IRS Return Selection:

Improved Planning, Internal Controls, and Data Would Enhance Large Business Division Efforts to Implement New Compliance Approach

GAO-17-324: Published: Mar 28, 2017. Publicly Released: Apr 27, 2017.

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James R. McTigue Jr.
(202) 512-9110
mctiguej@gao.gov

 

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The IRS's Large Business and International division audits large partnerships and corporations (worth at least $10 million) and wealthy individuals—which sometimes poses compliance challenges. For example, the underreported income tax of corporations alone was about $28 million annually between 2008 and 2010.

This division is implementing a new approach to compliance that focuses on specific issues, such as partnerships that underreport certain types of income. We found that the IRS has made progress in implementing this approach but recommended that it fully address all the project planning principles necessary to effectively implement it.

Conceptual Overview of How the Large Business and International Division Selects Tax Returns for Audit

A funnel graphic show five levels, starting at returns filed and ending at audit selection.

A funnel graphic show five levels, starting at returns filed and ending at audit selection.

Additional Materials:

Contact:

James R. McTigue Jr.
(202) 512-9110
mctiguej@gao.gov

 

Office of Public Affairs
(202) 512-4800
youngc1@gao.gov

What GAO Found

The Internal Revenue Service's (IRS) Large Business and International division (LB&I) uses a variety of methods, such as computer models and staff reviews of returns, to identify tax returns for audit consideration. From the returns identified, managers and auditors in LB&I field offices select the returns to be audited. For the eight methods LB&I uses for identifying and selecting tax returns for audit (selection methods) that GAO analyzed, LB&I documentation on its procedures and policies generally reflected 4 of the 10 internal control principles GAO reviewed. For example:

  • Related to the internal control principle of demonstrating commitment to integrity and ethical values, LB&I auditors who identify tax returns for audit consideration are prohibited from auditing those returns themselves or assigning them to specific individuals for audit. In addition, all LB&I staff completed a required training on ethics and impartiality in 2015, the latest available data.
  • Related to the internal control principle of demonstrating a commitment to competence, LB&I's procedures and manuals generally documented its training to help assure the competence of staff involved in audit selection. This training included courses on basic skills as well as instruction on more specific topics.

However, for the other 6 internal control principles GAO reviewed, there were gaps in documentation that limit LB&I's assurance that its selection methods are being implemented as designed and are supporting its objectives. For example:

  • Related to the internal control principle of identifying, analyzing, and responding to risk, LB&I documentation did not specify procedures or a process for how to respond to changing circumstances, such as a change in the law, in selecting returns for audit.
  • Related to the internal control principle of reporting on issues and remediating related deficiencies, LB&I documentation indicated that problems identified with selection methods were discussed in meetings, but not that corrective action was taken to address them.

GAO also found that LB&I has monitoring directives, but it does not have a standard process for monitoring field staff's audit selection decisions. Without such a process, LB&I lacks reasonable assurance that decisions are made consistently.

LB&I is in the process of implementing a new approach for addressing taxpayer compliance, including how it identifies tax returns for audit. LB&I plans to implement what officials call “campaigns,” which are projects focused on a specific compliance-related issue, such as partnerships underreporting certain income, rather than projects focused on the characteristics of whole tax returns. According to LB&I officials, campaigns could include conducting audits as well as other efforts, such as reaching out to taxpayers and tax professionals, issuing guidance, and participating in industry events. LB&I officials said certain audit selection methods that existed prior to the development of campaigns will operate while LB&I implements its campaign approach, and campaigns may subsume some of those methods.

GAO found that LB&I made some progress in implementing its new compliance approach, such as by involving stakeholders in plans and implementing the process for submitting proposals for campaigns. However, LB&I has not fully met five project planning principles set forth in prior GAO work (see table below). Until it fully meets these principles, LB&I management lacks reasonable assurance that its new compliance approach will succeed in accomplishing its overall objectives of encouraging voluntary compliance and fair treatment of taxpayers.

Large Business and International (LB&I) Division's Plans for New Compliance Approach Assessed against Project Planning Principles as of December 2016

Highlights_v5_100529_324

Why GAO Did This Study

LB&I audits large partnerships and corporations with $10 million or more in assets and high wealth individuals. These entities pose compliance challenges. For example, IRS reported that the gross underreported income tax of large corporations alone averaged an estimated $28 billion annually between 2008 and 2010, the most recent data. It is important for LB&I to have adequate controls for its audit procedures and to properly plan and implement its new approach to address noncompliance.

GAO was asked to evaluate how IRS selects returns and is implementing its new compliance approach. Among other objectives, this report (1) assesses the extent that LB&I's documented procedures and policies for its audit selection methods generally reflected relevant internal control principles, (2) assesses the extent that LB&I has a standard process to monitor audit selection decisions, and (3) assesses the extent that LB&I has planned and implemented its new approach to address compliance.

GAO reviewed LB&I procedures and policies for eight selection methods that involved the use of discretion and its plans for implementing a new compliance approach. Given the status of LB&I's plans for and implementation of its new approach, GAO did not assess LB&I's decision to create the approach. GAO held focus groups with LB&I staff responsible for selecting audits, and interviewed IRS official

What GAO Recommends

GAO recommends that IRS address documentation gaps in its selection method procedures and policies related to six internal control principles, develop a standard process to monitor field staff's audit selection decisions, and take seven actions to fully address planning principles in its efforts to implement its new compliance approach. In commenting a draft of this report, IRS agreed with all of 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: IRS officials said that workload selection for campaigns has been centralized and returns are prioritized and risk-assessed, based on established objectives and defined compliance goals. They also said objectives and risk tolerances for other selection methods are now defined in other agency guidance. As of October 2018, we are in the process of reviewing additional documentation IRS sent to support its actions.

    Recommendation: As LB&I finishes implementing its new approach and decides which selection methods will be used with the campaigns, the Commissioner of Internal Revenue should ensure that the documentation gaps in policies and procedures are addressed for six internal control principles for the selection methods that will be used, including defining objectives to identify risk and defining risk tolerances.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Open

    Comments: IRS officials said that they have closed documentation gaps for the two audit selection methods they still use by issuing new procedures and guidance. For the campaign selection method, IRS said it has developed a process that identifies, addresses and documents all risks. For selecting international individual compliance-miscellaneous audits, IRS said it has established a mitigation strategy for operational risks through the development of guide papers that are used by examiners and technical specialists making audit selections. As of October 2018, we are reviewing the evidence IRS has provided supporting these changes.

    Recommendation: As LB&I finishes implementing its new approach and decides which selection methods will be used with the campaigns, the Commissioner of Internal Revenue should ensure that the documentation gaps in policies and procedures are addressed for six internal control principles for the selection methods that will be used, including identifying, analyzing, and responding to risks to achieving the objectives.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Open

    Comments: IRS officials said that they have designed control activities for individual campaigns but has not addressed other active selection methods. As of October 2018, we are continuing to review additional IRS documentation submitted on this recommendation.

    Recommendation: As LB&I finishes implementing its new approach and decides which selection methods will be used with the campaigns, the Commissioner of Internal Revenue should ensure that the documentation gaps in policies and procedures are addressed for six internal control principles for the selection methods that will be used, including designing control activities to achieve objectives and responding to risks.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  4. Status: Open

    Comments: IRS officials said they are actively using quality results in their current metrics. Additionally, IRS officials said they are developing a standard governance process for each program for case selection that will address all of LB&I workload selection methods. Due to the development of the standardized programs case selection approach, these officials said they will need additional time to ensure they fully address each of the workload selection methods to satisfy this planned corrective action. As of October 2018, we will continue to monitor the progress IRS makes on standardizing its processes.

    Recommendation: As LB&I finishes implementing its new approach and decides which selection methods will be used with the campaigns, the Commissioner of Internal Revenue should ensure that the documentation gaps in policies and procedures are addressed for six internal control principles for the selection methods that will be used, including using quality information to achieve objectives.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  5. Status: Open

    Comments: IRS officials said they are developing a standard governance process for each program for case selection and will be using prioritization tools and feedback loops. They said this will ensure that IRS is using the appropriate tool for workload selection. IRS communications will address each of the workload selection methods. They said additional time is needed to develop a standardized governance process and feedback mechanism as well as to collect the appropriate documentation on the current workload selection methods. As of October 2018, we will continue to monitor IRS's progress.

    Recommendation: As LB&I finishes implementing its new approach and decides which selection methods will be used with the campaigns, the Commissioner of Internal Revenue should ensure that the documentation gaps in policies and procedures are addressed for six internal control principles for the selection methods that will be used, including communicating internally the necessary quality information about the objectives.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  6. Status: Open

    Comments: IRS officials said that the campaign development process includes a continual feedback mechanism that allows IRS to evaluate issues and remediate identified internal control deficiencies on a timely basis. They said that they have created similar procedures for their other selection methods as well. As of October 2018, we are in the process of reviewing this documentation.

    Recommendation: As LB&I finishes implementing its new approach and decides which selection methods will be used with the campaigns, the Commissioner of Internal Revenue should ensure that the documentation gaps in policies and procedures are addressed for six internal control principles for the selection methods that will be used, including evaluating issues and remediating identified internal control deficiencies on a timely basis.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  7. Status: Open

    Comments: IRS officials said they will design a standard process to monitor and review audit selection decisions in the field. Our report noted that at one time, IRS sampled surveyed returns as part of its annual review process. IRS officials said they agree that reviewing a sample of surveyed cases would be beneficial in evaluating processes for auditing tax returns in the field and helping to ensure proper controls are in place. IRS said it will evaluate resources needed to restart reviews on surveyed cases. As of October 2018, we will continue to monitor IRS's progress.

    Recommendation: Also in accordance with federal internal control standards, the Commissioner should direct LB&I to adopt a standard process for monitoring audit selection decisions in the field, such as by modifying the existing quality control system.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  8. Status: Open

    Comments: IRS officials said that LB&I has fully implemented the campaign program and has effectively documented each step of the campaign process. This process specifically shows a time-line of a campaign from inception to CIC approval and execution. As of October 2018, we are reviewing the documentation IRS sent to support this.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should create a timetable with specific dates for implementing its new compliance approach.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  9. Status: Open

    Comments: IRS officials said they have approved new performance metrics on campaigns and established a plan to use the metrics to assess the campaign program overall. They said the approved metrics and reports have been implemented. They also said the evaluation of established metrics and feedback will be continuous and adjustments made as improvements are identified. As of October 2018, we are reviewing the supporting documentation for the plan's implementation.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should establish metrics to help determine whether the campaign effort overall meets LB&I's goals.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  10. Status: Open

    Comments: IRS officials said they are developing a standard governance process for each case selection program. Campaigns will be run as projects to include scope and scheduled resources. The officials said they have completed an initial skills assessment but need additional time to develop a workload plan versus the utilization plan. They will use the feedback loop to make adjustments to resources to ensure subsequent campaigns are resourced appropriately. As of October 2018, we are reviewing documentation IRS sent on its progress.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should finalize and document plans to evaluate the human resources expended on campaign activities.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  11. Status: Open

    Comments: As of October 2018, IRS officials said LB&I has developed and deployed the Campaign Development Form and the LB&I Taxpayer Registry to capture stakeholder input and feedback. The form documents all actions and a decision made on a particular campaign and is used to monitor real-time performance. While this will help IRS document lessons learned moving forward, IRS officials have not said how they would document lessons learned in the past.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should document lessons learned from stakeholder input and past performance.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  12. Status: Open

    Comments: IRS officials said they have identified resources used in compliance activities, formed a baseline of resources from prior years, identified data sources and a resource calculator tool, and implemented an action plan to monitor resources across compliance programs. As of October 2018, we are reviewing additional documentation that IRS sent on the implementation of these plans.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should monitor overall performance across future campaigns, not just individual compliance projects, and in doing so ensure that the data used for monitoring accounts for the costs beyond the auditor's time can clearly be linked with specific selection methods, including the Discriminant Analysis System method, to the extent that the selection methods continue to operate.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  13. Status: Open

    Comments: IRS officials said that the Campaign Development Form records all decisions and allows LB&I staff to monitor effectiveness, as well as to prioritize for the highest compliance impact. IRS also has produced a campaign framework and campaign submission instructions. As of October 2018, we are in the process of reviewing additional information that IRS submitted documenting how closely the form addresses our recommendation.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should develop and document criteria to use in choosing selection methods for campaigns using audits.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  14. Status: Open

    Comments: IRS officials said they created a timetable to mitigate risks, prioritize selections, and document metrics for assessing whether progress is being made toward goals. The timetable includes the following: standardize a process to analyze and mitigate risk for campaign selection and implementation and create a standard process for tracking mitigations measure on the risks. As of October 2018, we are in the process of reviewing additional documentation that IRS sent as support.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should set a timetable to analyze and mitigate risks and document specific metrics for assessing mitigation of identified risks.

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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