TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION VISION STATEMENT

We are a respected member of the government community:

Хааааааа Independent, objective and professional in the conduct of our mission.

Хааааааа Dedicated and innovative professionals who take pride in promoting fair tax administration and good government.

Хааааааа Proud of our past and focused on our future.

аINSPECTOR GENERAL for TAXааааааа ADMINISTRATION

October 30, 2000

The Honorable Lawrence H. Summers
Secretary of the Treasury
Washington, D.C. 20220

Dear Mr. Secretary:

I am forwarding to you the Treasury Inspector General for Tax Administration's (TIGTA) Semiannual Report to the Congress for the six-month period ending September 30, 2000. Fiscal Year (FY) 2000 has been a highly productive year for TIGTA. We issued 162 audit reports during FY 2000; more than double the number of reports issued last fiscal year. Financial accomplishments resulting from our audit reports totaled $117.1 million, with an additional $1.4 billion in increased revenue and protected revenue. Our audit recommendations will improve tax administration for almost 11.4 million taxpaying entities.

TIGTA closed almost 4,200 investigations during FY 2000; a 43 percent increase over last fiscal year. Investigative recoveries totaled $12.9 million. During the year, our special agents focused on improving the timeliness of criminal and administrative referrals to help ensure the adjudication process is fair and the least intrusive.

The Office of Audit continues to dedicate its resources to supporting the major challenges that face the IRS including technology modernization, and providing customer service and ensuring tax compliance.а In addition, the annual requirements imposed by the IRS Restructuring and Reform Act of 1998 (RRA 98), which deal with taxpayer rights and information systems security, have been completed and are included in this report.

During this reporting period, TIGTA special agents conducted integrity awareness presentations for over 30,100 individuals.а IRS employees comprised 87 percent of these individuals. We believe these presentations heighten integrity awareness and have a potential deterrent effect on fraud and misconduct.а In addition, TIGTA continues to operate a responsive complaints processing center. We received almost 4,800 complaints of alleged criminal wrongdoing or administrative misconduct, of which 2,053 warranted further investigation.

I look forward to helping the IRS address the challenges it faces in FY 2001.

Sincerely,

Enclosure

Table of Contents

Office of the Inspector General for Tax Administration............................................................ 1
Authorities ....................................................................................................................................... 1
Major Issues Facing the IRS........................................................................................................... 1
Office of Audit................................................................................................................................9
Office of Investigations............................................................................................................... 25
Appendix I

Statistical Reports for the Office ofAudit..................................................................................39
аQuestioned Costs, Funds Put to Better Use, Additional Quantifiable Impact on Tax
аAdministration

Appendix II

Statistical Reports for the Office ofInvestigations....................................................................43
аInvestigative Results, Complaints/Allegations Receivedby TIGTA, Status of
аComplaints/Allegations Received byTIGTA, Complaints/Allegations Receivedby the IRS

Appendix III

Statistical ReportsЧOther........................................................................................................ 49
аAudit Reports With Unimplemented CoectiveActions, Access to Information,
аAudit Reports Issued in Prior Reporting Period With NoManagement Response,
аRevised Management Decisions, Disputed Audit Recommendations,
аReview ofLegislation and Regulations

Appendix IV

TIGTA Audit Report Listing........................................................................................................ 63

Appendix V

Section 1203 Standards............................................................................................................. 71

Appendix VI

Statutory TIGTA Reporting Requirements................................................................................ 73

Appendix VII

GovernmentPerformance and Results Act Audits................................................................. 79

Appendix VIII

Acronyms.................................................................................................................................. 83

Appendix IX

аOrganizationChart................................................................................................................... 85

Treasury Inspector General for Tax Administration September 30, 2000

Office of the Treasury Inspector General
for Tax Administration

INFORMATION ABOUT THE TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION

The Office of the Treasury Inspector General for Tax Administration (TIGTA) provides independent oversight of Internal Revenue Service (IRS) activities, the IRS Oversight Board and the IRS Office of Chief Counsel. TIGTA is organizationally placed within the Department of the Treasury, but is independent of the Department and all other Treasury offices.а TIGTAТs focus is devoted to all aspects of work performed in connection with tax administration.

TIGTAТs audit and investigative activities are designed to:

Хаааааааааа Promote economy, efficiency, and effectiveness in the administration of the nationТs tax system.

Хаааааааааа Detect and deter fraud and abuse in IRS programs and operations.

Хаааааааааа Protect the IRS against external attempts to corrupt or threaten its employees.

Other responsibilities include:

Хаааааааааа Investigating allegations of misconduct by IRS employees.

Хаааааааааа Reviewing and making recommendations regarding existing and proposed legislation and regulations relating to the programs and operations of the IRS and TIGTA.

Хаааааааааа Recommending actions to resolve fraud, abuses and deficiencies in the programs and operations of the IRS.

Хаааааааааа Informing the Secretary of the Treasury and the Congress of problems and the progress made in resolving them.

The functions that carry out these duties are the Offices of Audit, Investigations, Chief Counsel, Information Technology and Management Services.

AUTHORITIES

TIGTA has all the authorities granted under the Inspector General Act of 1978¹. TIGTA also has access to tax information in the performance of its responsibilities and the authority to report criminal violations directly to the Department of Justice. The Inspector General (IG) and the Commissioner of Internal Revenue have established policies and procedures delineating responsibilities to investigate offenses under the internal revenue laws.

In addition, the IRS Restructuring and Reform Act of 1998² (RRA 98) amended the Inspector General Act of 1978, to give TIGTA statutory authority to carry firearms and execute the provisions of the Internal Revenue Code (I.R.C.) Section 7608(b)(2).а These provisions include the law enforcement authority to execute and serve search warrants, serve subpoenas and make arrests.

MAJOR ISSUES FACING THE IRS

As the nationТs tax administrator, the IRS collects 95 percent of federal tax revenues. For Fiscal Year (FY) 2000, the IRS was projected to collect $1.8 trillion.а The IRS processes approximately 230 million tax returns and provides assistance to more than 125 million taxpayers annually.а The IRS also

¹ Pub. L. No. 95-452, 92 Stat. 1101, as amended, at 5 U.S.C. app. 3 (1994 & Supp. II 1996) ² Pub. L. No. 105-206, 112 Stat. 685

Treasury Inspector General for Tax Administration September 30, 2000

implements tax law changes and manages over 700 office locations.а This formidable task is carried out in an environment where providing customer service and fairly enforcing tax laws must go hand in hand.

In December 1999, TIGTA advised Congress of the following major challenges facing the IRS in FY 2000:

Хаааааааааа Modernizing the IRS:

"аааааааааа Technology modernization.

"аааааааааа Organization restructuring.

"аааааааааа Year 2000 (Y2K) compliance.

Хаааааааааа Providing security over information systems.

Хаааааааааа Processing returns and implementing tax law changes during the tax filing season.

Хаааааааааа Providing customer service and ensuring tax compliance.

Хаааааааааа Protecting taxpayer rights.

Хаааааааааа Protecting revenue and minimizing tax filing fraud.

Хаааааааааа Providing quality customer service operations.

Хаааааааааа Managing finances.

Хаааааааааа Implementing the Government Performance and Results Act of 1993³(GPRA).

Хаааааааааа Addressing the impact of the global economy on tax administration.

These major challenges have been the focus of TIGTAТs audit and investigative activities during this six-month reporting period.а The following sections provide a summary of the issues and TIGTAТs activities to help IRS address these issues. аDetails of some of the more significant audit and investigative activities, as well as information on statutory requirements, can be found on pages

³ Pub. L. No. 103-62, 107 Stat. 285

9 through 24, 25 through 37, and in Appendix VI, respectively.

MODERNIZING THE IRS

Creating a modernized IRS is a top priority of the Commissioner, as well as a principal goal of congressional oversight.а The ability to achieve the IRSТ modernization concept is largely dependent on restructuring the organization to better meet taxpayer needs and developing new technology to correct deficient and obsolete systems.

The General Accounting Office (GAO) has stated that three critically important challenges lie ahead for the IRS:а revamping business practices, effectively modernizing systems, and completing a performance management system.

Further, the Congress has ordered the IRS to achieve 80 percent electronic tax return filing by the year 2007. For the 2000 filing season, 30 percent of tax returns were filed electronically, so significant challenges lie ahead for the IRS to meet the Congressional mandate.а TIGTAТs Office of Audit reported that the IRS must first establish a performance and management plan to determine whether its telecommunications systems can handle 80 percent of its transactions electronically.

Treasury Inspector General for Tax Administration
Office of Audit

INTRODUCTION

The Office of Audit identifies opportunities to improve administration of the nationТs tax laws by conducting comprehensive, independent performance and financial audits of IRS programs and operations to:

Хаааааааааа Assess efficiency, economy, effectiveness, and program accomplishments.

Хаааааааааа Ensure compliance with applicable laws and regulations.

Хаааааааааа Prevent, detect, and deter fraud, waste, and abuse.

THE AUDIT PROGRAM

To assist the IRS in meeting the challenges it faced in FY 2000, the Office of Audit developed a comprehensive audit program. The program helped the IRS assure that tax administration programs were efficient and effective, and minimized fraud, waste, and abuse.

The audit program is presented in the Annual Audit Plan which communicates audit priorities for the current fiscal year.а Many of the activities described in the Plan address the fundamental goals related to the IRSТ mission to administer its programs effectively and efficiently.а Major management issues, as well as specific areas of concern to the Congress and the IRS Commissioner, are also addressed. As such, audit work is organized around the IRSТ core business activities with emphasis on the statutory coverage imposed by RRA 98.а Audit work also focuses on other statutory authorities and standards involving computer systems and financial management.

SIGNIFICANT AUDIT RESULTS

During this reporting period, the Office of Audit issued 101 audit reports which are listed in Appendix IV.

The results of the most significant reviews are discussed in the following sections.

Modernizing the IRS

Significant Risks Need to Be Addressed to Ensure Adequate Oversight of the Systems Modernization Effort (Reference No. 2000-20-099)

For more than a decade, the IRS has been attempting to modernize its outdated, paper-intensive tax processing system.а After spending over $3 billion with minimal improvement and under intense Congressional scrutiny, the IRS agreed to use a contractor to modernize its systems.а The IRS is currently in the early phases of a new multi-billion dollar, 15-year systems modernization effort.

The IRS has made progress in correcting organizational weaknesses from past systems modernization efforts. Top level IRS executives are heavily involved in this effort. Also, the IRS now recognizes the need to develop program management capabilities, risk management processes, and quality assurance policies and procedures.

The Office of Audit reported, however, that current oversight of the systems modernization effort has been hampered by the lack of a stable Program Management Office (PMO).а Program management staffing needs have not been determined; roles and responsibilities inside the IRS and between the IRS and the contractor have yet to be

Treasury Inspector General for Tax Administration September 30, 2000

clearly defined; and, key processes such as risk management and performance monitoring need to be improved.а These growing pains were a primary cause of the IRSТ decision to scale back or delay delivery of some modernization initiatives.

The Office of Audit recommended that IRS management stabilize the PMO designed to oversee the systems modernization effort and develop plans to ensure the adequacy of PMO staffing. Also, the IRS should establish offices responsible for developing and enhancing performance monitoring and risk management capabilities.а These recommendations should help IRS deliver systems that result in improved service to taxpayers through the implementation of quality modernization projects.

IRS management agreed with the recommendations and has initiated corrective action.

Additional Actions Are Needed to Strengthen the Development and Enforcement of the Enterprise Architecture (Reference No. 2000-20-158)

A critical component of the IRSТ modernization effort is the establishment of an Enterprise Architecture that defines concepts such as the organizationТs mission, vision, and future business objectives.а The IRSТ Modernization Blueprint, which is being used to guide and control the modernization efforts, contains the IRSТ initial steps toward defining the architecture.

The IRS is currently developing architecture work products that will become part of the planned September 2000 update of the Modernization Blueprint.а These documents will explain the IRSТ architecture standards, business requirements, and strategy for when and how the new computer systems will be implemented.

However, the Office of Audit reported that the IRSТ approach may not include all the necessary processes, activities, and work products to fully develop the Enterprise Architecture; ensure that the blueprint architecture meets the IRSТ needs; or, ensure that systems modernization projects follow architecture guidance.

The Office of Audit recommended that the IRS strengthen its controls and processes to ensure the architecture products meet the IRSТ needs, and systems development projects follow this guidance.

IRS management's response was not received prior to the issuance of the audit report.

The Security and Performance of Electronic Tax Return Processing Should Be Improved to Meet Future Goals (Reference No. 2000-20-095)

The Electronic Management System (EMS) is IRSТ primary system for receiving electronic tax returns from trading partners.а Through April 17, 2000, the EMS received approximately 41 million individual federal and state income tax returns, about 28 percent more returns than in the 1999 filing season.

The Office of Audit identified that the EMS had sufficient telecommunications and processing capacity to receive and store expected tax return volumes during the 2000 filing season. However, IRS management should implement performance and capacity management planning and evaluate processing efficiency to determine if the EMS can handle the significant increases in electronic filing anticipated in the future. Also, IRS management should improve EMS security and project management controls, and complete and test the disaster recovery plan.

IRS management agreed with the recommendations and has initiated corrective action.

Treasury Inspector General for Tax Administration September 30, 2000

Actions to Correct Service Center Mainframe Consolidation Contract Administration Issues Have Not Been Completed, But Progress Is Being Made (Reference No. 2000-20-140)

The IRS is in the process of consolidating the mainframe computer operations used to process tax data.а The consolidation involves moving mainframe processing from the IRSТ ten service centers to new mainframe computers located in two computing centers. As of March 2000, the five-year cost estimate for the consolidation project is nearly $480 million, which includes extensive contractor support.

The Office of Audit initiated this follow-up review of contract administration issues previously reported (Reference No. 199920068, dated September 1999), to determine whether IRS management effectively addressed those issues.

IRS management has begun work to address the contract administration issues.а Although corrective actions have not been completed as planned, the IRS has already realized measurable outcomes.а The prior audit report claimed $19 million in cost savings.а This current report is claiming an additional $28.8 million in cost savings.

The Office of Audit reported that delivery order definitization has not been completed and invoices for services are not adequately verified.а IRS management is continuing its work to complete the corrective actions; however, further delays increase the risks of incurring additional or inappropriate costs.

The Office of Audit recommended that IRS management ensure that the definitization of all delivery orders is completed for the Service Center Mainframe Consolidation Contract, and provide the resources needed to verify the invoices adequately.

IRS management agreed and will continue its efforts to complete the corrective actions.

Providing Security Over Information Systems

Certifying the Security of Internal Revenue Service Computer Systems Is Still a Material Weakness (Reference No. 2000-20-092)

The Office of Management and Budget and the Department of Treasury directives require all information systems that process sensitive but unclassified information, such as taxpayer data, be certified and accredited prior to being placed into operation.а In 1995, the IRS began monitoring its sensitive systems certification process as a potential management control weakness, and in 1997, the IRS officially reported the process as a material weakness. This issue continues to be an open item on the IRSТ FY 1999 assessment of management controls.

The Office of Audit reported that of the 258 sensitive systems listed on the January 2000 inventory, 232 (90 percent) systems were still not certified.а In addition, the Certification Program Office does not have sufficient information to monitor whether accreditations are granted and/or granted timely for certified systems.а The IRS is taking steps through contractor support to improve the certification process and alleviate the backlog of non-certified systems. However, more emphasis is needed to resolve this material control weakness in a timely manner.

The Office of Audit recommended that the IRS place more emphasis on building security controls into new information systems.а To ensure this happens, IRS management should not authorize the implementation of any new system until controls are sufficient and the system has the required security certification and accreditation. The Office of Audit estimated that the IRS will pay contractors $26 million to develop security documentation for systems that were rolled

Treasury Inspector General for Tax Administration September 30, 2000

out without the necessary security controls. Most of this cost could have been avoided if security controls had been built in and certification and accreditation had been accomplished during systems development.

IRS management generally agreed with the findings and recommendations.а Management is developing a new process for certifying new systems within the systems development life cycle.а Also, management anticipates that systems will be implemented without full certification only in special circumstances. Contractor support will continue to be used to reduce the backlog of uncertified systems.

The Office of Audit agrees with managementТs response, with one exception. Considering the sensitivity of the data processed by the IRS and the risks inherent in todayТs interconnected computer systems, the Office of Audit does not believe that any new system should be implemented without appropriate security controls.

A Comprehensive Program for Preventing and Detecting Computer Viruses Is Needed (Reference No. 2000-20-094)

Computer viruses pose a serious and rapidly increasing threat to computer systems.а The cost of cleaning up viruses and the negative impact on productivity caused by computer down time is significant.а Although the IRS did not have data on the extent and cost of viruses on its systems, industry data suggests that the cost to a business could be between $500,000 and $11.5 million annually.

The Office of Audit reported that the IRS did not have a comprehensive program for directing and overseeing the effectiveness of its computer virus prevention and detection activities. Accountability for a successful program had not been assigned to a senior manager or executive.а As a result, viruses were not effectively eliminated and continued to spread.а Anti-virus software was either not operating properly or did not have recent updates for 56 percent of the servers and workstations tested.а In addition, the IRS did not have a formal response capability for resolving major viral outbreaks.а Advance preparations outlining the procedures and mechanisms to be put in place when major outbreaks occur did not exist, and a team to manage and resolve outbreaks had not been formed.

The Office of Audit recommended that IRS management designate a senior official to be responsible for managing IRSТ virus prevention program and overseeing its effective implementation.

IRS management agreed with the recommendation and plans to implement corrective actions.а After the Office of AuditТs report was issued, the IRS was infected by the УI Love YouФ virus and responded effectively and efficiently by communicating with employees, eliminating the virus, and keeping disruptions to a minimum.

The Internal Revenue Service Should Improve Actions to Protect Its Critical Infrastructure (Reference No. 2000-20-097)

The Clinton AdministrationТs Policy on Critical Infrastructure Protection: Presidential Decision Directive (PDD) 63, dated May 1998, calls for a national effort to assure the security of the nationТs critical infrastructure.а The critical infrastructure consists of physical and computer-based systems essential to the minimum operations of the economy and government.а This includes, but is not limited to, telecommunications, banking and finance, energy, transportation, and essential government services.

The Office of Audit reported that, during the last three years, the IRS has taken significant

Treasury Inspector General for Tax Administration September 30, 2000

actions to identify and correct security weaknesses.а However, due to other priorities, the IRS has not met PDD 63 documentation requirements.а As a result, the IRS is in jeopardy of missing the first milestones required by the directive.а The December 2000 milestones are critical for the IRS to ensure that the vulnerabilities of its critical infrastructure are known and that remedial plans can be developed.а As a result, until mission essential assets are defined and adequately evaluated, IRS management will not have a complete accounting of its critical infrastructure vulnerabilities or a clear picture of the actions necessary to comply with PDD 63. The IRS, as well as other agencies and states that use IRS data, could be at undue risk of disrupted operations and processing delays.

To expedite efforts, the Office of Audit recommended that the IRS use the results of its ongoing security evaluation efforts, which are identifying and correcting security weaknesses, to comply with PDD 63. Additionally, IRSТ Chief Infrastructure Assurance Officer should coordinate with senior Department of the Treasury and IRS officials to expedite the definition and identification of mission essential assets for critical infrastructure protection.

IRS management agreed with the recommendations and plans to implement corrective actions prior to the end of December 2000.

Processing Returns and Implementing Tax Law Changes During the Tax Filing Season

The Internal Revenue ServiceТs Process for Controlling Filing Season Computer Programming Changes Does Not Ensure Critical Changes Are Effectively Implemented (Reference No. 2000-40-069)

IRSТ Submission Processing functions need an effective process to control computer programming changes. This process is critical since the IRS has determined that over 250 computer programming changes were needed for the 2000 filing season.

The Office of Audit reported that the IRS does not have a comprehensive process for controlling computer programming changes. IRSТ current process does not document all critical activities from the point the IRS identifies the need for a computer programming change until the program is implemented.а In addition, the IRS needs to ensure critical programming changes receive priority and that all IRS offices use the same process to control requests for programming changes.

To ensure that all requests for computer programming changes are effectively controlled, the Office of Audit recommended that the IRS improve its process for managing computer programming changes and providing accurate management information. This process should include documenting all critical activities within the Request for Information Services (RIS) process, as well as validating information in the existing RIS databases before it is combined into a centralized database.а Also, the IRS should develop written criteria for prioritizing RISТ and publish standardized procedures to assure that computer programming changes are effectively controlled for all offices.

Treasury Inspector General for Tax Administration September 30, 2000

The IRS agreed with the recommendations and is initiating corrective action.

The Internal Revenue Service Processed Most Estate and Gift Tax Returns Accurately, but Some Estates Did Not Receive the Maximum Tax Credit (Reference No. 2000-30-115)

The IRS processed most Tax Year (TY) 1999 estate and gift tax returns in accordance with the provisions of the Taxpayer Relief Act of 1997¹⁰. However, approximately one percent (197) of the 18,184 estate tax returns processed by the IRS from November 1999 through March 2000 were filed on outdated forms that showed a lower allowable unified credit.а IRS processing procedures were not designed to identify and correct the understated credit and the resulting $1.8 million in miscalculated estate tax.а IRS management took corrective actions based on the audit results provided to them during the course of this review.а The Office of Audit estimated that one percent of approximately 125,000 TY 1999 estate tax return filers may have overpaid $11.6 million in tax.

The Office of Audit recommended that IRS management revise the processing instructions to correct the credit amount when an outdated estate tax return form is filed.

IRS management agreed with the recommendation and has initiated corrective action.

¹⁰ Pub. L. No. 105-34, 111 Stat. 788

Providing Customer Service and Ensuring Tax Compliance

Improvements Are Needed in Resolving In-Business Trust Fund Delinquencies to Prevent Tax Liabilities From Pyramiding (Reference No. 2000-30-111)

The In-Business Trust Fund Taxpayer Program is among the highest FY 2000 priorities for cases in a revenue officerТs inventory in IRSТ Collection Field Function (CFf). The CFf is responsible for collecting delinquent accounts. Timely and effective collection is necessary because these taxpayers (employers) are still in business and can continue to pyramid liabilities every three months.а Approximately 39 percent of the delinquent taxpayers reviewed had at least five delinquent accounts in the CFf inventory, demonstrating how quickly these liabilities can pyramid.

The Office of Audit reviewed 116 delinquent in-business trust fund taxpayer cases where liabilities had pyramided.а Although revenue officers collected $4.9 million while working these cases, a greater amount in additional tax liabilities ($5 million) accrued while the cases were open in the CFf.

Revenue officers were effectively using certain collection tools, such as conducting timely and thorough initial contacts, informing taxpayers of their rights, giving clear instructions to taxpayers, setting deadlines, and informing taxpayers of the potential consequences of not paying. However, in many instances, actions on cases were not taken timely or additional tools could have been used more effectively to potentially prevent taxpayers from pyramiding liabilities; i.e., timely assignment of cases, taking additional enforcement actions, and monitoring of the Federal Tax Deposit (FTD) payments.

Treasury Inspector General for Tax Administration September 30, 2000

The Office of Audit recommended that IRS management adopt quicker time frames for assigning cases, re-emphasize the use of all available enforcement tools, identify a better way to monitor FTD payments, ensure taxpayers stay current with their payments, and gather trending information on taxpayers who do not comply.

IRS management generally agreed with the recommendations and has initiated corrective action as warranted.

Management Advisory Report: Evaluation of Reduction in the Internal Revenue ServiceТs Compliance Activities (Reference No. 2000-30-075)

Over the past several years, the number of IRS employees has steadily decreased due to budget limitations. Correspondingly, the number of employees examining tax returns and collecting taxes also decreased.а IRS management, members of the Congress, and others are concerned about this resource reduction and the related decrease in business results.

Revenue received by the IRS increased from $1.5 trillion in FY 1996, to $1.9 trillion in FY 1999. However, revenue collected as a result of compliance activity decreased 13 percent ($5 billion) from FY 1996 to FY 1999, while gross accounts receivable increased 19 percent ($41 billion).

Source: Enforcement Revenue Information System and Chief Financial Officer Financial Report

The Office of AuditТs evaluation showed that during the past four years, Collection and Examination compliance efforts and results, in most areas, have decreased.а Direct time spent by revenue officers collecting unpaid taxes and pursuing unfiled returns fell by 30 percent from FY 1996 to FY 1999.а Direct time spent examining returns fell by 28 percent during this time.

Source: Collection Reports 5000-23 and Examination Tables 37

The reduction in hours available for return examination was caused by several factors, including:а a decrease in staffing levels; diversion of resources to customer service activity; employee training; and, an increase in time to resolve cases due to ever-changing and increasing complexities of tax laws.

At this time, the IRS does not have a reliable method to measure voluntary compliance or to determine the impact that increased customer service has on voluntary compliance. Consequently, it is difficult to assess the benefits of using compliance resources for customer service, compared to the decrease in compliance results.

This audit report was advisory in nature and was issued to aid IRS management in making decisions regarding the allocation of resources and the development of new management information systems.а This report did not include specific recommendations and no response was required.

Treasury Inspector General for Tax Administration September 30, 2000

Millions of Dollars in Internal Revenue Service Excess Collections Accounts Could Be Credited to Taxpayers (Reference No. 2000-30-088)

As of March 1999, an estimated one million taxpayers had payments totaling $2.3 billion in Excess Collections Accounts.а When a payment cannot be associated with a taxpayerТs account or a tax return is not filed, the IRS will, after meeting processing requirements, transfer the payment to its Excess Collections Accounts.а These accounts include unidentified remittances (where the identities of taxpayers are unknown), miscellaneous fees, and voluntary contributions.

The Office of Audit reported that taxpayers do not always receive credit for certain tax payments due to computing system limitations and processing procedures, as well as the statutory provisions of the tax law.

To protect taxpayer rights and reduce the risk of inappropriate collection actions being taken, the Office of Audit recommended that the IRS immediately credit taxpayersТ accounts, where appropriate.а Also, the IRS needs to develop a coordinated, cross-functional strategy to minimize payments being transferred to Excess Collections Accounts.а This strategy needs to include interim and long-term measures that address systems and procedural limitations. Finally, the IRS should use these audit results to support pending legislative suggestions by the National Taxpayer AdvocateТs Office regarding statutory requirements for refunding and crediting payments.

IRS management agreed with the recommendations and has taken steps to improve its process for managing Excess Collections Accounts.

The Internal Revenue Service Needs to Improve Control of Its Compliance Research Program (Reference No. 2000-40-068)¹¹

As the IRS migrates to four operating divisions¹², its traditional approach to tax administration is changing to incorporate the needs of a diverse taxpayer population.а With this new approach, it is important for the IRS to effectively develop and use compliance research data to guide its programs.

The Office of Audit reported that the IRS does not have effective controls over its research activities and cannot quantify its value to tax administration.а Although the IRS recently implemented new procedures to better manage its compliance research program, it cannot accurately measure the cost-effectiveness or the impact of the information provided to its functional programs.

The Office of Audit recommended the IRS develop a process to identify and measure actual research outcomes and their related costs.а Also, to ensure that research activities provide value to its customers, the IRS should report research results to functional customers timely and involve them more in the research process.а The IRS should also maintain adequate project documentation to facilitate effective business decisions.

IRS management agreed with the recommendations and has taken steps to improve control over project costs.а IRS management did not agree to document

¹¹ The Office of Audit also conducted a separate review of Compliance ResearchТs security of taxpayer data, Reference No. 2000-20-159. ¹² The IRS is moving from a business structure based on functional processes to four operating divisions that will focus on the unique needs of particular taxpayer groups.а Each operating division will be responsible for all processing and service provided to a specific group of taxpayers.

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customer discussions, choosing instead to rely on current project prospectuses to ensure customer involvement.

Protecting Taxpayer Rights

Significant Improvements Are Needed in Processing Gift Tax Payments and Associated Extensions to File (Reference No. 2000-30-154)

IRS centers and lockbox processing sites misapplied most gift tax payments made by taxpayers who filed for an automatic extension of time to file Form 4868, U.S. Individual Income Tax Return.а These misapplied payments were incorrectly processed to taxpayersТ individual income tax accounts, and extensions were usually processed to individual income tax accounts instead of to both individual and gift tax accounts.

The Office of Audit estimated that $1.4 billion in gift tax payments were misapplied during the processing of TY 1996, 1997, and 1998 extensions.а Because processing guidelines were either not followed, incomplete, or unclear, the IRS sent taxpayers an estimated $237 million in erroneous refunds and over 18,300 incorrect notices.а In addition, the IRS charged taxpayers an estimated $3.2 million in penalties that they did not owe, and paid an estimated $8.1 million in interest to taxpayers for delayed refunds.

The Office of Audit recommended that IRS management require the review of all balance due notices for gift tax returns and instruct tax examiners to review the taxpayersТ corresponding individual and gift tax accounts; revise the IRS center and lockbox guidelines to ensure that processing instructions for payments and extensions involving gift tax returns are complete, clear, and followed; explore the possibility of updating the Integrated Submission and Remittance Processing System to permit the posting of payments and extensions to both the individual income and gift tax accounts; improve the reviews of lockbox performance; and, enhance the lockbox performance reports.

IRS management generally agreed with the findings and recommendations and has initiated corrective action.а IRS management did not agree with the following recommendations:а determining whether gift tax payments and extensions could be completely processed at lockbox sites; directing the lockbox coordinators to review correspondence with taxpayers; and, instructing the lockbox depository to review the extension forms during the 2001 filing season.а Instead, the IRS plans to rely on other improvements being made to help resolve some of these issues, and advised that the lockbox banks have agreed to focus on the processing of extension forms during its training for the 2001 filing season.

Increased Attention Is Needed to Ensure Timely, Accurate Determinations on Innocent Spouse Claims for Relief (Reference No. 2000-40-063)

The IRS considered the provisions for innocent spouse relief to be one of the ten most significant areas of RRA 98. Section 3201 of RRA 98 liberalized the factors that the IRS considers when evaluating requests for relief from income taxes under the innocent spouse provisions.а This liberalization significantly increased the number of claims that the IRS received. Between July 22, 1998, and December 31, 1999, the IRS received approximately 64,000 innocent spouse claims.

The IRS was not prepared to effectively process the increased volume of innocent spouse claims for relief. IRS management

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was slow to react to predictions of increased innocent spouse claims and failed to adequately staff the program when the predictions materialized.а Instead of setting up a fundamentally sound program with long-term solutions, IRS management initiated short-term solutions designed to reduce the inventory backlog. These steps were not successful and cases in open inventory reached a program high of 46,000 by December 31, 1999.

The IRS has taken several positive actions to address the problems of implementing the Innocent Spouse Program. These actions included changing the management structure, appointing a full-time national project manager with expanded authority, developing a job aid for making determinations, redesigning the application for relief to help taxpayers better understand eligibility requirements, and establishing a centralized quality review of innocent spouse case decisions.а However, IRS management needs to take additional actions to implement an effective program to provide timely, accurate determinations on innocent spouse claims.

The Office of Audit recommended that the IRS take the following actions:а set goals and standards for the Innocent Spouse Program; upgrade the current management information system and ensure that it provides complete, timely, accurate, and useful feedback; and, design and implement a system of internal controls that addresses the quantity, cost, and timeliness of the Innocent Spouse Program.

IRS management agreed with the recommendations and has initiated corrective action.

The Internal Revenue Service Needs to Better Address Bankruptcy Automatic Stay Violations (Reference No. 2000-30-162)

The Bankruptcy Code, 11 United States Code (U.S.C.) Section 362, prohibits creditors from taking certain actions against individuals after they have filed for bankruptcy, which is known as the Уautomatic stay.Фа As long as the automatic stay is in effect, creditors generally cannot take actions, such as initiating or continuing lawsuits, garnishing wages, or even making telephone calls demanding payments.

For FY 1999, IRS data shows nearly half of the individuals and businesses filing bankruptcy had outstanding tax liabilities totaling $3.4 billion.

The IRS is not always accomplishing its objective of identifying violations of the bankruptcy automatic stay provisions.а The Office of Audit reported that in its review of three IRS district offices, approximately 86,000 bankruptcies were input into the Automated Insolvency System during FY 1999. There was some indication that collection action (i.e., payments made and liens filed) may have been taken on 7,825 of the bankruptcy cases.а A review of 420 of these cases identified 143 (34 percent) violations of the automatic stay provisions.

As of January 2000, the IRS indicated that only one taxpayer nationwide had filed an administrative claim because of a violation of the automatic stay provisions.а However, taxpayers may not be aware of their right to file administrative claims, and should they become aware, the number could increase significantly.а The RRA 98 allows taxpayers to sue when an IRS employee willfully violates the automatic stay provisions.

The Office of Audit recommended that IRS management ensure that litigation transcripts are monitored to identify any violations and

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that appropriate action is taken if violations have occurred. The Internal Revenue Manual should be updated to include procedures for refunding payments received after the bankruptcy petition is filed.а In addition, employees should timely and effectively address internal reports to resolve cases and ensure posting of the bankruptcies to taxpayersТ accounts.

IRS managementТs response was not received prior to the issuance of the audit report.

Opportunities Exist to Identify Unreported Taxes from EmployerТs Quarterly Federal Tax Returns (Reference No. 2000-30-146)

There are significant unresolved differences between the tax information reported by employers to the IRS and the information reported to the Social Security Administration (SSA).а These discrepancies bring into question the accuracy of many Forms 941, EmployerТs Quarterly Federal Tax Return, including taxes employers are reporting and paying to the IRS, as well as refunds they are receiving.а The IRS can increase compliance efforts and identify potential unreported taxes on Forms 941 by using data received from the SSA.

The Office of Audit reported that in TY 1998, employers might have underreported social security, Medicare, and withholding taxes on their Forms 941.а By using IRSТ data, the Office of Audit identified 491 employers that potentially reported $5.4 billion less in wages to the IRS on their Forms 941 than they reported to the SSA on the Forms W-2, Wage and Tax Statement.

In addition, employers nationwide potentially reported, on Forms 941, that they paid their employees $170 million in advanced EIC, but the amount individual taxpayers reported on their income tax returns was only $97 million. The 491 employers potentially claimed $300,000 more in advanced EIC on Forms 941 than on Forms W-2.а Employers can deduct a dollar-for-dollar credit against their Form 941 taxes for advanced EIC payments.а While only one percent of employers claimed advanced EIC, they received 19 percent of the Form 941 refund dollars issued by the IRS.

The IRS Criminal Investigation (CI) office investigates potential tax fraud, but until recently had not been able to identify Form 941 refund fraud.а IRS CI has proposed expanding its involvement in employer-based refund fraud schemes.

The Office of Audit recommended that IRS management increase Form 941 compliance efforts.а In addition, IRS CI should follow through with its plan to expand its involvement in employer-based refund fraud schemes.

IRS managementТs response was not received prior to the issuance of the audit report.

Protecting Revenue and Minimizing Tax Filing Fraud

Letter Report: Internal Revenue Service Efforts to Deal With Executor Commissions Show Promise (Reference No. 2000-30-096)

Executors are paid millions of dollars in commissions each year for administering estates and distributing the property of decedents.а These commissions are deducted on estate tax returns, and the executors are to report the commissions on their individual income tax returns.а As a result of a previous Office of Audit report (Reference No. 970803, dated March 1997), the IRS implemented a project that focused on early intervention by sending inquiry letters to executors who may not have reported their commissions.

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This follow-up review reported that the IRSТ early intervention project was successful. The project identified $1.7 million in unreported income which generated $527,000 of additional recommended taxes and interest liabilities, of which $515,000 (98 percent) has been collected.

The Office of Audit recommended that the IRS expand early intervention efforts nationwide.а A nationwide effort could further reduce unreported commissions.

IRS management agreed with the recommendation and will initiate corrective action.

Management Advisory Report: Administration of the Earned Income Credit (Reference No. 2000-40-160)

The EIC is a refundable credit created by the Congress in 1975 to offset the impact of Social Security taxes on low-income families and to encourage low-income families to seek employment rather than welfare.а Since inception of the EIC, the IRS has faced problems with a complex processing structure, implementation of legislative changes, and a lack of reliable, current data on participation levels and noncompliance. The administration of the EIC has been forced into the IRSТ existing organizational structure, resulting in conflicting goals and approaches among functions that process approximately $30 billion in EIC claims from over 19 million taxpayers yearly.

The Office of Audit reported that despite a wide range of audit work and studies disclosing deficiencies and high-risk areas in the administration of the EIC, problems continue to exist. The results of some of these studies have not been reliable, are several years old, and have not been used by the IRS to establish baselines.а Without studies that establish valid and reliable baselines, IRS management cannot accurately identify the population of all eligible EIC taxpayers, measure the extent of noncompliance, or determine if planned activities will achieve desired outcomes.

Each year, the IRS allocates resources and implements activities designed to administer the EIC.а The Congress has become concerned with the IRSТ ability to achieve full participation by qualified taxpayers and reduce EIC noncompliance.а The IRS received $144 million in FY 2000 and will receive another $145 million in FY 2001 to fund its EIC activities.а However, current activities and plans for the new IRS structure do not improve the way IRS processes EIC returns.а As the IRS implements its new organizational structure, and works to implement GPRA, it should assess the EIC program to determine ways to improve compliance and identify EIC eligible taxpayers who do not claim the credit.

For this management advisory report, the primary purpose of the IRSТ response was to present an overview of the current status of the EIC compliance program. IRS management responded that it will soon release to the public the most recent EIC study, Compliance Estimates for Earned Income Tax Credit Claimed on 1997 Tax Returns.а This study will provide a starting point from which the IRS will be able to evaluate future efforts.

The response also stated that the IRS has recently launched new enforcement efforts to detect and prevent erroneous EIC claims before tax refunds are paid.а The IRS has also implemented a program aimed at educating paid preparers, and is continuing other outreach programs for state and local governments, faith-based organizations, community groups, business leaders, and low income taxpayer advocates.

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Procedures for Installment Agreements With In-Business Taxpayers Need to Be Strengthened (Reference No. 2000-30-123)

According to IRS records, businesses incurred more than $11 billion in tax liabilities in FY 1999. Almost $7 billion of these new delinquencies were for unpaid Form 941 liabilities.а If the taxpayer cannot fully pay these liabilities, the IRS considers allowing the taxpayer to make periodic (installment) payments.а Because in-business taxpayers may also potentially accrue additional Form 941 liabilities, while in an installment agreement, IRS procedures require close manual monitoring.

The Office of Audit identified a number of areas where procedures need to be improved. Specifically, improvement is needed with the evaluation of in-business taxpayersТ suitability for installment agreements, the monitoring of active agreements, and the verification of basic financial information before granting installment agreements.а In addition, 38 percent of the installment agreements reviewed by the Office of Audit showed that the agreements were not manually monitored consistently for compliance with their terms.а The Office of Audit also reported that the IRS does not maintain basic management information regarding manually monitored installment agreements.

The Office of Audit recommended that IRS management develop additional guidance to ensure sufficient research is performed to accurately determine in-business taxpayersТ suitability for installment agreements, and revise current agreement monitoring procedures to improve their effectiveness and efficiency.а In addition, management should implement a uniform methodology for coding manually monitored installment agreements so essential management information can be easily obtained and evaluated.

IRS management agreed with the audit recommendations and has issued revised procedures.

Providing Quality Customer Service Operations

Expanding the Electronic Tax Law Assistance Program (Reference No. 2000-30-120)

The IRSТ toll-free telephone system is the cornerstone of its customer service operations. For FY 2000 (as of April 22), taxpayers attempted over 62 million calls to the IRSТ three main toll-free telephone lines to obtain answers to their questions.а In addition, the IRS uses the ETLA Program to answer tax law and procedural questions submitted by taxpayers on the IRSТ Internet web site known as the Digital Daily.

The ETLA Program offers an alternative to the telephone for taxpayers needing tax law assistance, while at the same time increasing accessibility and convenience.а In FY 1999, IRSТ ETLA answered over 264,000 tax law questions, with nearly 350,000 expected for FY 2000.

The Office of Audit reported that the IRSТ ability to provide effective and efficient electronic tax law assistance is adversely affected by the current system design.а The ETLA design is basically a manual correspondence system with the Internet used only to transmit the questions and answers. For the past six years, the ETLA Program has remained a research project and has not progressed beyond the original system design. Although the initial concept and design were innovative in 1994, the rapid growth of the Internet and technology has directly affected the program.а The current system design will not significantly help achieve the IRSТ goals of making electronic communication so simple, inexpensive, and trusted that

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taxpayers will prefer it to calling and mailing; and, substantially increasing taxpayer access to electronic communication products and services.

The Office of Audit recommended that the IRS leverage technology that will provide enhanced access to tax information, maximize efficiency, and improve electronic customer service. The IRS also needs to fully commit to the ETLA Program by converting it from a long-term research project to a fully supported independent function. Until there are technological changes and an organizational commitment, the IRS needs to delay the marketing of the ETLA Program. In the interim, the IRS should expand the ETLA Program to additional call sites.

IRS management agreed with all of the facts reported, however, they disagreed with most recommendations. The Office of Audit is drafting a response to the IRS Commissioner on the disagreed recommendations.

Management Advisory Report: Comparison of Responses to Small Business/Self-Employed Taxpayer Questions From the Electronic Tax Law Assistance Program and Other Internet Tax Law Services (Reference No. 2000-30-126)

The Office of Audit conducted this study to provide the Customer Service function with a qualitative comparison of the responses submitted by the ETLA Program and free commercial Internet web sites to Small Business/Self-Employed tax law questions.

To avoid having an adverse effect on the ETLA Program and commercial web sites during the filing season, the Office of Audit limited the number of questions it introduced into both systems to 50.а Consequently, the results are not statistically valid.а However, the sample is sufficient to provide insight into the service the IRS provided to Small Business/Self-Employed taxpayers.

The Office of Audit reported that the ETLA Program responded correctly to 54 percent of the questions, while the commercial web sites provided correct answers 47 percent of the time.а All responses from both sites were received within four days.а The IRS responded within two days for 90 percent of the questions.а The commercial web sites provided quicker responses, either the same day or the following day for 81 percent of the questions.а However, the customer satisfaction surveys show that over 90 percent of the taxpayers who used the ETLA Program were satisfied with the IRSТ response times.

This review was a management advisory study and provided information to IRS management for their use; therefore, the Office of Audit did not provide recommendations and no management response was required.

Managing Finances

Letter Report: Improvements Are Needed in the Internal Revenue ServiceТs Federal Financial Management Improvement Act Remediation Plan (Reference No. 2000-10-105)

The Office of Audit assessed the IRSТ compliance with the FFMIA and reported that the IRSТ financial management systems do not comply with the federal financial management systems requirements, federal accounting standards, or the U.S. Government General Ledger.а As required, the IRS prepared a remediation plan to bring its financial management systems into compliance.

The Office of Audit reported that, overall, the remediation plan is reasonable and is consistent with the Department of TreasuryТs

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standard financial management system template. The remedies included in the plan appear sound, directly address the reported weaknesses, and provide long-term solutions. However, the remediation plan does not fully comply with the FFMIA requirements. Specifically, the plan does not include or is not clear on all reported weaknesses; target dates were not always identified or exceeded the three-year time frame without the Office of Management and Budget concurrence; and, resource commitments were not always identified or clear.а Without full compliance with FFMIA, the IRS cannot ensure that all financial management weaknesses are resolved adequately and timely.

The Office of Audit recommended that IRS management ensure that reported weaknesses are clearly included in the remediation plan, and target dates and resource commitments are clearly identified for each weakness. Also, IRS management should promptly notify the Department of Treasury of all target dates that exceed the three-year limit so that the Department can seek appropriate concurrence.

Overall, IRS management agreed with the recommendations.а However, IRS management indicated that the lack of a standardized general ledger was adequately addressed in the plan.а Nonetheless, the IRS took further action to clarify this issue, which satisfied the Office of AuditТs recommendation.

Improvements Are Needed to Ensure Control and Accountability Over Automated Data Processing Assets (Reference No. 2000-10-145)

The IRS has had problems controlling and accounting for its Automated Data Processing (ADP) property, as reported by the GAO when it identified this area as material weaknesses in FY 1999.а Recognizing that the lack of an organization solely dedicated to ADP property management was a significant factor contributing to the condition of its ADP property records, the IRS designated a responsible executive.

The IRS has made substantial progress to ensure control and accountability over its ADP property; however, additional actions are needed.а The Office of Audit recommended that the IRS verify the results of its inventory reconciliation process prior to forwarding ADP certifications to the IRS Commissioner.а Also, the IRS needs to fully implement the Single Point Inventory Function to ensure the accuracy of the inventory and to minimize the risk of continued criticism of its financial records.

IRS management agreed to the recommendations and has developed an implementation schedule for its corrective actions.

Implementing GPRA

The Office of Audit issued six reports that assessed IRSТ efforts to implement customer satisfaction GPRA measures.а The overall audit objectives, recommendations, and corrective actions for these reports are included in Appendix VII.

Addressing the Impact of the Global Economy on Tax Administration

Opportunities Exist to Enhance the International Field Assistance Specialization Program (Reference No. 2000-30-130)

The International Field Assistance Specialization Program (IFASP) was established to provide technical assistance in the examination of complex international tax issues.а The expected benefits included increased revenue raising capabilities, fewer

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disputes due to better developed issues, and less time spent on examinations.

The Office of Audit reported that the IFASP is an important resource to the International Enforcement Program and is staffed with experienced international examiners who are trained in complex areas of international law. However, limitations of the management information system prevent the IRS from determining whether the IFASP was realizing the benefits expected.

Opportunities exist to enhance the ability of the IFASP to provide assistance to the International Enforcement Program, a program that recommends approximately $2.1 billion in additional taxes annually.а The Office of Audit recommended that the IFASP indicator in the International Case Management System be linked to the specific international issues that the IFASP helped develop.а Also, more information should be accumulated and disseminated electronically through the IRSТ Intranet site.

IRS management agreed with the recommendations and has initiated corrective actions.

TIGTA ASSISTS FOREIGN TAX ADMINISTRATION

In January 2000, TIGTA detailed an audit manager to the Treasury DepartmentТs Office of Technical Assistance for a two-year assignment as a resident advisor to Georgia (the former Soviet Union Republic of Georgia).а As a direct result of this specialized tax policy and administration assistance, the President of Georgia established the first Office of the Inspector General (OIG) in June 2000.а In July, the Georgian President appointed the first IG for the Tax Revenue Ministry of Georgia (TRMG).

The new OIG is responsible for oversight of the TRMG, which consists of the Tax and Customs Departments, Excise Stamp Service, and the Ministry.а The OIG has two primary functions, audit and investigations.а The TIGTA resident advisor continues to provide technical assistance on all matters concerning the OIG, such as legislative and organizational issues; audit and investigative standards, methodologies, policies, and procedures; and, audit and investigation planning and programs.

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