Internal Revenue Service: Immediate and Long-Term Actions Needed To
Improve Financial Management (Letter Report, 10/30/98, GAO/AIMD-99-16).
Pursuant to a legislative requirement, GAO provided information on the
Internal Revenue Service's (IRS) internal controls and financial
management systems.
GAO noted that: (1) IRS' internal control system remains plagued by
weaknesses that adversely affect the agency's ability to safeguard
assets from material loss, ensure material compliance with relevant laws
and regulations, and ensure that material misstatements do not occur in
its financial statements; (2) left uncorrected, these weaknesses
significantly increase the risk that future financial statements of both
IRS and the entire federal government as well as other IRS reports may
not be reliable and that losses to the government could occur; (3) IRS'
general ledger cannot distinguish categories of unpaid assessments to
determine the portion that represents actual taxes receivable of the
federal government; (4) IRS also does not have a detailed listing, or
subsidiary ledger, for tracking and accumulating unpaid assessments; (5)
these weaknesses resulted in tens of billions of dollars in adjustments
to correct misclassifications and eliminate duplicate transactions; (6)
IRS also continues to lack adequate documentation to support its unpaid
assessments; (7) controls over service center cash and checks received
directly from taxpayers are not sufficient to adequately reduce the
exposure to loss; (8) between 1995 and 1997, IRS identified $5.3 million
in actual or alleged embezzlement by service center employees; (9) some
refunds should not have been issued and some refunds were issued for
incorrect amounts in fiscal year (FY) 1997; (10) control deficiencies
also make IRS vulnerable to issuing duplicate refunds to the same
person; (11) IRS is unable to determine the specific amount of revenue
it collects for three of the federal government's four largest revenue
sources at time of collection because it does not obtain the information
necessary to do so; (12) during FY 1997, IRS did not distribute excise
tax receipts to the relevant trust funds based on collections as
required by the Internal Revenue Code; (13) IRS officials have indicated
that they implemented a method in June 1998 for certifying excise tax
distributions based on collections; (14) IRS' general ledger cannot
routinely generate reliable and timely financial information; (15) as a
result, in FY 1997 IRS' systems did not comply with the Federal
Management Improvement Act of 1996; and (16) these weaknesses illustrate
the extent to which IRS still has extensive work ahead of it to fully
address and resolve its internal control and financial management system
deficiencies.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: AIMD-99-16
TITLE: Internal Revenue Service: Immediate and Long-Term Actions
Needed To Improve Financial Management
DATE: 10/30/98
SUBJECT: Financial statement audits
Tax refunds
Financial management systems
Internal controls
Federal agency accounting systems
Financial records
Accounting procedures
Tax administration systems
Systems conversions
Tax nonpayment
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Cover
================================================================ COVER
Report to the Commissioner of Internal Revenue
October 1998
INTERNAL REVENUE SERVICE -
IMMEDIATE AND LONG-TERM ACTIONS
NEEDED TO IMPROVE FINANCIAL
MANAGEMENT
GAO/AIMD-99-16
IRS Financial Management
(919180)
Abbreviations
=============================================================== ABBREV
EFTPS - Electronic Federal Tax Payment System
EIC - Earned Income Credit
FICA - Federal Insurance Contributions Act
FFMIA - Federal Financial Management Improvement Act
FMS - Financial Management Service
FTD - Federal Tax Deposit
IRS - Internal Revenue Service
OMB - Office of Management and Budget
SGL - U.S. Government Standard General Ledger
Letter
=============================================================== LETTER
B-280501
October 30, 1998
Mr. Charles O. Rossotti
The Commissioner of Internal Revenue
Dear Mr. Rossotti:
This letter is a follow-up to our report on the results of our audit
of the custodial financial statements of the Internal Revenue Service
(IRS) for fiscal year 1997.\1
For the first time since we began auditing IRS' financial statements
in fiscal year 1992,\2 we were able to conclude that IRS' fiscal year
1997 custodial financial statements were reliable in all material
respects. In issuing an unqualified opinion on these statements, we
reported that the over $1.6 trillion in tax revenue, $142 billion in
tax refunds, and $28 billion in net taxes receivable reported by the
IRS were fairly stated.
However, as we pointed out in our audit report and in subsequent
congressional testimony,\3 serious weaknesses in IRS' internal
controls and financial management systems continue to exist. This
report outlines what we believe needs to be done to address these
problems. It details our findings and presents conclusions and
recommendations for improvement.\4
--------------------
\1 Financial Audit: Examination of IRS' Fiscal Year 1997 Custodial
Financial Statements (GAO/AIMD-98-77, February 26, 1998).
\2 See list of related GAO products at the end of this report.
\3 Internal Revenue Service: Remaining Challenges to Achieve Lasting
Financial Management Improvements (GAO/T-AIMD/GGD-98-139, April 15,
1998).
\4 During our audit of IRS' fiscal year 1997 custodial financial
statements, we identified six material weaknesses, one reportable
condition representing a significant deficiency in IRS' internal
controls, and one instance of noncompliance with laws and
regulations. One of the material weaknesses we reported--controls
over computer security--is being dealt with in a separate report.
BACKGROUND
------------------------------------------------------------ Letter :1
Because of the volume and sensitivity of tax collections and refunds,
the adequacy of IRS' financial systems deserves careful attention.
Federal tax revenues, which represent over 90 percent of the federal
government's revenues, dwarf most other financial activities
undertaken by any single entity, public or private, in the world.
Therefore, it is imperative that IRS establish strong financial
management and internal controls to effectively carry out its
mission.
In accordance with the Chief Financial Officers Act of 1990, as
expanded by the Government Management Reform Act of 1994, we audited
IRS' fiscal year 1997 custodial financial statements. These
custodial financial statements report the assets, liabilities and
results of activities related to IRS' responsibilities for
implementing federal tax legislation, including collecting federal
tax revenues, refunding overpayments of taxes, and pursuing
collections of amounts owed. Its fiscal year 1997 administrative
financial statements, which were audited by the Treasury Inspector
General, report on the financial position and results of operations
related to the administration of IRS funded by appropriations and
reimbursements from other agencies, state and local governments, and
the public.
Prior to fiscal year 1997, we were unable to conclude that IRS'
custodial financial statements were fairly stated, mainly because
weaknesses in IRS' internal controls and financial management systems
prevented it from producing reliable financial information.\5
Therefore, our ability to conclude that the fiscal year 1997
custodial financial statements were reliable was a mark of progress.
However, this came only after IRS applied extensive ad hoc
programming and analysis to develop balances, which subsequently
required material adjustments to produce the financial statements.
Thus, many of the original internal control weaknesses still exist.
Fixing these weaknesses represents an additional and critical step
that IRS must take to meet its accountability goals and effectively
achieve its mission. To help IRS accomplish this, we made a total of
30 recommendations in our previous audits to assist IRS in addressing
the internal control and system weaknesses associated with its
custodial responsibilities, which are discussed in appendix II.\6
However, critical recommendations have not been implemented.
--------------------
\5 For fiscal year 1996, we were able to determine for the first time
that total net revenue collections as reported in IRS' financial
statements were reliable. However, we still could not conclude that
IRS correctly classified tax receipts and refunds by tax type because
IRS could not provide sufficient evidence supporting its
classification. As in prior years, we also could not determine the
reliability of reported net federal tax receivables.
\6 GAO has also made 29 recommendations related to IRS'
administrative responsibilities which are not discussed in this
report.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :2
IRS' internal control system remains plagued by weaknesses that
adversely affect the agency's ability to safeguard assets from
material loss, ensure material compliance with relevant laws and
regulations, and ensure that material misstatements do not occur in
its financial statements. In the aggregate, we reported these issues
as a material weakness in our report on the fiscal year 1997
consolidated financial statements of the U.S. government.\7 Left
uncorrected, these weaknesses significantly increase the risk that
future financial statements of both IRS and the entire federal
government as well as other IRS reports may not be reliable and that
losses to the government could occur.
Based on the internal control weaknesses we identified in our fiscal
year 1997 audit, we are making 11 new recommendations. In summary,
the weaknesses we identified and our key recommendations are as
follows:
-- Detailed accounting for unpaid assessments. IRS' general ledger
cannot distinguish categories of unpaid assessments to determine
the portion that represents actual taxes receivable of the
federal government. IRS also does not have a detailed listing,
or subsidiary ledger, for tracking and accumulating unpaid
assessments. These weaknesses resulted in IRS pursuing
collection from taxpayers even after amounts owed had been paid.
Lacking such capabilities, IRS must rely on computer programs to
extract data from its master files to prepare its financial
statements, a process which still resulted in tens of billions
of dollars in adjustments to correct misclassifications and
eliminate duplicate transactions. IRS also continues to lack
adequate documentation to support its unpaid assessments. In
the short-term, we recommend that IRS (1) improve the accuracy
of the master file extraction programs used to prepare the
financial statements and (2) establish minimum documentation
standards for its unpaid assessment files to facilitate its
classification and collection efforts. In the long-term, we
recommend that IRS' system improvement efforts include permanent
solutions to its internal control deficiencies over unpaid
assessments.
-- Controls over service center receipts. The volume and nature of
IRS' operations renders it highly vulnerable to losses of
taxpayer and government funds. IRS' current controls over
service center cash and checks received directly from taxpayers
are not sufficient to adequately reduce the exposure to loss.
Between 1995 and 1997, IRS identified $5.3 million in actual or
alleged embezzlement by service center employees. In the
short-term, we recommend that IRS consider instituting a number
of physical security controls, including installing surveillance
cameras and prohibiting personal belongings in the receipts
processing areas by providing and requiring the use of lockers,
to reduce the exposure of cash and checks to theft or loss.
-- Controls over refunds. Some refunds should not have been issued
and some refunds were issued for incorrect amounts in fiscal
year 1997. Control deficiencies also make IRS vulnerable to
issuing duplicate refunds to the same person. To reduce the
number of inappropriate refunds issued, IRS should in the
short-term study the cost-benefit of manually comparing third
party wage and other data to tax returns at the time they are
processed. In the long-term, IRS should ensure that its systems
improvement efforts provide for the capability to compare tax
returns to other third party-supplied information prior to
issuing refunds.
-- Detailed revenue accounting and reporting. IRS is unable to
determine the specific amount of revenue it collects for three
of the federal government's four largest revenue sources--Social
Security, Medicare, and individual income taxes--at time of
collection because it does not obtain the information necessary
to do so. In addition, during fiscal year 1997, IRS did not
distribute excise tax receipts to the relevant trust funds based
on collections as required by the Internal Revenue Code. IRS
officials have indicated that they implemented a method in June
1998 for certifying excise tax distributions based on
collections.
-- General ledger system. IRS' general ledger cannot routinely
generate reliable and timely financial information. As a
result, in fiscal year 1997 IRS' systems did not comply with the
Federal Financial Management Improvement Act (FFMIA) of 1996.\8
We recommend that IRS implement the first step of its systems
modernization plan as soon as possible and ensure that the
resulting system can routinely generate timely and reliable
financial management reports.
These weaknesses and resultant recommendations illustrate the extent
to which IRS still has extensive work ahead of it to fully address
and resolve its internal control and financial management system
deficiencies. Left uncorrected, the internal control weaknesses
identified will continue to hinder IRS from adequately managing its
financial operations and create situations in which taxpayers have to
expend unnecessary efforts to rectify problems created by IRS errors.
In addition, IRS will not regularly be able to prepare reliable,
timely financial reports.
--------------------
\7 Financial Audit: 1997 Consolidated Financial Statements of the
United States Government (GAO/AIMD-98-127, March 31, 1998).
\8 FFMIA requires agencies to implement and maintain financial
management systems that comply substantially with federal financial
management systems requirements, applicable federal accounting
standards, and the U.S. Government Standard General Ledger at the
transaction level.
OBJECTIVES, SCOPE, AND
METHODOLOGY
------------------------------------------------------------ Letter :3
As part of our audit of IRS' fiscal year 1997 custodial financial
statements, we conducted an evaluation of IRS' internal controls and
its compliance with selected provisions of laws and regulations. Our
first objective was to determine whether IRS management's assertion
about the effectiveness of internal controls in meeting the following
objectives was fairly stated: (1) safeguarding assets from material
loss, (2) assuring material compliance with laws governing the use of
budget authority and with other relevant laws and regulations, and
(3) assuring that there were no other material misstatements in the
custodial financial statements. Our second objective was to identify
any internal control weaknesses that prevented IRS from achieving its
three objectives. The purpose of this report is to discuss the
internal control and compliance findings from our fiscal year 1997
audit in more detail and to present our conclusions and
recommendations for improvement. Appendix I provides further details
on our scope and methodology.
We performed our work from May 1997 through February 1998 in
accordance with generally accepted government auditing standards and
Office of Management and Budget (OMB) Bulletin 93-06. We requested
comments on a draft of this report from the Commissioner of Internal
Revenue or his designee. The Commissioner provided us with written
comments, which are discussed in the "Agency Comments and Our
Evaluation Section" and reprinted in appendix III.
LACK OF DETAILED ACCOUNTING
INFORMATION AND DOCUMENTARY
SUPPORT IMPAIRS IRS' ABILITY TO
MANAGE UNPAID ASSESSMENTS
------------------------------------------------------------ Letter :4
IRS' general ledger--the primary structure of the accounting
system--cannot separate categories of unpaid assessments to determine
the portion that represents taxes receivable. The general ledger
also does not have a detailed listing, or subsidiary ledger, which
tracks and accumulates unpaid assessments on an ongoing basis and
provides support for the general ledger. Because it cannot readily
determine the amount of taxes receivable, IRS also cannot routinely
analyze its taxes receivable to determine the portion that is
estimated to be collectible. Such weaknesses in IRS' management of
its unpaid assessments resulted in IRS pursuing collection from
taxpayers even after amounts owed had been paid. In addition, IRS
continues to experience problems locating and providing supporting
documentation for unpaid assessments, primarily due to the age of the
items. Without either a general or subsidiary ledger that can
accurately categorize, track and accumulate unpaid assessments or
adequate documentation to support these amounts, IRS' ability to
effectively manage its unpaid assessments is significantly impaired.
IRS' GENERAL LEDGER SYSTEM
CANNOT SEPARATE CATEGORIES
OF UNPAID ASSESSMENTS
---------------------------------------------------------- Letter :4.1
Unpaid assessments consist of taxes that IRS has recorded as due to
the government from taxpayers for which payment has not yet been
received. Based on federal accounting standards,\9 unpaid
assessments are placed in one of the following three categories:
-- taxes receivable, which are amounts due from taxpayers for which
IRS can support the existence of a receivable through taxpayer
agreement (such as the filing of a tax return) or a court ruling
favorable to IRS;
-- compliance assessments, for which neither the taxpayer nor the
court has affirmed that the amounts are owed, such as an
assessment resulting from an audit of the taxpayer; and
-- write-offs, which are any unpaid assessments for which IRS does
not expect further collections due to factors such as the
taxpayer's bankruptcy, insolvency, or death.
Of these three, only taxes receivable are reportable in the principal
financial statements, with compliance assessments and write-offs
presented as supplemental information to the financial statements.
GAO's Standards for Internal Controls in the Federal Government
requires that transactions and other significant events be promptly
recorded and properly classified to maintain their relevance and
value to management in controlling operations and making
decisions.\10 Transactions and events are to be properly classified
in the summary records from which reports and financial statements
are prepared. Therefore, it is essential for IRS' records to
classify its unpaid assessments into these three categories in order
to present reliable information in its financial statements and to
enable management to make informed business decisions based on this
complete and reliable information.
However, IRS' general ledger system cannot distinguish those unpaid
assessment amounts which represent taxes receivable from those which
represent either compliance assessments or write-offs. To
compensate, IRS has to utilize specialized computer programs to
extract the universe of unpaid assessments from its master files--its
only detailed database of taxpayer information--and classify these
into the three categories that make up total unpaid assessments. IRS
then analyzes those unpaid assessments classified as taxes receivable
to estimate the amount deemed to be collectible (the net taxes
receivable). However, this approach has flaws. For example, the
amounts produced by this approach for the fiscal year 1997 financial
statements still required material adjustments totaling tens of
billions of dollars. As figure 1 shows, total unpaid assessments
extracted from the fiscal year 1997 master files required material
reductions in the amounts of taxes receivable and compliance
assessments, and material increases in write-offs, in order to arrive
at reliable amounts.
Figure 1: Comparison of Unpaid
Assessments Before and After
Audit Adjustments at September
30, 1997
(See figure in printed
edition.)
Note: The adjusted balance of taxes receivable presented above
represents the gross taxes receivable (i.e., does not include the
allowance for doubtful accounts). Additionally, the original unpaid
assessment balance of $236 billion was adjusted to $214 billion, due
primarily to duplicate assessments.
Source: IRS masterfiles and IRS fiscal year 1997 custodial financial
statements.
The most significant adjustments related to amounts originally
identified as taxes receivable or compliance assessments but which
were really write-offs. In fact, 149 of the 626 cases we
sampled--about 24 percent--that were initially identified as taxes
receivable in the master files were actually write-offs and consisted
primarily of corporate income and payroll taxes\11 owed by
corporations that had been defunct for years. Similarly, 23 percent
of the compliance assessments we sampled were also write-offs.
These adjustments were necessary due to limitations in the initial
criteria IRS used in its master file extraction programs to account
for federal payroll taxes owed by bankrupt and defunct businesses.
For example, IRS' criteria for identifying write-offs did not include
bankrupt taxpayers that owed federal payroll taxes. In many cases we
reviewed, the taxpayer was deceased, bankrupt, a defunct business, or
incarcerated, yet the items were still identified as taxes receivable
or compliance assessments. In these cases, we determined that the
items should be classified as write-offs and IRS subsequently agreed.
Had IRS expanded its master file extraction criteria for identifying
write-offs to include such characteristics as bankrupt employers
owing payroll taxes, it may not have had to make material adjustments
to the balances extracted.
The process of extracting the information from the master files is
labor intensive and time-consuming and thus, vulnerable to error.
The computer programs used to extract information from the master
files and classify unpaid assessments are critical because they
provide the only feasible means for determining the portion of unpaid
assessments that belong in each of the three categories and thus, the
portion that should be reported in IRS' financial statements.
However, the extensive reliance IRS must place on ad hoc procedures
to identify its taxes receivable and the significant adjustments
necessary to make these data reliable raise serious questions about
the integrity of unaudited IRS information and the ability of IRS to
effectively manage its unpaid assessments.
Historically the full amount of unpaid assessments has been
considered receivables. Therefore, it is significant to note that
after several years of audit scrutiny, IRS has finally been able to
determine that only $28 billion of its $214 billion in total unpaid
assessments--about 13 percent--actually represent collectible taxes
receivable. Thus, while the Congress and IRS may have been making
management and budgeting decisions based on a presumed level of taxes
receivable, in fact only a small portion of that balance represented
receivables for which collection could reasonably be expected. While
such information is necessary for IRS to prepare reliable financial
statements, on a broader level, good reliable financial data are
essential for management to accurately measure and report on IRS'
performance and for the Congress to make its budget decisions.
--------------------
\9 Statement of Federal Financial Accounting Standards No. 7,
Accounting for Revenue and Other Financing Sources and Concepts for
Reconciling Budgetary and Financial Accounting, May 10, 1996.
\10 GAO's Standards for Internal Control in the Federal Government,
issued in 1983, contains the internal control standards to be
followed by executive agencies in establishing and maintaining
systems of internal control as required by the Federal Managers'
Financial Integrity Act of 1982.
\11 Payroll tax withholdings are comprised of individual income tax
withholdings and employer and employee withholdings for Federal
Insurance Contribution Act (FICA), which include Social Security and
Hospital Insurance taxes.
IRS DOES NOT HAVE A
SUBSIDIARY LEDGER TO
ROUTINELY TRACK AND MONITOR
UNPAID ASSESSMENT ACTIVITIES
---------------------------------------------------------- Letter :4.2
IRS also lacks a subsidiary ledger to track and accumulate unpaid
assessments on an ongoing basis. Such a subsidiary ledger could have
compensated for the general ledger's inability to separate unpaid
assessments, and would improve IRS' ability to manage its unpaid
assessments. According to Federal Financial Management Systems
Requirements,\12 an agency's core financial system should be
supported by a general ledger account structure that complies with
the U.S. Government Standard General Ledger.\13 To support the
account balances in these Standard General Ledger accounts, the
general ledger should be supported by either detailed subsidiary
accounts or additional data elements. Specifically, IRS' subsidiary
ledger system should be able to routinely provide information useful
for managing unpaid assessments and assessing collectibility, such as
a history of payments and defaults, payment terms, and account
status. As we have previously reported, IRS' general ledger
structure does not include the required subsidiary support. As a
result, IRS cannot (1) ensure that all parties liable for certain
assessments get credit for payments made on those assessments and (2)
assess the effectiveness of its collection activities.
For example, when a company does not pay IRS the taxes that it has
withheld from employee's wages, such as Social Security or individual
income tax withholdings, IRS has the authority to assess the
responsible officers individually for the amount withheld from
employees. Thus, IRS may record assessments against several
individuals each for the employee withholding component of the
payroll tax liability in an effort to collect the total tax liability
of the business. While these assessments--known as "trust fund
recovery penalties"--are a necessary enforcement tool, IRS' current
systems cannot automatically link each of the multiple assessments
made related to one tax liability. This is due to the fact that the
corporation's tax liability is maintained in IRS' business master
files, while the trust fund recovery penalties assessed against the
corporation's officers are maintained in the individual master files.
These are two separate databases, each of which is independent of the
other, and they are not integrated.
As a result, we found instances where all parties liable for one
assessment were not given credit for payments received from other
liable parties. In fact, in 53 of 83 trust fund recovery penalty
cases reviewed involving multiple assessments for unpaid payroll tax
withholdings, we found that payments were not accurately recorded to
reflect each responsible party's tax liability reduction. In one
case, two of three officers were due a refund for at least a portion
of the $1.5 million in trust fund recovery penalties they paid,
because the bankrupt corporation subsequently settled its payroll tax
liabilities. More than 2 years after the corporation paid, IRS
records still show multimillion dollar balances on these three
officers' accounts and liens on their personal property, despite the
fact that it appears these accounts should be reduced to zero. In
cases such as this, incorrect accounting creates unnecessary effort,
or burden, by taxpayers to demonstrate that they are no longer liable
for the debt and to get the liens on their personal property removed.
If IRS had a detailed subsidiary ledger to properly manage its unpaid
assessments, payments like these could be matched against the tax
liability of all affected accounts and thus prevent IRS from pursuing
collections on tax liabilities that no longer exist.
In addition to ensuring that individual tax liabilities are
appropriately reduced, a proper subsidiary ledger for unpaid
assessments would also give management complete, up-to-date
information about the amounts due from each taxpayer, so that
managers will be in a position to make informed decisions about
collection efforts and collectibility estimates. Without readily
available information at the detailed subsidiary level, IRS cannot
routinely assess the effectiveness of current collection practices
and refine its collection strategies to maximize collections. By
developing a subsidiary ledger system which makes readily available
to management information such as the amount, nature, and age of all
unpaid assessments outstanding by tax liability and taxpayer, IRS
could improve the efficiency and effectiveness of its collection
activity by targeting taxpayer accounts with the greatest chance of
collection, and lessen the risk of pursuing erroneous collections due
to reliance on faulty information regarding the taxpayer's status.
It should be noted that, despite the fact that certain taxpayer
accounts have little likelihood of collection, IRS would generally
continue some efforts to collect, to reinforce continued compliance
by those taxpayers who appropriately report and pay their tax
obligations and to increase compliance by taxpayers who are not
compliant with respect to reporting and paying their tax obligations.
IRS is developing a "Modernization Blueprint" to outline its
long-term plan and process for upgrading and integrating its computer
systems over several years.\14
Part of the plan is to implement an accounting system that will
ultimately meet federal financial management system requirements and
accounting standards. To meet this goal, IRS has developed a
six-phase plan to move from its current systems to a target systems
environment. The first phase of this transition, Phase 0 (phase
zero), is intended to enhance its existing systems. However, Phase 0
does not include a subsidiary ledger for unpaid assessments and will
not identify and track duplicate assessments associated with trust
fund recovery penalties. Although IRS officials stated the new
target system will have capabilities similar to those of a subsidiary
ledger to track these assessments, the details on how that capability
will be provided and what information it will contain have not yet
been developed. In addition, its target system overall is a
long-term solution which likely will not be fully implemented for
over a decade.\15
--------------------
\12 These requirements are detailed in the Financial Management
Systems Requirements series issued by the Joint Financial Management
Improvement Program, OMB circular A-127, Financial Management
Systems, and OMB's September 9, 1997 guidance for the implementation
of FFMIA.
\13 The U.S. Government Standard General Ledger establishes a
standard chart of accounts, including account titles, definitions,
and uses. The primary purpose is to standardize federal agency
accounting, to support the external reports and financial statements
required by OMB and Treasury, and to provide comparable information
among agencies.
\14 Tax Systems Modernization: Blueprint is a Good Start But Not Yet
Sufficiently Complete to Build or Acquire Systems
(GAO/AIMD/GGD-98-54, February 24, 1998).
\15 IRS' modernization blueprint is not yet complete and thus, the
actual time it will take to fully implement its target system is
unknown. Although IRS is planning to implement its new system in six
phases, each phase is composed of up to five system releases. As the
primary financial management features--such as the integrated
tracking of financial data--are not planned for implementation until
the fifth phase, it will likely take at least a decade for these
needed system improvements to be made.
DOCUMENTATION FOR UNPAID
ASSESSMENTS REMAIN
INADEQUATE
---------------------------------------------------------- Letter :4.3
IRS continues to experience problems locating supporting
documentation for its unpaid assessments, primarily due to the age of
the items. Some of the supporting documentation for transactions we
reviewed, such as tax returns, offers-in-compromise, financial
statements, installment agreements, or past collection history, could
not be located, had been destroyed in accordance with IRS record
retention and destruction policy, or may not have been obtained. For
example, estate case files we reviewed generally did not include
audited financial statements or an independent appraisal of the
estate's assets--information that would greatly assist in determining
the potential collectibility and potential underreporting of these
cases.
GAO's Standards for Internal Controls in the Federal Government
requires that all transactions and other significant events be
clearly documented, and the documentation be readily available for
examination. This documentation should be complete and accurate and
should facilitate tracing the transaction or event and related
information from the time it occurs, while it is in process, to after
it is completed. Lacking such documentation, IRS cannot clearly
support or trace the transactions and events pertinent to specific
unpaid assessments, making it difficult for IRS and its auditors to
routinely assess the classification and collectibility of its unpaid
assessments.
The lack of adequate documentation to support the underlying
assessments could also affect IRS' ability to effectively pursue
collection from taxpayers for amounts owed. For example, IRS must
maintain on its books most types of unpaid assessments for at least
10 years, and collection can be pursued at any time throughout that
period. Therefore, it is important that IRS prepare and maintain an
adequate standardized taxpayer file similar to a bank loan file for
each receivable and compliance assessment\16 in order to ensure that
IRS collections staff have consistent background information
concerning past collection activities from which to assess
collectibility and pursue collection. This is particularly important
when staff turnover occurs, such as that of the revenue officers who
are responsible for pursuing collection and who are thus familiar
with the cases. Well-organized, complete files will minimize the
negative impact of revenue officer turnover.
When IRS conducts an income tax audit, or examination, of a taxpayer,
IRS examiners are required to meet minimum workpaper standards to
assure there is documentary support for the examiner's report and
conclusions. IRS' audit workpaper standard requires fully disclosing
the audit trail; assuring workpapers are clear, concise, legible and
organized; and adequately documenting the audit activity records
summarizing the auditor's contacts with the taxpayers and/or their
representatives. However, we saw no evidence during our audit that
IRS has similar documentation standards for its collection cases.
This is inconsistent, because IRS needs adequate documentation to
properly pursue collection of taxes receivable and compliance
assessments as much as it needs adequate documentation to determine
and support its conclusions on amounts that may become receivables.
Many of the collection files we reviewed (1) did not contain a clear
audit trail of documents that provide useful information about
collection prospects (such as appraisals, asset searches, etc.),
contacts made, and conclusions reached regarding the collectibility
of the case, (2) were not well-organized, and (3) did not contain
adequate or consistent documentation for review.
Because IRS' current financial systems do not adequately track and
classify unpaid assessments, maintaining complete and consistent
documentation related to taxes receivable is vital. Without it, IRS
will continue to experience problems determining the proper
classification and collectibility of its taxes receivable and
pursuing collection over time.
--------------------
\16 In the case of write-offs, IRS has already determined that there
is no future collection potential. Therefore, IRS does not continue
to gather documentation once that determination has been made.
IRS HAS NOT EFFECTIVELY
ADDRESSED UNPAID ASSESSMENT
PROBLEMS PREVIOUSLY
IDENTIFIED
---------------------------------------------------------- Letter :4.4
As just described, despite IRS' ability to produce reliable
information in its fiscal year 1997 financial statements, serious
internal control weaknesses over its unpaid assessments continue to
exist. We previously identified problems in IRS' ability to identify
and classify its unpaid assessments in prior audits, and recommended
that IRS act to ensure the accuracy of the net receivables balance
reported in its financial statements.\17 In the long-term, this would
require IRS to modify its financial systems so that they are capable
of (1) identifying which unpaid assessments represent taxes
receivables and (2) designating new assessments that should be
included in the receivables balance as they are recorded. Until
these capabilities were implemented, we recommended that IRS rely on
statistical sampling to determine what portion of its assessments
represent taxes receivables.
In response to our recommendations, IRS developed computer programs
to identify and extract unpaid assessments from its master files and
to classify these accounts by taxes receivable, compliance
assessments, and write-offs. However, even these extractions
required tens of billions of dollars in adjustments. IRS then used
statistical sampling to determine the portion of receivables that
were estimated to be collectible. Although IRS was able to make some
short-term fixes that enabled it to present reliable information
regarding taxes receivable on its fiscal year 1997 financial
statements, it still must address its longer-term financial
management needs through its systems modernization plan. Significant
financial management system changes are needed to ensure that IRS can
routinely identify, monitor, and report on both taxes receivable and
other unpaid assessments and effectively manage amounts owed by
taxpayers. This is particularly important since we found instances
in which IRS' financial system problems caused it to inappropriately
pursue collection from taxpayers even after the corresponding tax
liability had been paid.
--------------------
\17 See appendix II, recommendation 1.
RECOMMENDATIONS
---------------------------------------------------------- Letter :4.5
While certain systems improvements are needed to improve IRS' basic
accounting and tracking of its unpaid assessments, such changes may
take over a decade to implement. In the meantime, other short-term
actions are needed to begin making more immediate improvements to
IRS' management and reporting of its unpaid assessments.
SHORT-TERM
RECOMMENDATIONS
-------------------------------------------------------- Letter :4.5.1
To improve the accuracy of the information on unpaid assessments
contained in the master files, we recommend IRS manually review and
eliminate duplicate or other assessments that have already been paid.
This would ensure that all accounts related to a single assessment
are appropriately credited for payments received.
To better ensure that IRS can prepare timely, reliable financial
statements, we recommend that IRS improve the accuracy of its master
file extraction programs used to classify unpaid assessments so that
once the extractions are made, any subsequent adjustments needed
would not be material. At a minimum, IRS should consider the nature
of the adjustments made to the fiscal year 1997 amounts extracted and
adjust the extraction programs in future years accordingly.
To address its longstanding deficiencies with respect to documentary
support for its unpaid assessments, we recommend that IRS establish
minimum documentation standards or checklists for its collection
files. These standards or checklists should include minimum
documentation and file organization requirements for all receivable
and compliance assessment cases, specifying the types of
documentation required, standard file organization, and the retention
period that will ensure such documents are maintained until the
statute of limitations for collection has expired.
LONG-TERM RECOMMENDATIONS
-------------------------------------------------------- Letter :4.5.2
To address the system deficiencies affecting IRS' ability to
effectively manage and report on its unpaid assessments, we recommend
that the IRS Commissioner ensure that IRS' modernization blueprint
include plans to develop a subsidiary ledger to accurately and timely
identify, classify, track, and report all IRS unpaid assessments by
amount and taxpayer. This subsidiary ledger must also have the
capability to distinguish unpaid assessments by category in order to
identify those assessments that represent taxes receivable versus
compliance assessments and write-offs. In cases involving trust fund
recovery penalties, the subsidiary ledger should ensure that (1) the
trust fund recovery penalty assessment is appropriately tracked for
all taxpayers liable, but counted only once for reporting purposes,
and (2) all payments made are properly credited to the accounts of
all individuals assessed for the liability.
VULNERABILITIES IN CASH RECEIPT
CONTROLS EXPOSE IRS AND
TAXPAYERS TO POTENTIAL LOSSES
------------------------------------------------------------ Letter :5
During our fiscal year 1997 audit, we identified weaknesses in
controls over cash and checks received directly from taxpayers at IRS
service centers. Specifically, we found (1) insufficient deterrent
controls at service centers, (2) mail containing receipts being sent
unopened to units outside of the Receipt and Control Branch, and (3)
inappropriate receipt of payments in a service center lobby area.
These control weaknesses over receipts expose both government and
taxpayer funds to risk of loss, and can lead to increased taxpayer
burden. GAO's Standards for Internal Controls in the Federal
Government\18 require that access to resources be limited to
authorized individuals, and accountability for the custody of
resources be assigned and maintained to help reduce the risk of
unauthorized use or loss to the government. We recognize that
because of the volume of cash and checks received at service centers,
vulnerability to embezzlement and loss is inevitable. However, there
are a number of steps IRS can take to improve controls and better
ensure that receipts are properly credited to taxpayer accounts and
deposited to Treasury's general revenue fund.\19
--------------------
\18 See footnote 10.
\19 Payments made via the Federal Tax Deposit system, the Electronic
Federal Tax Payment System, or to a lockbox bank are not received at
service centers but instead are deposited directly to a federal
reserve bank for credit to the Treasury general revenue fund.
INSUFFICIENT DETERRENT
CONTROLS AT SERVICE CENTERS
---------------------------------------------------------- Letter :5.1
The Receipt and Control Branch at each IRS service center is
responsible for the receipt and up front processing of mail
containing tax returns and receipts (cash or checks) delivered to the
service centers.\20 It is located in a controlled and restricted area
with access limited to authorized personnel. However, during our
review of controls in the Receipt and Control Branch at 4 of IRS' 10
service centers, we found several vulnerabilities and control
weaknesses that expose IRS and taxpayers to potential losses.
One key vulnerability exists because mail sent directly from
taxpayers to IRS service centers was not logged or otherwise recorded
by mail room personnel at the point of receipt or by the mail
extraction unit during mail extraction.\21 In fact, receipts were not
counted nor dollar amounts verified until they reached the Remittance
Processing Unit\22 within the Receipt and Control Branch, which can
be the third or fourth stop in the process. Once at the Remittance
Processing Unit, the systems that process receipts assign each check
a document locator number\23 which can be used for tracking that
receipt. Before reaching this unit, however, receipts are handled by
several units, as illustrated in figure 2.
Figure 2: Initial Handling of
Service Center Mail
(See figure in printed
edition.)
Note: At different service
centers, the actual names of
the units may vary. Therefore,
the figure reflects the primary
function performed by different
units, which may or may not
correspond to the actual name
of the unit depending on the
service center. In addition,
"Receipt Processing Units"
encompasses both the manual and
automated receipt processing
units.
(See figure in printed
edition.)
While the service centers do not establish immediate accountability
for cash and checks received, such as immediately logging in receipts
and/or assigning a document locator number to each check upon
receipt, we recognize that doing so is not feasible given the service
centers' current systems and processes. For example, the tremendous
volume of receipts the service centers process daily--which can
exceed $400 million a day at a service center during the peak filing
season--makes it impractical to log in every check upon receipt. The
current automated systems for processing receipts cannot assign a
document locator number until the checks have been extracted and
sorted, and the volume of transactions precludes IRS from manually
assigning a document locator number to each receipt. As a result,
until accountability is established, vulnerability to embezzlement is
heightened.
This vulnerability thus underscores the need for effective deterrent
controls to aid in reducing the service centers' exposure to theft.
However, we found that IRS has less stringent deterrent controls for
receipts processed at service centers than it requires of third party
lockbox depositories that process receipts for IRS. For example, to
reduce vulnerabilities over handling cash and checks at lockbox
depositories, IRS requires lockbox depositories to use surveillance
cameras to monitor staff when they open mail containing cash and
checks. Further, lockbox receipt handlers are not permitted to bring
in handbags, briefcases, duffle bags, bulky outerwear, etc., into the
receipt processing areas. However, comparable controls were not
found at the 4 service centers where we reviewed controls over cash
receipts. At these locations, IRS allowed individuals to open and
sort through the mail unobserved by surveillance cameras, and relied
on them to accurately report any cash or checks received. Personal
belongings were also allowed in the receipt processing areas, further
increasing the service centers' vulnerability to theft. In fact, an
IRS internal review\24 noted that 9 of the 80 theft cases IRS
identified from January 1995 through July 1997 involved employees who
put stolen receipts in duffle bags, purses, or lunch boxes.
In addition, we found that personnel in the extraction unit did not
always identify checks that were attached to documents when opening
and sorting the mail. Clerks in the Receipt and Control Branch are
responsible for examining tax returns and other documents received in
the mail for any attached checks to ensure that the checks are
properly and promptly processed and deposited. However, some checks
attached to documents were overlooked by the extraction staff and
inadvertently forwarded to units outside of the Receipt and Control
Branch. In fact, we found that at one service center, 14 checks
totaling about $171,000 were overlooked by the extraction unit in one
day. An IRS study performed at one service center found that over a
4-week period, 330 checks totaling over $864,000 were overlooked.
These overlooked checks increase IRS' exposure to loss or theft,
because accountability for these checks is not established at the
point of receipt and thus, there is no record that the checks were
received by the service center at this point.
As a result, IRS must rely on individuals from these other units to
record the discovery of these receipts and send the checks back to
the Receipt and Control Branch to be deposited. These units
typically have less accountability over receipts than the Receipt and
Control Branch. For example, at one service center, we noted that a
unit outside the Receipt and Control Branch that did not have
restricted access had received mail containing receipts. As a
result, these overlooked receipts are more susceptible to theft.
--------------------
\20 At some service centers, the Remittance Processing Unit--which is
responsible for entering receipt data and endorsing taxpayers'
checks--may not be part of the Receipt and Control Branch
organizationally. However, the unit will still be located in a
restricted access area with other Receipt and Control Branch units.
\21 The mail extraction unit is responsible for removing, or
"extracting," the contents of the mail after it has been opened,
sorting the contents, and routing them to the appropriate units.
\22 IRS uses the terms "remittances" and "receipts" interchangeably
to refer to taxpayers' payments against their tax liabilities. To
the taxpayer, such amounts are remittances (payments), but to IRS
they are receipts.
\23 The document locator number is a 14-digit control number assigned
to every document input through IRS' systems. It is used to control,
identify, and locate documents as they are processed.
\24 Review of Remittance Processing Activities, Reference No.
082503, March 24, 1998, prepared by IRS' Internal Security and
Internal Audit.
MAIL CONTAINING CASH AND
CHECKS SENT UNOPENED TO
UNITS OUTSIDE OF RECEIPT AND
CONTROL
---------------------------------------------------------- Letter :5.2
In some cases, mail that contains receipts is routed to units outside
of the Receipt and Control Branch before being opened. At the
service centers we reviewed, unopened mail was routed to numerous
units outside the Receipt and Control Branch, thus increasing the
vulnerability of taxpayers' checks and cash--which may be contained
in such unopened mail--to loss or theft.
For example, certain units such as the Offer-in-Compromise unit are
authorized to receive unopened mail directly due to the need to
minimize processing time. "Administrative mail," such as mail
addressed to the service center Director's office, is also authorized
to be sent unopened directly to units located outside the Receipt and
Control Branch. However, administrative mail is typically sent to a
post office box that is shared by multiple units. At one service
center, over 100 units were authorized to receive administrative
mail. Consequently, such mail--which may contain taxpayer checks or
cash--may be accessible to units outside the Receipt and Control
Branch. In addition, some units with off-site addresses also receive
unopened mail without the authorization to do so.
Since these outside units are not located within the Receipt and
Control Branch, they have fewer controls in place. For example,
access to these units is not restricted and individuals can easily
remove mail that is sometimes left unattended on desks. Furthermore,
depositing of receipts opened by other units is generally delayed 3
to 5 days, costing the government interest income. An IRS study at
one service center found that over a 4-week period, this time delay
resulted in about $1 million interest lost on deposits.
INAPPROPRIATE RECEIPT OF
PAYMENTS IN LOBBY AREA
---------------------------------------------------------- Letter :5.3
At one service center, we observed that payments of checks and cash
were being accepted in the lobby area by the security guard, who
should not have been authorized to accept receipts. We also observed
the guard did not log in the payments or provide the taxpayers with a
receipt. Consequently, lost or stolen payments would be difficult to
trace. In fact, we observed one instance where a taxpayer complained
to the guard that her account was in default status because a hand
delivered payment given to a security guard was returned to her by
mail with postage due.
As a result of the vulnerabilities and weaknesses discussed above,
IRS and taxpayers are subject to potential losses and additional
taxpayer burden. For example, from 1995 through July 1997, IRS
identified instances of actual or alleged embezzlement of receipts
totaling about $5.3 million. These resulted from various schemes,
such as a check "cloning"\25 scheme where a taxpayer's check for
$590,000 was stolen from a service center and reprinted into several
checks. These cloned checks were made payable in smaller amounts to
avoid raising suspicion. In this case, several of these checks were
cashed before being discovered by the taxpayer and reported to the
IRS. In another scheme, an IRS employee and his co-conspirators
altered a taxpayer check to change the payee from "I.R.S." to "I.R.
Smith" and deposited the altered check into a personal checking
account. Such embezzlement cases result in additional burden to the
taxpayer. For example, taxpayers who identify that a problem exists
may spend time and incur costs to research and report the problem and
to close their bank accounts and open new ones; follow up to ensure
that the problem is resolved; ensure that they receive appropriate
credit for the tax assessments they intended to pay; and ensure that
they receive restitution of stolen funds. These cases underscore the
need for IRS to reduce its vulnerability to employee fraud and
embezzlement in its cash receipts processing activities.
Due to the nature of IRS' receipt processing operations, the volume
of transactions processed, and the number of employees involved,
there is no internal control system, no matter how well designed and
operated, that can completely eliminate the potential for
embezzlement or theft. We also recognize that establishing immediate
accountability for all cash and checks received in the service
centers is not feasible. However, there are a number of steps that
IRS can take immediately to reduce the risk of loss and provide
better safeguarding of assets at its service centers.
--------------------
\25 Once a perpetrator obtains information such as the bank and
account number from a valid check, that information can be used to
"clone" or duplicate the original check into multiple fraudulent
blank checks. These blank checks are then filled out to different
payees, and signed with a forged signature.
SHORT-TERM RECOMMENDATIONS
---------------------------------------------------------- Letter :5.4
To reduce IRS' vulnerabilities in its receipt processing activities,
we recommend that the IRS Commissioner examine and consider options
to increase deterrent controls at service centers. Some options IRS
should examine and consider include
-- installing surveillance cameras to monitor staff when they are
opening, extracting and sorting the mail, and when they are
processing receipts,
-- restricting personal items that can be brought into the receipt
processing areas, such as handbags, briefcases, and bulky
outerwear, and
-- providing lockers and require their use for storing personal
belongings outside of the receipt processing areas.
To limit the number of checks overlooked by the extraction staff and
thus inadvertently routed to units outside of the Receipt and Control
Branch, IRS should provide adequate training and monitoring of
extraction unit staff to ensure staff are informed and properly
trained on the necessary procedures, and that the procedures are
being followed.
To reduce the cash and checks that may be forwarded to units outside
the Receipt and Control Branch, we recommend that IRS limit the units
that may receive unopened mail directly to only those units which
require confidentiality due to the nature of their work, such as the
Inspections unit. At a minimum, mail addressed to off-site locations
should be routed through the service center first to identify mail
that may contain taxpayer receipts.
To further reduce the exposure of taxpayer cash or checks to loss or
theft, we recommend that IRS ensure that security guards and other
unauthorized service center personnel do not receive walk-in payments
from taxpayers.
WEAK CONTROLS OVER REFUNDS
RESULTED IN INAPPROPRIATE
PAYMENTS
------------------------------------------------------------ Letter :6
IRS issues billions of dollars in refunds each year.\26 In fiscal
year 1997 alone, IRS issued $142 billion in refunds. However, IRS
does not have sufficient preventive controls in place to ensure that
inappropriate refunds are not issued. Specifically, IRS does not
have matching procedures to identify inaccurate refund claims when
they are received. As a result, we found that some improper refunds
or refunds issued for incorrect amounts were made during fiscal year
1997. In addition, IRS lacks adequate controls to prevent duplicate
refunds. These control weaknesses over refunds expose the government
to risk of loss. This exposure is further demonstrated by several
instances IRS has identified of alleged employee embezzlement of
refunds.
--------------------
\26 While technically IRS does not actually issue the refunds, it
must authorize Treasury's Financial Management Service to issue a
refund before the funds can be disbursed.
CONTROLS TO IDENTIFY
INAPPROPRIATE REFUND CLAIMS
WERE LACKING
---------------------------------------------------------- Letter :6.1
IRS has insufficient verification procedures in place to identify
inappropriate refund claims when they are received. As a result,
inappropriate refunds were disbursed during fiscal year 1997. For
example, we found that in nine instances out of 220 refund cases we
reviewed, refunds were improperly disbursed or disbursed for improper
amounts. Three of the improper refunds were issued because IRS
procedures did not require comparing the tax returns to the attached
W-2 (Wage and Tax Statement) forms when the returns were initially
processed. Three other improper refunds were issued because the
associated tax returns were filed electronically and thus were not
reviewed by IRS staff because the actual W-2 forms were mailed in
later by the taxpayer. Such comparisons of the W-2 form against the
tax return would have identified the errors we noted in these six
cases. Of the remaining improper refunds we identified, two were
inappropriate because the tax returns did not contain valid social
security numbers. An additional refund was issued for an improper
amount due to an undetected taxpayer math error.
IRS procedures require that IRS staff review the W-2 form and compare
it to the tax return under specific circumstances. For example, the
W-2 should be compared to the return if (1) a W-2 is attached to the
return and the line on which income is to be reported on the tax
return is blank or (2) an Earned Income Credit (EIC) is claimed, in
which case the IRS reviewer is required to search the W-2 for
nontaxable income amounts. In three of the six cases mentioned
above, the nontaxable income amount reported on the W-2 form, such as
voluntary salary deferrals for 401(k) plans, was not included in the
taxpayer's EIC calculation to determine the amount of allowable
credit.\27 Although IRS procedures normally require reviewing the W-2
form for nontaxable income in EIC cases, these particular cases
involved tax returns that had been filed electronically. Because the
taxpayer must mail in the actual W-2 form later for electronically
filed returns, such returns are not subject to this review. As a
result, the refunds disbursed for these cases were greater than they
should have been.
Except as discussed above, IRS procedures generally do not require
that IRS staff compare, at time of processing, the income amounts on
the attached W-2 forms to the amount of income reported on the tax
return. As a result, IRS did not detect that the amount of income on
the W-2 forms did not match the amounts reported on the accompanying
tax returns in the other three of the six cases we identified. Such
inconsistencies generally go undetected until IRS completes its
document matching program, a "post-refund" control, which is
generally not completed until 7 months or more after a return is due.
This program involves matching tax return information with
information provided by third parties--such as W-2 wage data, form
1099\28 income data, and other applicable information--to identify
any unreported income or other inconsistencies for further
investigation. Thus, while an error may be detected several months
later, it may be too late to recover the improper refund.
The inappropriate refunds we identified are indicative of internal
control weaknesses which increase IRS' exposure to refund fraud and
theft. IRS identified 11 cases of employee embezzlement of refunds
that occurred during fiscal years 1995-1997, at both service centers
and district offices. In these cases, employees attempted to provide
false information, such as false returns to the IRS, in order to
fraudulently obtain refunds. In one case an IRS tax examiner who had
access to taxpayer payments and the ability to adjust taxpayer
accounts, refunded taxpayer payments to herself by issuing
approximately 10 manual refund checks totaling over $269,000 in her
maiden name. These cases illustrate IRS' vulnerability with respect
to its refund processing and underscore the need for sound controls
over this process.
--------------------
\27 Although nontaxable income is not included in the calculation of
a taxpayer's gross income, it is required to be included in the EIC
calculation. By not including non-taxable income in the EIC
calculation, the credit is improperly inflated.
\28 Various types of IRS 1099 forms are used to report interest
income, dividend distributions, and other miscellaneous income. Note
that form 1099s are not required to be submitted by the taxpayer at
the time of filing, unlike the W-2s. Consequently, verification of
interest, dividends, and other miscellaneous income cannot be
performed at the time of filing under current processes.
OTHER REFUND ISSUES
IDENTIFIED
---------------------------------------------------------- Letter :6.2
As we have reported in prior years, IRS is vulnerable to the issuance
of duplicate refunds made possible by gaps in IRS' controls.
Specifically, IRS' automated and manual refund systems are not
adequately coordinated to prevent duplicate refunds. IRS reported
this condition as a material weakness in its fiscal year 1997 Federal
Managers' Financial Integrity Act report.\29
Most refunds are authorized automatically when IRS' computing system
identifies a taxpayer payment which exceeds the taxpayer's assessment
or liability. The system then automatically generates a refund for
the overpayment. However, manual refunds may be issued for several
reasons. For example, if a large refund is due, IRS may authorize
issuance of a manual refund in order to ensure that the refund is
made promptly and thus, avoid paying interest to the taxpayer.
However, unless appropriate entries are posted to the taxpayer's
account on the master file to reflect this, the system will not know
a manual refund is already in process and may automatically authorize
a duplicate refund.
IRS has taken actions to correct this weakness which it plans to have
completed by December 1998. These actions include implementing
procedures that require IRS staff to (1) check the master file and
other systems to determine if another refund--manual or
automated--has already been issued before initiating a manual refund
for the same claim and (2), if necessary, take steps to prevent a
duplicate refund from being generated. IRS is developing computer
programs to automatically generate a report showing the transactions
and account status for taxpayers with two or more refunds processed
for the same tax type and period. Staff processing manual refunds
are to review this report to determine if both refunds are proper or
if one is a duplicate. If one of the refunds is a duplicate, IRS
staff are to prevent the duplicate refund payment from being issued.
We plan to continue to monitor IRS' progress in implementing these
actions during our fiscal year 1998 IRS financial audit.
--------------------
\29 The Federal Managers' Financial Integrity Act of 1982 requires
the head of each agency to report annually on whether the agency's
internal accounting and administrative controls comply with
prescribed standards and, if not in compliance, to report on any
material weaknesses identified and the plans and schedule for
correcting such weaknesses.
IRS HAS NOT EFFECTIVELY
ADDRESSED PROBLEMS
CONCERNING INAPPROPRIATE
REFUNDS
---------------------------------------------------------- Letter :6.3
While we recognize that IRS must balance the need to issue refunds
quickly against the time it takes to ensure that the refunds are
proper, additional controls to identify improper refund claims before
they are paid could significantly reduce the amount of inappropriate
refund payments issued. In 1993, GAO recommended that IRS give
priority to earlier matching of income and withholding information on
W-2s submitted by individuals and third parties.\30 If such matching
is performed prior to issuing refunds, fewer inappropriate refund
payments would be made. According to IRS' Action Plan For GAO
Recommendations dated January 15, 1998, IRS implemented changes that
cut in half the time it took for taxpayer notices resulting from the
matching program to be issued, from 14 months to 7 - 8 months after
the return due date. However, this action plan notes that attempting
to further accelerate the matching program under IRS' current
technology would result in errors and produce little, if any, revenue
while increasing costs and taxpayer burden. IRS reported that
performing the matching process more rapidly is not possible until it
completes its systems modernization efforts, which could take over a
decade. Therefore, IRS considers this recommendation closed. IRS
also reported that routine comparisons of tax returns with supporting
documentation, such as W-2s and other information, at the time
returns are initially processed, is not cost effective.
We are not aware of any study IRS has performed to determine the
actual cost effectiveness of such comparisons. Moreover, although
IRS does not plan to perform the matching process more rapidly until
it completes its systems modernization efforts, determining that
improper refunds were sent out 7 or more months after the payment has
been made is likely to result in low collection rates for these
inappropriate payments. After improper refunds have been issued, IRS
is compelled to expend both the time and expense to attempt to
recover them, with dubious prospect of success.
--------------------
\30 See appendix II, recommendation 7.
RECOMMENDATIONS
---------------------------------------------------------- Letter :6.4
Both short-term and long-term changes are needed to improve IRS'
controls over its refund processing.
SHORT-TERM RECOMMENDATION
-------------------------------------------------------- Letter :6.4.1
To address the problem of inappropriate refund payments, we recommend
that the Commissioner conduct a cost-benefit study to evaluate
whether preventive controls, such as manually comparing W-2
information to both paper and electronically filed tax returns at the
time returns are received rather than many months later, would be
cost beneficial. This study should include a complete analysis of
the projected costs and associated benefits of increases to
preventive controls over the issuance of refunds. If such controls
are determined to be beneficial, IRS should implement them to the
extent practical to reduce the amount of inappropriate refund
payments.
LONG-TERM RECOMMENDATION
-------------------------------------------------------- Letter :6.4.2
We recommend that, as part of a longer term solution to preventing
improper refund payments, the Commissioner ensure that IRS' systems
modernization plan includes the capability to compare W-2 and other
third party information to both paper and electronically filed tax
returns as they are processed to prevent improper refunds from being
issued.
IRS IS UNABLE TO DETERMINE
ACTUAL REVENUE COLLECTED FOR
SPECIFIC TRUST FUNDS AND
WITHHELD INDIVIDUAL INCOME
TAXES
------------------------------------------------------------ Letter :7
IRS cannot determine, on a current basis, the specific amount of
revenue it actually collected for the Social Security and Hospital
Insurance\31 trust funds, nor can it accurately report revenue
collected for individual income taxes. One of the reasons for this
weakness is that IRS does not obtain the detailed payment information
necessary to allocate tax payments among the proper trust funds and
individual income tax categories until the taxpayers file their
returns, which can be received as late as 9 months after the payments
are submitted. As a result, IRS had to combine Federal Insurance
Contributions Act (FICA)\32 and individual income tax collections on
its Statement of Custodial Activity for fiscal year 1997. In
addition, until recently, IRS certified amounts to be distributed to
selected excise tax-related trust funds based on taxes assessed, as
reflected on the relevant tax forms, rather than actual collections.
As a result, in fiscal year 1997 IRS' certification process did not
comply with specific provisions of the Internal Revenue Code.
--------------------
\31 The Hospital Insurance Trust Fund and the Supplemental Medical
Insurance Trust Fund comprise the accumulated funds of the Medicare
program. Of these two trust funds, only the Hospital Insurance Trust
Fund receives distributions from the Treasury's general revenue fund.
\32 FICA taxes include both employer and employee contributions.
Based on information certified by IRS and the Social Security
Administration, Treasury distributes FICA tax revenue--also referred
to as social security taxes--to three specific trust funds
established to finance the federal government's principal Social
Security programs: the Federal Old Age and Survivors Insurance Trust
Fund; the Federal Disability Insurance Trust Fund; and the Federal
Hospital Insurance Trust Fund.
TAX DEPOSIT SYSTEM DOES NOT
OBTAIN NEEDED INFORMATION
---------------------------------------------------------- Letter :7.1
IRS is unable to specifically identify revenue actually collected for
certain trust funds and for individuals at the time of collection in
part because the current Federal Tax Deposit (FTD) system, the
primary method of obtaining payment data from taxpayers, does not
acquire the necessary detail from taxpayers to enable payments to be
recorded by these categories. The recently implemented Electronic
Federal Tax Payment System (EFTPS), which allows taxpayers to make
their federal tax deposits electronically, can capture the detailed
payment data necessary to record collections by trust fund. However,
IRS does not require taxpayers to provide the detailed data and,
thus, does not use this capability for revenue accounting purposes.
In addition, IRS' custodial general ledger system is not programmed
to capture this level of detail to effectively use it.
Taxpayers make FTD payments using either paper FTD coupons\33 or by
making electronic payments through EFTPS. The FTD coupon system
requires taxpayers to identify the deposit by selecting one of 11
categories, which IRS' revenue accounting system then records into
one of six tax classes. However, several of the coupon categories
combine payments intended for more than one specific tax type, and
detailed information for the specific subcategories is not requested
at time of collection. For example, the "941" FTD coupon category
combines FICA tax payments and federal income taxes withheld from
employees into one aggregate figure. This is because the
corresponding tax return, Form 941 - Employer's Quarterly Federal Tax
Return, is filed by employers to report all employee taxes withheld,
whether for FICA or for employee federal income taxes. Similarly,
the "720" coupon category is used to combine payments for about 50
different excise taxes, reported by taxpayers filing Form 720 -
Quarterly Federal Excise Tax Return. As a result, the FTD coupon
does not provide, at time of collection, actual amounts of revenue
collected for various specific categories such as Social Security and
Hospital Insurance. Figure 3 is an example of an FTD coupon.
Figure 3: Sample FTD Coupon
(See figure in printed
edition.)
Although the majority of fiscal year 1997 FTD payments were made
using the paper coupon method, EFTPS represents a growing tax payment
method. Legislation requires phasing in EFTPS participation by
taxpayers. To meet the phase-in requirements, all taxpayers who had
employment tax obligations of over $50,000 in 1995 were originally
required to begin making federal tax deposit payments electronically
in January 1997, later extended to January 1998.\34 Unlike the paper
FTD coupon, EFTPS is capable of capturing the detailed information
necessary to enable IRS to determine actual trust fund collections
more promptly. For example, EFTPS provides the taxpayer with the
ability to directly enter specific payment amounts associated with
each of the approximately 50 specific excise taxes. Similarly, EFTPS
allows employers submitting FICA tax payments to indicate the
specific amounts designated for the Social Security and Medicare
trust funds as well as federal income tax withheld for employees.
The banks which process EFTPS payments on behalf of the Treasury
prepare daily and quarterly report files that summarize payments
received by these subcategories, which are available to IRS on-line.
Despite EFTPS' ability to capture and summarize more specific trust
fund-related accounting data, IRS does not require taxpayers to
provide the detailed subcategories of aggregate tax payments.
Instead, IRS only requests that taxpayers voluntarily provide
detailed payment information. However, due to technological
constraints, IRS' revenue accounting system is currently unable to
post even the voluntarily supplied trust fund-related payment data.
Specifically, the system is programmed to account for transactions by
aggregate tax class which, as already discussed, combines several tax
types (e.g. trust fund categories) into one category. Although the
tax returns do contain the details of amounts owed by subcategory,
the returns are not required to be filed until as late as 9 months
after the quarterly tax deposits are made.
In its initial response to our fiscal year 1997 custodial financial
statement audit report, IRS asserted that legislation would have to
be changed in order to require taxpayers to provide payment breakdown
information by trust fund in order to allocate tax receipts at the
time of receipt.\35 IRS also asserted that this is a taxpayer burden
issue, in that requiring the additional detail could impose an undue
reporting burden on taxpayers. We disagreed that IRS was legally
precluded from requiring taxpayers to provide such detailed payment
information. We also questioned whether providing such detailed
payment information would be a burden, as presumably taxpayers must
determine the payment amount for each of the subcategories (e.g.,
Social Security, Hospital Insurance, and specific excise taxes) in
deriving their total tax payment.
Subsequently, in response to our report, IRS initiated a study to
examine whether it should require taxpayers to provide the additional
detailed information necessary when the taxpayers remit payment to
IRS. The study's scope includes identifying the government entities
that need detailed tax type information at time of collection, the
volume of taxpayers that currently provide the detailed information
through EFTPS, and the efforts that might be needed to encourage
taxpayers to provide such detail. According to the proposal, once
the study is concluded, a decision can then be made on whether a
change in IRS' procedures is warranted. We will continue to work
with IRS to monitor the status and outcome of this study as it
progresses.
Unless IRS' collection systems are improved to enable it to capture
collection data by specific tax type and properly account for it,
such as capturing details on the amounts collected and to be credited
to specific recipient trust funds, IRS will not be able to provide
complete and timely data on collections by tax type. OMB's
requirements for the form and content of the governmentwide
consolidated financial statements\36 currently require separate
reporting of Social Security, Hospital Insurance, and individual
income taxes collected. Since FICA and individual income taxes are
the largest sources of income to the federal government, IRS'
inability to separately identify tax revenue collected by these
categories in fiscal year 1997 resulted in 83 percent of total
revenues being reflected in one category on the financial statements,
while the remaining six revenue categories reflected only 17 percent
of tax revenues. Given IRS' current systems and the manner in which
tax payment information is currently submitted to IRS, the agency
will not be able to comply with OMB's reporting requirements. OMB
has begun discussions with the Federal Accounting Standards Advisory
Board and with IRS to allow aggregate reporting of Social Security,
Hospital Insurance, and individual income taxes collected. We will
continue to monitor these discussions to determine what effect the
outcome may have on our fiscal year 1998 and future years' audits.
--------------------
\33 In some cases, FTD coupon information may be submitted on
magnetic tape, rather than on paper coupons.
\34 If a taxpayer's employment or other tax deposits during 1997
exceeded $50,000, the taxpayer is required to begin depositing
electronically for tax return periods beginning on or after January
1, 1999. However, no penalties for failure to deposit electronically
have yet been imposed on such taxpayers, and IRS currently will not
impose such penalties before January 1, 1999. IRS and the Treasury
Department have concluded at this time that the statutory requirement
for 1999 and subsequent years will be satisfied without the need to
reduce the mandatory threshold below $50,000.
\35 See Financial Audit: Examination of IRS' Fiscal Year 1997
Custodial Financial Statements (GAO/AIMD-98-77, February 26, 1998).
\36 Form and Content of the Financial Statements of the U.S.
Government (September 2, 1997).
IRS' CERTIFICATION OF EXCISE
TAXES DID NOT COMPLY WITH
LEGAL REQUIREMENTS
---------------------------------------------------------- Letter :7.2
Until recently, IRS certified excise taxes for distribution to trust
funds based on assessed amounts reflected on tax returns rather than
actual collections. This method of distribution did not comply with
the Internal Revenue Code, which requires IRS to certify the
distribution of excise taxes based on actual collections. As
discussed above, IRS does not obtain the details necessary at the
time of collection to be able to do this. IRS recently developed a
methodology to certify actual collections quarterly. IRS officials
said they implemented this in June 1998.
All excise tax receipts are classified in one summary category at
time of collection, regardless of which or how many of the
approximately 50 specific excise taxes the payment may relate.
Treasury's Financial Management Service (FMS) distributes monies to
the various excise tax-related trust funds, based on estimates
calculated by the Office of Tax Analysis. Until recently, for each
quarter IRS certified the final amounts to be distributed to each
individual trust fund based on assessments determined from filed tax
returns. Due to the time that it takes IRS to receive, process,
summarize and review the tax returns, the agency does not certify the
amounts designated for specific trust funds until about 6 months
after the end of a quarter. Once IRS certifies the actual amount to
be distributed, FMS must then reconcile the difference between the
Office of Tax Analysis estimates and the IRS certified amounts, and
make any needed adjustments to the amounts already distributed. In
contrast, if the detailed data were provided at time of collection,
IRS would have the information available to readily calculate and
certify the amounts to be distributed to the trust funds based on
actual amounts collected, thus eliminating the need for Office of Tax
Analysis estimates for the initial distribution and the subsequent
FMS reconciliations and adjustments.
We also found several deficiencies in IRS' process of certifying
excise tax distributions to the appropriate trust funds. These
deficiencies in controls over the certification process, which we
will detail in a separate report on excise taxes, relate primarily to
the lack of fundamental verification and review procedures which, in
fiscal year 1997, resulted in errors made in the distributions. As a
result of these weaknesses, trust funds may not have received the
proper amount of excise tax revenue during fiscal year 1997.
PAST ACTIONS BY IRS NOT
SUFFICIENT TO RESOLVE
PROBLEMS
---------------------------------------------------------- Letter :7.3
We first reported that IRS' systems do not maintain, and thus cannot
report, the amounts of specific excise and social security taxes
collected in our audit of IRS' fiscal year 1992 financial
statements.\37 We also reported this condition in 1993\38
and recommended that IRS develop a means of capturing information on
the specific taxes collected for trust funds so that the amounts
collected by trust fund are readily determinable and excise tax
receipts can be distributed as required by law.\39 IRS officials
stated that the EFTPS system currently has the capability of
capturing the detailed information needed at time of collection but,
as discussed above, IRS does not obtain the necessary information
from the taxpayers at the time of collection.
In this regard, IRS recently developed a method to allocate total
excise tax collections to specific excise tax-related trust funds
based on the related taxpayer returns, consistent with a previous GAO
recommendation. Rather than certifying total assessments for
distribution as it did in fiscal year 1997, IRS would certify total
collections for distribution, but use the assessment data to
determine the proportion of collections that should be allocated to
each trust fund. IRS officials indicated they used this method
beginning in June 1998 with the certification of distributions for
the first quarter of fiscal year 1998.\40 We will review their
methodology and its implementation during our fiscal year 1998 audit.
--------------------
\37 Financial Audit: Examination of IRS' Fiscal Year 1992 Financial
Statements (GAO/AIMD-93-2, June 30, 1993).
\38 Financial Management: Important IRS Revenue Information is
Unavailable or Unreliable (GAO/AIMD-94-22, December 21, 1993).
\39 See appendix II, recommendation 3.
\40 Although IRS certifies excise taxes for distribution quarterly,
the amounts certified each quarter are for tax collections from two
prior quarters because of the time it takes for the tax returns to be
processed and the information to be posted to the master files.
IRS' GENERAL LEDGER SYSTEM
CANNOT ROUTINELY GENERATE
RELIABLE AND TIMELY FINANCIAL
INFORMATION
------------------------------------------------------------ Letter :8
IRS' general ledger system was not designed to readily support the
preparation of financial statements. As a result, IRS' general
ledger system is not able to routinely generate reliable and timely
financial information for internal and external users. Specifically,
the general ledger does not
-- capture or properly identify tax receivables reported in the
Statement of Custodial Assets and Liabilities, and
-- classify revenue receipts activity by type of tax at the detail
transaction level to support IRS' Statement of Custodial
Activity and to facilitate the accurate distribution of excise
tax collections to the appropriate trust funds in accordance
with the Internal Revenue Code.
As a result of these weaknesses, IRS' general ledger does not comply
with federal financial management system requirements established to
enable the general ledger to provide a complete audit trail for
recorded transactions and to produce the basic documents needed for
the preparation of financial statements in the required formats.
These problems also prevent IRS from producing financial statements
on a monthly or quarterly basis as a management tool, which is
standard practice in private industry and in some federal entities.
As a result, IRS' systems do not substantially comply with the
Federal Financial Management Improvement Act of 1996, which requires
agency financial management systems to comply with Federal Financial
Management Systems Requirements, applicable federal accounting
standards, and the U.S. Government Standard General Ledger at the
transaction level.
GENERAL LEDGER CANNOT
PRODUCE INFORMATION TO
PREPARE FINANCIAL STATEMENTS
---------------------------------------------------------- Letter :8.1
Due to the general ledger system weaknesses, IRS cannot properly
report the correct amount of taxes receivable and revenue receipts at
the detail transaction level--the two most significant components of
the financial statements--and therefore prepare its financial
statements without bypassing the general ledger and relying on
alternative sources, extensive manual intervention and audit
adjustments. As we noted earlier in our discussion of unpaid
assessments, IRS' general ledger cannot capture or properly identify
taxes receivable reported in the Statement of Custodial Assets and
Liabilities. In addition, as noted in our discussion of revenue
accounting, IRS' general ledger system cannot sufficiently identify
tax revenues collected by specific type of tax. While IRS is making
some improvements to its general ledger system to better identify
revenue receipts by type of tax, it is still unable to identify the
specific amounts collected for FICA and individual income taxes.
Furthermore, refund activity is still only provided in the aggregate
in the general ledger system. As a result, IRS had to extract
detailed taxpayer information from its master files to derive the
refund amounts by tax type presented in supplemental information to
the financial statements. Beginning in fiscal year 1998, federal
accounting standards\41 require IRS to disclose refunds by tax type
in the notes to the financial statements.
As noted earlier in the discussion of unpaid assessments, IRS' method
of extracting information from the master files is very laborious and
requires extensive manual procedures and analyses. Moreover, the
amounts produced by this approach still required significant
adjustments. In addition to these issues with respect to unpaid
assessments, our review of IRS' fiscal year 1997 revenue
reconciliations identified numerous adjustments made by IRS to the
general ledger to reconcile it to the master file. For example, in
order to properly reflect FTD payments, such as employee
withholdings, by tax class on the general ledger, IRS had to make
manual adjusting entries totaling over $1.6 billion. These
adjustments had to be made because IRS does not receive the FTD
coupons needed to record these payments in the correct tax class
until after the general ledger has closed. The manual adjustments
are made to correct for misstatements and thus to ensure that these
amounts are properly reflected by tax class in the financial
statements.
--------------------
\41 Statement of Federal Financial Accounting Standards No. 7,
Accounting for Revenue and Other Financing Sources and Concepts for
Reconciling Budgetary and Financial Accounting, May 10, 1996.
IRS' GENERAL LEDGER DOES NOT
COMPLY WITH STANDARDS
---------------------------------------------------------- Letter :8.2
The Federal Financial Management Improvement Act requires federal
agencies to comply with the U.S. Government Standard General Ledger
(SGL) at the transaction level. For IRS, this requires that
-- data in internal and external financial reports that are
produced by IRS systems, such as the general ledger and the
master files, be directly traceable to SGL accounts established
in IRS' general ledger structure,
-- general ledger transactions be recorded consistent with SGL
definitions and processing rules, which include rules specifying
how and when specific types of transactions should be recorded,
and
-- transaction detail supporting general ledger account balances be
available in financial management systems such as the master
files and be directly traceable to specific SGL account codes.
IRS' general ledger system does not comply with SGL requirements.
For example, individual transactions cannot be traced from the
general ledger back to the source transactions, and IRS does not use
the standard general ledger accounts. IRS recognized these
shortcomings in its fiscal year 1997 Federal Managers' Financial
Integrity Act report and identified several planned steps to correct
this problem. However, these steps are not scheduled to be completed
until fiscal year 1999.
Since we reported in our fiscal year 1997 audit report that IRS'
systems do not substantially comply with FFMIA requirements, IRS is
required to make its own determination of compliance within 120 days
of our report. If IRS determines that its systems do not comply, it
is required to establish a remediation plan in consultation with OMB.
The plan must include resources, remedies, and intermediate target
dates necessary to bring its financial management systems into
substantial compliance generally no later than 3 years after the date
the determination is made. We will monitor IRS' progress in
developing its plan and implementing corrective actions during our
fiscal year 1998 financial statement audit of IRS.
PAST ACTIONS BY IRS NOT
SUFFICIENT TO RESOLVE
PROBLEMS
---------------------------------------------------------- Letter :8.3
We have been reporting problems with IRS' general ledger system since
our first audit of IRS' financial statements. For example, we
previously recommended that IRS reconcile detailed revenue
transactions for individual taxpayers to the master file and the
general ledger.\42 IRS' response produced the current approach which
has allowed it to reconcile the master files to the general ledger
and helped facilitate the preparation of reliable year-end financial
statements. As of the fiscal year 1997 financial statement audit, we
consider this recommendation closed. We also recommended that IRS
identify revenue reporting information needs, develop related sources
of reliable information, and establish and implement policies and
procedures for compiling this information.\43
IRS is acting to address these recommendations, such as working with
a contractor to develop and implement financial reporting policies
and procedures. However, IRS' general ledger system still does not
comply with Federal Financial Management Systems Requirements and the
SGL at the transaction level. Consequently, IRS' financial
management systems are not in substantial compliance with the
requirements of the Federal Financial Management Improvement Act.
Phase 0 of IRS' systems modernization plan is expected to comply with
the Standard General Ledger requirements and most of the federal
accounting standards for reporting of revenue and receivables.
Therefore, implementation of Phase 0 is a needed first step toward
improving IRS' overall financial management systems. However, it
will not accomplish full compliance with federal revenue accounting
standards, full traceability from the general ledger back to the
master files, nor reliable identification of the categories of unpaid
assessments. IRS does not plan to address these deficiencies until a
significant portion of IRS' systems modernization is achieved, which
we believe is over a decade away.
--------------------
\42 See appendix II, recommendation 10.
\43 See appendix II, recommendation 5.
RECOMMENDATION
---------------------------------------------------------- Letter :8.4
To address the weaknesses identified in IRS' general ledger system,
we recommend that the Commissioner implement Phase 0 of its overall
systems modernization plan as quickly as possible. In doing so, IRS
should incorporate plans to ensure that the resulting system can
routinely generate timely and reliable financial management reports
which can be used by internal and external users and which will
increase the timeliness of preparation and audit of its annual
financial statements. Until Phase 0 is implemented, IRS should
continue to utilize special computer programs and prepare manual
adjustments, as needed, to derive amounts to be reported in the
financial statements.
AGENCY COMMENTS AND OUR
EVALUATION
------------------------------------------------------------ Letter :9
In commenting on this report, the Internal Revenue Service generally
agreed with our findings and recommendations and noted that IRS has
already made significant progress in addressing a number of the
issues raised in the report. However, IRS disagreed with 3 of the 11
recommendations.
First, IRS stated that our short-term recommendation to manually
review and eliminate duplicate or other assessments related to trust
fund recovery penalties that have already been paid off is not
achievable as written, citing the cost of such a manual process. IRS
did state that it would consider studying ways to address this
problem prior to implementing its longer term solutions to its
financial management systems deficiencies. We believe the problem is
significant enough to warrant immediate action because it is an issue
of sensitivity to taxpayer rights. The high frequency of cases we
identified in our statistical sample of IRS' inventory of unpaid
assessments where taxpayer accounts had not been properly credited
for amounts paid (53 of 83 cases, or about 64 percent) results in
unnecessary taxpayer burdens. Such burdens could include
inappropriate liens on taxpayers' property, which could restrict
their ability to sell this property and obtain financing for other
purchases. Additionally, these burdens could result in cost to both
the taxpayer and, ultimately, to IRS in resolving the problems
created by these system deficiencies. This is a significant problem
that should not wait to be addressed until longer term solutions to
IRS' financial management system deficiencies--which will likely take
more than 10 years--are implemented. IRS should thus determine the
best way to deal with this problem manually until its systems changes
are fully implemented. Allowing these hardships to taxpayers to
continue for such an extended period of time is inconsistent with
IRS' new customer-oriented philosophy. IRS needs to ensure that
problems with its current financial management systems do not result
in additional burdens and costs to taxpayers.
Second, while IRS agreed that its record retention policies need to
be revisited, it disagreed that its ability to effectively pursue
collection from taxpayers for amounts owed could be hindered because
it does not maintain sufficient supporting documentation for its
unpaid assessments and does not have documentation standards for its
collection cases. IRS noted that it believed documentation standards
for well-organized, complete collection case files already exist,
that some of the documentation issues we noted are the result of IRS
personnel being unclear about the extent to which documentation
should be made available for audit purposes, and that our conclusions
are based only on documentation problems identified in those cases
sampled as part of the audit. We disagree. Throughout the audit, we
informed IRS of our documentation needs, but we were unable to obtain
certain critical documents, such as appraisals and asset searches.
These documents would have assisted not only us but also IRS
personnel in determining the proper classification of unpaid
assessments and in developing a sound estimate of the collectibility
of certain unpaid assessments. Such documentation was never made
available, nor did IRS personnel ever state that it existed. This is
not a new problem. We have been reporting documentation deficiencies
since we began auditing IRS' financial statements in fiscal year
1992. IRS' comments also imply that the documentation problems we
identified are limited to those cases we sampled as part of our audit
and that these conditions do not necessarily reflect the conditions
that exist for other cases that we did not specifically review. We
also disagree with this. Our conclusions are based on a detailed
review of a statistical sample of IRS' complete inventory of unpaid
assessments. As such, the documentation deficiencies we found in our
sample of unpaid assessment cases are representative of IRS' complete
inventory of unpaid assessments. This is a long-standing problem
that needs to be addressed.
Finally, IRS disagreed with our short-term recommendation to conduct
a cost-benefit study to determine whether instituting better
preventive controls over processing tax returns with refunds would be
cost beneficial in preventing erroneous refunds. In disagreeing with
this recommendation, IRS noted that instituting preventive
controls--such as manually comparing W-2s and other third party
documents to return information prior to processing the returns and
issuing refunds--was not practical and would not eliminate the need
for its post processing matching program. Some of these concerns
have merit. IRS is correct in noting that not all third party
documents that could be used to verify information on tax returns,
such as form 1099, are currently available for a manual comparison
when the tax return is filed. For this reason, we agree that better
preventive controls would not necessarily eliminate the need for a
post processing matching program. Nevertheless, certain enhancements
to IRS' tax returns processing controls could reduce the potential
for IRS issuing erroneous refunds like those we identified in our
audit. IRS should study the costs and associated benefits of
augmenting its procedures to implement preventive controls over tax
return processing and implement such controls if they are determined
to be cost beneficial. While IRS has made a preliminary estimate of
the cost of manually comparing W-2s to tax returns during processing,
it has not addressed the benefits in terms of reducing both the
dollar amount of erroneous refunds issued and the cost of IRS'
efforts to recover them. Until such a comprehensive study is
complete, IRS does not have an adequate basis for asserting that
instituting preventive controls is not cost beneficial, especially
considering that over $142 billion in refunds were disbursed in
fiscal year 1997.
The complete text of IRS' response to our draft report is presented
in appendix III.
---------------------------------------------------------- Letter :9.1
This report contains recommendations to you. The head of a federal
agency is required by 31 U.S.C. 720 to submit a written statement on
actions taken on these recommendations. You should send your
statements to the Senate Committee on Governmental Affairs and the
House Committee on Government Reform and Oversight within 60 days
after the date of this letter. A written statement also must be sent
to the House and Senate Committees on Appropriations with the
agency's first request for appropriations made over 60 days after the
date of this letter.
We are sending copies of this report to the Secretary of the
Treasury; the Director of the Office of Management and Budget; the
Chairmen and Ranking Minority Members of the Senate Committee on
Appropriations and its Subcommittee on Treasury and General
Government; Senate Committee on Finance and its 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 and its Subcommittee on Government Management,
Information and Technology; 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, at (202) 512-9521 if you have any questions
concerning this report. Major contributors to this report are listed
in appendix IV.
Sincerely yours,
Gregory D. Kutz
Associate Director
Governmentwide Accounting and
Financial Management Issues
SCOPE AND METHODOLOGY
=========================================================== Appendix I
To assess whether management's assertion about the effectiveness of
internal controls was fairly stated for fiscal year 1997, we
identified four transaction cycles relevant to IRS' custodial
financial statement balances: financial reporting, revenue, refunds,
and taxes receivable. To gain an understanding of these transaction
cycles, we interviewed IRS officials; reviewed IRS policy, procedure,
and accounting manuals; documented our understanding of the
transaction processes and relevant internal controls; and performed
walk-throughs to determine whether the internal controls were placed
in operation. We then designed audit procedures and tested relevant
controls such as tests for proper authorization, execution,
accounting, and reporting of transactions.
To determine whether custodial assets were safeguarded from loss, we
examined the (1) key revenue reconciliations performed by the service
centers, (2) adequacy of physical safeguards for custodial assets,
and (3) proper segregation of duties at 4 of IRS' 10 service centers,
chosen primarily because of the high volume of revenue receipts at
these locations.
To determine whether transactions were executed in accordance with
pertinent laws and regulations, we tested IRS' compliance with
selected provisions of laws and regulations as required by OMB
circular 93-06, Audit Requirements for Federal Financial Statements.
We examined IRS' financial management systems to enable us to report
on whether they substantially complied with the Federal Financial
Management Systems Requirements, applicable federal accounting
standards, and the U.S. Government Standard General Ledger at the
transaction level, as required by FFMIA. We also considered the
implementation guidance for FFMIA issued by OMB on September 9, 1997.
To determine whether there were material misstatements in the
financial statements, we reviewed IRS reconciliations, performed
multipurpose tests, and conducted analytical procedures to obtain
evidence about the achievement of specific control objectives. We
examined IRS' reconciliation of the detailed master files to IRS'
general ledger system to ensure that they reconciled in all material
respects. To perform multipurpose tests of revenue and refund
transactions, we selected statistical samples from seven populations
of transactions taken from IRS' master files for the first 9 months
of the fiscal year. These resulted in 1,341 total revenue and refund
transactions examined. We selected these seven samples to meet
specific audit needs. For example, we tested excise and federal
unemployment tax receipts and refunds separately to assist the
Department of Labor and Department of Transportation offices of
Inspectors General in their financial statement audits of those
agencies.\1
We also performed a predictive test\2 of total revenues by tax class
for the last 3 months of the fiscal year to gain additional assurance
that revenue and refunds reported at fiscal year-end were not
materially misstated. In addition, we reviewed IRS' fiscal year-end
reconciliations of its master files, general ledger, and U.S.
Treasury records to ensure that revenue and refund transactions from
these systems agreed in all material respects.
To perform multipurpose tests of unpaid assessments, we first
examined IRS' reconciliation of the detailed master files to IRS'
general ledger system to ensure that they reconciled in all material
respects. We then selected statistical samples of transactions from
each of the three unpaid assessment categories from IRS' master files
as of July 1997. This yielded a total of 730 sample items consisting
of financial receivables, compliance assessments, and write-offs.
Our detailed testing procedures included determining whether items
were correctly classified in each of the three categories. For those
items that remained correctly classified as taxes receivable, we
worked with IRS to assess collectibility for those items, and used
the results to project the estimated net collectible balance. We
performed analytical procedures to verify that the unpaid assessments
balance did not change unexpectedly between the test date and fiscal
year-end, and that the change was consistent with our expectations.
Our work was performed at IRS' National Office in Washington D.C.;
IRS' computing center in Martinsburg, West Virginia; and at all 10
IRS service centers located across the country.
--------------------
\1 See Agreed-Upon Procedures: Excise Taxes (GAO/AIMD-98-78R,
February 26, 1998) and Agreed-Upon Procedures: Federal Unemployment
Taxes (GAO/AIMD-98-79R, February 26, 1998).
\2 A predictive test consists of comparing recorded balances with
auditor's expectations. The auditor develops an expectation of what
the recorded amount should be based on an analysis and understanding
of relationships between the recorded amounts and other data.
STATUS OF GAO RECOMMENDATIONS ON
IRS CUSTODIAL ACTIVITY
========================================================== Appendix II
As a result of our financial audits of IRS from fiscal years 1992
through 1996, GAO made a total of 30 recommendations for improving
IRS' custodial accounting and internal controls. Action had been
completed on eight of these recommendations as of the end of the
fiscal year 1996 custodial financial statement audit, and thus were
closed. Of the 22 recommendations that remained open, 8 are
computer-related internal controls and will be reported on separately
in an upcoming report on computer controls. Three recommendations
were subsequently closed based upon agreement between GAO and IRS.
The following chart shows the updated status of the remaining 11
prior custodial accounting and internal control recommendations which
were still open at the completion of the fiscal year 1996 audit,
numbered 1-11 in the chart below. The chart also shows the status of
IRS' actions in response to these prior recommendations as reported
by IRS in its January 15, 1998 report to the Congress. We have also
added the 11 new recommendations we are making in this report as a
result of our fiscal year 1997 audit. They are numbered 12-22 in the
following chart.
Status of GAO
recommendation
s reported by
IRS on January GAO status of
Custodial recommendations 15, 1998 recommendations
---------------------------------- -------------- ----------------------------
Financial Audit: IRS Significantly
Overstated Its Accounts Receivable
Balance (GAO/AFMD-93-42, May 6,
1993)
1. Take steps to ensure the Closed. Closed. IRS has implemented
accuracy of the balances reported a statistical sampling
in IRS financial statements. In method to determine those
the long term, this will require unpaid assessments that
modifying IRS systems so that they represent taxes receivable.
are capable of However, we have made
(a) identifying which assessments additional recommendations
currently recorded in the Master 12, 13, and 15 below to
File System represent valid address this problem.
receivables and (b) designating
new assessments that should be
included in the receivables
balance as they are recorded.
Until these capabilities are
implemented, IRS should rely on
statistical sampling to determine
what portion of its assessments
represent valid receivables.
2. Modify the IRS methodology for Closed. Closed. IRS has implemented
assessing the collectibility of a statistical sampling
its receivables by method for assessing the
--including only valid accounts collectibility of its
receivable in the analysis; receivables. However, we
--eliminating, from the gross have made additional
receivables balance, assessments recommendations 12, 13, and
determined to have no chance of 15 below to address this
being collected; problem.
--including an analysis of
individual taxpayer accounts to
assess their ability to pay;
--basing group analyses on
categories of assessments with
similar collection risk
characteristics; and
--considering current and forecast
economic conditions, as well as
historical collection data, in
analyses of groups of
assessments.
Once the appropriate data are
accumulated, IRS may use modeling
to analyze collectibility of
accounts on a group basis, in
addition to separately analyzing
individual accounts. Such modeling
should consider factors that are
essential for estimating the level
of losses, such as historical loss
experience, recent economic
events, and current and forecast
economic conditions. In the
meantime, statistical sampling
should be used as the basis for
both individual and group
analyses.
Financial Management: Important
IRS Revenue Information Is
Unavailable or Unreliable (GAO/
AIMD-94-22, December 21, 1993)
3. Develop a method to determine Closed. Closed. As recommended, IRS
specific taxes collected by trust developed a method to
fund so that the difference allocate payments to
between amounts assessed and specific excise taxes based
amounts collected is readily on the related taxpayer
determinable and excise tax returns. We will review
receipts can be distributed as their methodology and its
required by law. This could be implementation during our
done by obtaining specific payment fiscal year 1998 audit.
detail from the taxpayer,
consistent with our April 1993 FTD
report. Alternatively, IRS might
consider whether allocating
payments to specific taxes based
on the related taxpayer returns is
a preferable method.
4. Determine the trust fund Closed. Closed.
revenue information needs of other
agencies and provide such
information, as appropriate. If
IRS is precluded by law from
providing needed information, IRS
should consider proposing
legislative changes.
5. Identify reporting information Open. Action in progress. During
needs, develop related sources of our fiscal year 1998 audit,
reliable information, and we will monitor actions
establish and implement policies implemented to determine if
and procedures for compiling this the issue is being
information. These procedures adequately addressed.
should describe any (1)
adjustments that may be needed to
available information and (2)
analyses that must be performed to
determine the ultimate disposition
and classification of amounts
associated with in-process
transactions and amounts pending
investigation and resolution.
6. Monitor implementation of Closed. Open. We will follow up on
actions to reduce the errors in IRS' implementation of this
calculating and reporting manual recommendation as part of
interest on taxpayer accounts, and our fiscal year 1998 audit.
test the effectiveness of these
actions.
7. Give a priority to the IRS Closed. We are closing this
efforts that will allow for recommendation and making
earlier matching of income and two more specific
withholding information submitted recommendations, see 20 and
by individuals and third parties. 21 below.
Financial Audit: Examination of
IRS' Fiscal Year 1993 Financial
Statements (GAO/AIMD-94-120, June
15, 1994)
8. Ensure that system development Closed. Open. We will follow up on
efforts provide reliable, IRS' implementation of this
complete, timely, and recommendation as part of
comprehensive information with our fiscal year 1998 audit.
which to evaluate the
effectiveness of its enforcement
and collection programs.
9. Establish and implement Closed. Open. We will follow up on
procedures to analyze the impact IRS' implementation of this
of abatements on the effectiveness recommendation as part of
of assessments from IRS' various our fiscal year 1998 audit.
collection programs.
10. Reconcile detailed revenue Open. Closed. IRS was able to
transactions for individual materially reconcile the
taxpayers to the master file and master files to the general
general ledger. ledger in all material
respects for fiscal year
1997.
11. Establish and implement Closed. Closed. We are closing this
procedures to proactively identify recommendation and making
errors that occur during several new and more
processing of data, and design and specific recommendations,
implement improved systems and see 12, 15, 20, and 21
controls to prevent or detect such below.
errors in the future.
Internal Revenue Service:
Immediate and Long-Term Actions
Needed to Improve Financial
Management (GAO/AIMD-99-16,
October 30, 1998)
12. Manually review and eliminate N/A -new New recommendation.
duplicate or other assessments recommendation
that have already been paid off to .
assure all accounts related to a
single assessment are
appropriately credited for
payments received.
13. Improve the accuracy of its N/A -new New recommendation.
master file extraction programs recommendation
used to classify unpaid .
assessments such that, once the
extractions are made, any
subsequent adjustments needed
would not be material. At a
minimum, IRS should consider the
nature of the adjustments made to
the fiscal year 1997 amounts
extracted and adjust the
extraction programs in future
years accordingly.
14. Establish minimum N/A -new New recommendation.
documentation standards or recommendation
checklists for collection files. .
These standards or checklists
should include minimum
documentation and file
organization requirements for all
taxes receivable and compliance
assessment cases, specifying the
types of documentation required,
standard file organization, and
the retention period that will
assure such documents are
maintained until the statute of
limitations has expired.
15. Ensure that IRS' modernization N/A -new New recommendation.
blueprint includes developing a recommendation
subsidiary ledger to accurately .
and promptly identify, classify,
track, and report all IRS unpaid
assessments by amount and
taxpayer. This subsidiary ledger
must also have the capability to
distinguish unpaid assessments by
category in order to identify
those assessments that represent
taxes receivable versus compliance
assessments and write-offs. In
cases involving trust fund
recovery penalties, the subsidiary
ledger should ensure that (1) the
trust fund recovery penalty
assessment is appropriately
tracked for all taxpayers liable,
but counted only once for
reporting purposes, and (2) all
payments made are properly
credited to the accounts of all
individuals assessed for the
liability.
16. Examine and consider options N/A -new New recommendation.
to increase deterrent controls at recommendation
service centers. Some options IRS .
should examine and consider
include:
--installing surveillance cameras
to monitor staff when they are
opening, extracting, and sorting
the mail, and when they are
processing receipts;
--restricting personal items that
can be brought into the receipt
processing areas, such as
handbags, briefcases, and bulky
outerwear; and
--providing lockers and require
their use for storing personal
belongings outside of the receipt
processing areas.
17. Provide adequate training and N/A -new New recommendation.
monitoring of extraction unit recommendation
staff to ensure that staff are .
informed and properly trained on
the proper procedures, and that
the procedures are being followed.
18. Limit the units that may N/A -new New recommendation.
receive unopened mail directly to recommendation
only those units which require .
confidentiality due to the nature
of their work. At a minimum, mail
addressed to off-site locations
should be routed through the
service center first to identify
mail that may contain taxpayer
receipts.
19. Insure that security guards N/A -new New recommendation.
and other unauthorized service recommendation
center personnel do not receive .
walk-in payments from taxpayers.
20. Conduct a cost-benefit study N/A -new New recommendation.
to evaluate whether preventive recommendation
controls, such as manually .
comparing W-2 information to tax
returns at the time returns are
received rather than many months
later, would be cost beneficial.
This study should include a
complete analysis of the projected
costs and associated benefits of
increases to preventive controls.
If such controls are determined to
be beneficial, IRS should
implement them to the extent
practical to reduce the amount of
inappropriate refund payments.
21. Ensure that IRS' modernization N/A -new New recommendation.
blueprint includes the ability to recommendation
compare W-2 and other third-party .
information to tax returns as they
are processed to further prevent
improper refunds from being
issued.
22. Implement Phase 0 of IRS' N/A -new New recommendation.
systems modernization plan as recommendation
quickly as possible. In doing so, .
IRS should incorporate plans to
ensure that the resulting system
can routinely generate prompt and
reliable financial management
reports which can be used by
internal and external users and
which will increase the timeliness
of preparation and audit of its
annual financial statements. Until
Phase 0 is implemented, IRS should
continue to utilize special
computer programs and prepare
manual adjustments, as needed, to
derive amounts to be reported in
the financial statements.
--------------------------------------------------------------------------------
(See figure in printed edition.)Appendix III
COMMENTS FROM THE INTERNAL REVENUE
SERVICE
========================================================== Appendix II
appendix.
(See figure in printed edition.)
(See figure in printed edition.)
The following is GAO's comment on the Internal Revenue Service's
letter dated September 14, 1998.
GAO COMMENT
1. Discussed in "Agency Comments and Our Evaluation" section.
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix IV
ACCOUNTING AND INFORMATION
MANAGEMENT DIVISION, WASHINGTON,
D.C.
Steven J. Sebastian, Assistant Director
SAN FRANCISCO FIELD OFFICE
Ellen Rominger, Senior Evaluator
Laurie King, Auditor
SEATTLE FIELD OFFICE
Doreen Eng, Assistant Director
Catherine Arnold, Evaluator
Susan Chin, Auditor-in-Charge
Richard Harada, Senior Auditor
Julianne Hartman Cutts, Auditor-in-Charge
Stan Stenersen, Reports Analyst
RELATED GAO REPORTS
=========================================================== Appendix 0
Federal Tax Deposit System: IRS Can Improve the Federal Tax Deposit
System (GAO/AFMD-93-40, April 28, 1993)
Financial Audit: IRS Significantly Overstated its Accounts
Receivable Balance (GAO/AFMD-93-42, May 6, 1993)
Financial Audit: Examination of IRS' Fiscal Year 1992 Financial
Statements (GAO/AFMD-93-2, June 30, 1993)
Financial Management: Important IRS Revenue Information is
Unavailable or Unreliable, (GAO/AIMD-94-22, December 21, 1993).
Financial Audit: Examination of IRS' Fiscal Year 1993 Financial
Statements (GAO/AIMD-94-120, June 15, 1994)
Financial Audit: Examination of IRS' Fiscal Year 1994 Financial
Statements (GAO/AIMD-95-141, August 4, 1995)
Financial Audit: Examination of IRS' Fiscal Year 1995 Financial
Statements (GAO/AIMD-96-101, July 11, 1996)
Financial Audit: Examination of IRS' Fiscal Year 1996 Custodial
Financial Statements (GAO/AIMD-98-18, December 24, 1997)
Tax Systems Modernization: Blueprint Is a Good Start But Not Yet
Sufficiently Complete to Build or Acquire Systems
(GAO/AIMD/GGD-98-54, February 24, 1998)
Financial Audit: Examination of IRS' Fiscal Year 1997 Custodial
Financial Statements (GAO/AIMD-98-77, February 26, 1998)
Internal Revenue Service: Remaining Challenges to Achieve Lasting
Financial Management Improvements (GAO/T-AIMD/GGD-98-139, April 15,
1998)
*** End of document. ***