IRS Return Selection:

Wage and Investment Division Should Define Audit Objectives and Refine Other Internal Controls

GAO-16-102: Published: Dec 17, 2015. Publicly Released: Jan 13, 2016.

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What GAO Found

Three offices in the Internal Revenue Service's (IRS) Wage and Investment division (W&I) are responsible for selecting returns for audit. Most returns are selected via computer systems that automatically send notices to taxpayers based on certain criteria, such as the validity of dependents. W&I program officials annually review the criteria and apply updates to the following filing season's returns. In 2014, about 59 percent of all W&I audits—more than 516,000—were selected with a specialized computer tool called the Dependent Database, while the remainder was selected through a combination of referrals and manual selection methods.

W&I generally has established a positive environment for internal controls but could improve several areas in its audit selection procedures to support its mission. GAO found several procedures that establish a positive environment for promoting internal controls, such as ethics training. In addition, IRS has guidance to help ensure that decisions about updates to audit selection criteria are correctly implemented in its automated systems. However, W&I does not have established objectives for its audit selection process, and existing performance measures focus on audit results rather than audit selection. In addition, W&I has not defined key terms such as “fairness and integrity,” as required by internal control standards. Documented objectives and key terms would help W&I hone the measures it uses to assess its audit selection efforts and bring a consistent understanding of “fairness and integrity” to audit selection staff.

GAO also found that not all elements of the selection process were appropriately documented. For example, W&I does not have clear documentation about how the three offices that select the majority of returns W&I audits interact with one another. Additionally, one guidance document notes that returns with the highest audit potential should be marked, but it does not describe how audit potential is determined or any related internal controls. Further, W&I also did not provide support showing that changes to automated audit selection processes and procedures were appropriately implemented in a timely manner. Moreover, the documentation indicates that W&I conducts an annual—rather than continuous—review of its audit selections and results as part of an annual 3-day working session. Strengthening controls in these areas would help provide greater assurance that W&I is fulfilling its mission to select tax returns with fairness and integrity. Additionally, the absence of a fully documented selection process may make it difficult for W&I to defend against accusations that it is not appropriately following its processes and procedures.

Why GAO Did This Study

Audit activities help ensure taxpayers pay the right amount of tax and help address the net $385 billion tax gap—the difference between the amount of taxes paid voluntarily and on time, and the amount owed. Audit programs in W&I mainly cover refundable credits reported on the Form 1040, Individual Income Tax Return. The hundreds of thousands of taxpayers whom W&I interacts with annually during audits make it critical to apply the tax law fairly. Unfair selection would increase burden on taxpayers and reduce public confidence in IRS.

GAO was asked to review W&I's audit selection process. This report (1) describes the W&I process for selecting tax returns for audit, and (2) determines how well W&I's audit selection procedures support its mission and goal to apply the tax law with integrity and fairness to all. GAO reviewed documentation on program procedures, an audit work plan, and various Internal Revenue Manual sections; analyzed audit data from fiscal years 2013 and 2014; and interviewed relevant IRS officials.

What GAO Recommends

GAO recommends, among other things, that IRS establish program objectives and definitions of key terms such as “fairness” that apply to audit selection and use those definitions in assessing its selection performance; document selection processes more thoroughly; and document that changes to procedures are done in a timely manner. IRS generally agreed with all seven recommendations and provided additional comments reprinted in appendix II.

For more information, contact Jessica Lucas-Judy at (202) 512-9110 or lucasjudyj@gao.gov.

Recommendations for Executive Action

  1. Status: Open

    Comments: In March 2016, IRS told us its definitions of fairness were documented in a policy statement and reflected in the IRS Taxpayer Bill of Rights. IRS said it agrees with the value of incorporating these definitions into its guidance for examiners and that it was taking appropriate action to do so. In addition, IRS said guiding principles for ensuring fairness in tax return examinations had been communicated from the Deputy Commissioner for Services and Enforcement to all Service and Enforcement employees. However, IRS did not provide documentation of this communication. IRS said it will use its definition as the basis of guidance to be incorporated into the Internal Revenue Manual to ensure the audit process supports IRS's mission of applying the tax law with integrity and fairness. IRS did not indicate how it would develop program-level objectives for W&I, as we recommended. Additionally, IRS said many of its existing performance measures provide key indicators and insights as to program performance with respect to fairness, such as the rate of examinations resulting in changes proposed to the reported tax, cycle time for the examination, and yield from the examination. However, as we noted in our December 2015 report, these performance measures focus on audit results rather than audit selection and W&I has not created indicators to evaluate what no-change rate is good or bad, or what rate would indicate fair selections. In March 2016, IRS said it would consider what additional objectives, performance measures, and indicators are needed. IRS told us it intends to implement our recommendation by October 2016. We will continue to monitor IRS's actions, including reviewing any supporting documentation the agency provides, to determine whether its actions address our recommendation.

    Recommendation: To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should clearly define and document: (1) key terms such as "fairness"; and (2) W&I program level objectives, performance measures, and indicators for audit selection to evaluate whether the audit selection process is meeting its mission of applying the tax law with integrity and fairness to all.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Open

    Comments: In March 2016, IRS said it was writing expectations about the definition of fairness that would be communicated at the beginning of each annual audit selection planning meeting. IRS told us it plans to implement this in July 2017.

    Recommendation: To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should clearly communicate these terms, objectives, measures, and indicators to all staff involved in the selection of returns for audit.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Open

    Comments: In March 2016, IRS said it would follow the risk process to officially report any risks associated with the outlined expectations identified during the review of the program level objectives, performance measures and indicators for audit selection. This recommendation will remain open until W&I develops program-level objectives--which would be related to its definition of fairness--and incorporates them into risk assessments for the audit selection process. IRS indicated it would implement our recommendation by October 2017.

    Recommendation: To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should incorporate the new objective(s) into W&I risk assessments done for audit selection processes.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  4. Status: Open

    Comments: In March 2016, IRS said that by July 2017, internal control information would be provided in the expectation document provided to each member of the annual audit selection planning meeting and that receipt would be documented.

    Recommendation: To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should ensure that internal control responsibilities are communicated and documented for all employees, including non-managers, tasked with revising or applying W&I audit selection criteria for potential audits.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  5. Status: Open

    Comments: In March 2016, IRS said procedures are in place to document and approve the criteria and methods used in the return selection program. It said it would review these procedures to ensure all criteria or methods used are consistently documented and approved by October 2016.

    Recommendation: To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should develop and implement procedures to ensure that all criteria or methods used in programs to select returns for audit are consistently documented and approved.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  6. Status: Open

    Comments: In March 2016, IRS said it would expand existing feedback mechanisms to specifically cover the audit selection process by July 2017. It is unclear what specific actions IRS plans to take to address the issues we reported in December 2015. For example, we found that the Internal Revenue Manual does not specify how non-managers should report a significant deficiency (such as a problem in the design or operation of an internal control) to the next level of management or that it should be reported in a timely manner. In addition, we reported that the form that W&I staff would use to report such deficiencies in the automated filters used for return selection does not include space for reporting internal control deficiencies that do not have a proposed solution. The form also states that the reason for modification should be self-explanatory, which may not appropriately highlight the deficiency the modification seeks to address.

    Recommendation: To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should develop and document a clear means for IRS staff members to promptly elevate to top management possible internal control issues related to audit selection in a timely manner.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  7. Status: Open

    Comments: In March 2016, IRS said it would review the processes that are in place for the documentation and timely implementation of selection controls and corrective actions to further ensure audit selection controls and corrective actions are implemented in a timely manner. IRS plans to complete this review by October 2016.

    Recommendation: To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should develop, document, and implement additional monitoring procedures to ensure audit selection controls and corrective actions are implemented in a timely manner.

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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