Management Report: Improvements Needed in Controls over IRS's	 
Excise Tax Certification Process (23-JUL-03, GAO-03-687R).	 
                                                                 
The Internal Revenue Service (IRS), along with other components  
of the Department of the Treasury, collects and distributes	 
excise tax receipts to government trust funds. As the nation's	 
tax collector, IRS plays a critical role in this process.	 
Consequently, trust funds and their administrators depend on IRS 
to have sound procedures and controls over this process to ensure
that excise taxes are appropriately distributed. This report is a
follow-up to two reports we recently issued discussing procedures
we performed to assist the Department of Transportation's Office 
of Inspector General (Transportation IG) in ascertaining whether 
the net excise tax collections and excise tax certifications	 
reported by IRS for the fiscal year ended September 30, 2002,	 
were supported by underlying records. The agreed-upon procedures,
along with our audit of IRS's fiscal year 2002 financial	 
statements, provided a sufficient basis to assist the		 
Transportation IG in forming an opinion on the departmentwide	 
financial statements and the financial statements of the trust	 
funds administered by the department, including the Highway Trust
Fund and the Airport and Airway Trust Fund.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-687R					        
    ACCNO:   A07669						        
  TITLE:     Management Report: Improvements Needed in Controls over  
IRS's Excise Tax Certification Process				 
     DATE:   07/23/2003 
  SUBJECT:   Financial statement audits 			 
	     Financial statements				 
	     Internal controls					 
	     Records management 				 
	     Strategic planning 				 
	     Tax administration systems 			 
	     Excise taxes					 
	     Trust funds					 
	     Financial records					 
	     Airport and Airway Trust Fund			 
	     Highway Trust Fund 				 

******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO Product.                                                 **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
******************************************************************
GAO-03-687R

Page 1 GAO- 03- 687R IRS Excise Tax Management Report United States
General Accounting Office

Washington, DC 20548

July 23, 2003 The Honorable Mark W. Everson Commissioner of Internal
Revenue Subject: Management Report: Improvements Needed in Controls over
IRS*s

Excise Tax Certification Process

Dear Mr. Everson: The Internal Revenue Service (IRS), along with other
components of the Department of the Treasury, collects and distributes
excise tax receipts to government trust funds. As the nation*s tax
collector, IRS plays a critical role in this process. Consequently, trust
funds and their administrators depend on IRS to have sound procedures and
controls over this process to ensure that excise taxes are appropriately
distributed.

This report is a follow- up to two reports we recently issued discussing
procedures we performed to assist the Department of Transportation*s
Office of Inspector General (Transportation IG) in ascertaining whether
the net excise tax collections and excise tax certifications reported by
IRS for the fiscal year ended September 30, 2002, were supported by
underlying records. 1 The agreed- upon procedures, along with our audit of
IRS*s fiscal year 2002 financial statements, 2 provided a sufficient basis
to assist the Transportation IG in forming an opinion on the
departmentwide financial statements and the financial statements of the
trust funds administered by the department, including the Highway Trust
Fund and the Airport and Airway Trust Fund. 3 In our reports discussing
the results of the agreed- upon procedures we performed in

fiscal year 2002, we described errors we identified in the certification
and distribution process. However, we did not discuss the underlying
internal control weaknesses

1 U. S. General Accounting Office, Applying Agreed- Upon Procedures:
Highway Trust Fund Excise Taxes, GAO- 03- 360R (Washington D. C.: Jan. 23,
2003) and Applying Agreed- Upon Procedures: Airport and Airway Trust Fund
Excise Taxes, GAO- 03- 361R (Washington D. C.: Jan. 23, 2003). 2 U. S.
General Accounting Office, Financial Audit: IRS*s Fiscal Years 2002 and
2001 Financial

Statements, GAO- 03- 243 (Washington D. C.: Nov. 15, 2002). 3 Because GAO
is responsible for auditing IRS*s financial statements, we performed
agreed- upon procedures to assist the Transportation IG in assessing
whether the net excise tax revenues distributed to the two trust funds for
fiscal year 2002 were supported by underlying records. These agreed- upon
procedures, in conjunction with additional testing by the Transportation
IG, provided Transportation*s IG sufficient basis to opine on the
department*s financial statements.

GAO- 03- 687R IRS Excise Tax Management Report Page 2 that allowed these
errors to go undetected, nor did we discuss actions needed to

address these weaknesses. 4 This report discusses these weaknesses and
presents our recommendations for corrective action.

Results in Brief

IRS*s internal controls over its process for certifying excise taxes for
distribution to federal government trust funds are not fully effective in
ensuring that the appropriate amounts are distributed to the trust funds.
Our work identified several internal control issues that affected the
amounts distributed to trust funds quarterly and that

could have affected total fiscal year distributions if IRS had not
corrected errors resulting from these control issues after we brought them
to its attention. The issues we identified include the following:

IRS lacked effective procedures to timely detect errors made by employees
when entering excise tax return information into its information systems.
IRS did not detect such errors until months after they occurred. As a
result, IRS understated certified collections to the Highway Trust Fund
for the quarters ended December 31, 2001, and March 31, 2002. Although IRS
subsequently identified and corrected the errors, it would not have had
adequate time to correct them if these errors had occurred later in the
fiscal year. Had that been the case, the amount of excise taxes
distributed to the Highway Trust Fund would have been less than it should
have been for fiscal year 2002.

IRS lacked effective supervisory review to timely detect errors made in
the preparation of excise tax certifications. As a result, amounts
certified to trust funds were misstated for certain quarters during both
fiscal years 2002 and 2001. IRS corrected the errors in the certifications
after we brought them to its attention. Had we not identified the errors
during our review and notified IRS, the amounts distributed to the Highway
Trust Fund would have been approximately $81 million less than they should
have been during fiscal year 2002 and approximately $1 million less than
they should have been during fiscal year 2001.

IRS did not effectively coordinate with other components of Treasury
involved in the excise tax distribution process when it implemented
changes to its method for recording excise tax credits in fiscal year
2002. As a result, IRS*s systemgenerated certification data were not in a
format usable by the Financial Management Service (FMS) or the Bureau of
the Public Debt (BPD) to facilitate the recording of adjustments to trust
funds. To make the data usable to FMS and BPD, IRS had to add steps to its
certification process to generate the information in the previous
reporting format. These added steps made IRS*s already complex
certification process even more cumbersome, increasing both the likelihood
that errors could be made and that they could go undetected by supervisory
review.

4 In performing the agreed- upon procedures, we conducted our work in
accordance with attestation standards established by the American
Institute of Certified Public Accountants. These standards stipulate that
reporting on such engagements be in the form of procedures and findings
only.

GAO- 03- 687R IRS Excise Tax Management Report Page 3 In addition to these
issues, we continued to find that IRS did not promptly certify

excise tax collections to the trust funds. Under IRS*s current
certification process, excise tax receipts for the fourth quarter of the
fiscal year, which ends September 30, are not certified until the
following March. Because the Department of Transportation*s financial
statements are currently required to be issued by February 1 of the
following year, 5 adjustments to initial distributions of excise tax
receipts for the last quarter of the fiscal year, based on IRS*s
certification, are not recorded in time to be reflected in the trust
funds* financial statements. However, this lag time in making final
adjustments will become more of an issue this year. Beginning with its
fiscal year 2004 accountability report, the Department of Transportation,
along with the other CFO Act agencies, will be required to issue its
report, including its audited financial statements, by November 15, 2004.
6 To help the transition to this earlier reporting date, the department is
planning to

accelerate the issuance of its fiscal year 2003 accountability report to
December 2003. If the Department of Transportation accelerates its
reporting date to December 2003 or earlier, certifications for the third
and fourth quarters of the fiscal year would be completed too late for any
adjustment to distributions resulting from the certifications to be made
and reflected on the trust funds* financial statements under IRS*s
existing process. As a result, the amount of annual excise tax revenue
distributed to the trust funds may not reflect the true amount that should
have been distributed, potentially resulting in significantly inaccurate
distributions and, in the case of the Highway Trust Fund, incorrect
allocations of revenues to states. 7 IRS has taken some actions to improve
controls over the excise tax certification

process, but additional action is needed to address the internal control
issues we identified. We are making recommendations to further strengthen
IRS*s verification and review procedures to help ensure that trust funds
receive the appropriate allocation of revenue in a timely manner and to
assist IRS in considering changes to its procedures to accelerate the
timing of its excise tax certifications.

In its comments, IRS generally agreed with our recommendations and
described actions it was taking or planned to take to address the internal
control issues described in this report. At the end of our discussion on
each of these issues, we have summarized IRS*s related comments and
provided our evaluation.

5 The Chief Financial Officers Act of 1990 (CFO Act), as expanded by the
Government Management Reform Act of 1994, requires the Department of
Transportation to annually submit audited financial statements to the
Office of Management and Budget (OMB). OMB requires agencies to submit
financial statements for fiscal year 2003 no later than February 1, 2004.
6 Office of Management and Budget, Memorandum for Chief Financial Officers
and Inspectors General (Washington D. C.: Oct. 18, 2002). 7 The
Transportation Equity Act for the 21 st Century, Pub. L. No. 105- 178, 112
Stat. 107 (1998), requires

highway program funds to be distributed to states on the basis of annual
Highway Account receipts information.

GAO- 03- 687R IRS Excise Tax Management Report Page 4

Background

The federal government levies excise taxes on entities and individuals for
the purpose of financing general federal activities and specific
government programs. Several bureaus and offices within Treasury collected
a total of about $69 billion in excise taxes in fiscal year 2002. IRS
accounted for the majority, collecting about $52 billion in excise taxes
on the purchase, use, or inventory of various types of goods and services,
such as gasoline and airline tickets. The processing of excise tax returns
is centralized at IRS*s Cincinnati Campus. The various excise taxes
accounted for by IRS are deposited into the general fund 8 of the Treasury
and subsequently into seven different trust funds, which are administered
by six federal agencies or entities. The largest of these trust funds are
the Highway Trust Fund and the Airport and Airway Trust Fund, both of
which are administered by the Department of Transportation. For fiscal
year 2002, the Highway Trust Fund received about $32.2 billion in excise
tax revenues and the Airport and Airway Trust Fund received about $8.9
billion. Because it collects federal tax revenue and then distributes it
to these government

trust funds, Treasury is considered a servicing organization by trust fund
administrators as well as by the auditors of these agencies. Consequently,
the trust fund administrators and their auditors need to rely on Treasury,
through its various bureaus and offices, including IRS, to properly
account for and distribute amounts transferred from the government*s
general fund to their trust funds.

Payers of excise taxes generally are required to make semimonthly deposits
to cover their quarterly tax liability. The excise taxes are deposited
into the general fund as they are received. Taxpayers are not required to
provide information at the time they make their excise tax payments that
would allow Treasury to immediately apply the payments to the appropriate
trust fund based on amount owed and paid. The information that ultimately
determines how these receipts are distributed is generally submitted by
taxpayers on Form 720, Quarterly Federal Excise Tax Return. 9 Because data
are not available to allocate excise taxes to the appropriate trust funds
when taxpayers make their excise tax deposits, Treasury uses a process to
estimate the initial distribution of excise taxes. Treasury*s Office of
Tax Analysis (OTA) prepares semimonthly estimates based on

historical IRS certification data and actual total current excise tax
revenue collections. FMS uses these estimates to prepare entries for the
initial distributions to the trust funds, which are recorded by BPD in the
books and records of the trust funds maintained by Treasury. Subsequent to
this initial distribution, IRS certifies

8 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.
9 Taxpayers file the quarterly excise tax return to report their excise
tax liability. Form 720 is generally due 30 days following the end of the
quarter.

GAO- 03- 687R IRS Excise Tax Management Report Page 5 quarterly the
amounts that should have been distributed to the excise tax related

trust funds based on the tax returns. FMS then uses these certifications
to prepare adjustments to the initial trust fund distributions for each
quarter, and BPD records the amounts on the trust fund books and records.
Figure 1 provides an overview of the entire process of collecting,
distributing, and certifying excise tax revenue reported to trust funds.

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

Collection/ accounting

Certification

General fund

FMS

Distribution/ adjustments

OTA

Estimation

BPD

Recordation/ accounting

Investments in special issue Treasury securities

Taxpayer

Payment/ filing Tax payments FMS

Quarterly tax return - Form

720 Source: GAO.

Semimonthly calculation of

estimates Record entries

into trust fund records

Trust funds 1. Highway 2. Airport and Airway 3. Aquatic Resources 4.
Leaking Underground Storage Tanks

5. Black Lung 6. Vaccine Injury

Compensation 7. Inland Waterways Record excise

tax payments in master file

Record excise tax liability in

master file Calculations and

certification of actual amounts

Prepare journal entries - record

estimates Prepare journal

entries - adjust estimates to

actuals

IRS currently certifies collections for each quarter approximately 5 and
one- half months after the end of the quarter. IRS relies on a combination
of manual and automated procedures to prepare its certification of excise
taxes to be distributed to the trust funds. This process is complex and
cumbersome. IRS calculates the trust fund distributions based on
assessment, credit, 10 and payment information in the master file. 11 When
taxpayers make their excise tax deposits, IRS enters payment information
into the taxpayers* master file accounts. As quarterly excise tax returns
are received, IRS enters the liability amounts by type of excise tax, such
as gasoline tax, into taxpayers* master file accounts. The tax types are
identified by certain

10 An assessment represents the taxes owed by a taxpayer for a given
period for a given tax. Typically, for excise taxes, this is the amount
reported by the taxpayer on the Form 720 excise tax return. Taxpayers are
allowed to claim excise tax credits for certain situations. For example,
due to IRS*s method for taxing fuel, there are situations when fuel could
be taxed more than one time. Taxpayers are allowed to claim a credit for
the second time the fuel is taxed. 11 The master file is a detailed
database of taxpayer accounts.

GAO- 03- 687R IRS Excise Tax Management Report Page 6 numbers preprinted
on the Form 720. IRS uses one set of numbers for tax

assessments, referred to as abstracts, and another set for tax credits,
referred to as credit reference numbers. For example, abstract 62
represents gasoline tax, and credit reference number 362 represents a
credit claimed on gasoline tax. IRS uses these numbers to identify excise
tax type information in its master file, and it is these numbers that
ultimately determine how amounts are distributed to the appropriate trust
funds.

IRS electronically transmits excise tax information from the master file
to its Collection Certification System. The Collection Certification
System uses the information to prorate 12 collections among the different
excise taxes. The system then summarizes the amount of prorated
collections, by tax type, on the Report of Excise Tax Collection. IRS uses
the information from these reports as the basis for calculating the gross
certified amount 13 for each type of tax. IRS analysts enter the
information from the Reports of Excise Tax Collection onto a series of
interconnected electronic spreadsheets, which further combine prorated
collection data and then allocate the gross prorated amount, for each type
of tax, among the general fund, trust funds, and trust fund accounts. 14
Analysts then record the allocated amount for each tax onto excise tax
distribution certification letters. IRS submits the certification letter
to FMS, which uses it to prepare adjustments to

the initial distributions to bring them in line with the IRS- certified
amounts. 15 FMS sends these adjustments to BPD, which records the entries
in the books and records of the trust funds maintained by Treasury. Figure
2 shows IRS*s process for certifying trust fund distributions.

12 IRS certifies to trust funds the amount of excise taxes actually
collected. Because there are occasions on which taxpayers have not paid
their full tax liability at the time of IRS*s certification, IRS must
allocate the amount of payments actually received among the different
excise taxes reported on the taxpayer*s return. IRS*s Collection
Certification System prorates a taxpayer*s payments among all taxes
reported owed on the tax return. For example, if a Form 720 indicates that
the taxpayer owes $4 million for gasoline tax, $2 million for diesel fuel
tax, and $1 million for gasohol tax, but the taxpayer

has paid IRS only $3. 5 million at the time IRS performs its
certification, the program prorates the $3. 5 million in the following
manner: $2 million to gasoline tax, $1 million to diesel fuel tax, and
$500, 000 to gasohol tax. 13 This is the total amount of certified
collections for each tax (e. g., gasoline) prior to distribution between
the general fund and trust fund. 14 The tax amounts for certain taxes,
such as some motor fuel taxes, are allocated among the general fund, the
Highway Account of the Highway Trust Fund, and the Mass Transit Account of
the Highway

Trust Fund. 15 This adjustment is determined by taking the IRS- certified
amount and subtracting from it the initial

distribution amount derived from the OTA estimate. If the resulting amount
is positive, it is transferred from the general fund to the trust fund. If
the resulting amount is negative, it is transferred out of the trust fund
to the general fund.

GAO- 03- 687R IRS Excise Tax Management Report Page 7

Figure 2: Overview of IRS Process for Certifying Excise Tax Collections
Taxpayer IRS tax return

processing units Office of

Revenue Systems IRS Centralized

Excise Tax Section (Cincinnati Campus) Martinsburg

Computer Center

Master file

Quarterly downloads to Collection Certification System

(Cincinnati Campus- Submission Processing)

(All 10 IRS Campuses) Report of Excise Tax Collection

FMS

Source: GAO. Tax return

Form 720 Input assessment

data from Form 720 into master file

Compare information on Form 720 returns over $1 million with data in
master file

Research apparent errors and correct as necessary

Review master file information and advise Cincinnati of potential errors

Payments (EFTPS, FTDs, etc.)

Input payment data from payment documents or electronic sources into
master file

Collection Certification

System Calculation of certification amounts using electronic spreadsheets

Certification letters

In addition to its certification of excise tax receipts to trust funds,
IRS performs a quarterly reclassification of excise tax refunds and
credits. As part of its normal processing procedures, IRS initially
records some excise tax refunds and credits as personal or corporate
refunds and credits. These are refund and credit claims made by
corporations or individuals who do not normally file excise tax returns
but are entitled to claim excise tax related credits on their corporate or
personal income tax returns. 16 IRS must subsequently reclassify these
credit claims to properly reflect them as excise tax credits. IRS refers
to these reclassifications as the excise tax refund/ credit certification.
IRS compiles the certification based on information from submission
processing campus 17 systems. IRS submits refund/ credit certification
letters to BPD, which uses them to prepare adjustments to reduce
distributions to trust funds.

16 Petroleum producers, who usually are assessed fuel excise taxes and pay
them to IRS, pass on these taxes to consumers in the form of higher
prices. Consumers who use the fuel for a tax- exempt purpose, such as
farming, can claim a credit for the excise taxes on their personal or
corporate income tax return.

17 IRS has 10 submission processing campuses, which receive and process
tax returns.

GAO- 03- 687R IRS Excise Tax Management Report Page 8

Objectives, Scope, and Methodology

The objective of the agreed- upon procedures work was to assist the
Transportation IG in ascertaining whether the net excise tax collections
and excise tax certifications reported by IRS for the fiscal year ended
September 30, 2002, were supported by the underlying records. The
objectives of this report are to (1) discuss the underlying internal
control issues that allowed errors identified in the agreed- upon
procedures work to occur, (2) discuss timing issues that have the
potential to affect the accuracy of excise tax distributions, and (3)
provide recommendations for effectively addressing these issues.

We conducted our work primarily from March 2002 through January 2003, with
some follow- up work through April 2003, in accordance with U. S.
generally accepted government auditing standards. We requested comments on
a draft of this report from the Commissioner of IRS. We received written
comments from the Deputy Commissioner for Operations Support and have
reprinted the comments in enclosure I of this report. Further details on
our scope and methodology are contained in enclosure II of this report.

Data Entry Errors Continue to Go Undetected

In conducting the agreed- upon procedures review for fiscal year 2002, we
found that IRS made data entry errors affecting the accuracy of taxpayer
account information in IRS*s master file, and that these errors were not
detected by existing review procedures. The lack of effective review
procedures over the entry of excise tax data increases the risk that
erroneous information will be used to prepare the quarterly excise tax
certifications, resulting in incorrect distributions to trust funds.

GAO*s Standards for Internal Control in the Federal Government requires
agencies to implement internal control procedures to ensure the accurate
and timely recording of transactions and events. 18 It also states that
internal controls should be designed to ensure that ongoing monitoring
occurs in the course of normal operations.

In a previous review, 19 we reported weaknesses in IRS*s procedures for
detecting data entry errors related to information reported on Form 720
excise tax returns. We recommended that IRS establish review procedures to
ensure the accuracy of excise tax information entered into the master
file. In response, IRS established post- input review procedures for
excise tax returns that report a tax liability of $1 million or more to
verify that information on the returns matches data entered into the
master

file. However, IRS does not have comparable procedures for reviewing
excise tax 18 U. S. General Accounting Office, Standards for Internal
Control in the Federal Government,

GAO/ AIMD- 00- 21. 3. 1 (Washington, D. C.: November 1999). 19 U. S.
General Accounting Office, Excise Taxes: Internal Control Weaknesses
Affect Accuracy of

Distributions to the Trust Funds, GAO/ AIMD- 99- 17 (Washington D. C.:
Nov. 9, 1998).

GAO- 03- 687R IRS Excise Tax Management Report Page 9 data entered using
another excise tax related form, Form 8849, Claim for Refund of

Excise Taxes. 20 On January 1, 2002, IRS implemented new procedures for
recording excise tax refunds and credits claimed by taxpayers. As part of
this change, IRS established a new set of credit reference numbers to
identify the type of excise tax refund or credit within a taxpayer*s
master file account. For example, a claim for a $200,000 refund on
gasoline tax would be recorded as $200,000 to credit reference number 362.
Under IRS*s prior procedures, it would have recorded this refund as a
negative $200,000 under the abstract number 62. This new procedure
affected how IRS recorded and summarized credit information necessary for
excise tax certifications, but did not change how the credits should
affect the taxpayer*s ultimate excise tax liability.

However, in testing a statistical sample of excise tax collections from
the first 6 months of fiscal year 2002, we identified 17 instances in
which IRS personnel entered the credit information into the taxpayer*s
master file account using both the old and new method, which resulted in
IRS counting these credits twice in the certification process. We estimate
that the net most likely error associated with counting credits twice is
an understatement of $14.1 million, but the understatement could be as
high as $198.2 million. Although we projected the effect of these errors
on the population of items tested, we are not able to project the effect
on the certification results because of the additional procedures IRS
performs on the data to derive certified amounts. However, the effect of
double- counting credits resulted in distributing smaller amounts to the
Highway Trust Fund than should have been distributed for the quarters
ended December 31, 2001, and March 31, 2002.

Although IRS ultimately detected and corrected these errors, they were
detected months later by personnel at IRS headquarters and not by
reviewers at IRS*s Cincinnati Compliance Campus. According to IRS, the
errors were attributable to one individual in the Cincinnati Compliance
Campus*s Excise Tax Unit who did not fully comprehend the new procedures.
We found that IRS did not have effective controls in its Cincinnati Excise
Tax Unit to timely detect and correct such data entry errors. Some of
these errors went uncorrected for 5 months or longer, and the corrections
were not fully reflected until IRS completed its certification to the
Highway Trust Fund for the quarter ending June 30, 2002. Thus, for the
quarters ended December 31, 2001, and March 31, 2002, these errors
resulted in amounts IRS certified to the Highway Trust Fund being
understated. Because IRS made these corrections in time for their
inclusion on the final certification reflected in the trust fund*s fiscal
year- end financial statements, there was no net effect on distributions
to the Highway Trust Fund for fiscal year 2002. Had these errors occurred
later in the year, IRS would not have had the time to make corrections,
and the amount of excise taxes distributed to the Highway Trust Fund would
have been less than they should have been for fiscal year 2002.

20 Taxpayers use the Form 8849 to claim certain fuel- related refunds,
such as nontaxable uses or tax paid on the resale of fuel previously
taxed.

GAO- 03- 687R IRS Excise Tax Management Report Page 10 Having effective
procedures to timely detect and correct data entry errors is essential

to maintaining accurate excise tax information in IRS*s master file. Since
the excise tax data from IRS*s master file serve as the basis for its
certification of receipts to trust funds, the lack of these procedures
could lead to erroneous excise tax data in IRS*s master file, resulting in
inaccurate certifications and distributions to trust funds.

Recommendation We recommend that you direct IRS management to develop and
implement post- input review procedures to verify the accuracy of excise
tax credit information in the master file. In establishing these
procedures, IRS could consider establishing a dollar threshold, similar to
the threshold it established for its reviews of excise tax assessment
information on the Form 720 excise tax returns, that would trigger
postinput verification of excise tax credit information.

IRS*s Comments and Our Evaluation IRS agreed with our recommendation. In
its response, IRS stated that it was working with the Cincinnati
Compliance Campus to develop and implement post- input review procedures
to verify the accuracy of excise tax credit information posted to the
master file. We will evaluate the effectiveness of IRS*s efforts in
conjunction with our fiscal year 2003 agreed- upon procedures review.

Excise Tax Certification Errors Continue to Go Undetected

In conducting the agreed- upon procedures review for fiscal year 2002, we
identified errors on IRS*s excise tax certifications that were not
detected by supervisory review. The lack of effective supervisory review
increases the risk that errors will be made in the preparation of excise
tax certifications and that such errors will not be detected on a timely
basis, resulting in incorrect excise tax distributions to the trust funds.

GAO*s Standards for Internal Control in the Federal Government requires
agencies to implement internal control procedures to ensure the accurate
and timely recording of transactions and events. In addition, Standards
for Internal Control in the Federal Government requires that qualified and
continual supervision be provided to ensure that internal control
objectives are achieved.

As discussed previously, IRS relies on a combination of manual and
automated procedures to prepare its excise tax certifications. This
process is very complex, cumbersome, and prone to error. In prior reviews,
21 we reported weaknesses in IRS*s controls over its certification
process. At that time, we recommended that IRS (1) develop, document, and
implement detailed written procedures for summarizing data used to prepare
trust fund certifications, (2) establish procedures requiring IRS
personnel to review distribution rates provided by OTA before those rates
are used in the certification, and (3) implement review procedures over
its process for

21 GAO/ AIMD- 99- 17 and U. S. General Accounting Office, Internal Revenue
Service: Recommendations to Improve Financial and Operational Management,
GA0- 01- 42 (Washington D. C.: Nov. 17, 2000).

GAO- 03- 687R IRS Excise Tax Management Report Page 11 summarizing data
used in its certifications. In response to our prior

recommendations, IRS created a checklist to guide reviewers and document
the review of the certification results. In addition, IRS finalized
written procedures for its certification process in November 2002.

Although the checklist assists IRS reviewers in identifying simple
mathematical errors, we continued to find logical and analytical errors in
fiscal year 2002 that were not detected by supervisory review. For
example, a report used by an IRS analyst to prepare the refund
certification for the quarter ended December 31, 2001, contained erroneous
amounts for gasohol and bus diesel fuel tax refunds. As a result, IRS
overstated its refund certification for the Highway Trust Fund for the
quarter by approximately $81 million. We readily identified the error
because the reported amounts for one of these taxes varied significantly
from previous quarters. Nevertheless, IRS did not detect the error even
though the certification results passed through multiple levels of review.
Had IRS not made a correction after we brought the matter to its
attention, distributions to the Highway Trust Fund would have been
approximately $81 million less than they should have been in fiscal year
2002.

In another instance, we discovered that IRS reported refund amounts as
credits and credit amounts as refunds on its refund/ credit certification
letters for both the Highway Trust Fund and the Airport and Airway Trust
Fund for the quarter ended September 30, 2002. Generally, IRS- certified
refunds for the Highway Trust Fund are one and a half times as large as
the certified credits for the fund. To have a situation where the opposite
occurred should have alerted the reviewer to a potential error. Although
we readily identified the errors during our review of the schedule
accompanying the certification letter, IRS did not detect the errors
through its review process. These errors did not affect the accuracy of
the distributions to the Highway Trust Fund or the Airport and Airway
Trust Fund in fiscal year 2002 because BPD adjusts trust fund
distributions using the combined amount of refunds and credits. However,
this is an example of a logical error that was not detected by IRS
reviews.

We had identified similar problems in our fiscal year 2001 review.
Specifically, IRS also reported refunds as credits and credits as refunds
on its refund/ credit certification for the quarter ended March 31, 2001.
Also, in our fiscal year 2001 review, we found that IRS used the wrong
excise tax and distribution rates for 10 percent gasohol on its Highway
Trust Fund receipt certification for the quarter ended March 31, 2001. The
IRS analyst used the excise tax and distribution rate table that was in
effect on December 22, 2000, rather than the rate table that became
effective on January 1, 2001. Consequently, IRS misstated certified
collections to both the Highway Account and the Mass Transit Account of
the Highway Trust Fund, resulting in about $1 million less being
distributed to the Highway Trust Fund.

In response to our finding that it had reversed reported refund and credit
amounts in 2002, IRS added another step to the review checklist to prevent
this error. However, while the checklist can assist reviewers in verifying
certification results, it cannot substitute for an in- depth understanding
of the certification process. For example, although the checklist contains
a specific procedure to verify that the analyst used the correct tax and
distribution rate for each type of taxable good or service (e. g., for

GAO- 03- 687R IRS Excise Tax Management Report Page 12 gasohol), it does
not assist a reviewer in determining whether the analyst used the

correct rate table (e. g., for the correct time period). Adding another
step to the checklist each time a new problem surfaces will not ensure
that proper reviews of the certification results are conducted.

While we do not specifically know why IRS*s supervisory review procedures
failed to detect these errors, we did note a lack of consistency in the
supervisory review responsibility. Specifically, during fiscal year 2002,
four different officials were responsible for reviewing the
certifications. A comprehensive understanding of IRS*s

certification process is essential to detecting logical and analytical
errors made by analysts. Absent this understanding, officials responsible
for reviewing excise tax certifications may continue to lack the ability
to perform an effective review of the certifications. Given the errors we
continue to find in our review of IRS*s certification process and their
potential to significantly affect the accuracy of the associated
distributions to trust funds, more needs to be done to ensure that
supervisory reviews over the certifications are effective.

Recommendations We recommend that you direct IRS management to

investigate why certification errors continue to go undetected through
IRS*s review procedures and

develop and implement an action plan to improve the certification review
process. IRS*s Comments and Our Evaluation IRS agreed with our
recommendations. In its response, IRS stated that it has a new

management team in place to review the current excise tax certification
process and to develop an action plan for improving the certification
reviews. We will evaluate the effectiveness of IRS*s efforts in
conjunction with our fiscal year 2003 agreed- upon procedures review.

Changes to Certification Process Were Not Effectively Coordinated

As discussed earlier, the collection, distribution, and certification of
excise tax revenues to trust funds are performed by four component
entities within Treasury*- OTA, FMS, BPD, and IRS. Coordination among
these entities is essential to ensure the proper distribution of excise
tax revenue to trust funds. In a prior review, we reported a deficiency in
IRS*s procedures for using OTA information in its certification process.
Specifically, we reported that IRS used tax and distribution rates from
OTA without first verifying their accuracy. 22 In response, IRS
established an informal working group within Treasury specifically to
discuss and coordinate issues related to trust fund tax revenue
distributions. However, in conducting our

22 GAO/ AIMD- 99- 17.

GAO- 03- 687R IRS Excise Tax Management Report Page 13 agreed- upon
procedures review for fiscal year 2002, we noted that effective

coordination was not always achieved. As we previously discussed, IRS, as
part of its receipt certification process in prior years, deducted credits
claimed by taxpayers from their excise tax liability before applying their
payments to the liability amount. Thus, IRS- certified excise tax receipts
were reduced by credit claims. However, IRS believed that the information
would be more useful, both internally and to the Department of
Transportation, if it summarized and reported these credits separately
rather then applying them against the tax liability amount. Therefore, in
fiscal year 2002, IRS developed changes to the way it records credit
information in its computer systems, as well as to the way it accounts for
and reports this information in its certifications.

On January 1, 2002, IRS implemented these procedural and system changes to
its method for recording and summarizing excise tax credits, including
changes to its procedures for recording taxpayer refund claims submitted
on Form 8849. Although IRS officials told us that they had notified the
Treasury working group of the planned changes, this notification was not
documented in the form of a letter, memorandum, or minutes to the Treasury
working group meeting. Further, IRS did not obtain written affirmation
from FMS or BPD that these entities understood the effect these changes
would have on the information reported to them. In fact, FMS and BPD were
unable to use the revised form of certification information to make
necessary adjustments to the trust fund distributions. Consequently, IRS
had to add steps to its certification process to revert to its previous
reporting format in order to make its certification data usable to these
entities. As a result, IRS further complicated its already complex
certification process. Although we did not identify any certification
errors directly attributable to the changes in procedure, the added
complexity increases the likelihood that errors could be made and go
undetected by IRS*s current review procedures.

Recommendation We recommend that you direct IRS management to communicate
in writing any potential changes in IRS*s certification process to other
Treasury entities that use the certification information, and to obtain
concurrence from these entities prior to implementing such changes.

IRS*s Comments and Our Evaluation IRS agreed with our recommendation. In
its response, IRS stated that it plans to provide documented
recommendations to the excise tax working group for potential changes to
the certification process. We will evaluate the effectiveness of IRS*s
actions in conjunction with our fiscal year 2003 agreed- upon procedures
review.

GAO- 03- 687R IRS Excise Tax Management Report Page 14

Certification Time Frame Will Not Accommodate Accelerated Reporting

As discussed previously, under IRS*s current certification process, IRS
certifies collections for each quarter about 5 and one- half months after
the quarter ends. As a result of this delay, excise tax receipts for the
fourth quarter of fiscal year 2002, which ended September 30, 2002, were
not certified until March 2003. Consequently, adjustments to initial
distributions of excise tax receipts for the fourth quarter that were
based on IRS*s certification were not recorded in time to be reflected in
the trust funds* financial statements for fiscal year 2002, which OMB
required to be issued by February 1, 2003.

Beginning with agencies* fiscal year 2004 performance and accountability
reports, OMB will require the issuance of these reports, including the
agencies* audited financial statements, by November 15. To prepare for
this, the Department of Transportation is planning to accelerate its
fiscal year 2003 reporting date to December 2003. This accelerated
reporting date will exacerbate the effects of the lag between the
collection of excise tax receipts and their subsequent certification by
IRS. As a result, under the current certification time frame, IRS*s
certification for the third quarter, historically completed in December,
would not be completed in time for any adjustments to the initial
distribution to the trust funds to be made and reflected on the trust
funds* financial statements for fiscal year 2003. Because the
certification of fourth quarter excise tax receipts also would not be
completed prior to the issuance of the financial statements, this means
that 6 months of excise tax distributions reported in the trust funds*
financial statements would not have been certified by IRS, increasing the
potential for significantly inaccurate distributions.

We believe the opportunity exists for IRS to accelerate the timing of its
excise tax receipt certifications. IRS has indicated that it needs the 5
and one- half month period between the end of a quarter and completion of
the certification to allow for submission and processing of returns and
for recording, reviewing, and analyzing payment and tax return data.
However, our review of IRS*s certification data for 4 quarters 23 shows
IRS has historically received and recorded at least 90 percent of the Form
720 excise tax returns related to the Highway Trust Fund and the Airport
and Airway Trust Fund 2 months prior to its cutoff for initiating the
certification. Our analysis further shows that fewer than 100 of the
largest payers of excise taxes* those with liabilities of $10 million or
more per quarter* account for over 91 percent of certified receipts to the
Highway Trust Fund and over 85 percent of certified receipts to the
Airport and Airway Trust Fund.

The combination of (1) excise taxes reported in tax returns with liability
amounts below $10 million that are received and recorded by IRS 2 months
prior to its certification cutoff and (2) excise taxes reported in tax
returns with liability amounts

23 We reviewed data from IRS*s Collection Certification System and master
file from the quarters ended June 30, 2001, September 30, 2001, December
31, 2001, and March 31, 2002. IRS had made these data available to us for
our fiscal years 2002 and 2001 agreed- upon procedures reviews and IRS
financial

statement audits.

GAO- 03- 687R IRS Excise Tax Management Report Page 15 of $10 million or
more accounts for more than 96 percent of the taxes IRS certified to

both the Highway Trust Fund and the Airport and Airway Trust Fund for
those quarters. Therefore, IRS could accelerate the timing of its
certifications of excise tax receipts to the Highway Trust Fund and the
Airport and Airway Trust Fund by at least 2 months by implementing
procedures to ensure that it has timely received and recorded tax returns
from the largest payers of excise taxes.

In each of the 4 quarters we reviewed, IRS data indicate that it has
generally received over 70 percent of the large returns 2 weeks after the
return due date. By taking a more proactive approach* tracking the status
of these taxpayers* returns, following up with those who have not filed
timely to encourage filing, and ensuring prompt processing of large
returns* we believe IRS should be able to accelerate completion of its
certification of excise tax receipts without significantly increasing the
potential for large amounts of quarterly receipts to go uncertified.
Unless IRS establishes procedures to allow it to significantly accelerate
its

certification of excise tax revenues to trust funds, the amount of annual
excise tax revenues reported by the Department of Transportation for the
Highway Trust Fund and the Airport and Airway Trust Fund for fiscal year
2003 and beyond will include 6 months of excise tax revenue distributions
based on estimates. To the extent these estimates differ significantly
from the actual amounts that should have been distributed to the trust
funds, the result could be both significantly inaccurate distributions
and, in the case of the Highway Trust Fund, incorrect allocations of
revenues to states. 24 Recommendations To enable IRS to accelerate its
excise tax receipt certification process, we

recommend that you direct IRS management to implement procedures to
proactively ensure the timely receipt and recording of the largest excise
tax returns. Specifically, IRS management should develop and implement
procedures at the Cincinnati Campus to

annually identify excise taxpayers with the largest excise tax liabilities
affecting the Highway Trust Fund and the Airport and Airway Trust Fund. In
identifying these taxpayers, IRS should consider the potential effect on
trust fund distributions if one or more of these taxpayers* returns were
omitted from its certification;

track the status of tax return filings for the largest payers of excise
taxes and contact these taxpayers if the submission processing campus has
not received their tax returns by 2 weeks after the due date; and

24 The Transportation Equity Act for the 21 st Century, Pub. L. No. 105-
178, 112 Stat. 107 (1998) enhanced the link between the amount of funds
received by states and the amount of tax receipts credited to the Highway
Trust Fund by requiring that highway program funds be distributed to
states on the basis of

annual highway account receipts.

GAO- 03- 687R IRS Excise Tax Management Report Page 16

monitor the receipt and processing status of these large returns to ensure
that they are promptly recorded in IRS*s master file prior to certifying
excise tax distributions.

IRS*s Comments and Our Evaluation IRS agreed with this issue and indicated
that it is taking action to address our findings. In its response, IRS
stated that it would identify and provide a list of the top 100 excise
taxpayers to the Cincinnati Submission Processing and Compliance Campuses
for the identification and expedited processing of these taxpayers*
returns. Additionally, IRS stated it was working with the Cincinnati
Compliance Campus to implement additional monitoring of the top 100 excise
taxpayers to ensure timely receipt of excise tax returns and will conduct
an analysis of these taxpayers* receipt pattern to support modifying IRS*s
current timeline for contacting the taxpayers for submission of their
returns.

While IRS does not plan to accelerate its certification of excise tax
receipts to trust funds for the third quarter of fiscal year 2003, it
stated that it would conduct *mock* nonpublished certifications to
determine the impact of an accelerated 4- month certification on all trust
funds. In our discussions with IRS officials, they have stated that IRS
plans to share this information with the Department of Transportation*s
auditors so that they can determine the extent to which adjustments may be
required to reported excise tax revenues on the trust funds* fiscal year
2003 financial statements. We will evaluate IRS*s actions in conjunction
with our fiscal year 2003 agreed- upon procedures review.

- - - - - 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
statement to the Senate Committee on Governmental Affairs and the House
Committee on Government Reform within 60 days after the date of this
report. 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 report.

This report is intended for use by the management of IRS. We are sending
copies to the Chairmen and Ranking Minority Members of the Senate
Committee on Appropriations; Senate Committee on Finance; Senate Committee
on Governmental Affairs; Senate Committee on the Budget; Subcommittee on
Transportation, Treasury and General Government, Senate Committee on
Appropriations; Subcommittee on Taxation and IRS Oversight, Senate
Committee on Finance; and the Subcommittee on Oversight of Government
Management, the Federal Workforce, and the District of Columbia, Senate
Committee on Government Affairs. We are also sending copies to the
Chairmen and Ranking Minority Members of the House Committee on
Appropriations; House Committee on Ways and Means; House Committee on
Government Reform; House Committee on the Budget; Subcommittee on
Transportation, Treasury, and Independent Agencies, House Committee on

GAO- 03- 687R IRS Excise Tax Management Report Page 17 Appropriations;
Subcommittee on Government Efficiency and Financial Management,

House Committee on Government Reform; and the Subcommittee on Oversight,
House Committee on Ways and Means. In addition, we are sending copies of
this report to the Chairman and Vice Chairman of the Joint Committee on
Taxation, the Director of the Office of Management and Budget, the
Secretary of the Treasury, the Secretary of Transportation, and the
Inspector General of the Department of Transportation. Copies will be made
available to others upon request. The report is also available at no
charge on GAO*s Internet site, at http:// www. gao. gov.

We acknowledge and appreciate the cooperation and assistance provided by
IRS officials and staff during our fiscal year 2002 review. If you have
any questions or need assistance in addressing these matters, please
contact Charles Payton, Assistant Director, at (213) 830- 1084.

Sincerely yours, Steven J. Sebastian Director Financial Management and
Assurance

GAO- 03- 687R IRS Excise Tax Management Report Page 18

Enclosure I Comments from the Internal Revenue Service

GAO- 03- 687R IRS Excise Tax Management Report Page 19

GAO- 03- 687R IRS Excise Tax Management Report Page 20

GAO- 03- 687R IRS Excise Tax Management Report Page 21

Enclosure II Objectives, Scope, and Methodology

The objective of the agreed- upon procedures work was to assist the
Inspector General of the Department of Transportation in ascertaining
whether the net excise tax collections and excise tax certifications
reported by IRS for the fiscal year ended September 30, 2002, 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.

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 (1) discuss the underlying
internal control issues that allowed errors identified in the agreed- upon
procedures work to occur, (2) discuss timing issues that have the
potential to affect the accuracy of excise tax distributions, and (3)
provide recommendations for effectively addressing these issues.

To accomplish our objectives, we examined, on a test basis, evidence
supporting the net excise tax collection amounts related to the Highway
Trust Fund and the Airport and Airway Trust Fund reported in the
Collection Certification System. We used dollar unit sampling to select a
sample of 94 prorated Highway Trust Fund related excise tax collections
from the audit files 25 for the first 6 months of fiscal year 2002, using
a confidence level of 80 percent, a test materiality of $315 million, and
an expected error amount of $94.5 million.

We selected a sample of 62 prorated Airport and Airway Trust Fund related
excise tax collections from the audit files for the first 6 months of
fiscal year 2002, using a confidence level of 80 percent, a test
materiality of $91 million, and an expected error amount of $27.3 million.

For each prorated excise tax collection sampled, we

checked to see that the assessment amount on the tax return for the
sampled abstract agreed with the amount recorded in IRS*s master file,
checked the mathematical accuracy of the taxpayers* calculations on the
tax

returns for the related abstract, and

recomputed the prorated collection amount based on information from the
master file and compared this amount to the sample items selected from the
Collection Certification System audit file.

We also performed detailed testing on the population of collections not
designated as related to the Highway Trust Fund or the Airport and Airway
Trust Fund to determine

25 The Collection Certification System produces what IRS refers to as
*audit files.* These audit files contain the individual prorated
collections, by abstract and taxpayer identification number, that make up
the certified total amounts for each abstract.

GAO- 03- 687R IRS Excise Tax Management Report Page 22 if they contained
any Highway Trust Fund or Airport and Airway Trust Fund excise

tax collections. Further, we performed the following procedures on IRS*s
certifications:

We verified the mathematical accuracy of the totals on the certification
letters for the Highway Trust Fund and Airport and Airway Trust Fund.

We traced certified amounts for selected excise taxes from the
certification letters through summary schedules to the supporting reports.

To determine the percentages of amounts certified to the Highway Trust
Fund and Airport and Airway Trust Fund that are accounted for by excise
tax returns with liabilities of $10 million or more and the amounts from
other excise tax returns received and recorded in IRS*s master file 2
months earlier than the certification cutoff, we analyzed IRS*s Collection
Certification System and master file data. IRS made these sources
available to us for our fiscal years 2002 and 2001 agreed- upon procedures
reviews and fiscal years 2002 and 2001 IRS financial statements audits.
These included the audit support files from the quarters ended June 30,
2001, September 30, 2001, December 31, 2001, and March 31, 2002. Using
these data, we

identified excise tax returns by tax period and categorized excise taxes
for the tax returns identified that related to the Highway Trust Fund and
the Airport and Airway Trust Fund using data from IRS*s audit support
file, and

summed the amounts related to the Highway Trust Fund and the Airport and
Airway Trust Fund for all tax returns with tax liabilities of $10 million
or more and amounts related to tax returns with liabilities below $10
million that had been recorded in IRS*s master file 2 months earlier than
the certification date.

We conducted our work primarily from March 2002 through January 2003, with
some follow- up work through April 2003, in accordance with U. S.
generally accepted government auditing standards.

We requested comments on a draft of this report from the Commissioner of
IRS. We received written comments from the Deputy Commissioner for
Operations Support.

GAO- 03- 687R IRS Excise Tax Management Report Page 23

Enclosure III GAO Contacts and Staff Acknowledgments

GAO Contacts Charles E. Payton, (213) 830- 1084 Ted Hu, (213) 830- 1108
Acknowledgments Staff making key contributions to this report were David
Elder, Gail Luna, Esther

Tepper, Julia Matta, and Sharon Byrd. (196005)

GAO s Mission The General Accounting Office, the audit, evaluation and
investigative arm of Congress, exists to support Congress in meeting its
constitutional

responsibilities and to help improve the performance and accountability of
the federal government for the American people. GAO examines the use of
public funds; evaluates federal programs and policies; and provides
analyses, recommendations, and other assistance to help Congress make
informed oversight, policy, and funding decisions. GAO s commitment to
good government is reflected in its core values of accountability,
integrity, and reliability. The fastest and easiest way to obtain copies
of GAO documents at no cost is

through the Internet. GAO s Web site ( www. gao. gov) contains abstracts
and full- text files of current reports and testimony and an expanding
archive of older products. The Web site features a search engine to help
you locate documents using key words and phrases. You can print these
documents in their entirety,

including charts and other graphics. Each day, GAO issues a list of newly
released reports, testimony, and correspondence. GAO posts this list,
known as Today s Reports, on its Web site daily. The list contains links
to the full- text document files. To have GAO e- mail this list to you
every afternoon, go to www. gao. gov and select Subscribe to e- mail
alerts under the Order GAO Products heading.

The first copy of each printed report is free. Additional copies are $ 2
each. A check or money order should be made out to the Superintendent of
Documents. GAO also accepts VISA and Mastercard. Orders for 100 or more
copies mailed to a single address are discounted 25 percent. Orders should
be sent to:

U. S. General Accounting Office 441 G Street NW, Room LM Washington, D. C.
20548

To order by Phone: Voice: ( 202) 512- 6000 TDD: ( 202) 512- 2537 Fax: (
202) 512- 6061

Contact: Web site: www. gao. gov/ fraudnet/ fraudnet. htm E- mail:
fraudnet@ gao. gov Automated answering system: ( 800) 424- 5454 or ( 202)
512- 7470 Jeff Nelligan, Managing Director, NelliganJ@ gao. gov ( 202)
512- 4800 U. S. General Accounting Office, 441 G Street NW, Room 7149
Washington, D. C. 20548 Obtaining Copies of

GAO Reports and Testimony Order by Mail or Phone To Report Fraud, Waste,
and Abuse in Federal Programs Public Affairs

This is a work of the U. S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. However, because this
work may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this material
separately.
*** End of document. ***