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: Open

    Comments: A new section of the Internal Revenue Manual, 4.75.9--which covers compliance checks, and compliance reviews--has been drafted and is under review prior to publication, according to an IRS official. Publication is expected in July 2016. A new section on Exempt Organizations Compliance Area classification is also expected to be published by Sept. 30, 2016.

    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 plans to review its monitoring procedures and establish a process for each examination area. The process will include reviews of samples of closed dismissed and examined cases. As of June 2016, EO has not provided any documentation addressing this recommendation.

    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: Open

    Comments: New additions to the Internal Revenue Manual (IRM) have been drafted to address procedures for proposing, developing, implementing, and reporting on Compliance Initiative Projects within the Exempt Organizations Examination unit (EOE). Specifically, EOE will follow IRM 4.17 on Compliance Initiative Projects, and sections 4.17.1-4 will include specific references to Tax Exempt and Government Entities. Also, new language has been added to draft IRM 4.75.8.2.1, "EOE Compliance Initiative." Any deviations from the procedures must be approved by the Director, EOE. The updated IRMs are expected to be published by September 30, 2016.

    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: Open

    Comments: The Exempt Organizations Examination unit (EOE) is drafting a new section of the Internal Revenue Manual (IRM) which will describe the composition and purpose of a triage team, the criteria for examination selection, the approval process for the criteria, and the required documentation. The IRM section is expected to be published by September 30, 2016.

    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: Open

    Comments: The Exempt Organizations Examination unit (EOE) plans to add new language to the Internal Revenue Manual (IRM) section 4.75.8.4.1(3) which provides that managers will receive reports to ensure that examinations related to projects are properly coded. The IRM section is expected to be published by September 30, 2016.

    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: Open

    Comments: The Exempt Organizations Examination unit (EOE) developed data dictionaries for the Reporting and Inventory Classification System (RICS) database and the Reporting Compliance Case Management System (RCCMS) database. As of June 2016, resources have not permitted EOE to develop data dictionaries for the Exempt Organizations Classification Area (EOCA) and EOCA Classification databases, according to EOE officials.

    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: Tax Exempt and Government Entities (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 is developing 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. 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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