IRS Audits:

Weaknesses in Selecting and Conducting Correspondence Audits

GGD-99-48: Published: Mar 31, 1999. Publicly Released: Mar 31, 1999.

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Pursuant to a congressional request, GAO reviewed the Internal Revenue Service's (IRS) program to audit income tax returns through correspondence, focusing on: (1) the number, results, and duration of correspondence audits as well as the characteristics of the audited returns; and (2) processes and requirements that IRS has had for years to govern correspondence audits.

GAO noted that: (1) several weaknesses were found in IRS' correspondence audit processes; (2) these weaknesses, individually or in combination, can erode the integrity of the correspondence audit processes, which are designed to help ensure that taxpayers pay the correct tax amounts and are treated properly; (3) during fiscal years 1992-1997, the annual number and results of correspondence audits conducted by IRS varied considerably; (4) the number ranged annually from just over 200,000 to about 1.1 million audits; (5) the rate at which IRS auditors closed audits without recommending additional taxes ranged from 13 percent to 46 percent; (6) when they did recommend additional taxes, the average amounts ranged from $1,300 to $2,800; (7) the rate at which taxpayers did not respond to these recommended additional taxes after being requested to do so by IRS ranged from 29 percent to 63 percent; (8) these variations resulted, in part, from an increase in the number of correspondence audits of returns claiming an earned income credit (EIC); (9) for the traditional correspondence audits closed in fiscal year 1996, the time between the filing of a return and the start of the correspondence audit averaged 10 months; (10) it then took 11 more months before IRS assessed any taxes that were recommended during the audits; (11) as for the characteristics of these 1996 returns, an estimated 75 percent had reported adjusted gross incomes of less than $15,000; (12) in part, this percentage reflects the correspondence audit's focus on simple tax issues and EIC; (13) IRS had weaknesses in implementing the correspondence audit requirements for four processes; (14) not all of the traditional correspondence audits closed in 1996 were manually reviewed (or classified) to identify all issues for audit, as required by IRS; (15) support for recommended audit findings was not adequately documented in the audit workpaper files, as required, for about one-third of the audits; (16) the taxpayer documentation that was required to justify EIC claims varied from service center to service center; (17) GAO found weaknesses in the reviews that IRS did on a sample of closed audits to measure their quality; and (18) in addition to the weaknesses in implementing the requirements, IRS allowed service centers to exclude certain types of audits that did not have all required documentation from being measured against the audit standard on workpaper documentation.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: IRS has implemented a new quality review system. First, it requires that all audits be subjected to quality review in IRM 21.8 and 21.10. Second, in analyzing the audits' quality, it requires (see exhibit 21.10.1-5) that quality reviewers always evaluate the support for the audit recommendations and the documentation for the audit steps (unless local procedures do not require documentation for audits of certain types of issues).

    Recommendation: The Commissioner of Internal Revenue should eliminate the discretion that service centers have to exclude audits that lack documentation on the audit steps and support for audit recommendations from the calculations IRS does to measure adherence to the audit quality standard on workpaper documentation.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Closed - Implemented

    Comments: IRS issued a May 1999 memo requiring supervisors to document their reviews of audit workpapers. IRS also revised manual section 114.1.7 to emphasize this requirement to document their reviews of audit workpapers.

    Recommendation: The Commissioner of Internal Revenue should require supervisors in the service centers to document their reviews of audit workpapers.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Closed - Implemented

    Comments: IRS has revised its IRM guidance (IRM 21.8.1.4.86.2). These revisions clarify that all types of audit cases are subject to the quality review sample.

    Recommendation: The Commissioner of Internal Revenue should improve controls to better ensure that IRS' correspondence audit processes adhere to existing audit requirements and standards on including all types of closed audits across the 10 service centers in the samples for measuring audit quality.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  4. Status: Closed - Implemented

    Comments: IRS officials provided documentation to show that they issued new guidelines, revised forms/notices, and revised procedures in its manuals to clarify the required evidence that taxpayers should provide, the need for third party verification, and the consistency by which examiners should review the evidence. IRS also provided documentation to show that quality reviewers should look for consistent application of these changes.

    Recommendation: The Commissioner of Internal Revenue should improve controls to better ensure that IRS' correspondence audit processes adhere to existing audit requirements and standards on ensuring consistency in the treatment of audited EIC claims by collecting and using the information required, including verification from third parties, to justify the claims.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  5. Status: Closed - Implemented

    Comments: IRS sent a memo to relevant parties on their role in assuring that the manual requirements for doing audit workpapers must be followed. In addition, IRS is enlarging the samples drawn and intensifying the reviews done through its audit quality program. A major quality standard involves adequate workpapers. This memo, in conjunction with the enhanced quality review effort, should meet the intent of the recommendation.

    Recommendation: The Commissioner of Internal Revenue should improve controls to better ensure that IRS' correspondence audit processes adhere to existing audit requirements and standards on documenting the support for audit findings and recommendations in the audit workpaper files.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  6. Status: Closed - Implemented

    Comments: IRS sent a memo to relevant parties to remind them of their roles in assuring adherence to the audit classification procedures in the manual. This action meets the general intent of the recommendation but does not necessarily institute a full control. Because this is a positive step and IRS does not plan further steps, GAO is closing this recommendation.

    Recommendation: The Commissioner of Internal Revenue should improve controls to better ensure that IRS' correspondence audit processes adhere to existing audit requirements and standards on classifying filed returns, and in particular, referring returns with complex schedules that may have potential tax changes to staff with sufficient knowledge to classify them.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  7. Status: Closed - Implemented

    Comments: IRS tasked its District Office Research and Analysis unit in North Florida to do this study on why taxpayers do not respond to the audit letters. In March 2001, IRS issued a report on this study. Although IRS designed the study to be valid, many taxpayers did not respond to IRS study letter on why they did not respond to IRS' audit letters. Even so, IRS believes the study generated some useful insights, which IRS hopes will lead to better ways to contact taxpayers and to induce their responses.

    Recommendation: The Commissioner of Internal Revenue should determine the reasons, through statistically valid and cost-effective means, for taxpayers' not responding to IRS' audit letters, so that IRS can identify ways to encourage more taxpayers to respond.

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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