IRS Examination Selection:

Internal Controls for Exempt Organization Selection Should Be Strengthened

GAO-15-514: Published: Jul 13, 2015. Publicly Released: Jul 23, 2015.

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What GAO Found

The Exempt Organizations (EO) unit within the Tax Exempt and Government Entities (TE/GE) division at the Internal Revenue Service (IRS) reviews organizations' applications for tax-exempt status to determine whether to grant status and oversees existing exempt organizations' compliance with the tax code. To identify exempt organizations for possible examination, EO uses a variety of information sources: for example, EO receives referrals of exempt organization noncompliance from third parties, such as the public, and other parts of IRS.

EO uses various controls intended to help it select exempt organizations for examination, in an effort to adhere to TE/GE's mission of “applying the tax law with integrity and fairness to all.” For example, EO maintains well-documented procedures for several examination selection processes in the Internal Revenue Manual (IRM), IRS's primary, official source of instructions to staff; staff can deviate from procedures that are included in the IRM only with executive management approval. In focus groups, EO staff generally told GAO that these procedures were valuable tools to help them administer the tax law.

However, there are several areas where EO's controls were not well designed or implemented. The control deficiencies GAO found increase the risk that EO could select organizations for examination in an unfair manner—for example, based on an organization's religious, educational, political, or other views. Examples of internal control deficiencies GAO found include the following:

Staff could deviate from procedures for some selection processes without executive management approval. GAO found that procedures for some processes—such as applying selection criteria to organizations under consideration for review—are not included in the IRM, as required by IRS policy. As a result, staff are not required to obtain executive management approval to deviate from these procedures. This increases the risk of unfair selection of organizations' returns for examination.

EO management does not consistently monitor selection decisions. GAO found that IRS does not consistently monitor examinations and database files to ensure that selection decisions are documented and approved, to help ensure fairness. GAO's review of examination files found that approval of some selection decisions was not documented, as required by EO procedures. For example, GAO's analysis of a sample of files suggests that an estimated 12 to 34 percent of cases where staff initially selected an organization for examination, but ultimately decided not to perform the examination, were missing the indication of management approval of the final decision, as required in the IRM. Continuous monitoring is an element of internal control; EO management has not been conducting sufficient monitoring to ensure that required approvals were taking place.

Why GAO Did This Study

IRS examines tax-exempt organizations to enforce their compliance with the tax code. Examinations can result in assessment of taxes or revocation of tax-exempt status, among other things.

GAO was asked to review IRS's criteria and processes for selecting exempt organizations for examination. This report (1) describes these processes and (2) assesses the adequacy of examination selection controls.

GAO reviewed IRS criteria, processes, and controls for selecting organizations for examination and spoke with IRS officials; assessed whether IRS controls followed Standards for Internal Control in the Federal Government ; reviewed random probability samples from two populations of examination files; and conducted tests on populations and random probability samples from three databases used in EO examination selection to determine the adequacy of EO's control implementation (for files closed in fiscal year 2014). GAO also conducted eight focus groups on internal controls topics with EO staff who conduct research or make examination selection decisions.

What GAO Recommends

GAO is recommending that IRS take 10 actions to improve selection control design and implementation, such as ensuring that all selection procedures are included in the IRM and thus subject to executive management approval, and developing additional examination selection monitoring procedures. IRS generally agreed with the recommendations.

For more information, contact James R. McTigue, Jr. at (202) 512-9110 or mctiguej@gao.gov.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: In August 2016, the Internal Revenue Service (IRS) issued a new Internal Revenue Manual (IRM) section, 4.75.9, covering compliance checks and Exempt Organization Compliance Area (EOCA) classification. The Exempt Organizations Unit no longer conducts compliance reviews, other than those required in the Patient Protection and Affordable Care Act. Formalizing this guidance in the IRM can help ensure that IRS employees have the approved policy and guidance they need to carry out their responsibilities in administering the tax laws and that certain guidance is available to the public.

    Recommendation: To better ensure the Exempt Organization (EO) unit's adherence to the Tax Exempt and Government Entities (TE/GE) division's mission of "applying the tax law with integrity and fairness to all" in selecting exempt organizations to review or examine, the Commissioner of Internal Revenue should direct EO to complete the development and formally issue the Internal Revenue (IRM) sections on compliance checks and compliance reviews, and develop and formally issue an IRM section on Exempt Organization Compliance Area (EOCA) classification.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Closed - Implemented

    Priority recommendation

    Comments: The Exempt Organizations Exam group completed an action plan for the process of reviewing and updating its Internal Revenue Manual (IRM) sections on an ongoing basis. Implementation of the plan began at the end of 2015, according to an Internal Revenue Service (IRS) official. The plan lists IRM sections and their revision statuses and authors, along with estimated completion dates. The plan is updated daily or weekly by the Exempt Organizations IRM Coordinator, according to an IRS official. Other procedures, outside of the IRM that we reviewed during our audit have either been updated or are in the process of being updated. Specifically, Exempt Organizations Compliance Area procedures will be incorporated into the IRM. The Referrals Procedures document has been updated and is included in a monthly management review.

    Recommendation: To better ensure the EO unit's adherence to the TE/GE division's mission of "applying the tax law with integrity and fairness to all" in selecting exempt organizations to review or examine, the Commissioner of Internal Revenue should direct EO to develop, document, and implement a process to ensure that Internal Revenue Manual (IRM) sections and other procedures are reviewed and updated annually, and that updates reflect current practice, as required.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Open

    Comments: The Internal Revenue Service's Exempt Organizations (EO) unit issued a memo, in October 2015, to Area Managers requiring that they complete monthly sample reviews of closed and dismissed cases to ensure that proper managerial approvals are documented. EO also issued a memo, in April 2016, to examination staff and managers, emphasizing the importance of documenting justifications for examination dismissals. Additionally, operational reviews are conducted to ensure that the monitoring samples are being reviewed. In January 2017, EO's Exempt Organization Classification Area (EOCA) resumed quality reviews, which includes a review of documentation and EOCA database entries. As of May 2017, monitoring has not increased for EO referrals.

    Recommendation: To better ensure the EO unit's adherence to the TE/GE division's mission of "applying the tax law with integrity and fairness to all" in selecting exempt organizations to review or examine, the Commissioner of Internal Revenue should direct EO to develop, document, and implement additional monitoring procedures in order to ensure case selection controls, including ensuring that procedures for obtaining required signatures and documenting explanations for selection decisions, are being followed.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  4. Status: Closed - Implemented

    Comments: In September 2016, the Internal Revenue Service (IRS) issued a new Internal Revenue Manual (IRM) section, 4.75.8, that describes how project teams should summarize and report examination selection criteria and project operations. The section also describes approvals for models or queries used for examination selection, and how changes to projects are monitored and approved. Formalizing this guidance in the IRM can help reduce the risk of projects selecting organizations for review in an unfair manner.

    Recommendation: To better ensure the EO unit's adherence to the TE/GE division's mission of "applying the tax law with integrity and fairness to all" in selecting exempt organizations to review or examine, the Commissioner of Internal Revenue should direct EO to develop, document, and implement procedures to ensure that all criteria or methods used in projects to select returns for examination are consistently documented and approved, including procedures related to documenting changes that occur during the course of a project, or new phases of a project.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  5. Status: Closed - Implemented

    Comments: In September 2016, the Internal Revenue Service (IRS) issued a new Internal Revenue Manual (IRM) section, 4.75.8, that describes triage teams, their responsibilities, criteria for examination selection, and documentation of decisions. Formalizing this guidance in the IRM can help ensure that triage teams are implementing management directives for examination selection.

    Recommendation: To better ensure the EO unit's adherence to the TE/GE division's mission of "applying the tax law with integrity and fairness to all" in selecting exempt organizations to review or examine, the Commissioner of Internal Revenue should direct EO to develop, document, and implement procedures for examination selection done by triage teams, including a process to consistently document selection criteria and triage team examination selection decisions.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  6. Status: Closed - Implemented

    Comments: In September 2016, the Internal Revenue Service (IRS) issued a new Internal Revenue Manual (IRM) section, 4.75.8, states that area managers would receive reports to help ensure that examinations associated with projects are properly coded. Additionally, Exempt Organization (EO) Unit staff identified project codes with no open examinations to be frozen or made unavailable for use. EO also developed a desk guide for submitting closures of project codes for management approval. Review of project codes and ensuring that EO staff can?t miscode examinations can help ensure that EO can accurately track performance and use of resources.

    Recommendation: To better ensure the EO unit's adherence to the TE/GE division's mission of "applying the tax law with integrity and fairness to all" in selecting exempt organizations to review or examine, the Commissioner of Internal Revenue should direct EO to determine what additional controls may be needed to ensure examinations related to projects are properly coded.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  7. Status: Closed - Implemented

    Comments: In 2015 and 2016, the Internal Revenue Service's (IRS) Exempt Organization (EO) unit issued data dictionaries for the four databases used during examination selection. The data dictionaries can help individuals newly using the system, including EO employees and system developers. Also, since data dictionaries assist users and developers with understanding these databases, the data dictionaries decrease the risk of data elements not being used accurately.

    Recommendation: To better ensure the EO unit's adherence to the TE/GE division's mission of "applying the tax law with integrity and fairness to all" in selecting exempt organizations to review or examine, for the databases EO uses during examination selection, the Commissioner of Internal Revenue should direct the EO to develop complete and up to date data dictionaries to define data elements used in the databases.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  8. Status: Closed - Implemented

    Priority recommendation

    Comments: In 2015, the Internal Revenue Service's Exempt Organizations unit initiated cross-training for 13 referrals classifiers and other staff. The training covered political and high profile referrals. In 2015, IRS also issued a memo effective immediately, that discontinued the use of committees to review referrals, with exception of the Political Activities Referral Committee. The memo established a group a peer review team of three classifiers rotated on an annual basis. The peer review team is responsible for reviewing high profile and church referrals. Cross-training the classifiers allows for shared responsibility for classifying sensitive referrals, which can reduce the potential for error and potential unfairness. Cross-training can also help with succession planning.

    Recommendation: To better ensure the EO unit's adherence to the TE/GE division's mission of "applying the tax law with integrity and fairness to all" in selecting exempt organizations to review or examine, the Commissioner of Internal Revenue should direct EO to provide cross-training for referrals classifiers, prioritizing training for classifiers who work with political activity, high profile, and church referrals; and develop, document, and implement a system to ensure that those referrals are not always reviewed by the same classifier.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  9. Status: Closed - Implemented

    Comments: In July 2015, the Internal Revenue Service (IRS) issued a memo stating that, effective immediately, select managers would be chosen at random to serve on the Political Activities Referral Committee (PARC) for a period of two years. In December 2015, IRS issued a memo, effective immediately, that discontinued the use of committees to review referrals, with exception of the PARC. The memo established a peer review team of three classifiers rotated on an annual basis. The peer review team is responsible for reviewing high profile and church referrals. Rotating staff may help ensure that a variety of staff review referrals, which serves as a safeguard for maintaining fairness and integrity in the classification of political activity and sensitive referrals.

    Recommendation: To better ensure the EO unit's adherence to the TE/GE division's mission of "applying the tax law with integrity and fairness to all" in selecting exempt organizations to review or examine, the Commissioner of Internal Revenue should direct EO to ensure that referral committee members rotate every 12 months by soliciting volunteers. If EO does not believe that 12 months is an appropriate rotation length, then the IRM should be revised to require an alternative rotation schedule.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  10. Status: Open

    Comments: In 2016, the Tax Exempt and Government Entities Unit (TE/GE) reviewed its internal processes and procedures and met with the Wage and investment (W&I) Files Unit to discuss procedures for requesting closed case files, according to Exempt Organizations Examinations (EOE) officials. TE/GE developed a desk guide for the Exempt Organizations Case Selection and Delivery Unit to document the procedures for requesting, tracking and monitoring closed case file requests. In addition, TE/GE provided recommendations to the W&I Files unit on modifications to the Internal Revenue Manual (IRM) that would facilitate coordination; as of June 2017, W&I has not implemented these recommendations. The EOE unit will also continue to expand electronic case management efficiencies.

    Recommendation: In addition, the Commissioner of Internal Revenue should determine what additional controls may be needed to ensure that all closed examination files are tracked and maintained accurately.

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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