IRS Return Selection: Wage and Investment Division Should Define Audit Objectives and Refine Other Internal Controls
Highlights
What GAO Found
Three offices in the Internal Revenue Service's (IRS) Wage and Investment division (W&I) are responsible for selecting returns for audit. Most returns are selected via computer systems that automatically send notices to taxpayers based on certain criteria, such as the validity of dependents. W&I program officials annually review the criteria and apply updates to the following filing season's returns. In 2014, about 59 percent of all W&I audits—more than 516,000—were selected with a specialized computer tool called the Dependent Database, while the remainder was selected through a combination of referrals and manual selection methods.
W&I generally has established a positive environment for internal controls but could improve several areas in its audit selection procedures to support its mission. GAO found several procedures that establish a positive environment for promoting internal controls, such as ethics training. In addition, IRS has guidance to help ensure that decisions about updates to audit selection criteria are correctly implemented in its automated systems. However, W&I does not have established objectives for its audit selection process, and existing performance measures focus on audit results rather than audit selection. In addition, W&I has not defined key terms such as “fairness and integrity,” as required by internal control standards. Documented objectives and key terms would help W&I hone the measures it uses to assess its audit selection efforts and bring a consistent understanding of “fairness and integrity” to audit selection staff.
GAO also found that not all elements of the selection process were appropriately documented. For example, W&I does not have clear documentation about how the three offices that select the majority of returns W&I audits interact with one another. Additionally, one guidance document notes that returns with the highest audit potential should be marked, but it does not describe how audit potential is determined or any related internal controls. Further, W&I also did not provide support showing that changes to automated audit selection processes and procedures were appropriately implemented in a timely manner. Moreover, the documentation indicates that W&I conducts an annual—rather than continuous—review of its audit selections and results as part of an annual 3-day working session. Strengthening controls in these areas would help provide greater assurance that W&I is fulfilling its mission to select tax returns with fairness and integrity. Additionally, the absence of a fully documented selection process may make it difficult for W&I to defend against accusations that it is not appropriately following its processes and procedures.
Why GAO Did This Study
Audit activities help ensure taxpayers pay the right amount of tax and help address the net $385 billion tax gap—the difference between the amount of taxes paid voluntarily and on time, and the amount owed. Audit programs in W&I mainly cover refundable credits reported on the Form 1040, Individual Income Tax Return. The hundreds of thousands of taxpayers whom W&I interacts with annually during audits make it critical to apply the tax law fairly. Unfair selection would increase burden on taxpayers and reduce public confidence in IRS.
GAO was asked to review W&I's audit selection process. This report (1) describes the W&I process for selecting tax returns for audit, and (2) determines how well W&I's audit selection procedures support its mission and goal to apply the tax law with integrity and fairness to all. GAO reviewed documentation on program procedures, an audit work plan, and various Internal Revenue Manual sections; analyzed audit data from fiscal years 2013 and 2014; and interviewed relevant IRS officials.
Recommendations
GAO recommends, among other things, that IRS establish program objectives and definitions of key terms such as “fairness” that apply to audit selection and use those definitions in assessing its selection performance; document selection processes more thoroughly; and document that changes to procedures are done in a timely manner. IRS generally agreed with all seven recommendations and provided additional comments reprinted in appendix II.
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| Internal Revenue Service | To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should clearly define and document: (1) key terms such as "fairness"; and (2) W&I program level objectives, performance measures, and indicators for audit selection to evaluate whether the audit selection process is meeting its mission of applying the tax law with integrity and fairness to all. |
In January 2018, IRS told us that its definition of fairness and its objective with audit selection is now documented in Internal Revenue Manual section 4.1.26. However, IRS has not indicated how it would develop program-level performance measures, as we recommended. IRS in May 2018 issued its definition of fairness and its objective for audit selection, which was "to ensure the process used for Correspondence Exam case selection is impartial and fair and administered with the highest degree of integrity." According to IRS guidance, the measures and indicators for this objective are reflected in a manager-reviewed certification document. The measures and indicators listed in the certification document include, for example, documenting whether expectations, as listed in the above objective, were communicated verbally to those charged with setting or revising audit selection criteria or making audit selections at each inventory selection criteria meeting. IRS officials said that the certificate is used in the development of all W&I selection methods. By stating the audit program's objective and establishing performance measures, indicators and key concept definitions, IRS will be better assured that the W&I's audit selection processes are fair and have integrity.
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| Internal Revenue Service | To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should clearly communicate these terms, objectives, measures, and indicators to all staff involved in the selection of returns for audit. |
In January 2018, IRS said it established an objective for audit selection in Internal Revenue Manual Section 4.1.26 and communicated this with staff. IRS in May 2018 issued guidance to all of its audit employees detailing the definition of fairness and its objective with audit selection, which was "to ensure the process used for correspondence exam case selection is impartial and fair and administered with the highest degree of integrity." The document used to communicate the objective also includes what IRS said were the audit selection measures and indicators. Moving forward, IRS officials said they will communicate the objective, measures and indicators in an annual meeting and through a certification procedure documented in IRS's Internal Revenue Manual. By communicating objectives measures and indicators, IRS will be better assured that the W&I's audit programs are applied fairly.
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| Internal Revenue Service | To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should incorporate the new objective(s) into W&I risk assessments done for audit selection processes. |
In April 2017, IRS said that Internal Revenue Manual (IRM) Section 4.1.26 incorporates its new objectives into risk assessments done for the audit selection process. W&I established in May 2018 a certification form that includes assessing risks as well as a description the program-level objective in a form for documenting program changes and approvals. IRS also documented the overall certification procedure in its Internal Revenue Manual. IRS officials said that the certification program applies to all audit selection methods W&I uses. By including program-level objectives in its risk-assessment process, IRS will be better assured that the W&I's audit programs are appropriately selecting returns for audit, consistent with its mission.
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| Internal Revenue Service | To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should ensure that internal control responsibilities are communicated and documented for all employees, including non-managers, tasked with revising or applying W&I audit selection criteria for potential audits. |
In January 2018, IRS provided evidence that it had communicated and documented internal control responsibilities to employees, though the evidence presented was not clear about whether the communication was made to all employees tasked with revising or applying audit selection criteria, as directed in the recommendation. W&I released in May 2018 new Internal Revenue Manual (IRM) procedures that spell out all employees' responsibilities for internal controls over selection methods. The new IRM went to all employees involved with revising or applying audit selection methods. By communicating internal control responsibilities to all relevant employees, IRS will be better assured that the W&I's audit selection criteria are fair.
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| Internal Revenue Service | To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should develop and implement procedures to ensure that all criteria or methods used in programs to select returns for audit are consistently documented and approved. |
In January 2018, IRS provided evidence to show that it had completed a process for ensuring that methods used in programs to select returns for audit were consistently documented and approved. In addition to documenting these criteria and methods, IRS created a form to document the request and approval for all changes to workload selection tools under these criteria and methods. IRS said that its staff members are now required to follow a process to request revisions or additions to audit selection criteria and methods. These work requests are documented and require different levels of executive review and approval. This process also has strict time frames outlining required submission dates to be followed for such revisions or additions. The procedures are documented in Internal Revenue Manual section 4.1.26.
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| Internal Revenue Service | To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should develop and document a clear means for IRS staff members to promptly elevate to top management possible internal control issues related to audit selection in a timely manner. |
In January 2018, Internal Revenue Service (IRS) officials provided evidence that IRS has started using a computer system to create a feedback loop that allows IRS campus employees to give feedback to IRS headquarters on any issues related to workload selection that they may come across while working audits. IRS directors prepared and issued an all-employee email advising them of the new feedback mechanism and included a link to the site. Headquarters staff are to respond to all related inquiries and feedback and all campus employees will be able to see the response.
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| Internal Revenue Service | To help ensure W&I meets its mission and selects audits fairly and with integrity, the Commissioner of Internal Revenue should develop, document, and implement additional monitoring procedures to ensure audit selection controls and corrective actions are implemented in a timely manner. |
In January 2018, Internal Revenue Service (IRS) officials provided evidence that IRS has begun documenting the request and approval of all changes to workload selection controls and that corrective actions are taken in a timely manner. To that end, IRS staff members are now required to follow a process to request revisions/additions to selection rules. These work requests are documented in a computer system and require different levels of executive review and approval. The process also has strict time frames outlining required submission dates to be followed for changes. To have IRS's information technology staff do the requested programming changes the required approved forms must be submitted timely. The procedures are documented in Internal Revenue Manual section 4.1.26.
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