SEMIANNUAL REPORT TO CONGRESS

MARCH 31, 2004

MESSAGE FROM TIGTA'S ACTING INSPECTOR GENERAL

The Treasury Inspector General for Tax Administration (TIGTA) plays a vital role in the Federal Government by ensuring the nation's tax administration system is operating effectively and is protected internally and externally. This year marks our fifth year of operation as an Inspector General (IG) organization. The world has changed dramatically in the past 5 years, particularly since September 11, 2001. In these days of terrorist activity and economic challenge, it is more important than ever that we promote the efficiency and effectiveness of tax administration and safeguard the operation of this key national system.

The results of our work for the past 6 months, from October 1, 2003, through March 31, 2004, indicate that TIGTA has risen to the challenges it faces. Our accomplishments during this reporting period helped improve tax administration and consequently aided taxpayers nationwide. With the issuance of 81 audit reports, we identified more than $732 million in cost savings, and an additional $3.45 billion in increased or protected revenue. Our audits assessed such Internal Revenue Service (IRS) operational and programmatic issues as providing quality customer service, information technology modernization, information system security, tax compliance initiatives, and erroneous payments.

To combat fraud, waste, and abuse, our investigative work centered on IRS employee and infrastructure security, employee integrity, and external attempts to corrupt Federal tax administration. During this reporting period, we received 3,545 complaints of alleged criminal wrongdoing or administrative misconduct. We opened 1,877 investigations and closed 1,989. Additionally, TIGTA's Office of Chief Counsel reviewed 116 proposed regulations and legislative requests. Highlights of our work are included in this Semiannual Report to Congress.

We are proud of all of our accomplishments during the past 5 years. As we focus on our future, we look forward to continuing to work with IRS, Congressional, and Treasury officials to help the IRS address current and future challenges to improve our nation's tax administration system.

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TABLE OF CONTENTS Page

Message from TIGTA's Acting Inspector General 1

TIGTA's Organizational Structure and Mission 5

Promote the Economy, Efficiency, and Effectiveness of Tax Administration 9

Providing Quality Customer Service 9

Information Technology Modernization 11

Information System Security 13

Employee and Infrastructure Security 14

Enhanced Enforcement Activities - Tax Compliance 15

Erroneous Payments 20

Protect the Integrity of Tax Administration 23

Employee Integrity 23

External Attempts to Corrupt Tax Administration 27

Congressional Testimony 31

Awards and Special Achievements 33

Appendices

Appendix I - Audit Statistical Reports

Audit Reports With Questioned Costs 35

Prior Period Reports 35

Reports With Recommendations That Funds Be Put to Better Use 36

Reports With Additional Quantifiable Impact on Tax Administration 37

Appendix II - Investigations - Statistical Reports

Investigations Opened and Closed 39

Financial Accomplishments 39

Status of Closed Criminal Investigations 39

Criminal Dispositions 40

Administrative Disposition on Closed TIGTA Investigations 40

Complaints/Allegations Received by TIGTA 41

Status of Complaints/Allegations Received by TIGTA 41

IRS Data Regarding Allegations of Misconduct Against IRS Employees 42

Report of Employee Misconduct for the Period 10/01/03 - 3/31/04

Summary by Disposition Groups 42

Report of Employee Misconduct for the Period 10/01/03 - 3/31/04

National Summary 42

IRS Summary of Substantiated §1203 Inquiries Recorded in ALERTS

for the Period 10/01/03 - 3/31/04 43

Appendix III - Statistical Reports - Other

Audit Reports With Significant Unimplemented Corrective Actions 45

Statistical Reports - Other 53

Appendix IV - Audit Products

October 1, 2003 - March 31, 2004 55

Appendix V - Statutory TIGTA Reporting Requirements 59

Appendix VI - Section 1203 Standards 63

Hotline Information 64

TIGTA'S ORGANIZATIONAL

STRUCTURE AND MISSION

TIGTA provides independent oversight of IRS activities, the IRS Oversight Board, and the IRS Office of Chief Counsel. Although TIGTA is organizationally placed in the Treasury Departmental Offices and reports to the Secretary of the Treasury and the Congress, it functions independently from the Departmental Offices and all other offices and bureaus within the Department. TIGTA's focus is devoted to all aspects of work related to Federal tax administration.

TIGTA protects the public's confidence in the tax system by overseeing the IRS as it strives to achieve its strategic goals, identifying and addressing the IRS' management challenges, and implementing the President's Management Agenda and the Department of the Treasury's priorities.

TIGTA's primary functional offices are the Office of Audit (OA) and the Office of Investigations (OI). TIGTA's Offices of Chief Counsel, Information Technology, and Management Services support OA's and OI's efforts. TIGTA's goal is to conduct audits and investigations designed to:

* Promote the economy, efficiency, and effectiveness of tax administration.

* Protect the integrity of tax administration.

Office of Audit

TIGTA's comprehensive, independent performance and financial audits of IRS programs and operations focus on mandated reviews and high-risk challenges facing the IRS. The audits address a variety of issues, including:

* Information technology

* Computer and employee security

* Tax compliance initiatives

* Performance and financial management

* Taxpayer protection and rights

* Tax return processing

* Customer service

* Tax fraud

TIGTA also performs audits to determine if the IRS adequately ensures fair and equitable treatment of taxpayers. Audit recommendations result in cost savings and increased or protected revenue, reduction of taxpayer burden, and protection of: taxpayer rights and entitlements; taxpayer privacy and security; and IRS resources.

Office of Investigations

TIGTA protects the Department of the Treasury's ability to collect revenue owed to the Federal Government. TIGTA accomplishes this goal by providing comprehensive investigative services focused on three programs: IRS employee integrity, IRS employee and infrastructure security, and external attempts to corrupt Federal tax administration.

In order to focus investigative resources on its primary program areas, TIGTA developed and implemented a performance model to help it achieve the most return on investment for the IRS, the Treasury Department, and the American taxpayer. TIGTA, through its investigative program, pursuant to its unique statutory charge, has responsibility to prevent and detect fraud, waste, and abuse in IRS programs and operations, including:

* Investigating allegations of criminal violations that impact tax administration, and of serious administrative misconduct by IRS employees.

* Conducting proactive investigative initiatives that ferret out criminal and administrative misconduct in the administration of IRS programs.

* Operating a Criminal Intelligence Program that manages threat information that could impact IRS employees and functions.

* Investigating assaults and threats made against IRS employees, facilities, and data infrastructures.

* Investigating fraud, waste, and abuse involving IRS procurements.

* Conducting Integrity/Fraud Awareness Program presentations for IRS employees and others, such as tax practitioners and community groups.

* Operating a hotline to receive and process complaints of fraud, waste, abuse, and misconduct involving IRS employees and programs.

* Conducting forensic examinations of physical and electronic evidence to support investigations.

* Using technical and investigative support, equipment, training, and other specialized services to enhance investigative operations.

AUTHORITIES

TIGTA has all the authorities granted under the Inspector General Act of 1978, as amended.1 TIGTA also has access to tax information in the performance of its tax administration responsibilities and the obligation to report potential criminal violations directly to the Department of Justice. The IG and the Commissioner of Internal Revenue have established policies and procedures delineating responsibilities to investigate potential criminal offenses under the Internal Revenue laws.

In addition, the IRS Restructuring and Reform Act of 1998 (RRA 98)2 amended the Inspector General Act of 1978 to give TIGTA statutory authority to carry firearms, execute and serve search and arrest warrants, serve subpoenas and summons, and make arrests as set forth in Section (§) 7608(b)(2) of the Internal Revenue Code (I.R.C.).

PROMOTE THE ECONOMY, EFFICIENCY, AND EFFECTIVENESS OF TAX ADMINISTRATION

PROVIDING QUALITY CUSTOMER SERVICE

The IRS' mission is to provide America's taxpayers top-quality service by helping them understand and meet their tax responsibilities, and by applying the tax laws with integrity and fairness to all. Customer service is a major concern of the Congress and other stakeholders. The RRA 98 mandated the IRS be more responsive to customer needs. There are many ways in which the IRS provides customer service, such as walk-in and toll-free telephone assistance, electronic customer service, and written communications to taxpayers. The IRS must also implement tax law changes and plan for activities and resources to ensure accurate and timely tax return processing during the filing season.3 The effectiveness of each of these services influences a taxpayer's ability and desire to comply voluntarily with the tax laws.

Overall, the 2003 Filing Season went well and most of the 122 million individual income tax returns received through May 30, 2003, were processed timely and accurately with appropriate refunds issued timely. The IRS also implemented correctly most, but not all, key tax law changes. TIGTA reported issues with the retirement savings contribution credits and potential unclaimed Additional Child Tax Credits (ACTC) that could result in the loss of taxpayer entitlements. TIGTA also identified instances of taxpayers receiving "dual benefit" from the tuition and fees deduction and the education credit, and wrongfully taking deductions for student loan interest, both of which could result in erroneous tax reductions. TIGTA recommended the IRS continue to notify taxpayers who appear to be eligible for the ACTC and strengthen controls to prevent some taxpayers from receiving tax reductions by claiming the tuition and fees deduction when they have also claimed an education credit. IRS management agreed with our recommendations. TIGTA is following up on these conditions during its review of the 2004 Filing Season.

The Congress has given the IRS a goal of having at least 80 percent of all tax returns electronically filed (e-file) by Calendar Year (CY) 2007. At present, the majority of e-filed tax returns are processed by Authorized IRS e-file Providers, called Electronic Return Originators (ERO). According to the IRS, over

154,000 EROs are authorized to participate in the IRS' e-file Program.

The IRS regulates EROs through an application screening process and a monitoring program. TIGTA reported the IRS continues to authorize individuals to participate in the e-file Program without ensuring they have met all required screening checks. In 2003, the IRS took steps to strengthen its ERO monitoring program by requesting computer programming that will monitor continuously the tax accounts of EROs for suspect transactions. However, weaknesses in the applicant screening and monitoring program have allowed filing fraud by EROs. TIGTA recommended strengthening the ERO screening and monitoring program and developing goals and measures to assess the effectiveness of the monitoring program. IRS management agreed to take action in this area.

In response to Congressional concerns throughout 2003, TIGTA evaluated whether IRS employees in Taxpayer Assistance Centers (TAC) provide accurate and timely responses to taxpayer questions. From January through October 2003, TIGTA auditors asked 679 tax law questions in 173 TACs and found IRS employees answered 70 percent of the questions correctly. The IRS continues to improve the quality of service at the TACs, and TIGTA commends the IRS for taking immediate action on issues identified in previous audit reports. The IRS has been actively implementing changes, which TIGTA believes have increased the accuracy rates compared to the same period in CY 2002.

Although accuracy rates are increasing, additional improvements are needed to provide taxpayers top-quality assistance. TIGTA recommended the IRS revise the Quality Assurance Program to include a systematic methodology to select scenarios and ensure the accuracy and sufficiency of captured information. IRS management agreed with the recommendation and has initiated corrective action. However, IRS management continues to disagree with TIGTA's method when computing the accuracy rate. They do not believe TIGTA's reported accuracy rates are a true measure of the quality of responses provided at TACs. Excluding the referrals to publications, service denied, and referrals to other employees, brings the accuracy rate to 75 percent, which IRS management recognizes is still inadequate.

Report Reference Nos. 2004-40-024, 2004-40-003, 2004-40-013, 2004-40-035,

2004-40-037, and 2004-40-065

Many aspects of the taxpayer experience in accessing the IRS' toll-free telephone system were improved significantly during the 2003 Filing Season. However, the IRS has opportunities to enhance further the taxpayer experience and reduce the costs of providing toll-free telephone services. A major improvement opportunity involves continuing difficulties with routing calls initially to the right Customer Service Representative (CSR). For the 2003 Filing Season, the IRS used call screeners to route tax law calls manually, at a cost of almost $3.6 million. Another improvement opportunity involved reducing high Assistor Availability4 levels. The IRS experienced an availability level of 11.2 percent versus a planned level of 5.5 percent, at an estimated additional cost of almost $6.4 million. In addition, the IRS still does not have a financial system that will track its cost-per-call accurately.

To address call routing problems, TIGTA recommended the IRS develop a set of key numerical identifiers taxpayers would select to link their calls to the correct tax law application, revise the menu scripts for tax law lines and test them for usability prior to implementation, and establish separate toll-free numbers for general account and tax law calls. To address continued high Assistor Availability levels, TIGTA recommended the IRS reevaluate whether some applications would benefit by being combined into a more pooled environment, retrain the CSRs so they can be transferred as needed to those applications for which availability is lowest, and reduce either staffing or hours of operation during those times of day when call demand is extremely low. TIGTA also recommended the IRS develop an Activity-Based Costing system that captures and reports reliably both the total cost and the cost-per-call of providing services on each toll-free product line. With the exception of developing a reliable costing system, IRS management did not agree with our recommendations. In addition, IRS management did not agree with TIGTA's estimates of the costs of using screeners to route calls manually and those of Assistor Availability.

Report Reference No. 2004-30-038

INFORMATION TECHNOLOGY MODERNIZATION

The IRS currently is modernizing its computer systems and business processes and practices, in a program called Business Systems Modernization (BSM). Since the inception of the BSM Program, it has been designated as high risk, in part because of its size, complexity, and immense importance to improving IRS performance and accountability. As part of the BSM Program, the IRS and its modernization contractors have worked to implement projects intended to improve tax administration and internal management. To assist in this effort, TIGTA has reviewed several systems under development and provided recommendations for improvement.

The e-Services project will provide a set of Web-based business products as incentives to third parties to increase e-filing, in addition to providing electronic customer account management capabilities. Although the initial release of the e-Services system was deployed in late August 2003, the project has continued to experience delays and cost increases due to requirements changes and testing environment problems. TIGTA identified opportunities for improvement in business case development, requirements management, and testing oversight.

TIGTA recommended the Chief Information Officer (CIO) ensure system requirements be fully developed before project development begins and changes after that point meet stringent criteria. Additionally, future submissions of project information should include up-to-date cost and schedule information. To improve testing, the CIO should require the BSM Office (BSMO) develop incentives to increase PRIME contractor5 accountability in the areas of software quality and testing. A process should also be established to review and accept test plans before allowing the PRIME contractor to begin testing. The IRS agreed with most of the recommendations and is taking action to address the issues identified.

The Integrated Financial System (IFS) is intended to modernize the IRS' financial systems and processes. The first release of the IFS will include such modules as Accounts Payable, Accounts Receivable, and the General Ledger. The IRS and PRIME contractor have made progress toward delivering the first release of the IFS by beginning important testing activities and ensuring compatibility with key infrastructure components. In addition, the IFS testing team developed test cases that, for the most part, contained a set of conditions, data, and expected results for a particular test objective; a corresponding test script to provide instructions to carry out the test case; and a test folder to document the results. Further, the testing team prepared a matrix to map accounting requirements to the corresponding test cases.

While progress has been made, testing practices could be improved, project costs have increased, some functionality has been postponed, and disaster recovery may not be optimal or fully tested prior to implementation. In addition, some test cases and test scripts were incorrect or incomplete, and the requirements matrix did not always provide an accurate traceability of requirements to be tested.

To help ensure a high-quality system is delivered, TIGTA recommended the CIO ensure testing practices are strengthened in future tests, the business risks of untimely IFS implementation are tracked formally, and disaster recovery capabilities are implemented and tested as soon as possible. In addition, the Chief Financial Officer, in concert with IFS project management, should ensure subsequent test plans, cases, and scripts are complete and accurate, and

all applicable financial system requirements can be readily accounted for

during the testing process. IRS management agreed to most of these recommendations and is taking corrective action.

Report Reference Nos. 2004-20-036, 2004-20-001, and 2004-10-052

The Federal Financial Management Improvement Act of 1996 (FFMIA)6 requires agencies to maintain financial management systems that comply substantially with Federal requirements, or establish a remediation plan with resources, remedies, and intermediate target dates to bring the agency into substantial compliance. The FFMIA further mandates IGs report to the Congress instances and reasons when an agency has not met intermediate target dates.

TIGTA reviewed the IRS' remediation plan and identified certain intermediate target dates were missed, extended, or were not established. The analysis also showed remediation plan resources were not always listed or updated to reflect current cost information. Reasons provided by the IRS for these issues centered on the delays and revisions to the plans of the individual financial management projects that are listed in the remediation plan. TIGTA did not offer specific recommendations, but did comment the IRS needs to actively address and continue to communicate the challenges it faces concerning the establishment of accurate and consistent intermediate target dates and resource estimates in light of the implementation uncertainty of significant IRS financial management projects. IRS management agreed with the conditions identified in the report.

Report Reference No. 2004-10-080

INFORMATION SYSTEM SECURITY

System administrators and security specialists have day-to-day responsibility for ensuring IRS computer systems are set up and maintained in a secure manner. Previous audits identified security vulnerabilities indicating these duties have not always been performed effectively. Recent evaluations of servers and workstations at five locations again identified significant security vulnerabilities. Employees with key security responsibilities did not have sufficient training and were not clear about their responsibilities, and duties were not separated properly and, in some cases, were duplicated. TIGTA recommended the IRS train these employees and develop a methodology to evaluate their performance with respect to security requirements. The IRS agreed with the recommendations and is addressing the findings as part of its strategy for eliminating computer security as a material weakness under the Federal Managers' Financial Integrity Act of 1982.7

Report Reference No. 2004-20-027

The IRS has over 900 contracts with vendors and consultants to conduct many activities for tax administration. Contractors are involved extensively in the IRS' information systems projects, including supplying computer hardware and software and designing and developing sensitive computer systems. Because these contractors commonly are given access to IRS computer systems and, in some cases, taxpayer data, they should be held to the same security standards as IRS employees.

Contractor personnel assigned to an IRS modernization project committed numerous security violations that placed IRS equipment and taxpayer data at risk. In some cases, contractors blatantly circumvented IRS policies and procedures even when security personnel identified inappropriate practices. IRS employees did not carry out their responsibilities for ensuring adequate security on contractor workstations and servers and for overseeing contractor activities. The IRS provided workstations to contractors that did not always comply with IRS policies and procedures, and contractors added unauthorized software to these computers. As a result, the likelihood of unauthorized disclosures of taxpayer information and the spread of virus infections was increased significantly. TIGTA recommended contractors' access privileges be limited and their activities monitored. In addition, all contractor employees' computer workstations should be updated to meet IRS standards. IRS management agreed with these recommendations and is taking corrective action.

Report Reference No. 2004-20-063 (Limited Official Use)

EMPLOYEE AND INFRASTRUCTURE SECURITY

Employee and infrastructure security is a critical element in protecting the Treasury Department's ability to administer the Federal tax laws. Threats and assaults against IRS employees, facilities, and data infrastructure impede the Treasury Department from effective tax administration. Historically, IRS buildings and operations have been targets of those who advocate violence against the Federal Government. Since TIGTA has the statutory responsibility to investigate activities involving threats to IRS personnel and facilities, it dedicates significant attention to deterring, detecting, and investigating threats from both foreign and domestic sources.

The following cases are examples of IRS Employee and Infrastructure Security investigations TIGTA conducted during this reporting period.

Individual Charged with Threatening to Blow Up Building

On February 3, 2004, an individual was charged in Texas with threatening to damage and destroy a building by use of an explosive. The individual called the IRS office about a tax refund and asked if it would be offset to pay delinquent child support. The caller allegedly expressed anger over the IRS allowing this and threatened to blow up the building.

Individual Charged with Threatening to Kill IRS Employees

On February 13, 2004, an individual was charged in Texas with making threats to IRS employees acting in their official capacities. In response to an IRS notice sent to another taxpayer, the individual claimed to have Power of Attorney (POA) to represent the taxpayer before the IRS, and stated intention to do so. When told the POA form permitting the individual to represent the taxpayer could not be located, the individual became angry and threatened to shoot and kill any IRS agents approaching the home.

Individual Charged with Mailing Threatening Letters to Public Officials

On November 19, 2003, an individual was indicted in South Dakota for mailing letters containing a threat. The individual allegedly mailed written communications to a Senator, an Assistant Attorney General, and a TIGTA Special Agent containing a threat to commit murder of another person.

Individual Arrested for Threatening to Kill TIGTA Special Agent

On March 12, 2004, an individual was arrested in California for threatening to kill a Federal law enforcement officer. The individual allegedly contacted the IRS toll-free telephone number and made statements about threatening to kill a TIGTA Special Agent. The individual was allegedly identified as a former IRS employee and blamed the TIGTA Special Agent for the loss of a job.

ENHANCED ENFORCEMENT ACTIVITIES -

TAX COMPLIANCE

Correspondence examinations of taxpayer records are conducted through the mail and generally involve the IRS asking taxpayers for more support on one or two simple tax issues. TIGTA auditors determined correspondence examinations did not always address strategic noncompliance priorities, and the Small Business/Self-Employed (SB/SE) Division's Campus Correspondence Examination Program could be used more effectively to reduce the tax gap and increase voluntary compliance. In addition, the IRS does not always use the most

cost-effective method to examine tax returns, and the current Examination Workload Selection Process results in inequitable treatment of taxpayers.

TIGTA recommended the IRS expand the tax issues that can be selected for correspondence examination to ensure more of the inventory addresses strategic noncompliance priorities, initiate any necessary training programs, and select the most cost-effective examination techniques based on cost and yield data. IRS management agreed the Campus Correspondence Examination Program should work more cases dealing with strategic priorities and plans to expand the tax issues and types of tax returns selected for this Program's inventory, after a period of limited testing. In addition, IRS management agreed to initiate necessary training programs to ensure the tax examiners have the skills to examine additional types of SB/SE tax issues. However, SB/SE Division management stated the RRA 98 prevented them from using cost and yield information to measure program performance. SB/SE Division management also disagreed with TIGTA's assessment of their use of the most cost-effective examination technique and their fair and equitable treatment of taxpayers.

Report Reference No. 2004-30-005

In October 2002, the IRS initiated the return examination phase of the National Research Program (NRP) to gather the data it needs to measure taxpayer compliance and support its strategic planning process. The NRP is expected to provide essential information that will allow the IRS to identify the tax returns with the highest compliance risks and reduce the burden on compliant taxpayers. The IRS planned to complete the NRP cycle for 41,000 individual tax returns in time to update the return selection formulas for 2005. However, delays occurred in installing computer servers, upgrading computer software, and assigning cases. As a result, formulas for selecting tax returns for examination will not be updated until 2006.

The IRS' efforts to reduce the burden of NRP examinations have yielded some positive results. In the cases TIGTA reviewed, wages, interest, and dividends generally were validated before contact with taxpayers, where applicable. However, 85 percent of the Forms 1040 TIGTA reviewed had a Schedule A8 and/or a Schedule C9 attached, and the vast majority of the total line items on these schedules still had to be validated during the face-to-face contact portion of the examination process. Certain operational issues could also adversely affect the study results or the goal to minimize taxpayer burden.

TIGTA recommended the IRS perform a thorough post-evaluation of the 2002 NRP and ensure similar problems are minimized for the next NRP cycle. In addition, TIGTA recommended the IRS revise classroom instruction regarding document request preparation, visit selected areas to help ensure examinations that were not started or were recently started are completed by the September 2004 deadline, incorporate random sampling in the NRP process, and develop interim milestones to help guide the next NRP cycle. IRS management agreed with most of the recommendations and is implementing corrective action.

Report Reference No. 2004-30-044

In response to the tragic events of September 11, 2001, the Congress passed, and the President signed into law, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001(USA PATRIOT Act).10 This new law made changes to the Bank Secrecy Act (BSA),11 effectively including financial institutions in the war on terrorism.12 The IRS performs compliance checks of non-bank financial institutions as part of its BSA compliance check program. This program, however, does not have meaningful performance measures and the risk of undetected noncompliance still exists. In addition, management information system data are not analyzed fully, case selection is not risk-based, cases do not have the documentation necessary to assess civil penalties, examiners cannot access Suspicious Activity Reports (SAR) for better case development, and education and outreach should be coordinated better with the Financial Crimes Enforcement Network (FinCEN). If, during the performance of a BSA compliance check, IRS examiners encounter large and suspicious transactions13 between the businesses under review and their customer(s), the examiners are required to prepare an Anti-Money Laundering referral. These referrals are forwarded for consideration of an income tax examination of the individual involved with the transactions. Income tax examinations from these referrals declined 47 percent from

June 2002 to June 2003. The IRS has now established these referrals as a

high-priority item for Fiscal Year (FY) 2004.

TIGTA reported, however, the Anti-Money Laundering referrals were not always evaluated comprehensively and selected for examination. Currency transaction information reports from financial institutions, trades, and businesses could also be used more effectively in the identification of taxpayers for potential examinations. Although the IRS revised its priority examination areas to include these referrals for FY 2004, it still does not consider all currency transaction information in the selection process. For example, the selection of non-filing taxpayers for examination is based on the amount of known potential income, such as wages and dividends, but does not consider specifically whether the taxpayer also has significant cash activity. The IRS estimates there were over 300,000 potential non-filers with $22 billion in currency transaction activity in Tax Year (TY) 2002. While the filing of a currency transaction report does not equate to unreported income, the presence of large transactions indicates the individual deals in large amounts of cash and may be involved in some type of ongoing business activity.

For the BSA compliance check program, TIGTA recommended the IRS establish measurable performance-based indicators, ensure the management information system provides useful reports for monitoring program performance, develop standardized risk-based case selection criteria, implement a centralized quality review process, and coordinate with the FinCEN on education and outreach strategies and to secure access to SARs. In addition, the IRS should develop a review checklist or other similar methodology to assist in ensuring all relevant factors are considered in evaluating Anti-Money Laundering referrals, and begin using currency transaction information to aid in the selection of individuals and businesses for income tax examinations. IRS management agreed with the recommendations and is implementing some corrective action; however, TIGTA believes more needs to be done to use these reports better to identify non-filer cases.

Report Reference Nos. 2004-30-068 and 2004-30-074

Upon completing an investigation where criminal violations of the law have been documented, the Criminal Investigation (CI) function forwards the results of the investigation to the Department of Justice for prosecution. The prosecution process could result in a sentence being imposed on the subject, which may include conditions relating to the settlement of civil tax liabilities such as the filing of tax returns or payment of tax liabilities. The CI function should take whatever steps are necessary to initiate appropriate legal action in any instance where subjects have failed to comply with the conditions of their sentence relating to the settlement of civil tax liabilities.

TIGTA's review of the CI probation-monitoring program determined existing IRS procedures did not effectively ensure convicted criminals, who did not comply with the conditional terms of their sentences requiring the settlement of their IRS tax liabilities, were reported to the courts for additional legal action, if necessary. The IRS procedures were either unclear or did not assign specific responsibility for monitoring taxpayer accounts. In addition, the CI function's Management Information System (CIMIS) contained data errors that could impact analyses used for internal management decisions or results presented in ad hoc reports provided to stakeholders.

TIGTA recommended IRS management develop clear and concise guidelines to define responsibilities and procedures to ensure the IRS controls and monitors the accounts of criminal subjects whose court sentences require the settlement of civil tax liabilities. In addition, TIGTA recommended IRS management ensure court documents are verified, create a periodic system report for first-line managers, and seek the advice of IRS Chief Counsel regarding the disclosure of tax returns and tax return information to probation officers to improve monitoring, develop a process to verify and validate the data in the CIMIS, and assess the clarity of guidance for coding some data fields. CI management generally agreed with the recommendations and will take steps to enhance the process.

Report Reference No. 2004-10-060

The Tax Exempt and Government Entities (TE/GE) Division's Independent Review Process (IRP) was created to provide TE/GE Division management with an internal mechanism to ensure consistency, fairness, and accuracy related to processing of complex cases. The TE/GE Division's IRP was envisioned as early as 1999, as part of the original plan to create the TE/GE Division. While the

stand-up14 of the TE/GE Division was completed in December 1999, the IRP did not become operational until March 2001 when the position of the Senior Technical Advisor was filled. TIGTA determined TE/GE Division management followed established procedures when referring cases to the IRP. However, press coverage related to TE/GE Division management's actions resulted in confusion and suspicion regarding the IRP. Effective August 25, 2003, the Commissioner, TE/GE Division, eliminated the IRP.

In addition, the extensive media coverage of the TE/GE Division management's actions related to the IRP, coupled with the IRS' limitations on discussing any details related to particular cases due to I.R.C. Section 6103, could result in a perception by external stakeholders the IRS has changed its position on allowable political activity by charitable organizations. TIGTA believes additional clarification on this issue is necessary. As a result, TIGTA recommended TE/GE Division management prepare and issue guidance to reemphasize the IRS' position on political activity and private benefit related to I.R.C. Section 501(c)(3) organizations. TE/GE Division management agreed with the recommendation.

Report Reference No. 2004-10-045 (Limited Official Use)

ERRONEOUS PAYMENTS

Stewardship responsibility over public funds is a major challenge facing IRS management. Both the President and the Congress have expressed concern with the large amount of erroneous or improper payments made by Federal agencies. Two recent pieces of legislation - the Improper Payments Information Act of 200215 and Section 831 of the National Defense Authorization Act for FY 200216 - provide an impetus for all agencies to address systematically improper payment activity annually, and to identify and recover contract overpayments. Improper and erroneous payments include inadvertent errors, payments for unsupported or inadequately supported claims, payments for services not rendered, payments to ineligible beneficiaries, and payments resulting from outright fraud and abuse by program participants and/or Federal employees.

The Earned Income Tax Credit (EITC) Program, a major Federal effort to assist the working poor, is a refundable credit available to taxpayers who file returns with certain earned income. The EITC was established to offset the impact of Social Security taxes on low-income families and encourage them to seek employment rather than welfare. Historically, the EITC Program has been vulnerable to high rates of noncompliance (overclaims),17 which has led the IRS to declare it a material weakness. The IRS estimates that, of the $31.3 billion in EITC claims made by taxpayers for TY 1999, $8.5 to $9.9 billion (27 to

32 percent) should not have been paid. The General Accounting Office has listed the IRS' administration of the EITC Program among the high-risk areas for the Federal Government.

IRS efforts to improve the administration of the EITC Program are ongoing. The IRS reports it has denied approximately $2.25 billion in erroneous claims since September 2000, and it has implemented a number of initiatives targeting outreach, education, and compliance efforts. The IRS has initiated a significant change to the way it will address EITC noncompliance. This includes conducting an EITC Proof of Concept Test (Test) to validate EITC applicants who meet certain pre-certification criteria and require new information on EITC returns.

In preparing for the 2004 Filing Season, IRS EITC Program management designed the Test to focus on selecting taxpayers whose EITC claims based on qualifying children may be unsubstantiated. TIGTA auditors determined the IRS has a