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 January 2018, IRS told us that its definition of fairness and its objective with audit selection is now documented in Internal Revenue Manual section 4.1.26. However, IRS has not indicated how it would develop program-level performance measures, as we recommended. IRS has told us that 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. As of April 2018, we continue to monitor IRS's actions, including reviewing any supporting documentation the agency provides, to determine whether its actions address all aspects of 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 January 2018, IRS said it established an objective for audit selection in Internal Revenue Manual Section 4.1.26 and communicated this with staff. In April 2018, IRS sent additional documentation on communication for its staff regarding an objective for audit selection. We are in the process of reviewing the additional documentation.

    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 April 2017, IRS said that Internal Revenue Manual (IRM) Section 4.1.26 incorporates its new objectives into risk assessments done for the audit selection process. As of April 2018, we are reviewing additional documentation IRS submitted toward fulfilling the remaining aspects of our recommendation.

    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 January 2018, IRS provided evidence that it had communicated and documented internal control responsibilities to employees, though the evidence presented was not clear about whether the communication was made to all employees tasked with revising or applying audit selection criteria, as directed in the recommendation. As of April 2018, we are continuing to communicate with IRS about additional evidence.

    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: Closed - Implemented

    Comments: In January 2018, IRS provided evidence to show that it had completed a process for ensuring that methods used in programs to select returns for audit were consistently documented and approved. In addition to documenting these criteria and methods, IRS created a form to document the request and approval for all changes to workload selection tools under these criteria and methods. IRS said that its staff members are now required to follow a process to request revisions or additions to audit selection criteria and methods. These work requests are documented and require different levels of executive review and approval. This process also has strict time frames outlining required submission dates to be followed for such revisions or additions. The procedures are documented in Internal Revenue Manual section 4.1.26.

    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: Closed - Implemented

    Comments: In January 2018, Internal Revenue Service (IRS) officials provided evidence that IRS has started using a computer system to create a feedback loop that allows IRS campus employees to give feedback to IRS headquarters on any issues related to workload selection that they may come across while working audits. IRS directors prepared and issued an all-employee email advising them of the new feedback mechanism and included a link to the site. Headquarters staff are to respond to all related inquiries and feedback and all campus employees will be able to see the response.

    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: Closed - Implemented

    Comments: In January 2018, Internal Revenue Service (IRS) officials provided evidence that IRS has begun documenting the request and approval of all changes to workload selection controls and that corrective actions are taken in a timely manner. To that end, IRS staff members are now required to follow a process to request revisions/additions to selection rules. These work requests are documented in a computer system and require different levels of executive review and approval. The process also has strict time frames outlining required submission dates to be followed for changes. To have IRS's information technology staff do the requested programming changes the required approved forms must be submitted timely. The procedures are documented in Internal Revenue Manual section 4.1.26.

    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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