Tax-exempt organizations often provide charitable services or membership benefits—and they generally don’t pay federal income taxes. However, they do file an annual return to report their tax-exempt activities.
In 2016, IRS started using analytical models as part of an approach to use data to select which of these returns to review for compliance with tax-exempt laws. The models score each return on the likelihood that it isn’t in compliance.
But the scores may not be reliable because of problems with the models, documentation errors, and incomplete procedures.
IRS Form 990
What GAO Found
The Internal Revenue Service (IRS) used data to select almost 70 percent of its examinations of Form 990 returns in fiscal year 2019. Almost half of these examinations were selected using models that score returns for potential noncompliance (see figure).
Figure: Increased Use of Data in Examination Selection, Fiscal Years 2016-2019
Of the returns examined that were selected using the model, 87 percent resulted in a change to the return, indicating that IRS identified noncompliance. GAO found that the model did not improve change rates compared to prior selection methods and a higher model score is not associated with a higher change rate.
IRS has not fully implemented or documented internal controls in its established processes for analyzing data for examination selection. For example:
IRS has not defined measurable objectives for using data to select returns for examination . Without measurable objectives, IRS cannot assess how well it is doing or fully implement other internal controls.
IRS's models have deficiencies affecting the validity and reliability of return scoring and selection . IRS has incomplete definitions and procedures and did not always follow its definitions when assigning point values for identifying potential noncompliance for examination. As a result, return scoring by the models is not always consistent.
IRS did not consistently document the processing and use of data in decision-making on examination selection . Without such documentation, IRS cannot support its use of data in examination selection in all cases.
IRS does not regularly evaluate examination selection. Examination data were inconsistent across years and IRS only tracks one prior year of data. IRS also did not save data on all returns that the models scored. Without data and regular evaluations, IRS cannot assure that its models are selecting returns as intended and that deficiencies are identified and corrected.
Why GAO Did This Study
Exempt organizations often provide charitable services, or in some instances, membership benefits in furtherance of an exempt purpose. They generally do not pay federal income tax. IRS examines exempt organization returns (Form 990 and others) to address noncompliance, which may promote confidence in the tax exempt sector. In 2016, IRS started using three analytical models using Form 990 data to identify potential noncompliance and select returns for examination.
GAO was asked to review IRS's use of Form 990 data. This report assesses (1) IRS's use of data to select returns for examination and, (2) the process IRS has established for selecting returns. GAO analyzed (1) examination data from fiscal years 2016 through 2019 including results from the largest Form 990 model, and (2) model documentation for a generalizable sample. GAO interviewed IRS officials and assessed IRS policies and procedures using relevant standards for internal control.
GAO makes 13 recommendations, including that IRS establish objectives, revise model documentation, fully document processing and using data in decisions, and regularly evaluate examination selection. IRS agreed with all recommendations except one related to evaluating examination selection methods using consistent historical data over time. GAO continues to believe that this recommendation is valid as discussed in the report.
Recommendations for Executive Action
|Internal Revenue Service||1. The Commissioner of Internal Revenue should document measurable objectives for using data in selecting exempt organization returns for examination. (Recommendation 1)|
|Internal Revenue Service||2. The Commissioner of Internal Revenue should document and consistently use clear criteria and decision rules on assigning point values to queries, using categories and sliding scales. (Recommendation 2)|
|Internal Revenue Service||3. The Commissioner of Internal Revenue should require a regular review of query descriptions and programming to ensure their accuracy and minimize queries that flag the same or similar compliance issue. (Recommendation 3)|
|Internal Revenue Service||4. The Commissioner of Internal Revenue should develop procedures and criteria to test new queries prior to implementation in the models. (Recommendation 4)|
|Internal Revenue Service||5. The Commissioner of Internal Revenue should more fully document how TE/GE processes data and uses data to make examination selection decisions for sources outside of the model such as research projects and other projects that use queries. (Recommendation 5)|
|Internal Revenue Service||6. The Commissioner of Internal Revenue should conduct an analysis to identify the optimal interval between model runs. (Recommendation 6)|
|Internal Revenue Service||7. The Commissioner of Internal Revenue should establish a process for regularly evaluating selection decisions and related outcomes for the models and other processes that use data to select returns for examinations. (Recommendation 7)|
|Internal Revenue Service||8. The Commissioner of Internal Revenue should document consideration or action on recommendations from its 2018 and 2020 contractor assessments. (Recommendation 8)|
|Internal Revenue Service||9. The Commissioner of Internal Revenue should document how score and query data for all returns in the models will continue to be saved over the long term. (Recommendation 9)|
|Internal Revenue Service||10. The Commissioner of Internal Revenue should ensure that historical data on examination outcomes are consistently defined and used when doing analysis of examination outcomes. (Recommendation 10)|
|Internal Revenue Service||11. The Commissioner of Internal Revenue should routinely analyze the reasons for not examining selected returns and identify any necessary actions to address the reasons. (Recommendation 11)|
|Internal Revenue Service||12. The Commissioner of Internal Revenue should annually review and update procedures as needed in relevant IRM sections on examination selection and issue interim guidance until the affected IRM sections are updated. (Recommendation 12)|
|Internal Revenue Service||13. The Commissioner of Internal Revenue should document why TE/GE has not identified any risks in its risk register for using data to select exempt organization returns for examination. If risks are subsequently identified, TE/GE should document how it plans to analyze and address them. (Recommendation 13)|