Internal Revenue Service: Composition and Collectibility of Unpaid
Assessments (Letter Report, 10/29/98, GAO/AIMD-99-12).

Pursuant to a congressional request, GAO provided information on the
composition and collectibility of the Internal Revenue Service's (IRS)
September 30, 1997, balance of unpaid assessments.

GAO noted that: (1) most of IRS' $214 billion in unpaid assessments as
of September 30, 1997, are not taxes receivable and are not collectible;
(2) of this balance, $76 billion, or 36 percent, consists of write-offs,
which are typically over 6 years old and have no potential for
collection; (3) write-offs consist primarily of corporate income and
payroll taxes owed by bankrupt or defunct businesses, including failed
financial institutions resolved by the Federal Deposit Insurance
Corporation and former Resolution Trust Corporation during the savings
and loan and banking crises of the 1980s and early 1990s; (4) another
$48 billion, or 22 percent, of the unpaid assessments represents
compliance assessments, which are amounts IRS has identified as owed to
the federal government, but which have not been agreed to by taxpayers
or a court; (5) many of these unagreed assessments result from IRS'
various compliance efforts; (6) the lack of acknowledgement by the
taxpayer or courts of the amounts owed, and evidence of little or no
payment activity on compliance assessments, diminish prospects for their
collection; (7) GAO noted less than $75,000 in collections since 1995 on
$2.6 billion of unpaid compliance assessments; (8) only $90 billion, or
42 percent of the September 30, 1997, balance of unpaid assessments,
represents taxes receivable under federal accounting standards; (9)
these are distinguished from compliance assessments in that they are
amounts that either taxpayers or courts have agreed are owed to the
federal government; (10) however, of this amount, only an estimated $28
billion, or 13 percent of the total balance of unpaid assessments, will
likely be collected; (11) the accounts comprising this $28 billion
balance show evidence of both willingness and ability on the part of the
taxpayers to pay their tax liability; (12) GAO found little or no
evidence of payments made on these uncollectible taxes receivable; (13)
these cases are older debts, with most predating the 1990 tax year; (14)
growth in the overall unpaid assessments balance reported by IRS in the
last several years is largely due to the accrual of interest and
penalties; (15) regardless of collection potential, IRS accrues interest
through the statutory collection period of the delinquent tax debt,
which can last 10 years or more; (16) as of September 30, 1997, $136
billion, or 64 percent, of IRS' balance of unpaid assessments
represented interest and penalties; and (17) most of these amounts will
not likely be collected.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-99-12
     TITLE:  Internal Revenue Service: Composition and Collectibility of 
             Unpaid Assessments
      DATE:  10/29/98
   SUBJECT:  Tax administration
             Government collections
             Voluntary compliance
             Financial management
             Debt collection
             Tax nonpayment
             Delinquent taxes

             
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Cover
================================================================ COVER


Report to the Subcommittee on Government Management, Information and
Technology, Committee on Government Reform and Oversight, House of
Representatives

October 1998

INTERNAL REVENUE SERVICE -
COMPOSITION AND COLLECTIBILITY OF
UNPAID ASSESSMENTS

GAO/AIMD-99-12

IRS Unpaid Assessments

(919183)


Abbreviations
=============================================================== ABBREV

  FDIC - Federal Deposit Insurance Corporation
  IRACS - Interim Revenue Accounting Control System
  IRS - Internal Revenue Service
  RTC - Resolution Trust Corporation
  SFFAS - Statement of Federal Financial Accounting Standards

Letter
=============================================================== LETTER


B-280501

October 29, 1998

The Honorable Stephen Horn
Chairman
The Honorable Dennis J.  Kucinich
Ranking Minority Member
Subcommittee on Government Management, Information
 and Technology
Committee on Government Reform and Oversight
House of Representatives

This report responds to your June 4, 1998, request for information on
our analysis of the composition and collectibility of the Internal
Revenue Service's (IRS) September 30, 1997, balance of unpaid
assessments.  The analysis is based on work performed as part of our
audit of the IRS' fiscal year 1997 Custodial Financial Statements.\1
Our opinion was separately reported in February 1998,\2

and the results shared with your Subcommittee in a hearing on IRS
financial management issues on April 15, 1998.\3

As part of our fiscal year 1997 financial statement audit, we
examined IRS' taxes receivable and other unpaid assessments.  Our
tests and analysis during the course of the audit provided us with
detailed information on the composition of IRS' total unpaid
assessments, and the key factors that contributed to the estimate of
the collectibility of these unpaid assessments as reported in the
financial statements.  As requested, this letter provides details
about the composition and collectibility of IRS' unpaid assessments
as of September 30, 1997. 

On July 22, 1998, the President signed into law the IRS Restructuring
and Reform Act of 1998.  The act requires changes in the structure
and management of IRS, the creation of an oversight board for the
agency, and expansion of taxpayer rights, including providing
additional protections for taxpayers in dealings with IRS.  This
letter does not specifically address the impact that provisions of
the act may have on the future composition and collectibility of IRS'
unpaid assessments.  However, it is important to note that certain
provisions of the act, such as limitations on IRS' assessing of
certain penalty and interest charges on delinquent tax debts and the
application of tax deposits to tax liabilities, could affect the
future composition of IRS' unpaid assessments. 


--------------------
\1 The Custodial Financial Statements report assets, liabilities, and
results of activities related solely to IRS' custodial
responsibilities for implementing federal tax legislation, including
collecting federal tax revenues, refunding overpayments of taxes, and
pursuing collections of amounts owed. 

\2 Financial Audit:  Examination of IRS' Fiscal Year 1997 Custodial
Financial Statements (GAO/AIMD-98-77, February 26, 1998). 

\3 Internal Revenue Service:  Remaining Challenges to Achieve Lasting
Financial Management Improvements (GAO/T-AIMD/GGD-98-139, April 15,
1998). 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

Most of IRS' $214 billion in unpaid assessments as of September 30,
1997, are not taxes receivable and are not collectible.  Of this
balance, $76 billion, or 36 percent, consists of write-offs, which
are typically over 6 years old and have no potential for collection. 
Write-offs consist primarily of corporate income and payroll taxes
owed by bankrupt or defunct businesses, including failed financial
institutions resolved by the Federal Deposit Insurance Corporation
(FDIC) and former Resolution Trust Corporation (RTC) during the
savings and loan and banking crises of the 1980s and early 1990s. 
Another $48 billion, or 22 percent, of the unpaid assessments
represents compliance assessments, which are amounts IRS has
identified as owed to the federal government, but which have not been
agreed to by taxpayers or a court.  Many of these unagreed
assessments result from IRS' various compliance efforts, such as
examinations and audits.  The lack of acknowledgement by the taxpayer
or courts of the amounts owed, and evidence of little or no payment
activity on compliance assessments, diminish prospects for their
collection.  We noted less than $75,000 in collections since 1995 on
$2.6 billion of unpaid compliance assessments. 

Only $90 billion, or 42 percent of the September 30, 1997, balance of
unpaid assessments, represents taxes receivable under federal
accounting standards.  These are distinguished from compliance
assessments in that they are amounts that either taxpayers or courts
have agreed are owed to the federal government.  However, of this
amount, only an estimated $28 billion, or 13 percent of the total
balance of unpaid assessments, will likely be collected.  The
accounts comprising this $28 billion balance show evidence of both
willingness and ability on the part of the taxpayers to pay their tax
liability.  For example, a substantial amount of this estimated
collectibility was based on evidence of regular payments made under
installment agreements by individuals and estates.  Also, most of the
cases making up this $28 billion balance are from the last 4 tax
years.  The remaining $62 billion, or 29 percent of the unpaid
assessments balance, represents taxes receivable that are estimated
to be uncollectible and will likely eventually be written off.  These
cases consist of amounts owed by individuals or businesses
experiencing serious financial difficulties, in some cases those in
the midst of bankruptcy proceedings, or with a history of delinquent
taxes and no viable means of repaying the amounts owed.  We found
little or no evidence of payments made on these uncollectible taxes
receivable.  These cases are older debts, with most predating the
1990 tax year. 

Growth in the overall unpaid assessments balance reported by IRS in
the last several years is largely due to the accrual of interest and
penalties.  Regardless of collection potential, IRS accrues interest
through the statutory collection period of the delinquent tax debt,
which can last 10 years or more.  For example, IRS continues to
accrue interest and penalties on hundreds of failed financial
institutions resolved by the FDIC and the RTC despite the fact that
these delinquent taxes will not likely ever be paid.  As of September
30, 1997, $136 billion, or 64 percent, of IRS' balance of unpaid
assessments represented interest and penalties.  Most of these
amounts will not likely be collected. 


   BACKGROUND
------------------------------------------------------------ Letter :2

Each year, the federal government, through the Internal Revenue
Service, collects tax revenue to fund government operations.  The
federal government relies on IRS to collect the proper amount of tax
revenue at the least cost to the public.  In fiscal year 1997, IRS
collected over $1.6 trillion used to finance various government
programs and activities.  These receipts represent payments by
individuals, businesses, corporations, estates, and other types of
taxpayers primarily for amounts owed as a result of wages, income,
employment, sales, and consumption.  To a large extent, the annual
receipts collected by IRS represent the amounts taxpayers owe for the
given period. 

However, not all taxpayers pay the amounts they owe the federal
government.  Some simply do not provide payments on their tax
liability when they file their tax returns.  Others underreport,
either mistakenly or deliberately, the amounts they owe the
government.  Still others do not report the amounts they owe.  While
some taxpayers eventually pay some or all of the amounts due, others
do not.  Also, those that do pay may pay over an extended period. 
This has resulted in a significant build-up in the amount of unpaid
taxes due the federal government because, in addition to taxes owed,
taxpayers also become liable for penalty and interest charges that
continue to accrue over time until the tax, plus accrued penalty and
interest charges, have either been paid in full or the statutory
period of collection has expired.\4 As of September 30, 1997,
information accompanying IRS' fiscal year 1997 financial statements
reflected a total balance of $214 billion in unpaid taxes, penalties,
and interest.  These amounts are referred to as unpaid assessments. 

IRS identifies unpaid assessments through a number of means.  Most
are identified through the filing of tax returns by the taxpayer.  In
cases where the taxpayer files a return that reflects an amount or
tax liability owed the federal government but does not provide
payment or provides only partial payment, the unpaid assessment
represents the difference between the tax liability as reflected on
the return and the amount actually paid by the taxpayer.  IRS refers
to these as self-assessments because the amount of the delinquent tax
is identified solely through information provided by the taxpayer. 

IRS also identifies unpaid assessments through its enforcement
programs.  Such programs include IRS' underreporter program, where
information such as wages, interest, and dividends contained on the
tax return is compared to other third party-supplied information,
such as wage and earnings statements and annual interest statements. 
Any differences identified through this process can result in the
identification of additional tax liabilities or assessments owed by
the taxpayer.  Also, IRS tax examinations and audits can identify
additional taxes owed the government.  IRS' substitute for return
program, where IRS constructs tax returns through the use of third
party information and prior taxpayer history for taxpayers who have
filed returns in the past but have not filed for the given period, is
another tool used by IRS to attempt to identify amounts that are owed
the government. 

Through these various enforcement programs, IRS attempts to close
what is referred to as the tax gap, which is the difference between
taxes actually collected and the amount that is legally due under the
Internal Revenue Code.  The tax gap can be further subdivided into
the "compliance gap" and the "collection gap." The compliance gap,
which is outside the scope of this report, represents the difference
between taxes that should actually be due and those that have been
identified by IRS, either through self-assessments or through
assessments resulting from IRS enforcement programs.  It is this
compliance gap that IRS' enforcement programs attempt to close,
although considerable amounts of taxes due on legal and illegal
income remain unassessed or underassessed each year. 

The collection gap represents the difference between the amounts that
have been identified as being due through assessments and the amounts
that will ultimately be collected on these assessments.  This
collection gap, which is the subject of this report, represents the
amount of IRS' unpaid assessments that is not collectible.  Like a
commercial lender's loan portfolio, IRS' ability to collect amounts
owed is constrained to a great extent by the financial condition of
the taxpayer.  However, unlike a commercial lender, who can review
the financial condition and viability of a prospective borrower prior
to extending a loan, IRS does not choose who owes the government
taxes.  Taxpayers who owe delinquent taxes generally do not have good
credit, reliable incomes, or significant assets and in many instances
are corporations that have gone out of business.  Consequently, IRS
cannot manage risk in a manner similar to commercial lenders.  This
makes closing the collection gap significantly more problematic for
IRS than for a commercial lender. 

The balance of unpaid assessments as of September 30, 1997, consists
of the types of taxes that IRS collects, the majority of which result
from individual income taxes, Social Security and Hospital Insurance
taxes, and corporate income taxes.  Payments for these taxes may be
made on a periodic basis, or for individuals by their employers via
withholdings from their wages.  The major types of taxes in IRS'
unpaid assessments balance are: 

  -- individual income taxes and self-employment taxes,\5

  -- payroll taxes,\6 and

  -- corporate income taxes, which are generally taxes on business
     profits. 

Other types of taxes in IRS' balance of unpaid assessments include
(1) unemployment taxes, (2) excise taxes, such as fuel,
communications, air transportation, sporting goods, alcohol, and
environmental taxes, and (3) estate taxes. 

Not all unpaid assessments are considered accounts or taxes
receivable.  Federal accounting standards provide criteria for
distinguishing which unpaid assessments constitute taxes
receivable.\7 IRS has had considerable difficulty properly
distinguishing and reporting taxes receivable in its financial
statements because its systems were not designed to generate
information for use in preparing financial statements in accordance
with these standards.  Fiscal year 1997 was the first time IRS was
able to successfully prepare reliable financial statements covering
its tax collection activities.  However, this required the use of
special programming to extract information from IRS' master
files--its only detailed database of taxpayer information--for use in
preparing the financial statements as its systems cannot readily
produce this information.  Also, this approach still required
significant manual intervention and, in the end, adjustments totaling
tens of billions of dollars, principally to correct significant
misclassifications and duplication of unpaid assessments.\8


--------------------
\4 The Internal Revenue Code allows IRS up to 10 years to collect any
unpaid assessments.  The collection statute period starts when the
tax assessment is recorded and is suspended only in certain
circumstances such as litigation, offers in compromise and bankruptcy
proceedings, or when there is an agreement between IRS and the
taxpayer to extend the collection period.  The unpaid assessment
balance is removed from IRS' records upon expiration of the statutory
collection period. 

\5 Self-employment taxes are Social Security taxes and Hospital
Insurance taxes for self-employed individuals. 

\6 Payroll taxes consist of (1) individual federal income tax
withholdings and (2) employer contributions and employee withholdings
under the Federal Insurance Contribution Act, which include Social
Security and Hospital Insurance taxes. 

\7 Statement of Federal Financial Accounting Standards (SFFAS) No. 
7, Accounting for Revenue and Other Financing Sources and Concepts
for Reconciling Budgetary and Financial Accounting, provides this
criteria. 

\8 See Financial Audit:  Examination of IRS' Fiscal Year 1997
Custodial Financial Statements (GAO/AIMD-98-77, February 26, 1998). 
This issue will be discussed further in a subsequent report on
internal controls identified in our fiscal year 1997 financial audit. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
------------------------------------------------------------ Letter :3

As part of our audit of IRS' fiscal year 1997 Custodial Financial
Statements, we reviewed IRS' unpaid assessments using statistical
sampling techniques.  Our objectives for the unpaid assessments
segment of that audit were to determine (1) whether IRS had properly
classified its balance of unpaid assessments between taxes
receivable, compliance assessments, and write-offs, (2) whether the
balances for taxes receivable, compliance assessments, and write-offs
were accurate, and (3) in conjunction with IRS, an estimate of the
amount IRS could reasonably expect to collect on its balance of taxes
receivable.  See appendix I for the scope and methodology used to
accomplish these objectives. 

The objective of this report is to provide detailed information on
the composition and collectibility of IRS' September 30, 1997,
balance of unpaid assessments based on the work we performed as part
of our audit of IRS' fiscal year 1997 custodial financial statements. 

It is important to note that, in performing our work, we did not
assess the effectiveness of IRS' enforcement and collection programs,
nor did we attempt to address the compliance gap component of the tax
gap.  Also, we did not specifically analyze the impact provisions of
the IRS Restructuring and Reform Act of 1998 may have on the future
composition and collectibility of IRS' unpaid assessments.  We
conducted our work from August 1997 through February 1998 in
accordance with generally accepted government auditing standards. 

In commenting on a draft of this report, IRS provided preliminary
oral comments, which we have incorporated where appropriate.  We
requested written comments on a draft of this report from the
Commissioner of Internal Revenue.  The Deputy Commissioner provided
us with written comments, which are discussed in the "Agency
Comments" section and are reprinted in appendix II. 


   NOT ALL IRS UNPAID ASSESSMENTS
   ARE TAXES RECEIVABLE
------------------------------------------------------------ Letter :4

Taxes receivable are one category of unpaid assessments, and they
comprised less than half the balance of IRS' unpaid assessments as of
September 30, 1997.  Under federal accounting standards, unpaid
assessments fall into three categories:  taxes receivable, compliance
assessments, and write-offs. 

Taxes receivable are taxes and associated penalties and interest due
for which IRS can support the existence of a receivable through
taxpayer agreement, such as the filing of a tax return without
sufficient payment, or a court ruling favorable to IRS.  The key
distinction between taxes receivable and compliance assessments is
the acknowledgement by the taxpayer or a court that the taxpayer owes
money to the federal government. 

Compliance assessments are unpaid assessments in which neither the
taxpayer nor a court has affirmed that the taxpayer owes money to the
federal government.  For example, an assessment resulting from an IRS
audit or examination in which the taxpayer does not agree with the
results of the audit or examination is a compliance assessment but is
not considered a receivable under federal accounting standards. 

Write-offs are unpaid assessments for which IRS does not expect
further collections due to factors such as the taxpayer's bankruptcy,
insolvency, or death.  Write-offs may at one time have been taxes
receivable, but the absence of any future collection potential
prevents them from being considered receivables under federal
accounting standards. 

Although compliance assessments and write-offs are not considered
receivables under federal accounting standards, they represent
legally enforceable claims of IRS--acting on behalf of the federal
government--against taxpayers.  There is, however, a clear
distinction between these categories from the standpoint of assessing
what they represent with respect to future cash flow to the federal
government.  Our review of these categories of unpaid assessments as
part of our fiscal year 1997 Custodial Financial Statement audit
confirmed that there are significant differences in their collection
potential, which clearly supports the usefulness of the distinctions
between unpaid assessments required under federal accounting
standards. 


      FISCAL YEAR 1997 FINANCIAL
      STATEMENTS PRESENTED FIRST
      RELIABLE REPORTING OF UNPAID
      ASSESSMENTS
---------------------------------------------------------- Letter :4.1

IRS' fiscal year 1997 Custodial Financial Statements for the first
time presented reliable information on the components of IRS' balance
of unpaid assessments.  The Statement of Custodial Assets and
Liabilities appropriately reflected that portion of IRS' unpaid
assessments that represented taxes receivable that were estimated to
be collectible.  In information accompanying the financial
statements, IRS separated the September 30, 1997, balance of unpaid
assessments into the three categories.  This categorization, along
with an understanding of what these categories represent, allows the
users of the financial statements to gain a useful perspective on the
portion of the unpaid assessments balance that represent viable
future cash flow for the federal government.  Figure 1 presents this
categorization. 

   Figure 1:  Components of IRS'
   $214 Billion of Unpaid
   Assessments (Dollars in
   Billions)

   (See figure in printed
   edition.)

Source:  IRS' fiscal year 1997 custodial financial statements. 

As reflected in figure 1 and as reported in the accompanying
supplemental information to IRS' fiscal year 1997 Custodial Financial
Statements, IRS' balance of unpaid assessments as of September 30,
1997, totaled about $214 billion.  It is important to note that IRS'
systems reflected unpaid assessments totaling about $236 billion,
which is $22 billion more than the final reported balance.  During
our audit, we found that most of this $22 billion represented amounts
recorded as assessments multiple times in IRS' systems.  These
amounts primarily represented "trust fund recovery penalties."

Such penalties can result when a business does not forward payroll
taxes to the government.  Each officer and director is individually
liable for the amounts withheld from employees, provided the officers
or directors were found willful and responsible for the nonpayment of
these taxes.  Consequently, IRS may record assessments against
several individuals, each for the total amount withheld from
employees in an effort to collect the total payroll tax liability of
the business.  Such recording of these multiple assessments is
necessary for enforcement tracking purposes.  However, IRS cannot
collect from these multiple individuals and the business more than
the total payroll tax liability owed.  Consequently, by counting each
of the individual and business assessments owed, IRS systems distort
the balance of amounts that IRS has authority to collect.  Also,
systems limitations lead to frequent erroneous balances, and have led
to collection of trust fund recovery penalties that had already been
paid.  This issue will be discussed further in a subsequent report on
internal control issues identified in our fiscal year 1997 financial
audit. 

It is also important to note that these systems limitations result in
IRS having to resort to unconventional means to obtain information
for use in preparing its financial statements.  In particular, the
lack of an adequate general ledger and a subsidiary ledger for taxes
receivable results in IRS running special computer programs against
the detailed taxpayer accounts in its master files to extract
information on unpaid assessments and attempt to classify this
information into the three unpaid assessment categories defined by
federal accounting standards.  The use of this process led to
significant misclassifications of unpaid assessment amounts within
these three categories.  The following table shows the extent of
misclassified items we found, by category of unpaid assessments, in
our statistical sample of 730 items. 



                                Table 1
                
                  Initial and Final Classification of
                     Unpaid Assessment Sample Items

                                            Original             Final
Category                              classification    classification
Taxes Receivable                                 626               465
Compliance Assessments                            74                90
Write-offs                                        30               197
Total                                            730             752\a
----------------------------------------------------------------------
\a The final count of items does not agree with the original number
of sample items because of a number of items that we and IRS
concluded needed to be eliminated or partially reclassified from
their original unpaid assessment classification.  These included
portions of taxes receivable items being reclassified as write-offs,
taxes receivable items being reclassified as both compliance
assessments and write-offs, and compliance assessments being
reclassified as both taxes receivable and write-offs. 

In total, the effect of these misclassifications was significant and
resulted in reclassification of tens of billions of dollars between
the three categories of unpaid assessments to arrive at reliable
fiscal year-end balances.  This issue is discussed more fully in our
report on internal control issues identified in our fiscal year 1997
financial audit. 


      A SIGNIFICANT PORTION OF
      UNPAID ASSESSMENTS CONSIST
      OF WRITE-OFFS
---------------------------------------------------------- Letter :4.2

Of IRS' $214 billion in unpaid assessments as of September 30, 1997,
$76 billion were write-offs.  Consequently, 36 percent of IRS'
balance of unpaid assessments consisted of amounts for which there is
virtually no hope of collection.  Write-offs are comprised largely of
amounts owed for corporate income taxes and payroll taxes by
businesses or corporations that have subsequently become bankrupt or
defunct.  For example, over $24 billion of unpaid assessments
classified as write-offs, or 32 percent, related to corporate income
taxes due from failed financial institutions resolved by the FDIC and
the former RTC. 

In our statistical sample of 730 unpaid assessments, 197 were deemed
wholly or partially write-offs.  Of these 197 write-offs, 123 (62
percent) consisted of amounts owed from defunct corporations such as
failed financial institutions, and another 41 (21 percent) consisted
of amounts owed by other bankrupt corporations or businesses.\9 Most
of the remaining 33 write-off cases (17 percent) included amounts due
from taxpayers who were deceased, whom IRS was unable to locate, or
who had no identifiable assets or other means of repaying the amounts
owed. 

Write-offs also consist primarily of older amounts owed.  Of the 197
items in our sample that were ultimately determined to be wholly or
partially write-offs, about 90 percent of the total amounts owed were
over 6 years old.  As we discuss later in this report, age is an
indicator of the extent to which unpaid taxes are likely to be
collected. 

Also, a significant portion of the total amounts classified as
write-offs were comprised of penalties and interest that have and
continue to accrue on the delinquent tax assessment balance.  Of the
197 items in our sample that were ultimately classified wholly or
partially as write-offs, 19 percent of the total outstanding amounts
owed were comprised of penalties and 45 percent of the total amounts
owed consisted of interest. 

IRS is required to maintain unpaid assessment accounts on its records
until the statutory period for collecting taxes, 10 years, has
expired.\10 During this period, IRS must continue to accrue interest
and penalties on the outstanding amounts owed regardless of whether
IRS concludes that the delinquent taxes owed will ever be collected. 
For example, IRS continues to accrue interest and penalties on
hundreds of failed financial institutions resolved by FDIC and the
former RTC, despite the fact that these were insolvent institutions
with no viable means of repaying their delinquent taxes.  In one
case, over 60 percent of the $1 billion balance of amounts owed by
the failed financial institution consisted solely of accrued interest
and penalties.  Consequently, with respect to write-offs, interest
and penalties continue to be accrued against the delinquent taxes
owed and thus continue to increase the total outstanding balance,
despite the fact that there is virtually no prospect for collection. 


--------------------
\9 A defunct corporation has discontinued its business operations.  A
bankrupt corporation has been declared insolvent by a court.  In
bankruptcy, the court decides how the corporation's remaining assets
will be distributed to its creditors. 

\10 Note that the requirement that IRS maintain delinquent tax
accounts in its records for the required statutory period does not
mean that these amounts are to be reflected on IRS' principal
financial statements.  Only those unpaid assessments meeting the
definition of taxes receivable are reported on the principal
financial statements.  Compliance assessments and write-offs are
reported as supplementary financial information. 


      COMPLIANCE ASSESSMENTS ALSO
      COMPRISE A SIGNIFICANT
      PORTION OF IRS' UNPAID
      ASSESSMENTS
---------------------------------------------------------- Letter :4.3

Forty-eight billion dollars of IRS' $214 billion balance of unpaid
assessments as of September 30, 1997, about 22 percent, consisted of
compliance assessments.  As discussed previously, the key distinction
between unpaid assessments classified as compliance assessments and
those considered taxes receivable is the lack of acknowledgement
either by the taxpayer or by a court that delinquent taxes are owed. 
Many of these unagreed assessments resulted from IRS' various
compliance efforts, such as its examinations or audits and its
various computer matching programs, in which IRS uses third-party
information to identify potential underreporting of tax liabilities. 

Compliance assessments are generally comprised of individual and
business income tax liabilities and payroll tax liabilities.  In our
sample of 730 unpaid assessments, 90 were ultimately classified
wholly or partially as compliance assessments.  Of these 90
compliance assessments, 60 (67 percent) consisted of amounts owed for
individual income taxes, 25 (28 percent) consisted of amounts owed
for business income taxes and payroll taxes, and 5 (5 percent)
consisted of other tax types, such as estate taxes, taxes on
transferor of property to a foreign entity, and other miscellaneous
taxes. 

While compliance assessments have some future collection potential,
the lack of taxpayer or court agreement as to the amounts identified
by IRS as owed reduces the likelihood of IRS collecting these
amounts.  As a category of unpaid assessments, compliance assessments
have significantly less likelihood of collection than those unpaid
assessments classified as taxes receivable.  Based on our sample, we
found that taxpayers who do not agree that they owe IRS usually do
not make payments.  Specifically, we noted less than $75,000 in
collections since 1995 on the $2.6 billion balance of amounts owed
for the 90 unpaid assessment sample items that were ultimately wholly
or partially classified as compliance assessments.  It should be
noted that, although compliance assessments are not likely to
generate significant revenue, IRS will generally pursue collection on
them (and on unpaid assessments classified as uncollectible taxes
receivable, discussed later in this report) to encourage compliant
taxpayers to continue to be compliant, and noncompliant taxpayers to
become compliant, with respect to reporting and paying their tax
liabilities. 

Like write-offs, a significant portion of the total amounts
classified as compliance assessments is comprised of penalties and
interest.  Of the 90 items in our sample that were ultimately
classified wholly or partially as compliance assessments, about 10
percent of the total outstanding amounts owed were comprised of
penalties, and about 72 percent of the total amounts owed consisted
of interest.  As noted in the discussion of write-offs, IRS'
requirement to continue to accrue penalties and interest through the
statutory collection period contributes to the higher and increasing
percentage of penalties and interest to the total outstanding amounts
owed.  It also contributes to an increasing balance that is unlikely
to generate significant revenues for the federal government. 


   TAXES RECEIVABLE COMPRISE ONLY
   A PORTION OF IRS' UNPAID
   ASSESSMENTS
------------------------------------------------------------ Letter :5

Collectively, write-offs and compliance assessments totaled $124
billion, which was 58 percent of IRS' balance of unpaid assessments
as of September 30, 1997.  This represents a significant portion of
IRS' unpaid assessments balance for which collection, based on our
audit work and IRS' financial statements, is highly unlikely. 

The remaining balance of IRS' unpaid assessments as of September 30,
1997, $90 billion (42 percent) represent amounts that are considered
to be taxes receivable under federal accounting standards.  These
amounts meet the definition of taxes receivable because they
represent amounts for which IRS has obtained concurrence, either by
the taxpayer or a court, that the amounts are in fact owed to the
federal government.  These unpaid assessments thus constitute the
most probable category of unpaid assessments from which there is
potential for collection of tax revenues. 

Of the 730 items in our statistical sample, 465 items were ultimately
classified wholly or partially as taxes receivable.  Of these items,
only 193 were determined by IRS and us to be fully or partially
collectible.  The other 272 items were determined by IRS and us to be
uncollectible as of September 30, 1997.  Based on a projection of
these items to the total population, only $28 billion, about 31
percent of the balance of unpaid assessments classified as taxes
receivable, was estimated to be collectible.  In contrast, $62
billion, 69 percent of the balance of taxes receivable, was estimated
to be uncollectible.  Consequently, of the $214 billion balance of
IRS' total unpaid assessments at September 30, 1997, only 13 percent
was estimated to be collectible.\11


--------------------
\11 Note that because of a lack of historical information, the amount
of compliance assessments that will ultimately be collected is not
reasonably estimable; however, we believe that any collectible
amounts would not be significant. 


      PROFILE OF TAXES RECEIVABLE
      SAMPLE ITEMS DETERMINED TO
      HAVE SOME COLLECTIBILITY
---------------------------------------------------------- Letter :5.1

As noted above, 193 sample items that were ultimately determined to
be taxes receivable had at least some future collection potential
based on available information.  In general, these items consisted of
taxes owed where IRS was receiving at least some payments from the
taxpayer, where the taxpayer had entered into agreements with IRS to
repay all or some of the amounts owed and appeared to have the
resources to comply with these agreements, or where IRS had
identified other means of obtaining full or partial payment.  Figure
2 shows the composition of the 193 items that we determined were
fully or partially collectible. 

   Figure 2:  Profile of Taxes
   Receivable Sample Items
   Determined to Have Some
   Collectibility

   (See figure in printed
   edition.)

Source:  193 taxes receivable sample items with some estimated
collectibility. 

The following paragraphs detail each of these categories, discussing
the primary consideration for determining that all or some portion of
each item's balance was collectible: 

  -- Sixty-one items consisted of amounts owed where individuals or
     businesses had entered into installment agreements to repay some
     or all of the delinquent taxes and associated penalties and
     interest.  It is important to note that the existence of an
     installment agreement alone was not a sufficient basis from
     which to conclude that some or all of the outstanding balance of
     a given item was collectible.  We and IRS accepted installment
     agreements as the basis for collectibility only if they were
     supported by evidence of a regular stream of payments.  On the
     other hand, if IRS was not receiving payments in accordance with
     the terms of the installment agreement, we and IRS generally
     considered the installment agreement to be in default and thus
     did not use it as a basis for determining collectibility. 

  -- Thirty-six items were determined to have full or partial
     collectibility based on payments IRS received subsequent to the
     sample selection.  In some instances, these payments were
     sufficient to fully pay the outstanding balance owed.  In these
     cases, because of the certainty of the payment, the item was
     classified as fully collectible. 

  -- Twenty-eight items involved amounts owed by taxpayers with a
     history of compliance, including 10 large established
     corporations. 

  -- Eighteen items involved installment agreements between IRS and
     taxpayer estates.  These estate cases are distinguishable from
     the other installment agreement cases involving individuals in
     that these items are not considered delinquent and are generally
     fully collectible due to the executors' fiduciary responsibility
     to manage the affairs of the estate and evidence of estate
     assets sufficient to satisfy the tax liability.  Specifically,
     in certain cases the Internal Revenue code allows estates to
     enter into 15-year installment agreements to pay their taxes. 
     These agreements are allowed so that estates do not have to sell
     family businesses or other nonliquid assets to satisfy tax
     liabilities. 

  -- Seventeen items involved amounts owed by taxpayers with a
     history of allowing IRS to keep overpayments from other tax
     periods to pay off some or all of the amounts owed.  The IRS
     refers to such cases as refund offsets, where refunds that would
     normally be paid to the taxpayer are instead kept by IRS and
     used to reduce the taxpayer's liability from another tax period. 

  -- Twelve items involved taxpayers who were in the process of
     entering into either an installment agreement or an
     offer-in-compromise to pay off some or all of the outstanding
     amounts owed, and where there was evidence, either through good
     faith payments or other financial resources, that the taxpayer
     would be able to comply with the agreement or offer. 

  -- Eight items involved situations in which IRS was in the process
     of levying taxpayer assets for amounts owed. 

  -- Seven items involved taxpayers in bankruptcy.  Estimates of
     collectibility were based on anticipated payments from the
     bankruptcy proceedings and evidence that assets available were
     sufficient to make payments. 

  -- Five items involved taxpayers who had submitted, and IRS had
     accepted, offers-in-compromise to satisfy the outstanding
     amounts owed.  In these cases, the payments had not yet been
     made but the taxpayer had the financial resources to pay off the
     compromised amount owed. 

  -- One item involved IRS seizing certain assets of the taxpayer to
     satisfy the outstanding amounts owed, but IRS had not yet
     liquidated the assets. 

Most of the items where we identified the likelihood of full or
partial collection of the outstanding amounts owed tended to be more
recent balances and were typically amounts owed within the last 4 tax
years.  The more recent age of the items limited the extent to which
the original tax assessment owed was compounded by accruals of
interest and penalties, in contrast to write-offs and compliance
assessments, as discussed earlier. 


      PROFILE OF TAXES RECEIVABLE
      SAMPLE ITEMS DETERMINED TO
      BE UNCOLLECTIBLE
---------------------------------------------------------- Letter :5.2

As discussed earlier, 272 items in our sample that were ultimately
classified wholly or partially as taxes receivable were assessed by
IRS and us as being uncollectible based on available information. 
These items consisted of taxes owed where the taxpayer, for a variety
of reasons, was deemed unwilling or unable to pay the amounts owed. 
Figure 3 shows the composition of the 272 items that we determined
were uncollectible. 

   Figure 3:  Profile of Taxes
   Receivable Sample Items
   Determined to Be Uncollectible

   (See figure in printed
   edition.)

Source:  272 taxes receivable sample items with no estimated
collectibility. 

A discussion of each of these categories and the primary
consideration for determining that all or some portion of each item's
balance was not collectible follows: 

  -- Sixty-seven items involved hardship cases, in which IRS
     determined that the taxpayer was unable to pay due to
     insufficient income and assets.  IRS will follow up if the
     taxpayer subsequently reports a certain level of income. 

  -- Forty-four items involved the portion of unpaid payroll taxes
     due from defunct or bankrupt businesses that were assessed as
     trust fund recovery penalties against the businesses' officers
     or directors who were found willful and responsible for the
     nonpayment of withheld payroll taxes.  In these cases, we saw no
     evidence of an ability or willingness on the part of these
     officers or directors to pay some or all of the amounts owed. 

  -- Thirty-nine items involved taxpayers in bankruptcy proceedings
     (the court had not yet determined whether any amount would be
     paid to IRS for delinquent taxes) or other defunct corporations. 
     In these cases, we found no evidence of either ability or
     willingness on the part of the taxpayers to pay some or all of
     the amounts owed. 

  -- Thirty-one items involved cases where IRS' collection source
     (levy, installment, etc.) would be applied to prior outstanding
     tax periods and was not sufficient to cover the taxes owed for
     our sample items. 

  -- Twenty-three items involved cases where the taxpayer defaulted
     on an installment agreement or offer-in-compromise and IRS
     records did not identify alternative collection sources. 

  -- Eighteen items involved cases where individuals or businesses
     had amounts due from multiple tax periods and in recent tax
     periods had stopped filing tax returns. 

  -- Sixteen items involved assessments that resulted from the
     discovery of illegal acts, including drug trafficking,
     embezzlement, prostitution, international arms dealing, and real
     estate fraud.  These were generally high-dollar cases related to
     criminal prosecutions.  In all cases, we saw little or no
     evidence of assets to satisfy the assessments.  Income from
     illegal acts is taxable and multiple penalties generally apply. 

  -- Twelve items related to taxpayers who had no payment history (no
     voluntary payments, levies, refund offsets, etc.). 

  -- Eight items involved amounts owed by individuals who we
     determined, through a review of IRS records and discussions, IRS
     was unable to locate or contact. 

  -- Eight items involved cases where IRS could not provide
     sufficient documentation to support the existence of collection
     sources identified in the collection files. 

  -- Four items related to unemployed taxpayers.  In these cases, IRS
     records did not identify any potential sources of collection. 

  -- Two items related to taxpayers involved in litigation with IRS,
     cases in which IRS expects no recovery. 

The age of the items is also an indicator of the extent to which the
outstanding amounts owed are not likely to be collected.  In contrast
to those taxes receivable sample items where we identified the
likelihood of full or partial collection, the items where we
identified no reasonable expected collection typically were older
items, with the majority of these cases predating the 1990 tax year. 
In fact, as illustrated in figure 4, for the 465 items in our sample
that were ultimately classified wholly or partially as taxes
receivable, the percentage of items where we identified the
likelihood of full or partial collection declined dramatically as the
age of the items increased. 

   Figure 4:  Age and
   Collectibility of Taxes
   Receivable Sample Items

   (See figure in printed
   edition.)

Source:  465 sample items ultimately classified as taxes receivable. 

The inability or unwillingness of taxpayers to pay the delinquent
taxes they owe results in the overall balance of IRS' unpaid
assessments continuing to age and also results in the continued
accrual of significant amounts of interest and penalties.  This
contributes to the high loss rate reflected in IRS' allowance for
doubtful accounts pertaining to its taxes receivable, as reported in
its fiscal year 1997 custodial financial statements. 

Another factor that presents difficulties for IRS in its effort to
collect amounts owed is the degree to which some taxpayers repeatedly
fail to pay taxes year after year.  For the majority of the 730 items
we reviewed, the taxpayers actually owed more than just the unpaid
assessment we examined.  This was particularly applicable for
officers and directors against whom trust fund recovery penalties
were assessed.  Of the 730 unpaid assessment sample items, 83 were
unpaid corporate payroll tax assessments related to trust fund
recovery penalties assessed against officers and directors of
businesses who were found willful and responsible for the nonpayment
of withheld payroll taxes.  In many of these 83 items, the same
officer was responsible for the nonpayment of withheld taxes over
multiple years.  Additionally, for 17 of these 83 items, the same
individual was responsible for nonpayment of withheld taxes at more
than one company.  In one of these instances, the same individual was
responsible for the nonpayment of eight tax periods for taxes
withheld from his employees at three different businesses, and in
another case, one individual was responsible for nonpayment of
withheld payroll taxes at five separate businesses.  In only 9 of the
83 unpaid payroll tax assessment items in our sample related to trust
fund recovery penalties did IRS and we determine that recovery of at
least some of the amounts owed was likely.  The remainder of these
items was determined to be uncollectible.  We will be examining
issues associated with trust fund recovery penalties further in
conjunction with our audit of IRS' fiscal year 1998 financial
statements. 


   GROWTH IN UNPAID ASSESSMENTS
   BALANCE LARGELY A RESULT OF
   CONTINUED ACCRUAL OF PENALTIES
   AND INTEREST
------------------------------------------------------------ Letter :6

Because IRS continues to accrue penalties and interest through the
statutory collection period of a delinquent tax assessment,
regardless of the likelihood of collecting on even the original tax
assessment owed, this has, over time, contributed substantially to
the buildup of IRS' balance of unpaid assessments.  According to IRS
records, $136 billion, over 60 percent of IRS' $214 billion balance
of unpaid assessments as of September 30, 1997, consisted of interest
and penalties.  Figure 5 breaks down the balance of unpaid
assessments between the original tax assessment and the accrued
interest and penalties. 

   Figure 5:  Unpaid Taxes
   Compared to Interest and
   Penalties Comprising the $214
   Billion in Unpaid Assessments
   (Dollars in Billions)

   (See figure in printed
   edition.)

Source:  IRS' fiscal year 1997 custodial financial statements and
masterfile data. 

While IRS records show that it accrued tens of billions of dollars in
interest and penalties on its unpaid assessments during fiscal year
1997, according to IRS it collected less than $13 billion in interest
and penalties during the year.  The large interest and penalty
amounts are a consequence of the age of IRS' unpaid assessments. 
According to IRS records and as reflected in figure 6, about 75
percent of its September 30, 1997, balance of unpaid assessments is
over 2 years old, and about 34 percent is in excess of 6 years old. 

   Figure 6:  Age of Unpaid
   Assessments

   (See figure in printed
   edition.)

Source:  Unaudited IRS masterfile data. 

The age of IRS' unpaid assessments leads to large and increasing
amounts of accrued interest and penalties.  IRS is required to
continue to accrue interest and penalties on all unpaid assessments,
regardless of their collection potential, until the statutory period
for collecting taxes has expired.  In contrast, major financial
institutions in the private sector place older nonperforming loans in
a nonaccrual status to stop interest and penalties from continually
increasing the outstanding loan balances. 

The statutory period for collecting taxes is generally 10 years from
the date of the tax assessment.  However, this period can be extended
under a variety of circumstances, and such extensions, we noted, do
occur.  For example, of the 730 unpaid assessment items in our
sample, 16 (2 percent) related to tax years prior to 1979.  In total,
290 sample items (40 percent) related to tax years prior to 1989, and
many of these items had extensions to their collection periods. 

In our sample items, we noted that a major reason for extending the
collection period was ongoing litigation, such as bankruptcy, appeal,
or tax court.  These actions result in the suspension of the 10-year
collection period until they have been resolved.  Also, offers
submitted by taxpayers for less than the amount owed, known as
"offers-in-compromise," also result in a suspension of the 10-year
period while IRS considers the offer.  Also, taxpayers often sign
waiver agreements that extend the collection period beyond the
initial 10 years.  Waivers are frequently used in conjunction with
installment agreements.  IRS has recently determined that the use of
waiver agreements in certain instances is inappropriate;\12 however,
we would not expect this to have a significant impact on IRS' unpaid
assessments. 

To illustrate how an older tax assessment can remain on IRS' records
for decades, an individual could file a 1979 tax return in 1980. 
IRS, based on its various enforcement programs, could identify and
assess additional taxes in 1983.  The taxpayer could bring the matter
to litigation.  Assume for the purpose of this illustration that this
litigation takes 6 years to resolve, at the end of which the court
could decide in favor of IRS.  The taxpayer could then enter into an
installment agreement in 1989 with repayment terms extending out
through the year 1999. 

IRS must accrue interest and penalties through the statutory
collection period, regardless of whether an unpaid assessment meets
the criteria for financial statement recognition or has any
collection potential.  For example, interest and penalties continue
to accrue on write-offs, such as the FDIC and RTC cases, as well as
on exam assessments where taxpayers have not agreed to the validity
of the assessments.  In fact, per IRS records, the balances for the
RTC cases alone will increase from about $22 billion (which was
already mostly interest and penalties) in 1997 to an estimated $40
billion by the year 2003, under current interest rates. 

According to IRS records, the overall growth in unpaid assessments
during fiscal year 1997 was wholly attributable to the accrual of
interest and penalties.  In fact, most of the year-to-year growth in
unpaid assessments during the past 5 years is attributable to
increases in interest and penalties, as noted in figure 7. 

   Figure 7:  Growth in Unpaid
   Taxes and Overall Unpaid
   Assessments (Dollars in
   Billions)

   (See figure in printed
   edition.)

Note:  Includes duplicative assessments, such as trust fund recovery
penalties, which amounted to $15 billion for 1997. 

Source:  Unaudited IRS masterfile data. 

Because much of IRS' inventory of unpaid assessments consists of (1)
write-offs, which have no future collection potential, (2) compliance
assessments, which have little likelihood of being collected, and (3)
taxes receivable with no estimated collectibility, and because these
items are mostly penalties and interest, a substantial portion of the
$136 billion in accumulated interest and penalties is not
collectible. 

It is important to note that the IRS Restructuring and Reform Act of
1998 contains several provisions that affect the manner in which IRS
will assess interest and penalties on future delinquent tax debts. 
For example, IRS will not be allowed to assess interest and certain
penalties for individual taxpayers if IRS does not send a notice to
the taxpayer of any tax deficiency within the statutory time frame
after the taxpayer files a return or the due date of the tax return,
whichever is later.  In addition, the penalty IRS assesses taxpayers
for failing to pay their original tax assessment is reduced by half
for taxpayers with active installment agreements with IRS.  Also,
IRS' application of tax deposits to taxpayers' tax liabilities will
no longer be based on a first in/first out principle, but will
instead be based on taxpayer designation.  This could result in a
reduction in IRS' assessed penalty for the failure to make tax
deposits. 


--------------------
\12 This determination was made on the basis of the fact that the
waivers obtained by IRS in these cases were subsequent to, and not in
conjunction with, the taxpayer entering into the installment
agreement. 


   CONCLUSIONS
------------------------------------------------------------ Letter :7

Less than half of IRS' balance of unpaid assessments as of September
30, 1997, was considered taxes receivable, and only about one-third
of the taxes receivable, about 13 percent of the $214 billion total
unpaid assessments balance, was estimated to be collectible.  The
composition of the unpaid assessments balance consisted largely of
amounts owed by businesses that no longer existed, deceased
individuals, taxpayers who cannot be located, or taxpayers who do not
have the financial ability or willingness to pay the amounts they owe
the federal government.  As a result, despite the fact that many of
these delinquent taxes will never be paid, many of these balances
remain on IRS' records through the statutory collection period and
continue to grow due to the accruing of penalties and interest. 
Unlike commercial lenders, IRS does not choose who owes the
government taxes, and much of what exists in IRS' balance of unpaid
assessments is more analogous to a commercial lender's list of
troubled loans or loans that have been written off than to a lender's
entire loans receivable portfolio. 

Given the serious financial problems of taxpayers who owe these
delinquent taxes, the fact that over one-third of the delinquent
taxes are over 6 years old, and the fact that nearly two-thirds of
the unpaid assessments balance at September 30, 1997, consisted of
penalties and interest, it is likely that IRS will collect only an
estimated 13 cents of every dollar of unpaid assessments. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :8

IRS stated that it was pleased with this report and appreciated our
efforts in better explaining the composition and collectibility of
IRS' unpaid assessments. 


---------------------------------------------------------- Letter :8.1

As agreed with your office, unless you publicly announce the contents
of this report earlier, we plan no further distribution until 30 days
from the date of this report.  At that time, we will send copies of
this report to the Commissioner of Internal Revenue; the Director of
the Office of Management and Budget; the Secretary of the Treasury;
and the Chairmen and Ranking Minority Members of the Senate Committee
on Appropriations, Subcommittee on Treasury and General Government,
Senate Committee on Finance, Subcommittee on Taxation and IRS
Oversight, Senate Committee on Governmental Affairs, Senate Committee
on the Budget, House Committee on Appropriations and its Subcommittee
on Treasury, Postal Service, and General Government, House Committee
on Ways and Means, House Committee on Government Reform and
Oversight, House Committee on the Budget, and other interested
congressional committees.  Copies will be made available to others
upon request. 

Please contact me at (202) 512-9505 or Steven J.  Sebastian,
Assistant Director, Governmentwide Accounting and Financial
Management Issues, at (202) 512-9521 if you or your staff have any
questions concerning this report.  Other major contributors are
listed in appendix III. 

Gregory D.  Kutz
Associate Director
Governmentwide Accounting and
Financial Management Issues


OBJECTIVES, SCOPE, AND METHODOLOGY
=========================================================== Appendix I

As part of our audit of IRS' fiscal year 1997 Custodial Financial
Statements, we reviewed IRS' unpaid assessments using statistical
sampling techniques.  Our objectives in the unpaid assessment segment
of the audit were to determine (1) whether IRS had properly
classified its balance of unpaid assessments between taxes
receivable, compliance assessments, and write-offs, (2) whether the
balances for taxes receivable, compliance assessments, and write-offs
were accurate, and (3) in conjunction with IRS, an estimate of the
amount IRS could reasonably expect to collect on its balance of taxes
receivable. 

To achieve these objectives, we requested that IRS run its computer
program against the master files to initially classify the population
of unpaid assessments into taxes receivable, compliance assessments,
and write-offs.  IRS' general ledger--the Interim Revenue Accounting
Control System (IRACS)--does not maintain detail transaction
information, nor does it classify unpaid assessments into the three
classifications, so it could not be used to develop the three
separate populations of unpaid assessments for testing purposes. 
However, it does contain overall summarized assessment data, so it
could be used to verify the completeness of the populations of unpaid
assessments obtained from the master files.  To gain assurance that
IRS provided us with a complete population of unpaid assessments from
which to draw our samples, we reviewed and recalculated IRS'
reconciliations of its unpaid assessments recorded in its master
files and compared them to the assessment information recorded in
IRACS. 

The populations were obtained from information contained in the
master files as of July 17, 1997.  We selected this interim date for
our detailed test work instead of September 30, 1997, because (1)
detailed testing of statistical samples of unpaid assessments as of
September 30, 1997, could not have been completed in time to
facilitate meeting our statutory audit report date of March 1, 1998,
and (2) we expected little change in the balance of unpaid
assessments between July 17, 1997, and September 30, 1997.  We
performed additional audit procedures of an analytical nature to
ensure that, in fact, no significant changes in either the overall
unpaid assessments balance or between the three categories of unpaid
assessments occurred between July 17, 1997, and the fiscal year-end. 

From the three separate populations of unpaid assessments, we
selected statistical samples of items on which to conduct detail
testing.  For the population of unpaid assessments initially
classified as taxes receivable, we employed a classical variable
sampling approach.  In addition to testing for the proper
classification and recorded amount, use of classical variable
sampling allowed us, in conjunction with IRS, to project a
statistically valid estimate of the amount of taxes receivable that
IRS could reasonably expect to collect.  We stratified the population
into 20 dollar ranges to (1) decrease the effects of variances in the
total unpaid assessment population, (2) gain assurance that the
sample amounts were representative of the population, and (3) obtain
assurance that the resulting net tax receivable amount is a reliable
estimate of the amount IRS can reasonably expect to collect. 
Separate random samples were then selected for 19 of the 20 strata. 
For the remaining strata, which consisted of all tax receivable items
in excess of $30 million individually, all items were selected for
testing.  We used $5 billion as our materiality level, a 95 percent
confidence level, and a planned precision level of plus or minus $2.5
billion.  This approach resulted in a total sample size of 626 tax
receivable items, totaling $5.9 billion, which is 4.6 percent of the
$127.8 billion in unpaid assessments initially classified as taxes
receivable by IRS. 

For the populations of unpaid assessments initially classified by IRS
as compliance assessments and write-offs, we employed dollar unit
sampling techniques to test their proper classification and amount
and to evaluate the significance of any misclassifications.  We used
$5 billion as our materiality level, a 95 percent confidence level,
and an expected aggregate error rate of $1.29 billion.  This resulted
in a sample size of 74 compliance assessment items totaling $3.7
billion, which is 5.1 percent of the $72.3 billion in unpaid
assessments initially classified as compliance assessments by IRS,
and a sample size of 30 write-off items totaling $8.4 billion, which
is 27.5 percent of the $30.6 billion in unpaid assessments initially
classified as write-offs by IRS. 

In total, we selected for testing 730 items totaling about $18
billion, 7.8 percent of the unadjusted unpaid assessments balance as
of July 17, 1997.  These items covered various tax types.  A summary
of the 730 sample items, broken down by major tax type, is presented
in table I.1. 



                               Table I.1
                
                  Summary of Unpaid Assessments Sample
                          Items by Type of Tax

                                                            Unadjusted
                                                            book value
                                                  Sample   (dollars in
Type of tax                                        items     billions)
------------------------------------------------  ------  ------------
Individual income and self-employment taxes          373         $ 1.3
Corporate payroll tax (includes individual           185           0.4
 withholdings and FICA)
Corporate income tax                                  97          13.3
Estate tax                                            24           0.5
Miscellaneous penalty                                 22         0.0\a
 (trust fund recovery penalties)
Employer's annual unemployment tax                    11         0.0\a
Other taxes                                           18           2.5
======================================================================
Totals                                               730         $18.0
----------------------------------------------------------------------
\a Book value of these sample items rounds to zero. 

To determine whether the taxes receivable sample items were properly
classified and recorded for the appropriate amounts, we examined
taxpayers' case files to determine whether IRS had sufficient and
reliable information to document (1) taxpayers' agreement to the
assessment or (2) evidence of court rulings favorable to IRS.  We
also analyzed detailed masterfile transcripts of the taxpayers'
accounts, reviewed correspondence between IRS and taxpayers, and
examined IRS internal documents to verify that the items were
recorded at the correct amounts. 

To determine if and to what extent IRS could reasonably expect to
collect the outstanding taxes receivable balance for each sample item
we concluded was properly classified as taxes receivable, we examined
detailed masterfile transcripts of the taxpayers' account and IRS
collection case files, which could include documentation of
taxpayers' income and assets, earnings potential, other outstanding
unpaid assessments, payment history, and other relevant collection
information that affected the taxpayers' ability to pay.  We also
considered the extent and results of IRS' documented efforts to
collect the assessment amount. 

To determine whether the compliance assessments and write-off sample
items were properly classified and recorded for the appropriate
amounts, we examined taxpayers' case files, reviewed taxpayers'
transcripts, reviewed correspondence between IRS and taxpayers, and
examined IRS internal documents to verify that the items were
recorded at the correct amounts. 

In testing these sample items, we identified numerous instances where
unpaid assessments were incorrectly classified between the three
categories of unpaid assessments.  We projected the impact of these
misclassified sample items to the three populations and proposed
adjustments based on these projections.  Additionally, we identified
unpaid assessment balances counted multiple times.  We proposed
adjustments to remove the associated amounts from the unpaid
assessments balance.  IRS reviewed all of these items, agreed with
our conclusions, and agreed with the proposed adjustments.  We
projected the results of our collectibility assessment to the
population of taxes receivable.  We then employed analytical
procedures to adjust September 30, 1997, balances for the results of
our detail testing of July 17, 1997, unpaid assessments data.  IRS
reviewed our estimates of amounts that were reasonably expected to be
collectible, our collectibility projection to the entire population,
and the adjustments from our analytical procedures and agreed with
the results. 

In conducting our work, we did not assess the effectiveness of IRS'
enforcement and collection programs, nor did we address issues
associated with the compliance gap component of the tax gap.  In
addition, we did not specifically analyze the impact provisions of
the IRS Restructuring and Reform Act of 1998 may have on the future
composition and collectibility of IRS' unpaid assessments. 

We conducted our work at IRS' National Office in Washington, D.C.,
and at the IRS Kansas City Service Center from August 1997 through
February 1998.  We conducted our work in accordance with generally
accepted government auditing standards. 




(See figure in printed edition.)Appendix II
COMMENTS FROM THE INTERNAL REVENUE
SERVICE
=========================================================== Appendix I


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix III

ACCOUNTING AND INFORMATION
MANAGEMENT DIVISION, WASHINGTON,
D.C. 

Steven J.  Sebastian, Assistant Director
West Coile, Assignment Manager
Helen Branch, Evaluator

ATLANTA FIELD OFFICE

Fannie Bivins, Senior Auditor
James Douglas, Senior Auditor
Alva Archie, Auditor
Veronica Mayhand, Auditor
Angel Sharma, Auditor

LOS ANGELES FIELD OFFICE

David Elder, Auditor
Gary Wiggins, Auditor

SAN FRANCISCO FIELD OFFICE

Laurie King, Evaluator

SEATTLE FIELD OFFICE

Alvin Finegold, Senior Evaluator
Pat Seaton, Senior Evaluator
Quan Thai, Senior Evaluator
Catherine Arnold, Evaluator

OFFICE OF GENERAL COUNSEL

Thomas Armstrong, Assistant General Counsel
Andrea Levine, Attorney


*** End of document. ***