for 
which IRS can support the existence of a receivable through taxpayer 
agreement or a favorable court ruling (federal taxes receivable), (2) 
compliance assessments where neither the taxpayer nor the court has 
affirmed that the amounts are owed, and (3) write-offs, which represent 
unpaid assessments for which IRS does not expect further collections 
due to factors such as the taxpayer's death, bankruptcy, or insolvency. 
Of these three classifications of unpaid assessments, only federal 
taxes receivable are reported on the principal financial statements. 

[14] IRS's master file contains detailed records of taxpayer accounts. 
However, the master files do not contain all the details necessary to 
properly classify or estimate collectibility for unpaid assessment 
accounts.

[15] When a company does not pay the taxes it withholds from employees' 
wages, such as Social Security or individual income tax withholdings, 
IRS has the authority to assess all responsible officers individually 
for the taxes withheld from employees. Although assessed to multiple 
parties, the liability need only be paid once. Thus, IRS may record 
assessments against each of several individuals for the employee-
withholding component of the payroll tax liability of a given business 
in an effort to collect the total tax liability of the business. The 
assessments made against business officers are known as trust fund 
recovery penalties.

[16] Based on our testing, we estimate that 65 percent of unpaid 
payroll tax cases where one or more individuals were assessed a trust 
fund recovery penalty could contain inaccuracies in the posting of 
payments. We are 95 percent confident that the percentage of such cases 
is between 50 percent and 79 percent.

[17] GAO-03-243.

[18] IRS 1099 forms are used by third parties, such as financial 
institutions, to report taxpayers' interest income, dividend 
distributions, and other miscellaneous income.

[19] The peak tax filing season primarily occurs from January 1 to 
April 15 of each year. 

[20] By statute, IRS must pay interest on refunds not paid within 45 
days of receipt or due date, whichever is later (26 U.S.C. § 6611).

[21] Because it is a tax credit, an EITC claim always results in a 
reduction of the taxpayer's calculated tax liability. However, 
depending on the taxpayer's amount of taxes withheld, it may or may not 
result in a refund for a particular tax year. 

[22] Internal Revenue Service, Compliance Estimates for Earned Income 
Tax Credit Claimed on 1999 Returns (Washington, D.C.: Feb. 28, 2002). 

[23] We used the fiscal year 2000 refund rate because most of the tax 
year 1999 refunds were paid in fiscal year 2000.

[24] As noted in the other accompanying information to the financial 
statements, IRS based this estimate on compliance data from the 1980s. 
Under IRS's National Research Program, its new effort to review 
taxpayer compliance, IRS expects to obtain more accurate and up-to-date 
information on compliance rates and sources of noncompliance.

[25] Individual tax returns are not due until April 15 of the following 
year (up to October 15 if extensions are filed), and the underreporter 
screening programs cannot be run until after the returns are filed. 
Consequently, tax year 2001 is the most recently completed tax year for 
which the cited data are available.

[26] GAO-03-243.

[27] An adjustment to a prior year's obligation is recorded when the 
dollar amount previously recorded is affected by a subsequent event, 
such as a change in the price of goods or services. See our audit 
report for fiscal years 2002 and 2001 (GAO-03-243) for detailed 
discussion regarding adjustments to prior year obligations.

[28] Candling is a process used to determine if any contents remain in 
open envelopes. This is often achieved by passing the envelopes over a 
light source.

[29] U.S. General Accounting Office, Internal Revenue Service: Status 
of Recommendations from Financial Audits and Related Financial 
Management Reports, GAO-03-665 (Washington, D.C.: May 29, 2003); 
Management Report: Improvements Needed in IRS's Internal Controls, GAO-
03-562R (Washington, D.C.: May 20, 2003); IRS Lockbox Banks: More 
Effective Oversight, Stronger Controls, and Further Study of Costs and 
Benefits Are Needed, GAO-03-299 (Washington, D.C.: Jan. 15, 2003); GAO-
03-243; and Internal Revenue Service: Progress Made, but Further 
Actions Needed to Improve Financial Management, GAO-02-35 (Washington, 
D.C.: Oct. 19, 2001).

[30] U.S. General Accounting Office, Internal Revenue Service: 
Recommendations to Improve Financial and Operational Management, GAO-
01-42 (Washington, D.C.: Nov. 17, 2000).

[31] Interim access allows a courier unescorted access pending 
completion of a full background investigation. If interim access is 
denied, the courier must be escorted.

[32] GAO-03-243.

[33] We are 95 percent confident that the error rate does not exceed 7 
percent. 

[34] We are 95 percent confident that the error rate did not exceed 23 
percent in fiscal year 2000.

[35] GAO-03-243.

[36] Freeze codes indicate that certain types of updates and closing 
actions will be prevented until the restriction is removed. A freeze 
code places a taxpayer's account in a condition that requires 
additional action before the account can be settled.

[37] We are 95 percent confident that the error rate does not exceed 31 
percent. 

[38] The statutory collection period for taxes is generally 10 years 
from the date of the tax assessment. However, this period can be 
extended by agreement between IRS and the taxpayer.

[39] We are 95 percent confident that the error rate does not exceed 14 
percent.

[40] This measure is part of the Taxpayer Protection and IRS 
Accountability Act of 2003, which passed the House of Representatives 
and was referred to the Senate Finance Committee on June 20, 2003. The 
measure, H.R. 1528 (108TH Congress, § 201), would amend section 6159 of 
the Internal Revenue Code by striking the requirement that all 
installment agreements fully satisfy the debtor's liability.

[41] Pub. L. No. 99-335, 100 Stat. 514 (1986) (codified as amended 
largely at 5 U.S.C. § 8351 and §§ 8401-8479).

[42] Agencies also are required by § 8432 to make certain matching 
contributions to TSP for those employees who make their own 
contributions.

GAO's Mission:

The General Accounting Office, the investigative arm of Congress, 
exists to support Congress in meeting its constitutional 
responsibilities and to help improve the performance and accountability 
of the federal government for the American people. GAO examines the use 
of public funds; evaluates federal programs and policies; and provides 
analyses, recommendations, and other assistance to help Congress make 
informed oversight, policy, and funding decisions. GAO's commitment to 
good government is reflected in its core values of accountability, 
integrity, and reliability.

Obtaining Copies of GAO Reports and Testimony:

The fastest and easiest way to obtain copies of GAO documents at no 
cost is through the Internet. GAO's Web site ( www.gao.gov ) contains 
abstracts and full-text files of current reports and testimony and an 
expanding archive of older products. The Web site features a search 
engine to help you locate documents using key words and phrases. You 
can print these documents in their entirety, including charts and other 
graphics.

Each day, GAO issues a list of newly released reports, testimony, and 
correspondence. GAO posts this list, known as "Today's Reports," on its 
Web site daily. The list contains links to the full-text document 
files. To have GAO e-mail this list to you every afternoon, go to 
www.gao.gov and select "Subscribe to e-mail alerts" under the "Order 
GAO Products" heading.

Order by Mail or Phone:

The first copy of each printed report is free. Additional copies are $2 
each. A check or money order should be made out to the Superintendent 
of Documents. GAO also accepts VISA and Mastercard. Orders for 100 or 
more copies mailed to a single address are discounted 25 percent. 
Orders should be sent to:

U.S. General Accounting Office

441 G Street NW,

Room LM Washington,

D.C. 20548:

To order by Phone: 	

	Voice: (202) 512-6000:

	TDD: (202) 512-2537:

	Fax: (202) 512-6061:

To Report Fraud, Waste, and Abuse in Federal Programs:

Contact:

Web site: www.gao.gov/fraudnet/fraudnet.htm E-mail: fraudnet@gao.gov

Automated answering system: (800) 424-5454 or (202) 512-7470:

Public Affairs:

Jeff Nelligan, managing director, NelliganJ@gao.gov (202) 512-4800 U.S.

General Accounting Office, 441 G Street NW, Room 7149 Washington, D.C.

20548: