Excise Taxes: Internal Control Weaknesses Affect Accuracy of
Distributions to the Trust Funds (Letter Report, 11/09/98,
GAO/AIMD-99-17).

Pursuant to a legislative requirement, GAO conducted a follow-up review
of the Internal Revenue Service's (IRS) controls over its process for
certifying excise taxes for distribution to the federal trust funds.

GAO noted that: (1) IRS does not have adequate controls over its process
for certifying excise taxes for distribution to the federal government
trust funds; (2) the lack of fundamental internal controls resulted in
errors in the certifications going undetected; (3) these errors
ultimately affected the amounts distributed to the trust funds during
fiscal year 1997; (4) IRS' ineffective controls over the certification
process resulted in undetected: (a) mistakes by taxpayers in preparing
excise tax returns; (b) input errors by IRS when entering excise tax
return information in its master files; and (c) errors by IRS in
preparing the excise tax certifications; (5) as a result of these
errors, trust funds did not receive the appropriate amount of excise tax
revenue; (6) these errors are particularly important to the Highway
Trust Fund, which receives over half of the excise taxes that are
accounted for by IRS; (7) these weaknesses were a contributing factor in
the Department of Transportation's (DOT) Inspectors General's: (a)
qualified opinion on the Highway Trust Fund financial statements; (b)
disclaimer of opinion on the Federal Aviation Administration's financial
statements; and (c) disclaimer of opinion on DOT's consolidated
financial statements; (8) the errors GAO found relating to taxpayer
mistakes, IRS data input, and certification preparation could have been
detected or prevented by effective IRS procedures; and (9) IRS has taken
some actions to improve certain controls over the excise tax
certification process.

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

 REPORTNUM:  AIMD-99-17
     TITLE:  Excise Taxes: Internal Control Weaknesses Affect Accuracy 
             of Distributions to the Trust Funds
      DATE:  11/09/98
   SUBJECT:  Accounting procedures
             Excise taxes
             Financial records
             Auditing standards
             Auditing procedures
             Tax administration
             Trust funds
             Financial statements
             Internal controls
IDENTIFIER:  Oil Spill Liability Trust Fund
             Highway Trust Fund
             Aquatic Resources Trust Fund
             Hazardous Substances Superfund Trust Fund
             Vaccine Injury Compensation Trust Fund
             Inland Waterways Trust Fund
             Black Lung Disability Trust Fund
             
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Cover
================================================================ COVER


Report to the Commissioner of Internal Revenue

November 1998

EXCISE TAXES - INTERNAL CONTROL
WEAKNESSES AFFECT ACCURACY OF
DISTRIBUTIONS TO THE TRUST FUNDS

GAO/AIMD-99-17

Excise Taxes

(919181)


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

  AQETL - Automated Quarterly Excise Tax Listing
  BPD - Bureau of the Public Debt
  DOL - Department of Labor
  DOT - Department of Transportation
  FMS - Financial Management Service
  IG - Inspector General
  IRS - Internal Revenue Service
  OTA - Office of Tax Analysis

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


B-280269

November 9, 1998

The Honorable Charles O.  Rossotti
Commissioner of Internal Revenue

Dear Mr.  Rossotti: 

This report is a follow-up to our report discussing procedures we
performed to assist the Department of Transportation (DOT) and
Department of Labor (DOL) Inspectors General (IG) in ascertaining
whether the net excise tax collections and excise tax certifications
reported by the Internal Revenue Service (IRS) for the fiscal year
ended September 30, 1997, were supported by underlying records.\1

The agreed-upon procedures, along with our audit of the IRS' fiscal
year 1997 Custodial Financial Statements,\2 and work performed at
other Department of the Treasury offices and bureaus, was necessary
to provide a sufficient basis to assist those IGs in forming an
opinion on the financial statements of their respective departments
and the relevant trust funds those departments administer, such as
DOT's Highway Trust Fund and DOL's Black Lung Disability Trust Fund. 

Our previous report presented errors we identified in performing
these procedures, but did not discuss the underlying internal control
weaknesses that allowed these errors to go undetected, nor did it
discuss actions needed to address these weaknesses.  This report
discusses such weaknesses and presents our recommendations for
corrective action. 


--------------------
\1 See Agreed-Upon Procedures:  Excise Taxes (GAO/AIMD-98-78R,
February 26, 1998). 

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


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

IRS does not have adequate controls over its process for certifying
excise taxes for distribution to the federal government trust funds. 
The lack of fundamental internal controls, such as supervisory
review, resulted in errors in the certifications going undetected. 
These errors ultimately affected the amounts distributed to the trust
funds during fiscal year 1997.  IRS' ineffective controls over the
certification process resulted in undetected (1) mistakes by
taxpayers in preparing excise tax returns, (2) input errors by IRS
when entering excise tax return information in its master files,\3
and (3) errors by IRS in preparing the excise tax certifications. 

As a result of these errors, trust funds did not receive the
appropriate amount of excise tax revenue.  These errors are
particularly important to the Highway Trust Fund, which receives over
half of the excise taxes that are accounted for by IRS.  These
weaknesses were a contributing factor in the DOT IG's (1) qualified
opinion on the Highway Trust Fund financial statements, (2)
disclaimer of opinion on the Federal Aviation Administration's
financial statements, and (3) disclaimer of opinion on the Department
of Transportation's consolidated financial statements. 

The errors we found relating to taxpayer mistakes, IRS data input,
and certification preparation could have been detected or prevented
by effective IRS procedures.  IRS has taken some actions to improve
certain controls over the excise tax certification process.  We are
making recommendations to strengthen IRS' verification and review
procedures to help ensure that trust funds receive the appropriate
allocation of revenue. 


--------------------
\3 The master file is a detailed database containing taxpayer
information. 


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

The federal government levies excise taxes on entities and
individuals for the purpose of financing general federal activities
and specific government programs.  Several different bureaus and
offices within Treasury collected about $59 billion of excise taxes
in fiscal year 1997.  The Bureau of Alcohol, Tobacco, and Firearms
accounted for about $13 billion in excise taxes on alcohol, tobacco
products, and firearms while the U.S.  Customs Service accounted for
about $1 billion in excise taxes on imported and exported goods and
services. 

However, the majority of excise taxes are accounted for by IRS.  In
fiscal year 1997, IRS collected about $45 billion in excise taxes on
the purchase, use, or inventory of various types of goods or
services, such as gasoline and airline tickets.  The various excise
taxes accounted for by IRS are deposited into the general fund\4 of
the Treasury and into nine different trust funds, which are
administered by six agencies or federal entities.  The trust funds
that received fiscal year 1997 tax revenues are shown in table 1.  A
list of excise taxes by trust fund is included in appendix II. 



                                Table 1
                
                    Trust Funds Receiving Excise Tax
                      Revenues in Fiscal Year 1997

                         (Dollars in millions)

                                                          Reported tax
Trust funds\a                                               revenues\b
--------------------------------------------------  ------------------
Highway                                                        $24,664
Airport and Airways                                             $4,232
Oil Spill Liability                                               $1\c
Aquatic Resources                                                $ 347
Hazardous Substance Superfund                                   $ 76\d
Black Lung Disability                                            $ 614
Vaccine Injury Compensation                                      $ 123
Inland Waterways                                                  $ 96
----------------------------------------------------------------------
\a The Trust Funds are administered by various federal agencies
including the Department of Transportation, Department of the
Interior, Environmental Protection Agency, Department of Labor,
Department of Health & Human Services, and the Corps of Engineers. 

\b Represents tax revenue distributions to the trust funds for the
fiscal year ended September 30, 1997. 

\c The taxing authority used to finance the fund expired on December
31, 1994. 

\d Superfund is supported primarily by an environmental tax on
corporations, cost recoveries of funds spent to clean up hazardous
waste sites, and fines and penalties.  Prior to December 31, 1995,
the fund was also supported by other taxes on crude oil and petroleum
and on the sale or use of certain chemicals.  The authority to assess
those taxes expired on December 31, 1995. 

Source:  Tax revenue amounts were obtained from the respective trust
fund financial statements as reported by the Bureau of the Public
Debt of the Department of the Treasury.  We did not audit or verify
these amounts. 

Administering agencies for the trust funds receiving excise tax
revenue rely on the Treasury to accurately collect and distribute
federal tax revenue to the appropriate trust funds.  Because it
collects federal tax revenue and then distributes it to government
trust funds, Treasury is considered a servicing organization by
agencies administering the trust funds as well as by the auditors of
these agencies.  Consequently, the administering agencies and their
auditors need to rely on Treasury, through its various bureaus and
offices, including IRS, to properly account for and distribute the
amounts transferred from the government's general fund to the
applicable trust funds. 

Excise taxes are deposited into the general fund as received. 
However, the information that ultimately determines how these
receipts are actually distributed is generally submitted via the Form
720, Quarterly Federal Excise Tax Return.\5

Because data are not available to allocate excise taxes to the
appropriate trust funds when deposits are made, Treasury uses a
process to estimate the initial distribution of excise taxes.  This
process involves the use of economic models prepared by the Office of
Tax Analysis (OTA) to estimate the initial distribution of tax
receipts.  Treasury's Financial Management Service (FMS) uses these
estimates to prepare entries for the initial distributions to the
trust funds, which are recorded by the Bureau of the Public Debt
(BPD) in the books and records of the trust funds maintained by
Treasury.  Subsequent to this initial distribution, IRS certifies
quarterly the amounts that should have been distributed to the excise
tax-related trust funds based on the tax returns.\6 FMS uses these
certifications to prepare adjustments to the initial trust fund
distributions.  These adjustments are recorded by BPD.  There is
typically a 6-month lag between the quarter end and the excise tax
certification by IRS.  Figure 1 provides an overview of the entire
process of collecting, distributing, and certifying excise tax
revenue reported to the trust funds. 

   Figure 1:  Overview of the
   Process for Distribution of
   Excise Tax Revenue to Trust
   Funds

   (See figure in printed
   edition.)

IRS relies on a combination of manual and automated procedures to
prepare its certification of excise taxes to be distributed to the
trust funds.  IRS calculates the trust fund distributions based on
assessment information in the master file.  As quarterly excise tax
returns are received, IRS personnel input the liability amounts by
type of excise tax, such as Diesel Fuel Tax, into its master file.\7
The tax types are identified by IRS numbers, or abstract numbers,
which are preprinted on the Form 720.  It is these abstract numbers
that ultimately determine how amounts are distributed to the
appropriate trust funds.\8

The assessment information by type of excise tax is electronically
transmitted from the master file to IRS' Automated Quarterly Excise
Tax Listing (AQETL) system.\9 An IRS analyst, who has sole
responsibility for preparing the excise tax certifications, accesses
this system, analyzes the data for reasonableness by, for example,
comparing current period assessments to amounts reported in prior
periods, and makes adjustments, as necessary.  The analyst may
identify necessary adjustments by analyzing significant variations
from prior quarter reported assessment amounts.  After making any
needed adjustments, the analyst generates a report from the AQETL
system which summarizes the assessment data by excise tax type.  The
analyst uses this report to prepare the certifications for all tax
distributions other than taxes related to the Highway, Airport &
Airway, and Inland Waterways Trust Funds. 

For the Highway, Airport & Airway, and Inland Waterways Trust Funds,
the analyst manually enters the assessment data from the report
generated from the AQETL system onto electronic spreadsheets.\10
These spreadsheets contain distribution rates to allocate the
assessments between the trust funds and the general fund based on the
assessment data entered by the analyst.  The distributions from these
spreadsheets, and the AQETL-system report for the other taxes, become
the basis for preparing the quarterly excise tax certification
letters.\11 IRS submits the certification letters to FMS, which uses
it to prepare adjustments to the initial distributions based on the
OTA estimates to bring them in line with the IRS certified amounts. 
These adjustments are sent to BPD, which records the entries in the
books and records of the trust funds maintained by Treasury.  Figure
2 shows IRS' process for certifying the trust fund distributions. 

   Figure 2:  Overview:  IRS
   Process for Certifying Excise
   Tax Distributions

   (See figure in printed
   edition.)


--------------------
\4 The general fund accounts for receipts that are not earmarked by
law for specific purposes, the proceeds of general borrowing, and the
expenditure of these moneys for the general support of federal
government activities. 

\5 The quarterly excise tax return is filed by taxpayers to report
excise tax liability. 

\6 As we have reported in several past financial statement audit
reports, IRS policies and procedures for certification to Treasury of
the distribution of the excise tax collections to the designated
trust funds do not comply with the Internal Revenue Code.  The Code
requires IRS to certify the distribution of these excise tax
collections to the recipient trust funds based on actual collections. 
However, until recently, IRS based its certifications of excise tax
amounts to be distributed to specific trust funds on the assessed
amount, or amounts owed, as reflected on the tax returns filed by
taxpayers.  In June 1998, IRS implemented a new procedure to certify
the excise tax distributions based on estimated collections.  We will
review this new certification process as part of our fiscal year 1998
financial statement audit. 

\7 IRS refers to reported tax assessments on returns as "liabilities"
until the information posts to the master file.  For the purposes of
this report, we use the term "assessments" whether or not the
information has been posted to the master file. 

\8 See appendix III for an example of the form 720 package, which
shows the different excise tax types reported on the Form 720 by
abstract number. 

\9 This system is used by IRS to assist tax examiners in monitoring
excise tax assessments reported on Form 720. 

\10 The electronic spreadsheet for the Highway Trust Fund is provided
by the Office of Tax Analysis (OTA) while the other spreadsheets are
created internally by IRS. 

\11 IRS prepares separate certification letters for each of the trust
funds, with the exception of the Oil Spill Liability Trust Fund and
the Hazardous Substance Superfund, which are reported on one letter. 


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

The objective of the agreed-upon procedures work was to assist the
Inspectors General of the Department of Transportation and Department
of Labor in ascertaining whether the net excise tax collections and
excise tax certifications reported by IRS for the fiscal year ended
September 30, 1997, were supported by the underlying records.  The
objectives of this report are to discuss the underlying internal
control weaknesses that allowed errors identified in the agreed-upon
procedures work to occur and to provide recommendations for
correcting these weaknesses.  See appendix I for a detailed
discussion on the scope and methodology used to accomplish the
objectives. 

We conducted our work primarily from October 1997 through February
1998, with some follow-up work through June 1998, in accordance with
generally accepted government auditing standards. 


   TAXPAYER ERRORS NOT IDENTIFIED
------------------------------------------------------------ Letter :4

For the majority of excise taxes reported on the Form 720, taxpayers
are required to provide the purchase, use, or inventory amounts of
the goods or services (e.g., number of gallons of fuel) used in
determining the tax assessment.  The taxpayer multiplies these
amounts against the preprinted tax rates on the Form 720 to report
the excise tax assessment.  Thus, information contained on the tax
form allows IRS to mathematically verify liability amounts reported
by the taxpayer. 

However, we found that IRS did not require its personnel to verify
that the tax assessment amounts calculated by the taxpayers and
reported on the returns agree with the supporting information
provided on the tax returns.  This led to inconsistencies between the
assessed amount and supporting information provided by taxpayers,
which IRS did not detect and correct.  In 13 of the 230 taxpayer
returns we reviewed, either assessment amounts we recalculated based
on information contained in the return differed from the tax
assessment reported on the return or all the required information was
not included on the return to verify the assessment amount calculated
by the taxpayer. 

IRS procedure manuals required that IRS personnel review tax returns
that contain $1 million or more in excise tax assessments for
reasonableness and accuracy.  The manuals provided guidance for
performing the reviews; however, this guidance was too general.  As a
result, the types of reviews performed by IRS analysts varied.  In
some cases, tax calculations were verified and taxpayers were
contacted if data were missing, while in other cases, the return was
only scanned for reasonableness. 

The lack of adequate and consistent review procedures increases the
likelihood that incorrect assessment amounts reported by the taxpayer
on the tax return would not be detected and corrected by IRS. 

As a result of our agreed upon procedures work, IRS officials
indicated that IRS has acted to address the internal control
weaknesses discussed above.  Specifically, these officials indicated
that IRS implemented procedures to improve the review of tax returns
over $1 million.  Also, IRS now requires the math verification of all
tax assessments, as applicable, and analysts are required to
follow-up with taxpayers to clarify inconsistent information on tax
returns. 

We also noted that IRS centralized its excise tax processing in the
Cincinnati Service Center to improve the consistency of processing
and reviewing excise tax returns and to more closely monitor refund
claims.  Within that center, IRS established an Excise Program
Section that specializes in reviewing excise tax returns and refund
claims.  It is significant that many of the errors we identified
during our agreed upon procedures work related to tax returns
processed at other service centers prior to IRS centralizing its
excise tax processing. 


   INPUTTING ERRORS NOT CAUGHT
   THROUGH REVIEW
------------------------------------------------------------ Letter :5

As discussed above, taxpayers report the majority of excise taxes to
IRS quarterly using the Form 720.  Taxpayers record on the Form 720
assessment amounts owed for each abstract number listed on the form. 
IRS uses the Form 720 to input assessment information into the master
files. 

We found errors in this input process in fiscal year 1997. 
Specifically, we found that all or a portion of the assessment
amounts for 13 of the 230 taxpayer returns reviewed were recorded in
incorrect abstract numbers in the master file.  In one case, IRS
incorrectly recorded assessments of $176 million from the tax return
in one abstract, yet the tax return indicated that this amount should
have been divided among eight different abstracts.  Because the
abstract numbers identify the type of excise tax (for example, Diesel
Fuel Tax) to which the assessment applies and are used in the
certification of amounts ultimately distributed to the various trust
funds, this directly affected the accuracy of IRS' certifications. 
IRS officials indicated that these errors would be corrected in
subsequent certifications made in fiscal year 1998. 

The structure of the Form 720 itself contributed to several errors. 
The Form 720 tax return is a complex tax form consisting of three
distinct parts and two additional schedules.\12 Information on the
schedules includes details on excise tax assessments by semimonthly
period (Schedule A), and adjustments to correct errors in previously
filed Form 720s and claims against previously paid taxes (Schedule
C).  The information on Schedule C containing the claim and
adjustment data is broken down by abstract number; however, it is
aggregated into one total line on page 2 of the Form 720. 
Consequently, taxpayers record on the Form 720 assessment amounts
owed for each abstract number listed on the form but do not reflect
claims and adjustments, by abstract, on pages 1 and 2 of the Form
720.  To assist in processing the tax return, IRS requires its staff
to copy claims and adjustments listed on Schedule C, by abstract, to
pages 1 and 2 of the Form 720.  This procedure provides the data
entry staff with the capability of inputting assessment, claim, and
adjustment amounts, by abstract, directly off the first two pages of
the tax return form without having to scan the schedules for claim
and adjustment amounts to be input.  However, the procedure of IRS
staff manually copying claim and adjustment amounts from the
schedules prepared by taxpayers increases the risk of errors, and
consequently the likelihood that assessment, claim, and adjustment
amounts will be incorrectly recorded in the master files. 

Nine of the 13 errors that we identified were the result of (1) IRS
personnel incorrectly copying the adjustment information from the
Schedule C to pages 1 and 2 of the tax return, (2) IRS personnel
failing to copy adjustment information from the Schedule C to pages 1
and 2 of the tax return, or (3) data entry personnel misreading the
handwritten adjustments made by other IRS staff on the Form 720 when
inputting this information into the master files.  For example, in
one case, a taxpayer claimed a credit of $683,000, consisting of a
$685,000 decrease for gasoline tax and a $2,000 increase for aviation
fuel tax.  However, IRS staff incorrectly recopied the credit amounts
from the Schedule C to page 1 of the Form 720, resulting in the
entire amount being recorded as gasoline tax.  In another case, a
taxpayer claimed a credit for $681,000 for taxed diesel fuel.  An IRS
employee copied the abstract number unclearly to page 1 of the Form
720, and the amount was erroneously recorded as a credit to tax on
dyed diesel fuel used in trains. 

In total, in the 13 cases, we identified $179 million of IRS errors
in inputting excise tax return information to the master files.  The
Comptroller General's Standards for Internal Controls in the Federal
Government specifies that transactions are to be promptly recorded
and properly classified.  The identified errors may have been avoided
had procedures been in place to verify the input process.  Also,
errors resulting from the need for IRS staff to transfer information
from the attached schedules to pages 1 and 2 of the Form 720 for each
abstract could be avoided by revising the tax return form so that
taxpayers, and not IRS personnel, enter the claim and adjustment
amounts by abstract from Schedule C to pages 1 and 2 of the tax
return. 


--------------------
\12 See appendix III for an example of the Form 720 tax return and
schedules. 


   CERTIFICATION ERRORS NOT
   PREVENTED OR DETECTED
------------------------------------------------------------ Letter :6

As discussed previously, one analyst is responsible for compiling the
quarterly certifications.  This involves accessing quarterly the
assessment information from the AQETL system, analyzing and adjusting
these data as necessary and, for the Highway Trust Fund, inputting
these data into an electronic spreadsheet, provided by OTA, to derive
the quarterly certifications.  We found that there is no supervisory
review of the analyst's work until the certification letters are
prepared, at which point they are forwarded to the Branch Chief for a
high-level review and signature.  We found no evidence that a
detailed supervisory review is performed of the documentation
supporting the certifications at any point during the certification
process.  Finally, we found that IRS does not review the distribution
rates contained on the OTA-provided spreadsheet used to allocate
certain assessments between the general fund and the Highway Trust
Fund.  The absence of such reviews was a factor in not detecting
numerous errors in the certifications performed in fiscal year 1997
with respect to the Highway Trust Fund and the general fund. 


      SUPPORT FOR CERTIFICATIONS
      NOT ADEQUATELY REVIEWED
---------------------------------------------------------- Letter :6.1

IRS' AQETL system contains the assessment data electronically
transmitted from the master file.  Because it is not integrated with
the electronic spreadsheet used to prepare the certifications for the
Highway Trust Fund, manual data entry is necessary to accomplish the
calculations and summarize the information.  This information is a
basis for preparing the certifications.  Without adequate supervisory
review of these tasks, all of which are performed by one individual,
there is a high risk that errors will be made and not detected and
corrected.  The Comptroller General's Standards for Internal Controls
in the Federal Government specifies that qualified and continuous
supervision is to be provided to ensure that internal control
objectives are achieved.  The lack of adequate supervisory review can
lead to incorrect certifications and inaccurate distributions to the
trust funds. 

We found a number of such errors that occurred in fiscal year 1997. 
For example, we found that assessment amounts were (1) inadvertently
omitted from the certifications and (2) did not agree with supporting
documentation.  In one case related to heavy vehicle use tax, the
supporting schedule summarizing the tax return information reflected
an assessment amount of $195 million but the amount certified was
$128 million.  As a result, the certified amount for the Highway
Trust Fund was understated by $67 million.  In another case,
assessments for compressed natural gas totaling over $500,000 were
omitted from the Highway Trust Fund certification.  IRS officials
indicated that both of these errors were corrected in a subsequent
certification that was made in fiscal year 1998.  However, proper
supervisory review of the analyst's work would likely have detected
these errors and prevented these inaccurate distributions. 


      DISTRIBUTION RATE PROBLEMS
      AFFECTED HIGHWAY TRUST FUND
      DISTRIBUTIONS
---------------------------------------------------------- Letter :6.2

IRS does not have procedures for verifying the accuracy of
distribution rates contained on the electronic spreadsheet provided
by OTA.  These rates, many of which are based on complex formulas
derived from provisions of laws, are used to allocate assessments
between the general fund and the Highway Trust Fund.  The lack of IRS
review of the distribution rates on this spreadsheet resulted in
errors in the excise tax certifications for the Highway Trust Fund
going undetected.  For example, we found the following problems in
the electronic spreadsheet provided by OTA: 

  -- incorrect application rates to allocate gasohol taxes, which
     resulted in an overstatement to the Highway Trust Fund and a
     corresponding understatement to the general fund of $89,000;

  -- misapplied application rates between the Highway Account and
     Mass Transit Account for diesel fuel inventory in the
     certifications for the quarters ending December 1996 and March
     1997, which resulted in a net understatement of the Highway
     Account and a corresponding net overstatement of the Mass
     Transit Account of $19,000; and

  -- missing distribution rate formulas from the spreadsheet, which
     resulted in tax assessment amounts of $1,000 and $7,000 being
     excluded from the Highway Trust Fund certification. 

An IRS review of the distribution rates contained on the spreadsheet
could have identified these problems and prevented the distribution
errors. 


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

The errors we found in the review of the fiscal year 1997 excise tax
certification process are the direct result of weaknesses in
fundamental internal controls, specifically the lack of appropriate
verification and review procedures, at all critical points in the
excise tax certification process.  These weaknesses led to taxpayer,
IRS, and OTA errors going undetected and directly resulted in
inaccurate distributions of excise tax revenue to the trust funds in
fiscal year 1997. 


   RECOMMENDATIONS
------------------------------------------------------------ Letter :8

To strengthen internal controls over IRS' process of inputting tax
return information into the master file, we recommend that IRS: 

  -- Determine if it would be cost effective to develop and implement
     procedures requiring either key verification of the assessment
     amount by excise tax type before final processing or to
     implement other post-input controls to verify the accuracy of
     assessment amounts by excise tax type on the master file.  In
     making this determination, IRS should consider establishing a
     dollar threshold that would ensure coverage of 90 percent of
     total excise tax assessments from the tax returns. 

  -- Revise the Form 720 tax return to reflect a separate column
     adjacent to the column for entering the tax assessment, by
     abstract number, for the taxpayer to report on pages 1 and 2 of
     the tax return claims and adjustments, by abstract number, based
     on the information the taxpayer reports on Schedule C. 

To strengthen internal controls over IRS' process of certifying
excise tax distributions to the general fund and federal trust funds,
we recommend that IRS: 

  -- Develop, document, and implement review procedures over the
     adjustment and summarization of assessment data used in the
     certifications.  Specifically, IRS should require detailed
     supervisory review be performed and documented to ensure that
     adjustments are reasonable and adequately supported,
     calculations are appropriately performed, and the certification
     letter agrees with the supporting schedules.  IRS recently
     changed its procedures to certify excise taxes based on
     estimated collections.  Despite this change, review procedures
     are still necessary. 

  -- Establish and implement specific procedures requiring that IRS
     personnel review the distribution rates provided by OTA prior to
     those rates being used in the certification of Highway Trust
     Fund distributions and document evidence of these reviews. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :9

In commenting on this report, the IRS Commissioner stated that
overall he agreed with our findings and recommendations.  The
Commissioner noted actions either planned or already in process or
implemented to address most of the issues raised in this report. 
These include (1) implementing post-input controls to include a 100
percent review of all returns with tax assessments of $1 million or
more, (2) developing review procedures over the adjustment and
summarization of collection data used in the certifications,
including supervisory reviews prior to final certification, and (3)
reviewing, as part of a recently-formed Intra-Treasury Working Group,
distribution rate charts provided by OTA prior to using these rates
in the certification of Highway Trust Fund distributions. 

However, the Commissioner disagreed with our recommendation to revise
the Form 720 tax return to require taxpayers to report claims and
adjustments information on pages 1 and 2 of the tax return form.  He
expressed concern with how the draft report characterized the tax
return form and the accompanying Schedules A and C of the form. 
Additionally, he noted it would be inappropriate to require the
taxpayer to net the tax liability by the claim and adjustment amounts
reported on the accompanying Schedule C. 

We have modified the report to more appropriately reflect the nature
of the Form 720 and its accompanying schedules.  Consistent with
these changes, we modified the recommendation to eliminate the
reference to having the taxpayer net the tax liability, by abstract
number, for any adjustments or claims, by abstract number, as
reported on the accompanying Schedule C.  However, we believe that
revisions to the tax return form are needed because of the frequency
of errors made by IRS in either copying claim and adjustment
information from Schedule C to pages 1 and 2 of the tax return or in
inputting information copied from the tax return to the master files. 
Specifically, the Form 720 tax return should be revised to reflect a
separate column in which the taxpayer would report claims and
adjustments from the Schedule C, by abstract number, adjacent to the
column reflecting the tax assessment, by abstract number, on pages 1
and 2 of the Form 720.  The complete text of the IRS Commissioner's
response to our draft report is presented in appendix IV. 


---------------------------------------------------------- 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 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 Director of the Office of
Management and Budget, the Secretary of the Treasury, the Secretary
of Transportation, the Secretary of Labor, and the Inspectors'
General of the Department of Transportation and Department of Labor. 
Copies of this letter will be made available to others upon request. 

If you have any questions, please call me at (202) 512-9505 or Steven
J.  Sebastian, Assistant Director, at (202) 512-9521. 

Sincerely yours,

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


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

The objective of the agreed-upon procedures work was to assist the
Inspectors General of the Department of Transportation and Department
of Labor in ascertaining whether the net excise tax collections and
excise tax certifications reported by IRS for the fiscal year ended
September 30, 1997, were supported by the underlying records.  We did
not perform work on excise taxes collected by other Treasury bureaus,
such as the Customs Service and the Bureau of Alcohol, Tobacco, and
Firearms.  We did include in our review the Federal Aid to Wildlife
Restoration Fund because IRS uses different procedures to certify
this trust fund. 

In performing the agreed-upon procedures, we gained an understanding
of the internal controls over the excise tax collection and
certification process.  The objectives of this report were to discuss
the underlying internal control weaknesses that allowed errors
identified in the agreed upon procedures work to occur and to provide
recommendations for correcting these internal control weaknesses. 

To accomplish our objectives, we examined, on a test basis, evidence
supporting the net excise tax collection amounts reported on the
fiscal year 1997 Custodial Financial Statements; specifically, we

  -- used Dollar Unit Sampling to select a sample of 396 combined
     excise tax collection and refund transactions from the master
     file for the first 9 months of fiscal year 1997, using a
     confidence level of 80 percent, a test materiality of $400
     million, and an expected error amount of $200 million.  Of this
     total, 390 transactions represented collections and six
     transactions represented refunds;

  -- verified sampled excise tax transactions to source documents to
     determine if the transactions were accurately recorded, posted
     to the proper tax class, and reported in the appropriate period;

  -- performed a predictive test\1 of excise tax revenue collections
     for the final 3 months of the fiscal year to determine if
     reported fiscal year 1997 revenue appears consistent and
     reasonable;

  -- reviewed IRS' revenue receipts and refund reconciliations
     between its records and Treasury for fiscal year 1997, to
     determine whether year-end excise tax collection balances from
     the general ledger materially agree with IRS' master files and
     Treasury records; and

  -- obtained an understanding of internal controls related to
     safeguarding assets, compliance with laws and regulations, and
     financial reporting. 

In addition, to assess the reliability of key data inputs and
assumptions used in the excise tax certification, we: 

  -- Recalculated the excise tax assessments on the 230 tax returns
     associated with the sample of 390 excise tax collections based
     on the information provided on the returns (e.g., number of
     gallons of fuel multiplied by the tax rate equals the assessed
     tax).  We reviewed only 230 returns because in some instances
     more than one receipt transaction related to the same return. 
     Because the sample was selected based on excise tax collections,
     we were not able to project any errors identified on the
     corresponding tax assessment amounts. 

  -- Verified that the excise tax assessment amounts by abstract
     number on the 230 tax returns were accurately recorded in the
     IRS master file and in the AQETL report. 

  -- Determined if the rates used to allocate assessments between
     selected trust funds and the general fund for the final quarter
     of fiscal year 1997 were adequately supported. 

Further, we: 

  -- verified the mathematical accuracy for selected excise tax
     certifications and

  -- traced, on a selected basis, excise tax certifications to
     supporting schedules. 

We conducted our work primarily from October 1997 through February
1998, with some follow-up work through June 1998, in accordance with
generally accepted government auditing standards. 


--------------------
\1 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. 


TYPES OF EXCISE TAXES BY TRUST
FUND
========================================================== Appendix II


      HIGHWAY TRUST FUND
------------------------------------------------------ Appendix II:0.1

  -- Gasoline removed or entered for gasohol production containing at
     least 10 percent alcohol

  -- Gasoline removed or entered for gasohol production containing at
     least 7.7 percent alcohol but less than 10 percent alcohol

  -- Gasoline removed or entered for gasohol production containing at
     least 5.7 percent alcohol but less than 7.7 percent alcohol

  -- Gasohol containing at least 10 percent alcohol

  -- Gasohol containing at least 7.7 percent alcohol but less than 10
     percent alcohol

  -- Gasohol containing at least 5.7 percent alcohol but less than
     7.7 percent alcohol

  -- Diesel fuel

  -- Special Motor Fuels

  -- Gasoline

  -- Dyed diesel fuel used in certain intercity or local buses

  -- Other alcohol fuels

  -- Compressed Natural Gas

  -- Diesel fuel inventory

  -- Retail on truck, trailer, and semitrailer chassis and bodies,
     and tractors

  -- Highway type tires

  -- Heavy vehicle use


      AIRPORT AND AIRWAYS TRUST
      FUND
------------------------------------------------------ Appendix II:0.2

  -- Ticket tax

  -- Facilities use

  -- Air freight

  -- Aviation gasoline

  -- Aviation fuel (other than gasoline)

  -- Aviation fuel (other than gasoline) for use in commercial
     aviation

  -- Aviation fuel (floor stocks)

  -- Aviation gasoline (floor stocks)


      OIL SPILL LIABILITY (EXPIRED
      DECEMBER 31, 1994)
------------------------------------------------------ Appendix II:0.3

  -- Imported petroleum

  -- Domestic petroleum


      AQUATIC RESOURCES
------------------------------------------------------ Appendix II:0.4

  -- Fishing rods, artificial lures, etc. 

  -- Electric outboard motors and fish finding devices


      HAZARDOUS SUBSTANCE
      SUPERFUND
------------------------------------------------------ Appendix II:0.5

  -- Imported petroleum

  -- Domestic petroleum

  -- Certain chemicals

  -- Imported substances


      LEAKING UNDERGROUND STORAGE
      TANK (NOT IN EFFECT DURING
      FISCAL YEAR 1997)
------------------------------------------------------ Appendix II:0.6

  -- Railroad diesel

  -- Aviation fuel


      BLACK LUNG DISABILITY
------------------------------------------------------ Appendix II:0.7

  -- Underground mined coal at $1.10 per ton

  -- Underground mined coal-limitation at 4.4 percent of sale price

  -- Surface mined coal at $0.55 per ton

  -- Surface mined coal-limitation at 4.4 percent of sale price


      VACCINE INJURY COMPENSATION
------------------------------------------------------ Appendix II:0.8

  -- Diphtheria, pertussis, and tetanus (DPT) Vaccine

  -- Diphtheria and tetanus (DT) Vaccine

  -- Measles, mumps, and rubella (MMR) Vaccine

  -- Polio Vaccine


      INLAND WATERWAYS
------------------------------------------------------ Appendix II:0.9

  -- Inland waterways fuel use




(See figure in printed edition.)Appendix III
QUARTERLY FEDERAL EXCISE TAX
RETURN,
FORM 720
========================================================== Appendix II



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)




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



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)


The following are GAO's comments on the Internal Revenue Service's
letter dated September 25, 1998. 

GAO COMMENTS

1.  The technical comments from the Chief Counsel have been
incorporated as appropriate, but the enclosure has not been included
in this appendix. 

2.  Discussed in "Agency Comments and Our Evaluation" section. 


MAJOR CONTRIBUTORS TO THIS REPORT
=========================================================== Appendix V

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

Steven Sebastian, Assistant Director
Paul Foderaro, Assignment Manager

LOS ANGELES FIELD OFFICE

Charles Payton, Assistant Director
Barbara House, Senior Evaluator
Ted Hu, Senior Auditor
Eric Johns, Senior Auditor
Stacey Osborn, Auditor


*** End of document. ***