Financial Audit: IRS's Fiscal Years 2007 and 2006 Financial	 
Statement Audits (09-NOV-07, GAO-08-166).			 
                                                                 
Because of the significance of Internal Revenue Service (IRS)	 
collections to overall federal receipts and, in turn, to the	 
consolidated financial statements of the U.S. government, which  
GAO is required to audit, and Congress's interest in financial	 
management at IRS, GAO audits IRS's financial statements annually
to determine whether (1) the financial statements are reliable,  
and (2) IRS management maintained effective internal controls.	 
GAO also tests IRS's compliance with selected provisions of	 
significant laws and regulations and its financial systems'	 
compliance with the Federal Financial Management Improvement Act 
of 1996 (FFMIA).						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-08-166 					        
    ACCNO:   A78092						        
  TITLE:     Financial Audit: IRS's Fiscal Years 2007 and 2006	      
Financial Statement Audits					 
     DATE:   11/09/2007 
  SUBJECT:   Accountability					 
	     Audit reports					 
	     Financial management				 
	     Financial management systems			 
	     Financial statement audits 			 
	     Information security				 
	     Internal controls					 
	     Noncompliance					 
	     Reporting requirements				 
	     GAO High Risk Series				 

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GAO-08-166

   

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U.S. Government Accountability Office: 
GAO: 

Report to the Secretary of the Treasury: 

November 2007: 

Financial Audit: 

IRS's Fiscal Years 2007 and 2006 Financial Statements: 

GAO-08-166: 

GAO Highlights: 

Highlights of GAO-08-166, a report to the Secretary of the Treasury. 

Why GAO Did This Study: 

Because of the significance of Internal Revenue Service (IRS) 
collections to overall federal receipts and, in turn, to the 
consolidated financial statements of the U.S. government, which GAO is 
required to audit, and Congressï¿½s interest in financial management at 
IRS, GAO audits IRSï¿½s financial statements annually to determine 
whether (1) the financial statements are reliable, and (2) IRS 
management maintained effective internal controls. GAO also tests IRSï¿½s 
compliance with selected provisions of significant laws and regulations 
and its financial systemsï¿½ compliance with the Federal Financial 
Management Improvement Act of 1996 (FFMIA). 

What GAO Found: 

In GAOï¿½s opinion, IRSï¿½s fiscal years 2007 and 2006 financial statements 
are fairly presented in all material respects. However, serious 
internal control and financial management systems deficiencies 
continued to make it necessary for IRS to rely on resource-intensive 
compensating processes to prepare its financial statements. Because of 
these and other deficiencies, IRS did not, in GAOï¿½s opinion, maintain 
effective internal controls over financial reporting (including 
safeguarding of assets) or compliance with laws and regulations, and 
thus did not provide reasonable assurance that losses, misstatements, 
and noncompliance with laws and regulations material in relation to the 
financial statements would be prevented or detected on a timely basis. 

IRS has continued to make significant strides in addressing its 
financial management challenges and has substantially mitigated several 
material weaknesses in its internal controls. For example, IRS (1) 
enhanced its reporting of tax receipts and accelerated its 
certification of excise tax receipts to recipient trust funds, (2) 
issued its first cost accounting policy to serve as guidance for 
costing its services and activities, (3) enhanced its use of available 
information to better target collection efforts on outstanding tax debt 
and reduce the risk of improper refund disbursements, and (4) made 
progress in establishing the framework for implementing a subsidiary 
ledger for its tax administration activities. However, IRSï¿½s ability to 
fully address its remaining financial management issues largely depends 
on addressing the limitations of its automated systems used to process 
tax-related activities. IRS has also not determined how to apply the 
cost information that resides in its core general ledger system for non-
tax activities to the activities processed by its separate tax 
processing systems. Thus, it is unclear how or when these issues will 
be resolved. GAO continues to consider issues related to IRSï¿½s controls 
over financial reporting, management of unpaid assessments, collection 
of revenue and issuance of tax refunds, and information security to be 
material weaknesses. Additionally, while IRS continued to make progress 
in addressing weaknesses in controls over hard-copy taxpayer receipts 
and data, GAO concluded that remaining issues related to this activity 
constituted a significant deficiency. Also, GAO found that IRS was not 
always in compliance with the law concerning the timely release of tax 
liens. 

IRS management faces serious challenges from its continued use of 
obsolete financial management systems that do not conform to the 
requirements of FFMIA. These challenges adversely affect IRSï¿½s ability 
to fulfill its responsibilities as the nationï¿½s tax collector because 
it is unable to routinely obtain comprehensive, timely, accurate, and 
useful information for day-to-day decision making. In addition, as IRS 
continues to progress toward ever more automated financial management 
processes, the presence of material weaknesses in controls over these 
systems, especially in the area of information security, could have 
serious implications for our ability to determine whether IRSï¿½s 
financial statements are fairly stated. 

What GAO Recommends: 

Based on prior audits, GAO made numerous recommendations to IRS to 
address the internal control and compliance issues that persisted 
during fiscal year 2007. GAO will continue to monitor IRSï¿½s progress in 
implementing the 144 recommendations that remain open as of the date of 
this report, of which 69 relate to the material weakness in information 
security. 

IRS agreed with the reportï¿½s findings and noted that it fairly 
presented IRSï¿½s progress and challenges. IRS noted that improving 
information security continues to be a priority, and that it has a 
solid management team in place to address remaining financial 
management challenges. 

For a fuller understanding of GAOï¿½s opinion on IRS's fiscal years 2007 
and 2006 financial statements, readers should refer to the complete 
audit report, available by clicking on [hyperlink, http://www.GAO-08-
166], which includes information on audit objectives, scope, and 
methodology. For more information, contact Steven J. Sebastian, (202) 
512-3406, [email protected]. 

[End of section] 

Contents: 

Letter: 

Auditor's Report: 

Opinion on IRS's Financial Statements: 

Opinion on Internal Controls: 

Compliance with Laws and Regulations: 

Systems Compliance with the Requirements of FFMIA: 

Consistency of Other Information: 

Objectives, Scope, and Methodology: 

Agency Comments and Our Evaluation: 

Management Discussion and Analysis: 

Financial Statements: 

Balance Sheets: 

Statements of Net Cost: 

Statements of Changes in Net Position: 

Statements of Budgetary Resources: 

Statements of Custodial Activity: 

Notes to the Financial Statements: 

Required Supplementary Information: 

Other Accompanying Information: 

Appendixes: 

Appendix I: Material Weaknesses, Significant Deficiency, and Compliance 
Issues: 

Material Weaknesses: 

Significant Deficiency: 

Compliance Issues: 

Appendix II: Details on Audit Methodology: 

Appendix III: Comments from the Internal Revenue Service: 

[End of section] 

Comptroller General of the United States: 
United States Government Accountability Office: 
Washington, DC 20548: 

November 9, 2007: 

The Honorable Henry M. Paulson, Jr.: 
The Secretary of the Treasury: 

Dear Mr. Secretary: 

The accompanying report presents the results of our audits of the 
financial statements of the Internal Revenue Service (IRS) as of, and 
for the fiscal years ending, September 30, 2007, and 2006. We performed 
our audits in accordance with the Chief Financial Officers (CFO) Act of 
1990, as expanded by the Government Management Reform Act of 1994. This 
report contains our (1) unqualified opinions on IRS's financial 
statements, (2) opinion that IRS's internal controls were not effective 
as of September 30, 2007, (3) conclusion that IRS did not comply with 
one provision of the laws and regulations we tested, and (4) conclusion 
that IRS's financial management systems were not in substantial 
compliance with the requirements of the Federal Financial Management 
Improvement Act of 1996 as of September 30, 2007. 

Our unqualified opinions on IRS's fiscal years 2007 and 2006 financial 
statements were made possible in part by the continued extraordinary 
efforts of IRS senior management and staff to compensate for serious 
internal control and financial management systems deficiencies. IRS is 
currently in the midst of a major business systems modernization that 
is ultimately intended to resolve its most serious financial systems 
challenges. However, it is unclear when this effort will be completed 
or if it will be fully successful. In the interim, preparing reliable 
financial statements will continue to be a difficult challenge for IRS, 
requiring continued reliance on extraordinary compensating measures. To 
date, these measures have proved successful: for the eighth consecutive 
year, we have been able to render an unqualified opinion on IRS's 
financial statements. 

IRS has made great strides over the last several years in addressing 
its financial management challenges and has resolved or substantially 
mitigated several material weaknesses and other less significant 
weaknesses in its internal controls. This progress continued in fiscal 
year 2007. For example, during fiscal year 2007, IRS accelerated the 
certification of excise tax receipts, thereby improving the timeliness 
of distributions of such taxes to recipient trust funds. IRS also has 
begun presenting estimates of its Social Security and Medicare tax 
collections in other information accompanying its financial statements, 
and presenting the most recent available information on the amount of 
excise tax receipts certified to the Airport and Airways, Black Lung 
Disability, and Highway Trust Funds in its Management Discussion and 
Analysis. These actions enhanced the quality and disclosure of the 
information presented to financial statement users, and enabled us to 
conclude that these reporting issues no longer constitute internal 
control deficiencies. IRS also made notable progress in using existing 
management information to enable it to make more informed decisions 
regarding collection of unpaid taxes and payment of refunds. However, 
IRS has not yet developed the agencywide cost-benefit information 
needed to assist in determining the optimum level of resources to 
devote to maximizing collections of unpaid taxes and minimizing 
payments of improper tax refunds in the context of its overall mission 
and responsibilities, or to develop related cost-based performance 
measures to assist in monitoring progress and adjusting strategies to 
better address areas of noncompliance. IRS developed a cost accounting 
policy during fiscal year 2007 that provides guidance on managerial 
cost concepts for the agency, and has initiated cost pilot projects to 
explore ways to apply its cost information to its various activities. 
These actions represent a major step forward for IRS in its efforts to 
develop the cost-benefit information it needs to make better informed 
managerial decisions. However, the results of the cost pilots are not 
expected until the last quarter of fiscal year 2008, and how 
effectively IRS will apply the cost principles embodied in its new 
policy remains unclear. In addition, IRS has continued to progress in 
its efforts to develop detailed subsidiary records for its tax 
administrative activities, but much remains to be done on this 
multiyear effort. IRS has also continued to improve controls over hard-
copy taxpayer receipts and information at its submission processing 
centers and lockbox banks. However, IRS has not yet reduced the risk of 
loss of taxpayer receipts and information to an acceptable level. 

IRS cannot fully address the financial management issues caused by the 
limitations of its automated financial management systems without 
additional modernization. In formulating its strategy for dealing with 
these issues, IRS will also need to address how it will ultimately 
apply cost information to its tax administration functions, including 
collection of taxes, payment of tax refunds, and management of unpaid 
tax assessments, which are accounted for in automated systems that are 
physically separate from the Integrated Financial System that 
encompasses IRS's cost module. As noted above, IRS has initiated 
several pilot projects intended to explore ways of addressing this 
issue, but the ultimate solution remains unclear. In 1995, we 
designated financial management and systems modernization at IRS as 
high-risk areas.[Footnote 1] We continue to consider these issues as 
high risk and include them in our Business Systems Modernization high-
risk area.[Footnote 2] 

Among the most serious financial management issues still remaining to 
be addressed is the continued material weakness in IRS's information 
security. As IRS continues its efforts to modernize its financial and 
operational systems, it is critical that IRS take actions to establish 
and maintain more effective information security controls on a 
continuing basis, through an ongoing cycle of risk management 
activities, to protect the processing, storage, and transmission of 
financial and sensitive data. Until IRS successfully manages its 
information security risks, management will not have adequate assurance 
of the integrity and reliability of the information generated from its 
financial management systems. In addition, as IRS continues to progress 
toward ever more automated financial management processes, options for 
alternate procedures to verify the accuracy of the information 
contained in these systems without relying on automated controls within 
them diminish. If IRS does not resolve this issue before these options 
disappear, it could have serious implications for our ability to 
determine whether IRS's financial statements are fairly stated. 

We commend IRS for the improvements it has continued to make in its 
financial processes and operations. The agency has made substantial 
progress in improving its financial management since our first attempt 
to audit its financial statements in fiscal year 1992. Nonetheless, IRS 
management and staff will continue to be challenged to sustain the 
level of extraordinary effort needed to produce reliable financial 
statements that it has demonstrated over the past 8 years. Until the 
agency is able to fully address the underlying systems and internal 
control issues that have made this process so time consuming and 
resource intensive, such efforts will continue to be necessary. While 
it has made important progress, IRS continues to lack accurate, useful, 
and timely financial information and sound controls with which to make 
fully informed decisions day-to-day and to ensure ongoing 
accountability, which is a primary objective of the CFO Act. It is 
therefore important that its financial management initiatives continue 
in order to achieve comprehensive and lasting financial management 
reform. 

IRS also continues to face a significant challenge in strengthening its 
enforcement of the nation's tax laws, another challenge that we have 
designated as high risk.[Footnote 3] As we have previously reported, 
the resources IRS has been able to dedicate to enforcing the tax laws 
have not kept pace with the increases it has seen in its enforcement 
workload. At the same time, IRS continues to face significant 
compliance-related issues, including combating abusive tax shelters and 
tax schemes, on which it is placing a high priority. Critical to IRS's 
efforts in improving enforcement and, ultimately, taxpayer compliance, 
is the need to have current information on the rate of compliance, both 
overall and by type of taxpayer. In 2006, IRS completed a study of the 
rate of compliance with the nation's tax laws by individuals and some 
small business taxpayers, and is in the process of conducting a study 
of S-corporations' compliance.[Footnote 4] In October 2007, IRS also 
initiated a study of individual income reporting compliance, and has 
requested funding for fiscal year 2008 to support multiple, 
simultaneous compliance studies, potentially including corporate 
taxpayers, partnerships, employment taxpayers, or tax-exempt entities. 
However, until such studies have been conducted, and the results 
analyzed, IRS will lack current information on compliance rates. 
Additionally, the continued lack of reliable cost-benefit information 
and a systematic, agencywide strategy to effectively employ it will 
hamper IRS's ability to make the most effective use of the information 
acquired during such efforts to enable IRS to better fulfill its 
mission. 

The accompanying report also discusses other significant issues that we 
identified in performing our audit that we believe should be brought to 
the attention of IRS management and users of IRS's financial 
statements. 

We are sending copies of this report to the Chairmen and Ranking 
Members of the Senate Committee on Appropriations; Senate Committee on 
Finance; Senate Committee on Homeland Security and Governmental 
Affairs; Subcommittee on Taxation and IRS Oversight, Senate Committee 
on Finance; House Committee on Appropriations; House Committee on Ways 
and Means; and House Committee on Oversight and Government Reform. We 
are also sending copies of this report to the Chairman and Vice 
Chairman of the Joint Committee on Taxation, the Acting Commissioner of 
Internal Revenue, the Director of the Office of Management and Budget, 
the Chairman of the IRS Oversight Board, and other interested parties. 
The report is available at no charge on GAO's Web site at [Hyperlink, 
http://www.gao.gov]. 

This report was prepared under the direction of Steven J. Sebastian, 
Director, Financial Management and Assurance, who can be reached at 
(202) 512-3406 or s [Hyperlink, [email protected]] [email protected]. 
If I can be of further assistance, please call me at (202) 512-5500. 
Contact points for our Offices of Congressional Relations and Public 
Affairs may be found on the last page of this report. 

Sincerely yours, 

Signed by: 

David M. Walker: 
Comptroller General of the United States: 

[End of letter] 

Comptroller General of the United States: 
United States Government Accountability Office: 
Washington, DC 20548: 

To the Acting Commissioner of Internal Revenue: 

In accordance with the Chief Financial Officers (CFO) Act of 1990, as 
expanded by the Government Management Reform Act of 1994,[Footnote 5] 
this report presents the results of our audits of the financial 
statements of the Internal Revenue Service (IRS) for fiscal years 2007 
and 2006. The financial statements report the assets, liabilities, net 
position, net costs, changes in net position, budgetary resources, and 
custodial activity related to IRS's administration of its 
responsibilities for implementing federal tax legislation. The 
financial statements do not include an estimate of the amount of taxes 
that are owed the federal government but have not been paid by 
taxpayers, often referred to as the tax gap,[Footnote 6] nor do they 
include information on tax expenditures.[Footnote 7] 

In its role as the nation's tax collector, IRS has a demanding 
responsibility in collecting taxes, processing tax returns, and 
enforcing the nation's tax laws. IRS is a large and complex 
organization, adding unique operational challenges for management. IRS 
employs tens of thousands of people in its Washington, D.C., 
headquarters, 10 service center campuses, 3 computing centers, and 
numerous other field offices throughout the United States. In fiscal 
years 2007 and 2006, IRS collected about $2.7 trillion and $2.5 
trillion, respectively, in tax payments; processed hundreds of millions 
of tax and information returns; and paid about $292 billion and $277 
billion, respectively, in refunds to taxpayers. 

One of the largest obstacles continuing to face IRS management is the 
agency's lack of an effective financial management system capable of 
producing the reliable, useful, and timely information IRS managers 
need to assist in making day-to-day decisions, which is a primary 
objective of the CFO Act. IRS continued to make progress in modernizing 
its financial management capabilities, and continued to make strides in 
addressing its financial management challenges. IRS nonetheless 
continued to confront many of the pervasive internal control weaknesses 
that we have reported each year since our first attempt to audit its 
financial statements in fiscal year 1992.[Footnote 8] In fiscal year 
2007, for the eighth consecutive year, IRS was able to produce 
financial statements covering its tax administration and nontax 
administrative activities that are fairly stated in all material 
respects. However, until IRS resolves the issues affecting the 
automated systems it relies on to process the administration of tax-
related transactions, it will continue to be challenged to sustain the 
level of effort needed to produce reliable financial statements in a 
timely manner. 

During fiscal year 2007, IRS continued to make significant progress in 
its efforts to address its weaknesses in controls over several critical 
areas, including reliability of financial reporting, management of 
unpaid tax assessments, collections of unpaid taxes and disbursements 
of improper tax refunds, and security over hard-copy taxpayer receipts 
and data. For example, IRS separately reported estimated receipts of 
Social Security and Medicare taxes in the other accompanying 
information to its financial statements, and significantly accelerated 
its certification of excise tax receipts to the recipient trust funds. 
On the basis of these improvements, we no longer consider these 
matters, which have been long-standing components of broader IRS 
financial reporting issues, to represent internal control deficiencies. 

IRS also continued to enhance the capabilities of its Custodial Detail 
Data Base (CDDB), which is intended to ultimately serve as a subsidiary 
ledger for IRS's tax administration activities, including tax revenue 
receipts, tax refund disbursements, and unpaid tax debt. IRS plans for 
CDDB to achieve this goal by linking account information in IRS's 
master files[Footnote 9] with its general ledger for tax administration 
activities. In fiscal year 2006, IRS implemented the first phase of 
CDDB, which primarily consisted of computer programs that analyze and 
classify related taxpayer accounts from IRS's masterfile that are 
associated with unpaid payroll taxes.[Footnote 10] However, these 
programs only had the capability to process less complex accounts 
recorded in IRS's masterfiles beginning in August of 2001. During 
fiscal year 2007, IRS enhanced CDDB to process a larger percentage of 
accounts associated with unpaid payroll taxes. Also, during fiscal year 
2007, IRS implemented CDDB programs to begin journalizing tax debt 
information from its master files to its general ledger weekly, a first 
step in establishing CDDB's capability to serve as a subsidiary ledger 
for unpaid tax debt. However, IRS is still unable to use CDDB as its 
subsidiary ledger for external reporting, and must continue to use a 
labor-intensive, manual compensating process to estimate the year-end 
balances of the various categories of unpaid tax assessments to avoid 
material misstatements to its financial statements.[Footnote 11] For 
example, IRS had to make over $20 billion in adjustments to the year-
end gross taxes receivable balance produced by CDDB as a result of its 
manual estimation process for financial reporting. Full operational 
capability of CDDB is several years away and depends in part on the 
successful implementation of future system releases. 

During fiscal year 2007, IRS continued to expand processing of the less 
complex individual tax returns through its Customer Account Data Engine 
(CADE), the system IRS is implementing to replace its individual master 
files. However, because of problems IRS identified during testing, 
start-up of the latest release of CADE was delayed and it did not 
achieve the level of processing originally planned. According to IRS, 
this latest release of CADE did not become fully operational until May 
2007, which was about 5 months behind schedule. IRS informed us that it 
originally intended CADE to process 33 million tax returns during 
fiscal year 2007, which would have been over four times the 7.3 million 
tax returns processed by CADE during fiscal year 2006. However, due to 
the delay, CADE did not achieve this goal. During fiscal year 2007, 
CADE processed 11.2 million tax returns, including 10.9 million tax 
refunds totaling $11.6 billion, which represented about 4 percent of 
all tax refunds disbursed by IRS in fiscal year 2007. It is unclear 
when IRS will be able to rely on CADE to process all individual tax 
collections and related tax refunds. In addition, once fully 
implemented, CADE is only intended to replace the individual master 
files; it is unclear how or when IRS will replace the business master 
files. 

IRS has made notable progress in using existing management information 
as a basis for more informed decisions on collection of unpaid taxes 
and payment of tax refunds. However, IRS has not yet developed the 
agency-wide cost-benefit information needed to better determine the 
optimum level of resources to devote to maximizing collections of 
unpaid taxes and minimizing payments of improper tax refunds in the 
context of its overall mission and responsibilities, or to develop 
related cost-based performance measures to assist in monitoring 
progress and adjusting strategies to better address areas of 
noncompliance. IRS has developed a cost policy to provide guidance on 
managerial cost accounting concepts for the agency and has initiated 
cost pilot projects to explore ways to apply its cost information to 
its various activities. These actions represent a major step forward 
for IRS in its efforts to develop the cost-benefit information it needs 
to provide a basis for well-informed management decisions. However, the 
results of the cost pilots are not expected until the last quarter of 
fiscal year 2008, and how effectively IRS will apply the cost 
accounting principles embodied in its new policy remains unclear. 

While IRS has made notable improvements throughout fiscal year 2007, 
control deficiencies over financial reporting, management of unpaid tax 
assessments, and collection of tax revenue and issuance of tax refunds
continued to represent material weaknesses.[Footnote 12] These 
weaknesses are caused primarily by IRS's continued reliance on outdated 
automated systems to provide the financial information that management 
needs to make well-informed decisions, and similar weaknesses and 
problems will continue to exist until these legacy systems are 
replaced. In addition, we continue to consider issues related to 
information security to be a material weakness. The persistent, serious 
deficiencies in information security increase the risk that 
confidential IRS and taxpayer information will be compromised, and have 
serious implications related to the reliability of financial management 
information produced by IRS's systems. As IRS continues to increase the 
automation of accounting and reporting processes, the need for 
effective security over the data these systems process becomes 
increasingly more critical. Absent effective information security, 
confidential taxpayer records will remain at risk and we, as IRS's 
auditors, will continue to be unable to rely on the automated controls 
built into these systems to obtain assurance that the reported balances 
generated by them are reliable. Opportunities for us to utilize the 
types of alternate audit procedures we have applied in the past to 
compensate for this condition, such as reviewing comparisons between 
automated systems and utilizing remaining hard-copy records, are 
diminishing as IRS's modernization efforts progress. If IRS does not 
resolve its information security material weaknesses before these 
options disappear, it could have serious implications for our ability 
to determine whether IRS's financial statements are fairly stated. 

Opportunities for further improvement in IRS's financial reporting in 
the near term are unclear. IRS has not fully addressed how it will 
apply the cost information provided by its Integrated Financial System 
to the tax-administration-related transactions, which are processed by 
the separate systems that support financial management of IRS's tax 
administration functions, including its collection of tax revenue 
receipts, disbursement of tax refunds, and identification, management, 
and collection of outstanding federal taxes. It is therefore unclear 
how or when IRS will acquire the ability to fully measure the cost-
effectiveness of its operational activities or develop related cost-
based performance measures to facilitate informed decision-making by 
management, and to more effectively support requests to Congress for 
additional resources. 

Opinion on IRS's Financial Statements: 

IRS's financial statements, including the accompanying notes, present 
fairly, in all material respects, in conformity with U.S. generally 
accepted accounting principles, IRS's assets, liabilities, net 
position, net costs, changes in net position, budgetary resources, and 
custodial activity as of, and for the fiscal years ended, September 30, 
2007, and September 30, 2006. 

However, misstatements may nevertheless occur in other financial 
information reported by IRS as a result of the internal control 
deficiencies described in this report. 

IRS's financial statements include tax revenues collected during the 
fiscal year as well as the total unpaid taxes for which IRS and the 
taxpayers or courts agree on the amounts owed. Cumulative unpaid tax 
assessments for which there is no future collection potential or for 
which there is no agreement on the amounts owed are not reported in the 
financial statements. Rather, they are reported as write-offs and 
compliance assessments, respectively, in required supplemental 
information to IRS's financial statements. Also, in conformity with 
U.S. generally accepted accounting principles, to the extent that taxes 
owed in accordance with the nation's tax laws are not reported by 
taxpayers and are not identified through IRS's various enforcement 
programs, they are not reported in the financial statements nor in 
required supplemental information to the financial statements. 
Additionally, in conformity with U.S. generally accepted accounting 
principles, tax expenditures represent the amount of revenue the 
government forgoes resulting from federal tax law provisions that (1) 
allow a special exclusion, exemption, or deduction from gross income, 
or (2) provide a special credit, preferential rate, or deferred tax 
liability. Tax expenditures are not reported in the financial 
statements but rather presented as other accompanying information. 

Opinion on Internal Controls: 

Because of the material weaknesses in internal controls discussed 
below, IRS did not maintain effective internal controls over financial 
reporting (including safeguarding of assets) or compliance with laws 
and regulations, and thus did not provide reasonable assurance that 
losses, misstatements, and noncompliance with laws material in relation 
to the financial statements would be prevented or detected on a timely 
basis. Our opinion is based on criteria established under 31 U.S.C. ï¿½ 
3512 (c), (d), commonly referred to as the Federal Managers' Financial 
Integrity Act of 1982 (FIA), and Office of Management and Budget (OMB) 
Circular No. A-123, Management's Responsibility for Internal Control. 

Despite its material weaknesses in internal controls and its systems 
deficiencies, IRS was able to prepare financial statements that were 
fairly stated in all material respects for fiscal years 2007 and 2006. 
Nonetheless, IRS continues to face the following key issues that 
represent material weaknesses in internal controls: 

* weaknesses in controls over the financial reporting process, 
resulting in IRS not (1) being able to prepare reliable financial 
statements without extensive compensating procedures and (2) having 
current and reliable ongoing information to support management decision 
making and to prepare cost-based performance measures; 

* weaknesses in controls over unpaid tax assessments, resulting in 
IRS's inability to properly manage unpaid tax assessments and leading 
to increased taxpayer burden; 

* weaknesses in controls over the collection of tax revenues due the 
federal government and over the issuance of tax refunds, resulting in 
lost revenue to the federal government and potentially billions of 
dollars in improper tax refund payments; and: 

* weaknesses in information security controls, resulting in increased 
risk of unauthorized individuals accessing, altering, or abusing 
proprietary IRS programs and electronic data and taxpayer information. 

These material weaknesses in internal controls may adversely affect any 
decision by IRS's management that is based, in whole or in part, on 
information that is inaccurate because of these deficiencies. In 
addition, unaudited financial information reported by IRS, including 
performance information, may also contain misstatements resulting from 
these deficiencies. The issues encompassed by these material weaknesses 
were reflected in the material weaknesses reported by IRS in its fiscal 
year 2007 FIA assurance statement to the Department of the Treasury 
(Treasury). 

In addition to the material weaknesses discussed above, we identified 
one internal control deficiency that although not a material weakness, 
represents a significant deficiency in the design or operation of 
internal control that adversely affects IRS's ability to meet the 
internal control objectives described in this report.[Footnote 13] This 
deficiency entails weaknesses in IRS's controls over hard-copy taxpayer 
receipts and related information that increase the risk that this 
information may be lost, stolen, or compromised. IRS included this 
issue as a significant deficiency in its fiscal year 2007 FIA assurance 
statement to the Treasury. 

We have reported on these material weaknesses and the significant 
deficiency in prior audits and have provided IRS recommendations to 
address these issues.[Footnote 14] One hundred and forty-four 
recommendations were still open as of the date of this report, of which 
69 relate to the material weakness in information security. IRS 
continues to make strides in resolving these matters. We will follow up 
in future audits to monitor IRS's progress in implementing these 
recommendations. For more details on these issues, see appendix I. 

Compliance with Laws and Regulations: 

Our tests of compliance with selected provisions of laws and 
regulations disclosed one area of noncompliance that is reportable 
under U.S. generally accepted government auditing standards and OMB 
guidance. This area relates to IRS not releasing federal tax liens 
against taxpayers' property on time.[Footnote 15] Except as noted 
above, our tests for compliance with laws and regulations disclosed no 
other instances of noncompliance that would be reportable under U.S. 
generally accepted government auditing standards or OMB audit guidance. 
However, the objective of our audit was not to provide an opinion on 
overall compliance with laws and regulations. Accordingly, we do not 
express such an opinion. For more details on these issues, see appendix 
I. 

Systems Compliance with the Requirements of FFMIA: 

We found that IRS's financial management systems did not substantially 
comply with the requirements of the Federal Financial Management 
Improvement Act of 1996 (FFMIA) as of September 30, 2007.[Footnote 16] 
Specifically, IRS's systems did not substantially comply with Federal 
Financial Management System Requirements (FFMSR), federal accounting 
standards (U.S. generally accepted accounting principles), and the U.S. 
Government Standard General Ledger (SGL) at the transaction level. Our 
conclusion is based on criteria established under FFMIA; OMB Circular 
No. A-127, Financial Management Systems[Footnote 17] (which includes 
the Joint Financial Management Improvement Program (JFMIP)/OMB series 
of system requirements documents); U.S. generally accepted accounting 
principles; and the SGL.[Footnote 18] 

The issues resulting in IRS's nonconformance with the requirements of 
FFMIA relate to the material weaknesses discussed above, and were 
reflected in the material weaknesses in IRS's fiscal year 2007 FIA 
assurance statement to Treasury. IRS's FFMIA remediation plan details 
its planned corrective actions for the weaknesses that render its 
financial management systems noncompliant with the requirements of 
FFMIA. For more details on these issues, see appendix I. 

Consistency of Other Information: 

IRS's Management Discussion and Analysis and required supplementary and 
other accompanying information contain a wide range of data, some of 
which are not directly related to the financial statements. We did not 
audit and do not express an opinion on this information. However, we 
compared this information for consistency with the financial statements 
and discussed the methods of measurement and presentation with IRS 
officials. Based on this limited work, we found no material 
inconsistencies with the financial statements, U.S. generally accepted 
accounting principles, or OMB guidance. 

Objectives, Scope, and Methodology: 

Management is responsible for (1) preparing the annual financial 
statements in conformity with U.S. generally accepted accounting 
principles; (2) establishing, maintaining, and assessing internal 
control to provide reasonable assurance that the broad control 
objectives of 31 U.S.C. ï¿½ 3512 (c), (d) (FIA) are met; (3) complying 
with applicable laws and regulations; and (4) ensuring that IRS's 
financial management systems substantially comply with the requirements 
of FFMIA. 

We are responsible for obtaining reasonable assurance about whether (1) 
the financial statements are presented fairly, in all material 
respects, in conformity with U.S. generally accepted accounting 
principles, and (2) management maintained effective internal controls, 
the objectives of which are the following: 

* Financial reporting--transactions are properly recorded, processed, 
and summarized to permit the preparation of financial statements in 
conformity with U.S. generally accepted accounting principles and 
assets are safeguarded against loss from unauthorized acquisition, use, 
and disposition. 

* Compliance with laws and regulations--transactions are executed in 
accordance with laws governing the use of budget authority and with 
other laws and regulations that could have a direct and material effect 
on the financial statements and any other laws, regulations, and 
governmentwide policies identified by OMB audit guidance. 

We are also responsible for (1) testing compliance with selected 
provisions of laws and regulations that have a direct and material 
effect on the financial statements and laws for which OMB audit 
guidance requires testing, (2) testing whether IRS's financial 
management systems substantially comply with the three requirements of 
FFMIA, and (3) performing limited procedures with respect to certain 
other information appearing in these annual financial statements. For 
more details on our methodology and the laws and regulations we tested, 
see appendix II. 

We did not evaluate all internal controls relevant to operating 
objectives as broadly defined by FIA, such as controls relevant to 
preparing statistical reports and ensuring efficient operations. We 
limited our internal control testing to testing controls over financial 
reporting and compliance with laws and regulations. We did not test 
compliance with all laws and regulations applicable to IRS. We limited 
our tests of compliance to those laws and regulations that had a direct 
and material effect on the financial statements or that were required 
to be tested by OMB audit guidance that we deemed applicable to IRS's 
financial statements for the fiscal years ended September 30, 2007, and 
2006. We caution that noncompliance may occur and not be detected by 
these tests and that such testing may not be sufficient for other 
purposes. We performed our work in accordance with U.S. generally 
accepted government auditing standards and OMB audit guidance. 

Agency Comments and Our Evaluation: 

In responding to this report, IRS agreed that the report fairly 
presents its financial management progress and remaining management and 
systems challenges. IRS also noted its significant accomplishments in 
addressing its financial management challenges, including (1) 
implementation of another phase of the CDDB, which created an interface 
between CDDB and IRACS for posting summary unpaid assessment and 
accrual data to IRACS, (2) improvement in the timely release of liens 
to an 88 percent timeliness rate, which represented a 19 percentage 
point increase over the timeliness rate in fiscal year 2006, (3) 
achievement of a 21 percent increase in the Trust Fund Recovery Penalty 
accuracy rate through the use of CDDB, (4) issuing of IRS's first cost 
accounting policy, and (5) improvement in its capability to capitalize 
or expense assets and properly account for Business Systems 
Modernization costs in internal use software. 

IRS also recognized the importance of the information security issues 
discussed in the material weakness in information security, and noted 
certain steps it has taken to address these issues. These steps include 
(1) establishing an Office of Privacy, Information Protection, and Data 
Security to provide direction and oversight of the security and 
protection of sensitive information, (2) developing an integrated 
Information Technology Security Schedule and Plan and a comprehensive 
security strategy, (3) encrypting all laptop data and tapes used in 
electronic data exchanges, and (4) implementing an enterprise anti-
virus internet gateway solution to detect and quarantine malicious 
content from invading systems. IRS also recognized that while 
challenges remain, it has a solid management team dedicated to 
promoting the highest standard of financial management, and will 
continue to focus on information security while improving financial 
reporting. 

The complete text of IRS's response is included in appendix III. 

Signed by: 

David M. Walker: 
Comptroller General of the United States: 

November 5, 2007: 

[End of section] 

Management Discussion and Analysis: 

The Internal Revenue Service: 
FY 2007 Management Discussion and Analysis At a Glance: 

Linda Stiff became Acting Internal Revenue Service (IRS) Commissioner 
on September 10, 2007. The Commissioner administers, manages, and 
directs the execution and application of the Internal Revenue laws, 
along with directing the collection of tax revenue that funds most 
federal government operations and public services. 

History: 

The IRS is one of the oldest bureaus in the United States Government. 
Article 1, Section 8 of the Constitution gave the Federal Government 
the power to ï¿½lay and collect Taxes, Duties, Imposts and Excises, to 
pay the Debts and provide for the common Defense and general Welfare of 
the United Statesï¿½ï¿½ The roots of the IRS go back to the Civil War when 
President Lincoln and the Congress, in 1862, established the Bureau of 
Internal Revenue and the nationï¿½s first income tax. In 1953, the Bureau 
of Internal Revenue name was changed to the Internal Revenue Service 
(IRS). 

Vision: 

The IRS will be a 21st Century agency with the human capital and 
technology capabilities to effectively and efficiently collect the 
taxes owed with the least disruption and burden to taxpayers. 

Organization: 

The organizational structure (Appendix A) of the IRS closely resembles 
the private sector model, with core business activities organized around
customers with similar needs. The scope of IRS operations includes 
collection of individual and corporate taxes, examination of returns, 
taxpayer assistance, as well as oversight of the tax exempt 
organizations and the Earned Income Tax Credit program, the nationï¿½s 
largest federally administered means-tested benefits program. 

Operating Divisions: 

* Wage and Investment (W&I); 
* Small Business and Self Employed (SB/SE); 
* Large and Mid-Size Business (LMSB); 
* Tax-Exempt and Government Entities (TE/GE). 

Employees: 

The IRS employs over 100,000 employees. 

Location: 

The IRS is headquartered in Washington, D.C. The IRS also has employees 
located at 748 field offices in all states and territories and some U.S.
embassies and consulates. 

IRS FY 2007 Statistics: 

Total Revenue Collected: $2.69 trillion; 
Total Enforcement Revenue Collected: $59.2 billion; 
Total Refunds: $292 billion; 
Number of Hits on IRS.gov: 1.35 billion; 
Number of Information Reporting Documents Processed: 1.45 billion; 
Number of Downloads from IRS.gov: 157 million; 
Number of Returns Filed: 235 million; 
ï¿½Whereï¿½s My Refund?ï¿½ Usage: 32.1 million; 
Number of Taxpayers Assisted: 63.3 million; 
Number of Returns Filed Electronically: 89.2 million. 

Financial Resources: 

The IRS FY 2007 budget was $10.6 billion in direct appropriations, 
supplemented by $198.8 million in user fee revenue and $73.3 million in 
reimbursable resources for a total operating level of $10.9 billion. 

Internet: 

The IRS provides tax information, taxpayer services, forms, and 
publications at [hyperlink, http://www.irs.gov]. 

ï¿½Taxes are the price we pay for living in a civilized societyï¿½: US 
Supreme Court Justice Oliver Wendell Holmes. 

Serving The Nationï¿½ï¿½s Taxpayers: 

Strategic Plan Framework: 

Mission: 

Provide Americaï¿½s taxpayers top-quality service by helping them 
understand and meet their tax responsibilities and by applying the tax 
law with integrity and fairness to all. 

Goals And Objectives: 

* Improve Taxpayer Service: 
- Improve service options for the tax paying public; 
- Facilitate participation in the tax system by all sectors of the 
public; 
- Simplify the tax process. 

* Enhance Enforcement Of The Tax Law: 
- Discourage and deter non-compliance with emphasis on corrosive
activity by corporations, high-income individual taxpayers and other
contributors to the tax gap; 
- Ensure that attorneys, accountants and other tax practitioners
adhere to professional standards and follow the law; 
- Detect and deter domestic and off-shore based tax and financial
criminal activity; 
- Deter abuse within tax-exempt and governmental entities and
misuse of such entities by third parties for tax avoidance or other
unintended purposes. 

* Modernize The IRS Through Its People, Processes, And Technology: 
- Increase organizational capacity to enable full engagement and
maximum productivity of employees; 
- Modernize information systems to improve service and enforcement; 
- Ensure the safety and security of people, facilities and information
systems; 
- Modernize business processes and align the infrastructure support to 
maximize resources devoted to frontline operations. 

Service + Enforcement = Compliance. 

IRS Resources: 

Funding by Appropriation: 
Enforcement: 44%; 
Operations Support: 32%; 
Taxpayer Services: 20%; 
Business Systems Modernization: 2%; 
Health Insurance Tax Credit Administration: 0%; 
Other: 2%. 

Appropriations (dollars in thousands): 

In FY 2007, the Congress implemented a new appropriations structure for 
the IRS that realigned resources from its three major operating
appropriations into three new accounts ï¿½ Taxpayer Services, 
Enforcement, and Operations Support. Appropriated funds are shown 
below: 

* Taxpayer Services [$2,156,988] funds processing tax returns and 
related documents, assistance for taxpayers in filing returns and
paying taxes due. 

* Enforcement [$4,741,680] funds examination of tax returns, 
collection of balances, the administrative and judicial settlement of 
taxpayer appeals of examination findings, as well as providing 
resources for strengthened enforcement to reduce invalid claims and
erroneous filings associated with the Earned Income Tax Credit (EITC) 
program. 

* Operations Support [$3,470,882] funds administrative services, policy 
management and IRS-wide support. The appropriation also funds staffing, 
equipment, and related costs to manage, maintain, and operate critical
information systems that support tax administration. 

* Business Systems Modernization [$212,659] funds capital asset 
acquisitions of information technology systems to modernize key tax
administration systems. 

* Health Insurance Tax Credit Administration [$14,856] funds the 
administration of the Health Coverage Tax Credit (HCTC). 

* Other: Mandatory Appropriation (Special Funds): User Fees [$167,405] 
financed by payment for goods and services provided and Private 
Collection Agency [$10,757] collection fees. 

How IRS Uses Its Resources: 
Compliance Services: 64%; 
Filing and Account Services: 30%; 
Taxpayer Assistance and Education: 4%; 
Administration of Tax Credit Programs: 2%. 

Use of Resources: 

The Statement of Net Cost reflects the use of IRS resources in 
conducting its major programs. The IRS uses a cost allocation 
methodology to assign support and overhead costs to each program
described below. The Statement of Net Cost reports the full costs of 
these programs in accordance with the Statement of Federal
Financial Accounting Standards No. 4, ï¿½Managerial Cost Accounting.ï¿½ 

* Taxpayer Assistance and Education [4%] activities include taxpayer 
education and outreach, tax publication issuance and distribution. 

* Filing and Account Services [30%] activities include filing tax 
returns, maintaining customer accounts, and processing taxpayer
information. 

* Compliance Services [64%] activities include pre-filing agreements, 
document matching, examination, collection, and criminal investigation 
activities. 

* Administration of Tax Credit Programs [2%] includes costs for EITC 
and HCTC program activities. 

The following table shows comparative data on the use of IRS resources 
by major programs: 

Use of Resources (dollars in thousands): 

Taxpayer Assistance and Education: 
Fiscal Year 2007: $478,663; 
Fiscal Year 2006: $407,599. 

Filing and Account Services: 
Fiscal Year 2007: $3,640,565; 
Fiscal Year 2006: $3,689,626. 

Compliance Services: 
Fiscal Year 2007: $7,701,812; 
Fiscal Year 2006: $7,408,340. 

Administration of Tax Credit Programs: 
Fiscal Year 2007: $190,881; 
Fiscal Year 2006: $191,965. 

The Tax Gap: 

The gross tax gap is the difference between the total tax imposed on
taxpayers by law for a given tax year and the amount of that tax 
liability that is paid on time. The most recent IRS estimate (completed 
in 2006) of the gross tax gap is $345 billion for Tax Year 2001. 

The net tax gap is currently estimated as follows: 

Net Tax Gap: 
Gross Tax Gap: $345 billion; 
Enforced and Other Late Payments: $55 billion; 
Net Tax Gap: $290 billion. 

The components of the tax gap are: 

Gross Tax Gap: 
Underreporting: 82%; 
Underpayment: 10%; 
Nonfiling: 8%. 

In August 2007, the IRS released the report, ï¿½Reducing the Federal Tax
Gap: A Report on Improving Voluntary Compliance,ï¿½ a follow-up to 
Treasuryï¿½s ï¿½Comprehensive Strategy for Reducing the Tax Gapï¿½ issued in 
September 2006. The report presents the current tax gap activities and 
the steps taken to improve compliance. The report: 

* Details information on steps being taken to reduce opportunities for 
tax evasion, leverage technology, and support legislative proposals 
that will improve compliance; 
* Presents an outreach approach to ensure all taxpayers understand
their tax obligations; 
* Recognizes the importance of having a multi-year research program
to help the IRS understand both the scope of and reasons for non-
compliance. 

This report, combined with legislative changes and tax simplification, 
will guide IRS efforts to reduce the tax gap. 

Fiscal Year (FY) 2007 Performance: 

The IRS improved compliance through taxpayer service and enforcement 
efforts, with 23 of its 30 performance measures [Footnote 19] meeting 
or within 98.5% of the target. In addition, 83% of the measures showed 
performance at or above FY 2006 levels. In FY 2007, 75% (9 of 12) of 
the Taxpayer Service targets and 78% (14 of 18) of the Enforcement 
targets were met or within 98.5% of the target. Detailed information on
performance is contained in this section of the report; Appendix B, 
Performance Data; and Appendix C, Explanation of Shortfalls. 

FY 2007 was also a record year for collections related to enforcement 
activities; over $59.2 billion was collected, a 75% increase over FY 
2001. 

IRS Enforcement Revenues (dollars in billions): 
FY01: $33.8; 
FY02: 34.1; 
FY03: 37.6; 
FY04: 43.1; 
FY05: 4.3; 
FY06: 48.7; 
FY07: 59.2. 

The steady increase in enforcement revenue is primarily a result of 
concerted efforts by the IRS to detect and deter noncompliance with the 
tax code. 

In FY 2007, the IRS worked to improve its estimates of noncompliance to 
pinpoint areas where taxpayers are not in compliance with federal tax 
laws. A reporting compliance study for Subchapter S corporations was 
initiated and the examination phase was completed in FY 2007. A Tax Year
(TY) 2006 individual income reporting compliance study began in October 
2007. In addition, the IRS updated its workload selection models for TY 
2006 using data from prior reporting compliance studies, enabling the 
IRS to better leverage limited enforcement resources and reduce the
burden on compliant taxpayers. 

The IRS established a set of enterprise-wide long-term goals, which 
were approved by the IRS Oversight Board in March 2007. These long-term 
goals link to the IRS FY 2005-2009 Strategic Plan and serve as 
overarching indicators of achievement of the objectives that support 
the IRSï¿½s mission critical programs. These goals include measures of 
voluntary compliance, electronic filing, non-revenue enforcement
activity, taxpayer satisfaction, and employee engagement/satisfaction. 

Strategic Goal: Improve Taxpayer Service; 

Objectives: 
* Improve Service Options for the Tax Paying Public; 
* Facilitate Participation in the Tax System by All Sectors of
the Public; 
* Simplify the Tax Process. 

Taxpayer Assistance Facts: 

IRS.gov keeps taxpayers current with information they need to file
their tax returns. The ï¿½1040 Centralï¿½ page contains news releases, fact
sheets, and tax tips all designed to keep taxpayers informed of changes
as they happen. 

Taxpayers continue to call the IRS and use toll-free services to obtain
answers to their tax law and account related questions. In FY 2007, the
IRS: 

* Achieved an 82.1% customer service representative level of service, 
meeting the target; 
* Answered 33.2 million assistor telephone calls and completed 23.1 
million automated calls; and; 
* Correctly responded to 91.2% of tax law questions and 93.4% of 
account questions received via the telephone. 

The IRS also provides toll-free service for customers such as business
and specialty taxpayers, practitioners, international taxpayers, and
the National Taxpayer Advocate. 

The IRS provides 5,397 different tax forms, which can be downloaded
from the IRS.gov website. In FY 2007, 72.5 million forms were 
downloaded by taxpayers. Each year, the IRS also mails out tax forms to 
individual and business taxpayers. In FY 2007 the number of forms 
mailed was 112 million. Many forms are available for Spanish language 
taxpayers. In FY 2007, 47 different forms were available in Spanish. 

Improve Taxpayer Service: 

Helping taxpayers understand their tax reporting and payment 
obligations is the cornerstone of taxpayer compliance. In FY 2007, 75% 
(9 of 12) of the Taxpayer Service performance targets were met or 
within 98.5% of the target. The remaining three measures fell within 
95% of the target. Improved service options for taxpayers and 
simplifying the tax process are key strategies for improving service. 

The IRS continued to make improvements in key services for taxpayers in 
FY 2007. Assisting taxpayers with their tax questions before they file 
their returns addresses inadvertent non-compliance and reduces 
burdensome post-filing notices and other correspondence from the IRS. 
The IRS provides assistance to millions of taxpayers through toll-free 
call centers, the IRS.gov website, Taxpayer Assistance Centers, 
Volunteer Income Tax Assistance, and Tax Counseling for the Elderly 
sites. 

In addition, developing and maintaining relationships with IRS 
stakeholders and partners in tax administration has become a key 
strategy in developing and distributing tax information to our 
customers. By augmenting and opening these avenues of communication, 
the IRS is able to quickly identify and respond to emerging issues in 
tax compliance and to more efficiently provide education and outreach 
to a wider population of taxpayers to improve compliance. 

More taxpayers are interacting with the IRS through the IRS.gov 
website. Information available on-line has improved customer 
satisfaction because of its speed, accessibility, and accuracy. For 
example: 

* More than 1.35 billion web pages were viewed on IRS.gov, an increase 
of 3.8% over 2006; 

* More than 32.1 million taxpayers used ï¿½Whereï¿½s My Refund?,ï¿½ an 
increase of 30% over 2006; 

* 443,558 taxpayers used the new sales tax deduction calculator 
developed for the 2007 filing season. The calculator helped taxpayers 
determine the correct amount of optional general sales tax they were 
eligible to claim; and; 

* The popular IRS website, IRS.gov, received an overall customer 
satisfaction score of 74 based on a 100 point scale as measured by the 
American Customer Satisfaction Index (ACSI). This represents a five 
point increase over the 2005 filing season score, which can be 
attributed to the redesign of IRS.gov making information easier for
taxpayers to find. The increased score places IRS.gov among the better 
performing Federal websites. 

Taxpayer Assistance Blueprint (TAB): 

TAB represents the most extensive IRS research conducted on the needs, 
preferences, and behaviors of taxpayers and partners who assist them in 
complying with the tax laws. The Phase 1 TAB Report issued in FY 2006 
focused on research and key strategic improvement themes. 

The IRS delivered the Phase 2 Report to Congress on April 11, 2007. The 
report included the TAB Strategic Plan, and the recommendations focused 
on specific categories of work and services. 

The IRS established a Taxpayer Services Program Management Office and 
IRS Services Committee to formalize integrated service investment 
decision-making. 

Significant Insights Revealed: 

* The majority of taxpayers who used IRS assistance indicated a
willingness to use electronic services; 

* Fewer customers visit Taxpayer Assistance Centers relative to
other options such as phone and correspondence; 

* Taxpayers are most concerned with first contact resolution; 

* 9 out of 10 taxpayers using IRS services in 2005 reported they
would use the same methods again. 

Next Steps: 

* Continue TAB Strategic Plan integration in planning and budgeting
processes. Implement service improvement initiatives and future
research projects identified by the TAB Strategic Plan, which were
incorporated into the FY 2008 Budget Submission. 

* Implement Multi-year Research Portfolio by making service-related
decisions based on taxpayer data. 

* Develop new measures for compliance, taxpayer, partner, and
government value. 

* Continue solicitation of stakeholder and employee input. 

Highlights of the 2007 Filing Season: 

The IRS delivered a successful 2007 filing season even with addressing 
new challenges associated with the implementation of the Telephone 
Excise Tax Refund (a one-time payment designed to refund long distance 
telephone taxes), introducing split refund capability, which provided 
taxpayers with more control over their refunds by allowing direct 
deposit of a refund to up to three financial accounts, and making the
necessary changes to forms and systems to accommodate late passage of 
provisions of the Tax Relief and Health Care Act of 2006. Results of 
the 2007 filing season include: 

* Processed more than 139.7 million individual returns and issued more 
than 105.5 million refunds totaling $261 billion; 

* Maintained a telephone level of service of 82.1% while answering 33.2 
million calls; 

* Served over 7 million taxpayers at 401 Taxpayer Assistance Centers; 

* Increased electronic filing: 
- Individual returns electronically filed reached 57.1%, up from 54.1% 
in 2006; 
- Business returns electronically filed reached 19.1%, up from 16.6% in 
2006; 
- Home computer filing increased to 22.5 million returns, an 11% 
improvement over 2006; 
- Tax professional use of e-file increased to 57.2 million
returns or 10% over 2006; and; 
- More than 4.1 million taxpayers used the free services offered by the 
Free File Alliance. 

Customer satisfaction of individual tax return filers increased from a 
score of 64 in 2005 to 65 in 2006 based on the ACSI - 100 point scale. 

Over 83,000 taxpayer returns requested the split refund option. The 
capability to split refunds in the 2007 filing season provided 
individual taxpayers with a new option of choosing direct deposit for 
depositing their tax refunds. All taxpayers who filed using any of the 
1040 series forms had the option to divide their refunds in up to three 
financial accounts including individual retirement accounts, over 500
college savings plans, savings bonds, or a variety of other accounts. 

More than 1,000 revisions affecting 137 of the 164 filing season 
products used by taxpayers were made with minimal impact to the filing 
season. For the second year in a row, the IRS responded quickly to late-
in-the-year passage of tax legislation. Due to the late passage of 
provisions of the Tax Relief and Health Care Act of 2006, the IRS had 
to quickly make changes to the processing systems and create or revise 
forms to allow taxpayers to take advantage of the Actï¿½s provisions. 

Telephone Excise Tax Refund (TETR): 

The IRS successfully implemented TETR, a one-time payment available on 
federal income tax returns to refund previously collected long distance 
telephone taxes. The integrated approach included: 

* Using regular IRS income tax processing channels and existing income 
tax forms by adding a line for TETR on every form; 

* Developing a method for claiming the credit using a standard amount
for individuals and an estimation formula for businesses; 

* Reprogramming major filing systems to process the TETR credit with 
the filing of individual tax returns; 

* Creating a new form for individuals without an income tax filing
requirement to claim the credit; 

* Implementing an extensive communication strategy that focused on 
education, maximizing media reach, and publicizing compliance issues. 


For the 2007 filing season, the IRS issued 22 news releases, 8 ï¿½Tax 
Tips,ï¿½ and messages included in over 4,000 articles related to taxes 
and tax filing. To further assist taxpayers and the practitioner 
community, the IRS launched a TETR web page on IRS.gov that was viewed 
by more than 4.5 million people. 

Successful delivery of the integrated TETR approach enabled the filing 
of over 94 million 2006 federal income tax returns, which claimed more 
than $4.81 billion in telephone excise tax refunds. 

In addition, the IRS prevented more than $40 million in erroneous 
refunds through in-depth analysis of TETR claims and split refund
requests. The comprehensive approach to administering this refund
allowed the IRS to successfully meet taxpayer and stakeholder 
expectations. 

Taxpayer Outreach: 

The IRS enhanced its outreach and educational services through 
partnerships between the IRS and public organizations. Outreach 
involves direct contact with customers through IRS participation at 
conferences, seminars, and workshops or indirect contact with customers 
through newsletters, websites, and customer partnerships. 

The IRS partners with partner organizations such as state taxing 
authorities and volunteer groups to serve taxpayer needs. Through its 
11,922 Volunteer Income Tax Assistance and Tax Counseling for the 
Elderly sites, the IRS provided free tax assistance to the elderly, 
disabled, and limited English proficient individuals and families. The 
76,619 volunteers located at the sites filed approximately 2.63 million
returns, a 14% increase over FY 2006. 

The IRS established 16 new low income tax clinics (LITC) in rural areas 
to help taxpayers who cannot afford representation obtain competent 
assistance in meeting their obligations. LITCs reduce taxpayer 
uncertainty and errors by clarifying taxpayer rights and 
responsibilities, and through their outreach efforts, offer effective 
information and education. 

The Earned Income Tax Credit (EITC) is a refundable Federal income tax 
credit for low-income working individuals and families. The IRS 
improved services for EITC participants through the following actions: 

* Developed a three-point plan expanding outreach initiatives and 
identified ways to simplify and improve forms and make IRS.gov more 
user friendly; 

* Held a Nationwide EITC Awareness Day to increase awareness of the 
EITC among eligible taxpayers, especially those with limited English 
proficiency; 

* Developed outreach products and strategies to reach and increase 
participation among the underserved EITC populations, such as Hispanic 
and rural communities; and; 

* Increased partnerships with community-based organizations dedicated 
to assisting taxpayers with financial literacy, return preparation and 
tax return filing. As a result, the IRS increased outreach by 15% and 
return preparation by 18% over FY 2006. 

Strategic Goal: Enhance Enforcement Of The Tax Law: 

Objectives: 

* Discourage and Deter Non-Compliance with Emphasis on Corrosive 
Activity by Corporations, High-Income Individual Taxpayers and Other
Contributors to the Tax Gap; 

* Ensure that Attorneys, Accountants and Other Tax Practitioners Adhere 
to Professional Standards and Follow the Law; 

* Detect and Deter Domestic and Off-Shore Based Tax and Financial 
Criminal Activity; 

* Deter Abuse within Tax-Exempt and Governmental Entities and Misuse of 
such Entities by Third Parties for Tax Avoidance or Other Unintended 
Purposes. 

Enforcement Facts: 

Enforcement authority is used to collect the taxes that are due from
people who do not fulfill their tax obligations. Non-compliance may
not be deliberate and can stem from a wide range of causes, including
lack of knowledge, confusion, poor record-keeping, differing legal
interpretations, unexpected personal emergencies, and temporary cash
flow problems. However, some noncompliance is willful, even to the
point of criminal tax evasion. 

Efforts to minimize the burden for compliant taxpayers support the
overall goal of full participation in the tax system. 

The IRS Oversight Board conducts an annual survey to gain deeper
understanding of taxpayerï¿½s attitudes. The 2007 results showed: 

* 84% of survey participants thought it was not at all acceptable to
cheat on your income taxes; 

* 89% of survey participants agreed that everyone who cheats should
be held accountable. 

Enhance Enforcement of the Tax Law: 

Potential for narrowing of the nationï¿½s tax gap hinges primarily on IRS 
efforts to improve compliance with U.S. tax laws. IRS enforcement was 
within 98.5% of the target for 78% (14 of 18) of its program targets. 

Highlights of Enforcement Performance: 

IRS examination and collection programs targeted a wide range of 
contributors to the tax gap and, in FY 2007, the IRS showed steady 
progress, building on the FY 2006 successes: 

* Increased enforcement revenue 22%; 
* Increased high-income taxpayer audits 29%; 
* Increased individual audits 8%; 
* Increased small business audits 17%, and corporate
audits 3%; and; 
* Increased collection case closures 12%, and dollars
collected 13%. 

Maintaining a strong enforcement presence in the tax-exempt and 
governmental sectors (including religious, charitable, social, 
educational, political, and other not-for-profit organizations, as well 
as employee pension plans and tax-exempt bonds) is particularly 
important given the role that a small number of these entities play in 
accommodating abusive transactions entered into by taxable parties. In 
FY 2007, the IRS expanded its enforcement presence including: 

* Increased enforcement contacts 12% over FY 2006
levels; and; 
* Conducted reviews of executive compensation practices among tax-
exempt organizations and initiated a new phase of the project to 
address loans to officers. 

The IRS continued to investigate significant tax, money laundering, and 
other financial activities that adversely affect tax administration. 
The IRS also took steps to combat fraudulent and financial crime 
schemes identified through improved case development efforts and 
partnership with other law enforcement agencies. Performance levels for 
the criminal investigation program remained high in FY 2007: 

* Completed criminal investigations totaled 4,269, exceeding the target 
of 4,000; 
* Maintained a conviction rate of over 90%; 
* Increased acceptance rate by the Department of Justice to 94.6%, 
higher than the FY 2006 rate of 92.2%, and the acceptance rate by the 
U.S. Attorney increased to 90.2%, 2% higher than the 88.3% achieved in 
FY 2006; 
* Obtained over 2,155 convictions, exceeding the 2,069 target; and; 
* Stopped fraudulent claims in excess of $1 billion through IRS Fraud 
Detection Centers. 

The IRS also developed the Compliance Resolution Program and strategies 
to advance compliance goals and minimize burden on taxpayers. This 
Compliance Resolution Program partners with external stakeholders in 
order to address a specific tax issue that arose from the American Jobs 
Creation Act of 2004 regarding the treatment of taxes due by employees 
who exercised specific stock rights. The IRS permitted employers to 
voluntarily pay certain taxes and interest for employees who exercised 
certain discounted stock options and stock appreciation rights in 2006. 
In FY 2007, 78 employers participated in the Compliance Resolution
Program with $116.3 million received. 

In the tax exempt sector, new outreach initiatives included: 

* Launching [hyperlink, http://www.stayexempt.org], a popular tax 
compliance website for exempt entities and providing new web-based 
tools to help tax-exempt entities understand their federal tax 
requirements; and; 
* Conducting workshops to assist remote tribal villages in 
understanding federal and state employment tax and other reporting 
requirements. 

Compliance Assurance Process (CAP) Pilot Program: 

Under this pilot program, the IRS works with large business taxpayers
to identify and resolve issues prior to return filing, which provides a 
high level of certainty to taxpayers that corporate tax returns are 
substantially compliant when filed. 

Currently 78 taxpayers have participated in the CAP program. 

Compliance Assurance Process (CAP) Participation (Cumulative): 
TY 2005: 17; 
TY 2006: 34; 
TY 2007: 78. 

The CAP program benefits both the IRS and the taxpayer by fostering
compliance, reducing the time it takes to process a return, and
improving both customer and employee satisfaction while maintaining
a high level of quality. 

From the taxpayersï¿½ perspective, CAP represents improvements to
their internal business processes as corporate tax departments interact
with the IRS on a real-time basis. CAP allows emerging compliance
issues to be identified and addressed much sooner than the traditional 
IRS audit process would allow. 

CAP offers many other benefits: 

* Communication about completed transactions occurs sooner and allows 
for an analysis of material items affecting the tax return; 
* Immediate review of transactions after completion, while knowledgeable
personnel and necessary records are most accessible; 
* Compliance issues in need of resolution are identified early. 

Globalization of Tax Administration: 

In FY 2007, the IRS reorganized its international organization to 
better address the increasing scope of international tax administration 
where non-compliance is a significant and growing problem. In addition, 
the IRS developed a comprehensive strategy to identify and highlight 
activities that will improve customer service, enhance international tax
compliance, and modernize the IRS to more effectively keep pace with 
globalization. 

The exchange of information between a foreign revenue agency and the 
IRS led to the recent unraveling of an abusive cross-border tax scheme 
involving hundreds of taxpayers and tens of millions of dollars in 
improper deductions and unreported income. In late 2007, the Joint 
International Tax Shelter Information Centre (JITSIC) will open a second
office in London and the Japanese National Tax Agency will join. JITSIC 
shares information and expertise in identifying and curbing tax 
avoidance and shelters. As collaboration between member countries 
continues to grow, more crossborder schemes will be uncovered, shared, 
and addressed. 

Tax Shelter and Promoters and Abusive Tax Initiatives: 

The IRS continues to deter tax shelter abuse and tax scheme promoters 
through targeted audits, aggressive litigation, and publicity. 

Tax Shelter Promoter Program: 

The IRS made significant progress in resolving civil matters with 
promoters of abusive and listed tax shelter transactions. In addition 
to large penalty assessments and public admissions of regrettable 
behavior by businesses and some of their former employees, the IRS is 
obtaining future compliance agreements from promoters. For FY 2007,
penalties assessed and collected from the Promoter program totaled
nearly $69 million. 

Tax Preparer and Promoter Activities: 

The IRS continues to investigate and prosecute preparers involved in
criminal activity. Many taxpayers rely on the advice and counsel
provided by a tax preparer to fulfill their tax responsibilities. The 
IRS is engaged in ensuring tax preparers and promoters are working 
within the frame of the tax code. The IRS is targeting preparers whose 
tax work indicates questionable return preparation practices and/or 
disseminating questionable advice or promoting questionable tax 
avoidance strategies. 

Abusive Tax Avoidance Initiatives: 

The IRS focused its efforts to combat abusive tax avoidance transactions
(ATAT) by providing early guidance, addressing shelters at the promoter 
level, and increasing the strength of the IRS response. The IRS will 
continue to aggressively address abusive transactions through enhanced 
identification techniques, published guidance, traditional examination 
processes, alternative dispute resolutions, communication, and resource 
allocation. 

Productivity Improvements: 

The IRS continued to improve quality, efficiency, and service delivery 
through a wide-range of initiatives designed to increase service 
coverage to taxpayers and increase productivity. Improvements in 
workload selection techniques, streamlining and centralizing work 
processes, focusing on case quality and the use of embedded quality 
reports, decreasing cycle time, and increasing managerial involvement 
in casework were all factors contributing to IRS productivity 
improvements. 

The IRS substantially enhanced its productivity by implementing 
technological and process improvements in the Automated Underreporter 
(AUR), Examination, and Compliance Services Collection Operations. 
Significant improvements made in FY 2007 included: 

* Implemented a new AUR case selection and scoring methodology for 
individuals, resulting in a 20.5% increase in AUR assessments; 

* Controlled and directed incoming Examination toll-free calls through 
an Intelligent Call Management system resulting in a 6.1% increase in 
the service level; and; 


* Automated the processing of over 43% of installment agreement problem 
cases, which freed resources to process additional installment 
agreement compliance work. 

The IRS continued to reengineer its examination and collection 
procedures to reduce time, increase yield, and expand coverage. 
Emphasizing early identification of tax liabilities through increased 
audits and more focused collection activities, the IRS undertook the 
following actions: 

* Piloted new Automated Substitute for Return screening and batching 
procedures, with the increased efficiencies resulting in a productivity 
improvement of over 156%, from 7.5 cases per hour to 19.2 cases per 
hour; 

* Increased detection of fraudulent activities and increased the number 
of recommendations for civil fraud penalties by 49% over the prior year 
level; and; 

* Developed an Employment Tax Strategy that includes 
eliminating/reducing overlaps and gaps in processes to enhance 
organizational effectiveness; expanding work relationships with federal 
and state authorities; conducting studies to better understand the tax 
gap; and assessing new ways to impact taxpayer behavior. 

Strategic Goal: 

Modernize the IRS through its People, Processes, and Technology: 

Objectives: 

* Increase Organizational Capacity to Enable Full Engagement and 
Maximum Productivity of Employees; 

* Modernize Information Systems to Improve Service and Enforcement; 

* Ensure the Safety and Security of People, Facilities and Information 
Systems; 

* Modernize Business Processes and Align the Infrastructure Support to 
Maximize Resources Devoted to Front-line Operations. 

BSM Project Schedule Accomplishments: 
Met: 77%; 
Not Met: 23%. 

BSM Project Cost Accomplishments: 
Met: 92%; 
Not Met: 8%. 

Modernization Facts: 

* The IRS maintains over 290 million individual and business taxpayer 
accounts; 
* The IRS processes up to 624 million real-time transactions per month; 
* The IRS has over 400 automated systems and maintains over 72 million 
lines of code. 

Modernize the IRS through its People, Processes, and Technology: 

The increased reliance on technology and its impact on business 
processes and the ability to maintain a talented workforce are 
positively changing how IRS employees conduct business and deliver 
services. The IRS delivered the majority of major project milestones 
within the target of +/- 10% variance for cost and schedule, a 
significant achievement that continues to validate Business Systems
Modernization (BSM) program management effectiveness. 

Business Systems Modernization (BSM): 

For the third year in a row, the IRS made substantial progress in 
meeting project deliverables and has continued to build foundational 
processes, controls and governance that are essential to continued 
success in managing the complex system development efforts. In FY 2007, 
the IRS implemented a new governance structure for its information 
technology (IT) investment projects. The new structure facilitates the 
ability to identify and address project-related issues and risks, 
ensuring IT investment projects deliver required results. Project-level 
accountability and decision making are promoted for projects that do 
not have problems or issues, while the new governance model specifies 
appropriate thresholds for elevating project-related issues that may 
arise. 

The IRS also developed a five-year IT Modernization Vision and Strategy 
that addresses priorities for modernizing frontline tax administration 
functions. The strategy guides IT investment decision making for 2007 
and beyond. Important aspects include: establishing partnerships among 
IT and business leadership; leveraging existing systems; emphasizing 
the delivery of smaller, incremental releases; and unifying the 
portfolio-level view of investments. 

Notable modernization accomplishments for FY 2007 include: 

* Delivered new Customer Account Data Engine (CADE) filing 
capabilities, enabling CADE to process over 11 million returns and 
issue refunds of $11.6 billion; and; 

* Added new capabilities to the Modernized e-File (MeF) system that 
allowed the receipt of electronically filed Partnership Returns (Forms 
1065 & 1065B), meeting the mandate for taxpayers with 100 or more 
partners to file electronically. MeF received over two million 
corporate, non-profit, and partnership forms for processing. 

* Deployed the first two releases of the Accounts Management Services 
(AMS) system which is designed to enable authorized users to resolve 
taxpayer issues by accessing integrated account data. AMS builds the 
applications and databases that enable IRS employees to use the data in
CADE to facilitate faster, more accurate issue resolution and results 
in quick and accurate access to authoritative account information in 
response to customer inquiries. AMS delivered functionality to provide 
daily rather than weekly updates to the authoritative account and began 
the Domain Architecture which will describe the business vision and 
supporting conceptual technical architecture that will drive AMS 
releases for the next five years. 

In addition to the key modernization projects, several initiatives and 
improvements were undertaken in 2007 to effectively integrate the 
systems with the legacy production environment, and to improve the 
technology infrastructure. New and improved processes were also put in 
place to better integrate business and technology strategies, and to 
allow the IRS to operate more efficiently with improved productivity. 

* Institutionalized the use of the Enterprise Architecture into the 
Modernization Vision and Strategy process where the IRS received the 
prestigious E-Gov award as the Best Civilian Agency to use the 
Enterprise Architecture for Government Business Transformation. 

* Completed the Enterprise Service Oriented Architecture strategy and 
established the process to identify Enterprise Common Services in order 
to achieve operation excellence and cost savings. 

* Delivered high-priority portal platform improvements and stabilized 
operations to meet near term needs for the 2007/2008 filing seasons for 
tax practitioners and internal IRS users. 

* Integrated the Enterprise Application Integration Broker into the 
core infrastructure to enable the use of common services to leverage 
data and applications between legacy and modernized environments. 

* Expanded the Infrastructure Center of Excellence to include 
configuration management, measurement and analysis, capacity planning 
and performance engineering, and project monitoring and control. 

Expansion of Mandatory Corporate Modernized e-File (MeF): 

Corporations with assets over $50 million that file 250 or more returns 
annually were required to electronically file their Form 1120 or 1120S 
tax return for tax years ending on or after December 31, 2005. For tax 
years ending on or after December 31, 2006, the asset threshold was 
reduced to $10 million. 

The IRS worked extensively with stakeholder groups throughout the
implementation of the e-file mandate to address impediments to e-filing.
As a result, most corporations required to e-file complied with the
mandate. 

For filing year 2006, 11,000 large corporations with more than $50
million in assets were required to efile. Ultimately, more than 15,000
large corporations electronically filed including more than 4,000 large
corporate taxpayers who voluntarily e-filed during 2006. 

To ensure the successful expansion of its business e-file program, the
IRS established an E-Filing Project Office to work with external and
internal stakeholders, address e-file issues, and monitor taxpayer 
compliance with the corporate e-file mandate. In filing year 2007, more
than 16,900 corporate taxpayers efiled their returns. 

For FY 2007, new MeF capabilities allowed the receipt of electronically
filed Partnership Returns (Forms 1065 and 1065B), meeting the mandate 
for taxpayers with 100 or more partners to file electronically. MeF 
received over 2 million corporate, non-profit, and partnership forms 
for processing. 

The expansion of business e-file promotes a more efficient and timely
filing process. 

Protection of Sensitive Information/Information Technology (IT) 
Security: 

Security of infrastructure and IT systems remains a top priority for 
the IRS. In FY 2007, the IRS continued to update its systems, processes,
and training efforts to ensure taxpayer information is properly 
safeguarded. The IRS completed all required Federal Information 
Security Management Act activities; contingency plan testing on the 260
applications and systems on the master inventory; and live disaster 
recovery testing for all major applications. The IRS also established 
new offices and governing bodies to provide direction and oversight
regarding the security and protection of sensitive information. 

The IRS security effort to protect sensitive information included: 

* Installed automatic full disk encryption on all of the total deployed 
inventory of over 50,000 IRS laptops; 

* Implemented a secure electronic online solution for data exchanged 
with federal, state, and other partners; 

* Updated employee required online training courses with the most 
recent policy guidance and employee responsibilities related to the 
protection of sensitive information and the use of encryption tools; 

* Deployed mandatory information protection training for all IRS 
employees and contractors having access to sensitive information; 

* Issued updated data protection policies, processes, and education
training tools to improve employee awareness and skill levels; 

* Deployed upgraded firewall intrusion detection devices. 

Human Capital: 

Workforce planning is a significant challenge. With a diverse 
population of more than 100,000 employees and more than 700 locations 
across the country, the IRS works continuously to ensure that its 
employees are in the right place at the right time and have the skills 
and competencies needed to accomplish the IRS mission. 

In FY 2007, the IRS continued to hire and train candidates to fill key 
mission critical occupations: 

Mission Critical Occupation: Revenue Agents; 
FY 2007 Targeted Staff Level: 12,691; 
Met: [Check]. 

Mission Critical Occupation: Special Agents; 
FY 2007 Targeted Staff Level: 2,672; 
Met: [Check]. 

Mission Critical Occupation: Tax Examiners & Tax Compliance Officers; 
FY 2007 Targeted Staff Level: 11,656; 
Met: within 98% of target. 

Mission Critical Occupation: Revenue Officers; 
FY 2007 Targeted Staff Level: 5,675; 
Met: within 95% of target. 

Continuing to use enforcement resources effectively while recruiting, 
hiring, and developing new and existing talent to meet the demands of 
the future resulted in a consistent increase in enforcement revenue 
over the past four years. 

In FY 2007, the IRS established Human Capital outcome indicators of 
talent, performance culture, leadership, and knowledge management to 
assess how well it is strategically managing human capital to achieve 
the IRS mission. For example, to meet changing business and 
technological demands, the IRS initiated a program to identify targeted
occupations, skill sets, and hard-to-fill positions. The program 
features integration of all recruitment, hiring, and compensation 
efforts, along with the development of new and improved methods of 
predicting future attrition through retirements. Developing activities 
specifically targeted toward mitigating the impact of retirements as 
well as attracting and retaining new hires with advanced skills 
continues to be critical to the successful delivery of IRS business 
goals. 

The IRS continued to work on development of a human capital strategy in 
FY 2007. The strategy includes bringing critical personnel on board and 
includes objectives for employee training, leadership development, and 
workforce retention. Actions taken in FY 2007 included: 

* Established a Center of Excellence Office to determine the skills and 
competencies for each area of expertise; and; 

* Developed training requirements and a new recruitment strategy. 

Future efforts are aimed at synchronizing the hiring of new staff with 
the retirement of older staff such that adequate knowledge transfer 
occurs. 

OMB Circular A-123, ï¿½Managementï¿½s Responsibility for Internal Controlï¿½: 

The IRS conducted the required evaluation of the effectiveness of its
internal control over financial reporting in accordance with Appendix A 
of OMB Circular A-123. 

For FY 2007, the IRS conducted the following A-123 activities: 

* Tested 35 transaction processes material to Treasuryï¿½s Consolidated
Financial Statements, including: 
- 29 administrative processes related to $10 billion in administrative 
transactions; 
- 6 custodial tax-related processes related to $2.69 trillion in tax
revenues; 

* Reviewed controls over the IRSï¿½s financial reporting, specifically
Treasury Information Executive Repository reporting; 

* Conducted a self-assessment of the internal control environment using 
the Government Accountability Officeï¿½s (GAOï¿½s) abbreviated Internal 
Control Evaluation Checklist; 

* Reviewed IRS compliance with applicable laws and regulatory 
requirements regarding financial reporting and internal control; 

* Reviewed GAO and Treasury Inspector General for Tax Administration 
audit reports and findings. 

Based upon the results of the evaluation, the IRS provided qualified 
assurance that its internal controls were operating effectively. 

The qualified assurance is based on the condition of four material 
weaknesses reported by GAO in the IRS's FY 2006 and FY 2005 audited 
financial statements. GAO, however, acknowledged the development of 
compensating procedures to produce financial statements that are
fairly stated and issued an unqualified opinion. 

In May 2007, GAO reported on the IRSï¿½s FY 2006 A-123 testing noting 
that the IRS appropriately planned and implemented its first-year
assessment. 

Systems Controls and Legal Compliance: 

The IRS continued to enhance financial management and appropriate 
controls that are an integral component of all IRS programs. 

Federal Managersï¿½ Financial Integrity Act (FMFIA): 

During FY 2007, the IRS complied with the internal control requirements 
of FMFIA, the Office of Management and Budget (OMB) Circular A-123, and 
the Reports Consolidation Act of 2000. The IRS organizations operated 
in accordance with the procedures and standards prescribed by the 
Comptroller General and OMB Guidelines. 

The systems of management control for the IRS organizations are 
designed to ensure that: 

* programs achieve their intended results; 
* resources are consistent with the overall mission; 
* programs and resources are free from waste, fraud, and
mismanagement; 
* laws and regulations are followed; 
* controls are sufficient to minimize improper and erroneous
payments; 
* performance information is reliable; 
* system security is in substantial compliance with all relevant
requirements; 
* continuity of operations planning in critical areas is sufficient to 
reduce risk to reasonable levels; and; 
* financial management standards are in compliance with Federal 
financial systems standards, i.e., FMFIA Section 4 and Federal 
Financial Management Improvement Act (FFMIA). 

Because the IRS has open material weaknesses and the financial 
management systems do not substantially comply with the FFMIA, the IRS 
provides qualified assurance that the above listed systems of 
management control objectives were achieved by the IRS during FY 2007. 
This assurance is provided relative to Sections 2 and 4 of FMFIA. The 
material weaknesses are: 

* Improve Modernization Management and Processes; 
* Earned Income Tax Credit (EITC) Non-Compliance; 
* Computer Security; 
* Financial Accounting of Revenue ï¿½ Custodial. 

Federal Financial Management Improvement Act (FFMIA): 

The IRS has made significant progress bringing financial management 
systems into compliance with FFMIA. During FY 2007, the IRS implemented 
a new interface between the Custodial Detail Data Base (CDDB) and the 
Interim Revenue Accounting Control System to create a summary of unpaid
assessment and accrual data. 

Lien Release Non-Compliance Issue: 

As of September 30, 2007, the IRS did not consistently comply with 
section 6325 of the Internal Revenue Code regarding the timely release 
of federal tax liens. The IRS Financial and Management Controls 
Executive Steering Committee (FMC ESC) monitors the action plan which
addresses issues identified by the IRS, Government Accountability 
Office (GAO), and the Treasury Inspector General for Tax Administration 
(TIGTA). 

Property and Equipment: 

GAO concluded in the report on the IRSï¿½s FY 2006 and FY 2005 Financial 
Statements that Property and Equipment (P&E) accounting records no 
longer constitutes a reportable condition. However, the IRS continued 
to strengthen internal controls and procedures that enhanced its 
ability to account for P&E. Specifically, the IRS revised the dollar 
threshold for review of P&E accounting transactions and conducted 
intensive reviews of the large dollar transactions increasing the 
accuracy of P&E reporting. The IRS improved its capability to 
capitalize assets or expense other items and properly account for 
Business System Modernization costs in internal use software. 

Federal Information Security Management Act (FISMA): 

In accordance with the requirements of FISMA, the IRS took actions to
establish a stronger agency-wide information security program due to
the IRS's Computer Security Material Weakness: 

Actions: Certification and Testing of systems; 
Status: Two thirds complete [1]. 

Actions: Systems Accreditation; 
Status: 98% Approved. 

Actions: Specialized training; 
Status: 99% of Employees. 

Actions: Annual Awareness Training; 
Status: 99% of Employees and Contractors. 

Actions: Contractor Systems Reviews; 
Status: 100%. 

Actions: Annual Security Controls Testing; 
Status: 100%. 

Actions: Annual IT Contingency Plan Testing; 
Status: 100%. 

Actions: Privacy Impact Assessment; 
Status: 100%. 

Actions: System of Record Notice; 
Status: 100% compliance. 

[1]The final one-third will be completed in 2008. 

[End of table] 

* The IRS certification program is in the third year of a three year 
cycle to certify all IRS reported systems. There are 260 systems 
operating under a full Authority to Operate (ATO), 4 with an Interim ATO
(IATO), and 2 certifications are currently in progress. For all ATO
and IATO Systems, Security Test and Evaluations are documented in a 
Plan of Action and Milestones. 

* Maintained the 24 X 7 incident response center to monitor IRS 
computer and network security, and created a second center to provide 
back-up capabilities. 

* Completed all required FISMA activities contingency plan testing on 
all of the 260 applications/ systems on the master inventory and live 
disaster recovery tests for all major applications. 

The IRS's strategy is to implement an enterprise-wide risk management
approach that cost-effectively focuses resources on major systems and 
assets supporting tax administration. 

Reports Consolidation Act of 2000: 

The IRS provided assurance that its critical performance measures are 
reliable. Internal Revenue Manual 1.5, ï¿½Managing Statistics in a 
Balanced Measurement System Handbook,ï¿½ provides a detailed template 
that documents each measureï¿½s definition, formula, reliability, and 
reporting frequency. These controls ensure that the data is consistently
and accurately collected over time. 

Continuity of Operations (COOP): 

IRS leaders practiced scenarios during the annual COOP exercise to make 
sure the IRS could sustain operations after a catastrophic event. 
Scenarios included: workplace violence; weather disasters; 
international, domestic, and cyberterrorism; and blackouts. 

Months of intricate planning and extensive logistical coordination were 
conducted to prepare for the realistic, one to two-day drills. Practice 
scenarios involved computer hackers penetrating information systems, 
bombs, explosions or shootings at offices, and floods or weather-related
destruction. IRS executives reviewed the results of each exercise to 
learn where the IRS could make necessary changes to strengthen its 
overall plan. Other important practice activities like simulation 
exercises and tests of individual business resumption plans took place 
on a smaller scale. 

Major Management Challenges and High-Risk Areas: 

Over the last several years, GAO, TIGTA, and the Office of Inspector 
General for Treasury have identified several Management Challenges and 
High-Risk areas facing the IRS. In FY 2007, TIGTA reorganized the 
challenges by dividing the category of Tax Compliance Initiatives into 
two subcategories: Business and Individual and Tax Exempt Entities. 
These subcategories better defined the need to administer tax 
regulations and collect tax dollars from businesses and individuals, 
and to oversee compliance issues for tax-exempt entities. Appendix E 
identifies specific steps and actions being taken for the ten 
management challenges below: 

* Modernization of the Internal Revenue Service; 
* Tax Compliance Initiatives; 
* Security of the Internal Revenue Service; 
* Providing Quality Taxpayer Service Operations; 
* Complexity of the Tax Law; 
* Using Performance and Financial Information for Program and Budget 
Decisions; 
* Erroneous and Improper Payments; 
* Taxpayer Protection and Rights; 
* Processing Returns and Implementing Tax Law Changes During the Tax 
Filing Season; 
* Human Capital. 

Limitations of Financial Statements: 

The principal financial statements have been prepared to report the 
results of IRS operations, pursuant to the requirements of 31 U.S.C. 
3515(b). The statements were prepared from the books and records of the 
IRS in accordance with generally accepted accounting principles for 
Federal entities and the format prescribed by OMB. The statements are 
in addition to the financial reports used to monitor and control 
budgetary resources, which are prepared from the same books and 
records. The statements should be read with the realization that they 
are a component of the U.S. Government, a sovereign entity. 

Progress Made on Earned Income Tax Credit (EITC) Material Weakness: 

The IRS continued progress on its action plan for the EITC material
weakness by providing a current estimate of error, an explanation of
the methodology, and an action plan to reduce error. The following
actions were also taken in FY 2007: 

* Incorporated EITC into the National Research Program study for Tax 
Year 2006. Results, expected in 2009, will enable the IRS to provide 
updated estimates of error for the Improper Payment Information Act 
based on recent compliance data; 

* Began development of a holistic, data-driven, five-year strategy
designed to use enforcement and outreach treatments involving taxpayers,
preparers, and third parties to reduce EITC errors and protect revenue; 

* Conducted a nationwide EITC Awareness Day for EITC eligible 
taxpayers; 

* Delivered key compliance activities including 500,000 audits, over
390,000 misreported income cases and 500,000 math error notices, 
protecting revenue of $2.6 billion; 

* Tested alternative treatments, such as soft notices, as compared to 
more costly standard compliance treatments, i.e., examinations; 

* Completed return preparer compliance tests designed to identify and
deter preparers of large numbers of erroneous EITC claims; 

* Completed reports on the second and third year of the EITC 
certification tests and in the process of completing a cumulative 
report,
which will be used to make informed decisions about implementation of 
certification as a compliance treatment. 

Overview of Revenue and Administrative Accounts: 

The IRS FY 2007 financial statements received an unqualified audit
opinion for the eighth consecutive year. 

The Balance Sheet reflects total assets of $31 billion of which $26 
billion (83%) are Federal Taxes Receivable, which represents amounts 
expected to be collected from past due accounts. The $5 billion 
increase in total assets is primarily attributable to the increase in 
Federal taxes receivable. The majority of IRSï¿½s liabilities consist of
amounts due to Treasury related to Federal taxes receivable. 

The Statement of Custodial Activity shows that IRS programs collected
$2.69 trillion in federal tax receipts. 

Financing Sources: 

The IRS receives the majority of its funding through annual and 
multiyear appropriations, which are available for use within certain
specified statutory limits. Besides appropriations, the IRS used other
financing sources. These included net transfers from other federal 
agencies and revenue from user fees for direct services provided to 
customers (for example, installment agreement fees, photocopy fees, and 
letter rulings and determinations fees). 

Financial Highlights: 

Revenue and Refund Trend Information: 

FY 2007 revenue receipts collected by IRS, $2.69 trillion, increased by 
approximately 7% from FY 2006. Federal tax revenues are collected 
through six major classifications: individual income FICA/SECA, 
corporate income, excise taxes, estate and gift taxes, railroad 
retirement, and federal unemployment taxes. 

FY 2007 tax refund activity, $292 billion, increased by approximately 
5% from FY 2006. Federal tax refunds include payments for tax, 
interest, and Earned Income Tax Credit and Child Care Tax Credit in 
excess of the tax liability. In FY 2007, the IRS issued payments of $64 
million for Advanced Earned Income Tax Credit. 

Excise Tax Trust Fund: 

The Quarterly Federal Excise Tax Return, Form 720, reports liability 
for excise taxes. Taxpayers make periodic deposits in advance of filing 
the return. These deposits are classified as Federal Excise Tax. After 
the IRS receives and processes the returns, the IRS certifies amounts 
for several Trust Funds. Amounts reported on the Statement of Custodial
Activity are for fiscal year collections (October 1 through September 
30). Because Form 720 reporting requirements are completed after 
receipt of most of the deposits, the certification amounts will not 
match the amounts collected in the fiscal year. The table below shows 
revised receipts certified to the Airport and Airway Trust Fund, Black 
Lung Disability Trust Fund and the Highway Trust Fund for the eight 
liability quarters from December 2004 through September 2006. The 
Treasury Departmentï¿½s Financial Management Service and the Bureau of 
Public Debt prepare the warrants and allocations to the various Trust 
Funds. 

Table: 

Airport & Airway Trust Fund: 
Liability Quarter Ended, December 2004 ï¿½ September 2005: 
$10,379,502,000; 
Liability Quarter Ended, December 2005 ï¿½ September 2006: 
$10,183,465,000. 

Black Lung Disability Trust Fund: 
Liability Quarter Ended, December 2004 ï¿½ September 2005: 612,445,000; 
Liability Quarter Ended, December 2005 ï¿½ September 2006: 607,881,000. 

Highway Trust Fund: 
Liability Quarter Ended, December 2004 ï¿½ September 2005: 
39,537,447,000; 
Liability Quarter Ended, December 2005 ï¿½ September 2006: 
41,266,551,000. 

Total: 
Liability Quarter Ended, December 2004 ï¿½ September 2005: 
$50,529,394,000; 
Liability Quarter Ended, December 2005 ï¿½ September 2006: 
$52,057,897,000. 

Analysis of Unpaid Assessments ï¿½ Most Unpaid Assessments Are Not 
Receivables and Are Largely Uncollectible: 

The unpaid assessment balance includes amounts owed by taxpayers who 
file returns without sufficient payment as well as amounts assessed 
through the IRS enforcement programs. As reflected in the supplemental 
information to the IRS FY 2007 Financial Statements, the unpaid 
assessment balance was about $263 billion as of September 30, 2007. 
Under federal accounting standards, unpaid assessments require taxpayer 
or court agreement to be considered federal taxes receivable. 
Assessments not agreed to by taxpayers or the courts are considered 
compliance assessments and are not considered federal taxes receivable. 
Assessments considered to have no future collection potential are 
called writeoffs. The following provides detail on unpaid assessments: 

* Taxes receivable represent $98 billion (37%) of unpaid assessments 
and increased $7 billion (8%) from 91 billion as of September 30, 2006. 
About $72 billion (73%) of this balance is estimated to be 
uncollectible due primarily to the taxpayerï¿½s economic situation. 
Except for bankruptcy situations, the IRS may continue collection 
actions for 10 years after the assessment. About $26 billion (27%) of
taxes receivable is estimated to be collectible. 

* Compliance assessments of $65 billion represent amounts that have not 
been agreed to by either the taxpayer or a court. These assessments 
result primarily from various IRS enforcement programs promoting
voluntary compliance. 

* Write-off amounts of $100 billion include amounts owed by defunct 
corporations with no assets and failed financial institutions. The 
remaining amounts are owed by taxpayers with extreme economic and/or 
financial hardships, deceased taxpayers, and taxpayers who are 
insolvent due to bankruptcy. 

* About $151 billion (58%) of the unpaid assessment balance as of 
September 30, 2007, consists of interest and penalties and is largely 
uncollectible. 

Custodial Detail Data Base (CDDB): 

CDDB was implemented by the IRS in FY 2006 to comply with the Federal 
Financial Management Improvement Act and to resolve a material weakness 
in financial systems relating to accounting for duplicate Trust Fund 
Recovery Penalty assessments and the lack of a subsidiary ledger. 

CDDB is an enhancement to the Financial Management Information System, 
an operational system supplying reports and data used for the audit of 
the Custodial Financial Statements of the IRS and provides data to 
support the annual financial audit. CDDB is comprised of four primary 
releases. 

For FY 2007, CDDB accomplishments and implementation progress included: 

* Completed the interface between CDDB and the Interim Revenue 
Accounting Control System (IRACS) in April 2007 to post to the IRACS 
data base unpaid assessments segregated by each of the financial 
classifications used in the financial statements, the duplicate and non-
duplicate amounts related to taxpayer accounts associated with unpaid
payroll taxes, and their related accrued penalty and interest. 

* Completed CDDB Release 2B Systems Acceptance Testing (SAT) to post 
the revenue transactions to a data base. Loading the pre-posted 
payments from Electronic Federal Tax Payment System at the transaction 
level will begin in November 2007. 

* Conducting SAT for posting a Trace ID Number to revenue transactions 
in the remaining payment systems for Release 3 by December 2007, and 
going into production in January 2008. 

The Integrated Financial System (IFS): 

Since IFS implementation in FY 2005, the IRS has expanded its 
capabilities. For example, enhancements and interfaces were implemented 
for several programs, including Homeland Security Presidential 
Directive #12, Federal Highway Administration, and Income Verification 
Express Service user fees. Also, customized budget execution and cost 
reports produced from the IFS business warehouse were developed. New 
training for IFS users was delivered providing techniques for fully 
using the extensive reporting capabilities of IFS. 

Appendix A: Organization Chart: 
Department Of The Treasury, Internal Revenue Service: 

[See PDF for image] 

Commissioner; Chief of Staff: 
* Appeals; 
* Chief Counsel; 
* National Taxpayer Advocate. 

Commissioner; Chief of Staff: 
* EEO and Diversity; 
* Research, Analysis and Statistics; 
* Communications and Liaison. 

Commissioner; Chief of Staff: 
* Deputy Commissioner, Services and Enforcement; 
- Office of Professional Responsibility; 
- Whistleblower Office. 

Commissioner; Chief of Staff: 
* Deputy Commissioner, Services and Enforcement; 
- Small Business/Self Employed; 
- Large and Mid-Sized Business; 
- Criminal Investigation; 
- Tax Exempt and Government Entities; 
- Wage and Investment. 

Commissioner; Chief of Staff: 
- Deputy Commissioner, Operations Support; 
- Chief Information Officer; 
- Agency-Wide Shared Services; 
- Human Capital Officer; 
- Chief Financial Officer; 
- Privacy, Information Protection and Data Security Office. 

[End of appendix] 

Appendix B: Performance Measurement Data: 

Measure: Customer Service Representative (CSR) Level of Service; 
2004: 87.3%; 
2005: 82.6%; 
2006: 82.%; 
2007, Target: 82%; 
2007: Actual: 82.1. 

Measure: Customer Contacts Resolved per Staff Year; 
2004: 8,015; 
2005: 7,585; 
2006: 7,414; 
2007, Target: 7,702; 
2007: Actual: 7,648. 

Measure: Percent of Eligible Taxpayers Who File for EITC (CY): 
2004: 80.0%; 
2005: 80.0%; 
2006: *; 
2007, Target: 75-85%; 
2007: Actual: *. 

Measure: Customer Accuracy ï¿½ Tax Law Phones; 
2004: 80.0%; 
2005: 89.0%; 
2006: 90.9%; 
2007, Target: 91.0%; 
2007: Actual: 91.2%. 

Measure: Customer Accuracy ï¿½ Customer Accounts (Phones): 
2004: 89.3%; 
2005: 91.5%; 
2006: 93.2%; 
2007, Target: 93.3%; 
2007: Actual: 93.4. 

Measure: Timeliness of Critical Filing Season Tax Products to the 
Public: 
2004: 76.0%; 
2005: 91.4%; 
2006: 83.0%; 
2007, Target: 85.2%; 
2007: Actual: 83.5%. 

Measure: Timeliness of Critical Other Tax Products to the Public: 
2004: 76.0%; 
2005: 80.0%; 
2006: 61.2%; 
2007, Target: 79.6%; 
2007: Actual: 84.0%. 

Measure: Percent Individual Returns Processed Electronically: 
2004: 46.5%; 
2005: 51.1%; 
2006: 54.1%; 
2007, Target: 57.0%; 
2007: Actual: 57.1. 

Measure: Cost per Taxpayer Served ($) (HCTC): 
2004: N/A; 
2005: N/A; 
2006: $13.71; 
2007, Target: $14.25; 
2007: Actual: $14.93. 

Measure: Sign-Up Time (days) ï¿½ Customer Engagement (HCTC): 
2004: N/A; 
2005: 98.1; 
2006: 98.7; 
2007, Target: 97.0; 
2007: Actual: 93.3. 

Measure: Percent Business Returns Processed Electronically: 
2004: 17.4%; 
2005: 17.8%; 
2006: 16.6%; 
2007, Target: 19.5%; 
2007: Actual: 191.1%. 

Measure: Refund Timeliness ï¿½ Individual (Paper): 
2004: 98.3%; 
2005: 99.2%; 
2006: 99.3%; 
2007, Target: 99.2%; 
2007: Actual: 99.1%. 

Measure: Taxpayer Self Assistance: 
2004: 46.4%; 
2005: 42.5%; 
2006: 46.8%; 
2007, Target: 48.6%; 
2007: Actual: 49.5. 

Measure: Examination Coverage ï¿½ Individual: 
2004: 0.8%; 
2005: 0.9%; 
2006: 1.0%; 
2007, Target: 1.0%; 
2007: Actual: 1.0%. 

Measure: Field Examination Embedded Quality (EQ): 
2004: N/A; 
2005: N/A; 
2006: 85.9%; 
2007, Target: 87.0%; 
2007: Actual: 85.9%. 

Measure: Office Examination Embedded Quality (EQ): 
2004: N/A; 
2005: N/A; 
2006: 88.2%; 
2007, Target: 89.0% 
2007: Actual: 89.4. 

Measure: Examination Quality ï¿½ Industry: 
2004: 74.0%; 
2005: 77.0%; 
2006: 85.0%; 
2007, Target: 88.0%; 
2007: Actual: 87%. 

Measure: Examination Quality ï¿½ Coordinated Industry: 
2004: 87.0%; 
2005: 89.0%; 
2006: 96.0%; 
2007, Target: 97.0%; 
2007: Actual: 96.0%. 

Measure: Examination Coverage ï¿½ Business (Corps. >$10M): 
2004: 7.5%; 
2005: 7.8%; 
2006: 7.3%; 
2007, Target: 8.2%; 
2007: Actual: 7.2%. 

Measure: Examination Efficiency ï¿½ Individual (1040): 
2004: N/A; 
2005: 121; 
2006: 128; 
2007, Target: 136; 
2007: Actual: 137. 

Measure: Automated Underreporter (AUR) Efficiency: 
2004: 1,514; 
2005: 1,701; 
2006: 1,832; 
2007, Target: 1,932; 
2007: Actual: 1,956. 

Measure: Automated Underreporter (AUR) Coverage: 
2004: 1.9%; 
2005: 2.2%; 
2006: 2.4%; 
2007, Target: 2.5%; 
2007: Actual: 2.5%. 

Measure: Collection Coverage ï¿½ Units: 
2004: N/A; 
2005: 53.0%; 
2006: 54.0%; 
2007, Target: 54.0%; 
2007: Actual: 54.0%. 

Measure: Collection Efficiency ï¿½ Units: 
2004: N/A; 
2005: 1,514; 
2006: 1,677; 
2007, Target: 1,723; 
2007: Actual: 1,828. 

Measure: Field Collection Embedded Quality (EQ): 
2004: N/A; 
2005: N/A; 
2006: 84.2%; 
2007, Target: 86.0%; 
2007: Actual: 84.0%. 

Measure: Automated Collection System (ACS) Accuracy: 
2004: 87.8%; 
2005: 88.5%; 
2006: 91.0%; 
2007, Target: 91.0%; 
2007: Actual: 92.9%. 

Measure: Criminal Investigations Completed: 4,387 4,104 4,157 4,000 
4,269
2004: 4,387; 
2005: 4,104; 
2006: 4,157; 
2007, Target: 4,000; 
2007: Actual: 4,269. 

Measure: Number of Convictions: 
2004: 2,008; 
2005: 2,151; 
2006: 2,019; 
2007, Target: 2,069; 
2007: Actual: 2,155. 

Measure: Conviction Rate: 
2004: 91.2%; 
2005: 91.2; 
2006: 91.5%; 
2007, Target: 92.0%; 
2007: Actual: 90.2%. 

Measure: Conviction Efficiency Rate ($): 
2004: 362,849; 
2005: 295,316; 
2006: 328,750; 
2007, Target: 314,008; 
2007: Actual: 301,788. 

Measure: TE/GE Determination Case Closures: 
2004: 143,877; 
2005: 126,481; 
2006: 108,462; 
2007, Target: 118,200; 
2007: Actual: 109,408. 

Measure: BSM Project Cost Variance by Release/Subrelease: 

2004: N/A; 
2005: N/A; 
2006: **; 
2007, Target: 10.0%; 
2007: Actual: **. 

Measure: BSM Project Schedule Variance by Release/Subrelease: 
2004: N/A; 
2005: N/A; 
2006: **; 
2007, Target: 10.0%; 
2007: Actual: **. 

* The methodology for estimating the eligibility rate is being revised.
** Cost and Schedule variance is based on +/- 10% and is reported on 
several project releases/subreleases. 

[End of appendix] 

Appendix C: Explanation of Shortfalls: 

Customer Contacts Resolved per Staff Year: The Customer Contacts 
Resolved per Staff Year target was set using preliminary FTE levels. 
For FY 2007, the actual was 7,648, within 1% of the target of 7,702. 
The IRS completed almost 4 million additional web services than 
projected. During the latter part of the fiscal year, an emphasis was 
placed on reducing inventory levels in the Accounts Management paper 
programs, resulting in more FTE spent than were used in calculating the 
target. Completing a web service is defined as providing a service 
requested by a taxpayer or tax practitioner through self-assist 
internet-based applications such as Internet Refund Fact of Filing 
("Where's My Refund"), Transcript Delivery System, Preparer Tax 
Identification Number, Internet-EIN, Prior Year Earned Income Option, 
and Disclosure Authorizations. 

Timeliness of Critical Filing Season Tax Products to the Public: For FY 
2007, the Timeliness of Critical Filing Season Tax Products to the 
Public was 83.5%, 1.7 percentage points below the FY 2007 target of 
85.2% and 0.6% above the prior yearï¿½s performance of 83.0. The late 
passage of Extender Legislation affecting state and local sales taxes 
and education expenses was the primary cause for the IRS not meeting 
this target. More than 1,000 tax product revisions affecting 137 of the 
164 filing season products used by taxpayers were changed with no 
impact to the start of the filing season. A total of 27 tax products 
were delayed. Eleven tax products were directly impacted by the 
Extender legislation and the remaining sixteen were indirectly impacted 
by the Extender legislation as a result of workload modifications to 
accommodate priority forms and publications. These products were 
originally scheduled for processing between October and December 2006. 

Cost Per Taxpayer Served ($): For FY 2007, the Cost Per Taxpayer Served 
was $14.93, sixty-eight cents above the FY 2007 target of $14.25. The 
shortfall was a result of having to absorb a one-time expense to 
purchase Health Care Tax Credit Program Kits for taxpayers at a cost of 
$300,000 to replace outdated supplies. The $300,000 cost was not 
factored in when the target was set. 

Percent of Business Returns Processed Electronically: For FY 2007, 
19.1% of the business returns processed were filed electronically. This 
is 2% below the plan of 19.5% and 15% above the prior year's 
performance of 16.6%. For the fiscal year, business returns
processed are running more than 500,000 above total projections. Of 
this overall increase over total projections, those from paper 
submissions are almost 800,000 above projections, while those from 
electronic submissions are almost 475,000 below projections. The 
majority of the electronic submission under run continues to be 
employment returns (primarily Forms 941, Employer's Quarterly Federal 
Tax Return) and corporation returns (primarily Forms 1120, U.S.
Corporation Income Tax Return). The combination of e-File being under 
schedule and the total business returns (paper and e-File combined) 
being over schedule exacerbates the percentage of business returns e-
Filed. 

Refund Timeliness ï¿½ Individual (Paper): The IRS was within 1% of 
target. For FY 2007, Refund Timeliness was 99.1%, 0.1 percentage point 
below the FY 2007 target of 99.2%. Delays associated with taxpayer 
identification number processing, including: increases in the number of 
Individual Taxpayer Identification Number (ITIN) applications; 
verification of required documentation (which is often submitted in a 
foreign language); and ITIN System stability issues that caused work 
stoppages during the peak processing season were the sources for delay. 
Assignment of an ITIN must be completed before the associated tax return
can be processed and any refund claim released for processing. 

Field Examination Embedded Quality: For FY 2007, Field Examination 
Embedded Quality was 85.9%, 1.1 percentage points (a statistically 
insignificant amount) short of the FY 2007 target of 87%. The FY 2007 
target assumed a 10% improvement factor in the previously weakest 
quality attributes. Although the 10% increase did not occur, there were 
significant improvements in several other attributes that brought IRS 
close to the target. Actions taken to improve the quality score 
included studying the consistency between front-line manager Embedded 
Quality Review System and the National Quality Review System processes 
that produced the measurements. In addition, an Exam Process Challenge 
Team was established to improve the audit process, with focus on the 
quality attributes in most need of enhancement. 

Examination Quality ï¿½ Industry: The Exam Quality - Industry score of 
87% was one percentage point (a statistically insignificant amount) 
below the FY 2007 target of 88% because of scores slightly below 
expectations in three of the four quality measurement technical 
standards as well as in the administrative procedures standard. The 
three technical standards were: Planning the Examination, 
Inspection/Fact Finding, and Workpapers & Reports. The Quality 
Assurance Staff continued to focus on the importance of meeting the 
Technical Standards through direct feedback to field teams, partnering 
with the industries in Quality Improvement Efforts, Quality Quotes, 
Quarterly Reports and outreach to field teams. In addition, while the 
field completed the Administrative Procedures Checksheet at a higher
percentage than in prior fiscal years, there were still some instances 
where all administrative procedures were not properly documented. The 
Quality Assurance Staff continued to stress the importance of properly 
completed Administrative Procedures Checksheets and ensured all
administrative and statutory requirements were properly executed and 
documented. 

Examination Quality ï¿½ Coordinated Industry: The Exam Quality ï¿½ 
Coordinated Industry score was 96%, one percentage point (a 
statistically insignificant amount) below the FY 2007 target of 97%. 
The IRS did not meet its target due to several factors related to the 
examination planning process, specifically identification of material 
issues and mandatory referrals to specialists. Another contributing 
factor was missing or unsigned Administrative Procedures Documents. The 
IRS continues to focus on the importance of meeting the Auditing 
Standards through direct feedback to field teams, partnering with the 
industries in Quality Improvement Efforts, Quality Quotes, Quarterly 
Reports and outreaches to IRS field teams. 

Examination Coverage ï¿½ Business: The Exam Coverage ï¿½ Business score was 
7.2%, one percentage point below the FY 2007 target of 8.2%. Key 
factors contributing to the shortfall, included the implementation of 
currency and cycle time initiative, which resulted in substantially
more current coordinated industry cases (CIC) that contain fewer cycles 
and fewer returns; increased time spent on the Compliance Assurance 
Program (cases addressing issues in a pre-filing environment), which 
resulted in less numbers of closed returns from a comparable CIC 
examination; and the rollout of the Issue Management System, (a case 
management tool used during the examination process) which consumed 
more agent time than planned. 

Field Collection Embedded Quality: The Field Collection Embedded 
Quality score was 84%, two percentage points below the FY 2007 target 
of 86%. Although the Field Collection quality score improved over last 
fiscal year, the FY 2007 target was established assuming Embedded 
Quality would be fully implemented at the start of FY 2007. However, 
implementation was delayed until March 2007, and the first quarterly 
report was not available until June 2007. These reports provide 
managers with data that allows them to focus improvements on specific
attributes. Quality remains a core goal of the Collection organization 
and is emphasized in both the Collection Program letter and the 
business plans for FY 2008. The IRS took the following actions to 
improve quality results: 1) conducted quarterly reviews in each area to 
ensure consistent application of the quality attributes and evaluated 
trends in order to identify areas that require additional rating 
guidance and clarity. The IRS will continue these reviews in FY 2008;
2) developed quality improvement action plans for each Collection area, 
which focused on specific elements that dropped 5% or more in each 
attribute. 

Conviction Rate: Criminal Investigation (CI) has historically achieved 
one of the highest conviction rates of any Federal law enforcement 
agency. The FY 2007 conviction rate was 90.2%, 1.8 percentage points 
below the 92% target rate. The drop in FY 2007 appears to be largely
attributable to an increase in dismissals, many involving complex legal 
issues and multiple defendants. Some of these dismissals were appealed 
by the government. It is possible to materially reduce the number of 
dismissals by selecting less sophisticated cases, however, over the 
past five years, CI demonstrated that investigating sophisticated high 
dollar, high impact legal source income cases fosters effective 
deterrence, although these cases entail risk. 

Tax Exempt and Government Entities (TEGE) Determination Case Closures: 
The IRS fell short of the combined target of 118,200 determination case 
closures by 7%. This was caused by several factors. First, workload in 
this area is driven by external demand; for various reasons, the IRS 
received 12,000 fewer applications than expected. Responding to customer
requests, the IRS extended certain filing deadlines. In addition, 
following a major revision to the user fee schedule for determination, 
a large number of submissions were returned to applicants due to 
incorrect user fees. Finally, legislative changes in the Pension 
Protection Act shifted workload priorities toward a number of time-
consuming cases, resulting in fewer closures overall. 

[End of appendix] 

Appendix D: Performance Measurement Descriptions: 

Customer Service Representative (CSR) Level of Service: 
The number of toll free callers that either speak to a Customer Service 
Representative or receive informational messages divided by the total 
number of attempted calls. 

Customer Contacts Resolved per Staff Year: 
The number of Customer Contacts resolved in relation to staff years 
expended. 

Percent of Eligible Taxpayers Who File for EITC: 
The number of taxpayers who claim the Earned Income Tax Credit (EITC) 
compared to the number of taxpayers who appear to be eligible for the 
EITC. 

Customer Accuracy ï¿½ Tax Law Phones: 
The percentage of correct answers given by a live assistor on Tollfree
tax law inquiries. 

Customer Accuracy ï¿½ Customer Accounts (Phones): 
The percentage of correct answers given by a live assistor on Tollfree
account inquiries. 

Timeliness of Critical Filing Season Tax Products to the Public: 
The percentage of critical filing season tax products (tax forms, 
schedules, instructions, publications, tax packages, and certain 
notices required by a large number of filers to prepare a complete and 
accurate tax return) available to the public in a timely fashion. 

Timeliness of Critical Other Tax Products to the Public: 
Percentage of critical other tax products, paper and electronic, 
available to the public in a timely fashion. 

Percent Individual Returns Processed Electronically: 
The percentage of electronically filed individual tax returns divided
by the total individual returns filed. 

Cost per Taxpayer Served ($) (HCTC): 
The costs associated with serving the taxpayers including program kit 
correspondence, registration and program participation. 

Sign-Up Time (days) ï¿½ Customer Engagement (HCTC): 
The length of time between the first Program Kit mailing and first
payment received. 

Percent Business Returns Processed Electronically: 
The percentage of electronically filed business tax returns divided
by the total business returns filed. 

Taxpayer Self Assistance Rate: 
The percentage of taxpayer assistance requests resolved using self-
assisted automated services. 

Refund Timeliness ï¿½ Individual (Paper): 
The percentage of refunds resulting from processing Individual Master 
File paper returns issued within 40 days or less. 

Examination Coverage ï¿½ Individual (1040): 
The sum of all individual 1040 returns closed by Small Business/Self 
Employed (SB/SE), Wage & Investment (W&I), and Large and Mid-Sized 
Business (LMSB) (Field Exam and Correspondence Exam programs ) divided 
by the total individual return filings for the prior calendar year. 

Field Examination Embedded Quality (EQ): 
The score awarded to a reviewed field examination case by a Quality 
Reviewer using the National Quality Review System (NQRS) quality 
attributes. 

Office Examination Embedded Quality (EQ): 
The score awarded to a reviewed office examination case by a Quality 
Reviewer using the NQRS quality attributes. 

Examination Coverage ï¿½ Business (Corps. >$10M): 
The number of LMSB ï¿½customer baseï¿½ returns (C and S Corporations with 
assets over $10 million and all partnerships) examined and closed by 
LMSB during the current fiscal year divided by the number of filings 
for the preceding calendar year. 

Examination Efficiency ï¿½ Individual (1040): 
The sum of all individual 1040 returns closed by SB/SE, W&I, and LMSB 
(Field Exam and Correspondence Exam programs) divided by the total Full-
Time Equivalent (FTE) expended in relation to those individual returns. 

Automated Underreporter (AUR) Efficiency: 
The total number of W&I and SB/SE contact closures (a closure resulting 
from a case where we made contact) divided by the total FTE, including 
overtime. 

Automated Underreporter (AUR) Coverage: 
A percentage representing the total number of W&I and SB/SE contact 
closures (a closure resulting from a case where SBSE and W&I made 
contact) divided by the total return filings for the prior year. 

Examination Quality ï¿½ Industry: 
Average of the scores of Industry Cases reviewed. Case scores are based 
on the percentage of elements passed within each auditing standard. 

Examination Quality ï¿½ Coordinated Industry: 
Average of the scores of Coordinated Industry Cases reviewed. Case 
scores are based on the percentage of elements passed within each 
auditing standard. 

Collection Coverage ï¿½ Units: 
The volume of collection work disposed compared to the volume of 
collection work available. 

Collection Efficiency ï¿½ Units: 
The sum of all modules disposed by Automated Collection System (ACS) 
(SB/SE & W&I) and by SB/SE Field Collection divided by the total 
collection FTE. 

Field Collection Embedded Quality (EQ): 
The score awarded to a reviewed collection cases by a Quality Reviewer 
using the NQRS quality attributes. 

Automated Collection System (ACS) Accuracy: 
The percent of taxpayers who receive the correct answer to their ACS 
question. 

Criminal Investigations Completed: 
The total number of subject criminal investigations completed during 
the fiscal year, including those that resulted in prosecution 
recommendations to the Department of Justice as well as those 
discontinued due to a lack of prosecution potential. 

Number of Convictions: 
The number of criminal convictions. 

Conviction Rate: 
The percent of adjudicated criminal cases that result in convictions. 

Conviction Efficiency Rate ($): 
The cost of Criminal Investigationï¿½s (CI's) program divided by the 
number of convictions. The number of convictions is the total number of 
cases with the following statuses: guilty plea, nolo contendere, judge 
guilty or jury guilty. The CI financial plan includes direct and 
reimbursable costs, including employeesï¿½ salaries, benefits, and 
investigative expenses, as well as facility costs (office space, 
heating, cleaning, computers, security, etc.), and other overhead 
costs. 

TE/GE Determination Case Closures: 
The number of cases closed in the Employee Plans or Exempt 
Organizations Determination programs, regardless of type of case
or type of closing. 

BSM Project Cost Variance by Release/Subrelease: 
Percent variance by release/sub-release of a Business Systems 
Modernization (BSM) funded project's initial, approved cost estimate 
versus current, approved cost estimate. Cost variances less than or 
equal to +/- 10% are categorized as being within acceptable tolerance 
thresholds. Cost variances greater than +/- 10% of the variance are 
categorized as being outside of acceptable thresholds. 

BSM Project Schedule Variance by Release/Subrelease: 
Percent variance by release/sub-release of a BSM funded project's 
initial, approved schedule estimate versus current, approved schedule 
estimate. Schedule variances less than or equal to +/- 10% will be 
categorized as being within acceptable tolerance thresholds. If 
schedule variances are greater than +/- 10%, the variance will be 
categorized as being outside of acceptable thresholds. 

[End of appendix] 

Appendix E: Major Management Challenges and High-Risk Areas With Future 
Challenges: 

Over the last several years GAO, TIGTA, and the OIG for Treasury have 
identified several Management Challenges and High-Risk Areas facing the 
IRS. The IRS has identified specific steps and actions to address these 
issues through its existing program activities. Measures of these 
program activities serve to show progress in addressing the management 
challenges and high-risk areas. The following summarizes each 
Management Challenge and High-Risk issue, FY 2007 accomplishments, 
actions identified for completion in FY 2008 and beyond, and future 
challenges. 

Challenge/Issue: Modernization of the Internal Revenue Service 
(Computerized Systems and Business Structure) and IRS Business Systems: 
Bring the IRSï¿½s business systems and financial systems to a level that 
provides management current and reliable information to support 
informed decision making. GAO, in its FY 2005 High Risk series,
has consolidated IRS Business Systems Modernization and IRS Financial 
Management into one Business Systems Modernization high-risk area. 
Actions Taken in FY 2007 and Actions Planned or Underway: 
Actions Taken: 
* Deployed Customer Account Data Engine (CADE) Release 2 enabling CADE 
to process over 11 million returns and issue refunds of $11.6 billion. 
* Added new capabilities to the Modernized e-File (MeF) system that 
enabled the receipt of electronically filed Partnership Returns (Forms 
1065 & 1065B), meeting the mandate for taxpayers with 100 or more 
partners to file electronically. MeF received over two million 
corporate, non-profit, and partnership forms for processing. 
* Deployed the first two releases of the Accounts Management Services
(AMS) system, designed to deliver improved customer support and
functionality by leveraging existing IRS applications. 
* Continued development of a comprehensive strategy for the future 
beyond 2007, known as the Modernization Vision & Strategy (MV&S). The 
MV&S includes an Enterprise Transition Strategy that addresses 
priorities for modernizing front-line tax administration functions and 
guides IT investment decision making. 
* Implemented a new governance structure to account for all IT 
investment projects, regardless of dollar value. 

Actions Planned or Underway for FY 2008 and Beyond: 
* Continue focus on modernization of the tax administration systems to
provide additional benefits to taxpayers and maintain continuity of the
program while mitigating risk through improved governance. 
* Expand modernized electronic filing capabilities to US income tax 
returns for foreign corporations to accommodate the 2008 electronic 
filing requirement for exempt organizations with less than $25,000 in 
gross receipts. 
* Continued deployment of improved management through the High Priority
Initiative process. 

Challenge/Issue: Tax Compliance Initiatives: 
Administer programs to deal with tax gap issues, especially those 
resulting from corporate and high income individual taxpayers, as well 
as domestic and off-shore tax and financial criminal activity. Address 
the evolving challenge of unpaid taxes and continuing Earned Income Tax 
Credit (EITC) non-compliance. 

Individuals and Businesses, Actions Taken: 
* Collected $59.2 billion in enforcement revenue, a 75% increase since 
2001. 
* Released ï¿½Reducing the Federal Tax Gap: A Report on Improving
Voluntary Compliance,ï¿½ which, combined with legislative changes, will 
guide organizational efforts to reduce the tax gap. 
* Initiated a compliance study for Subchapter S corporations and a Tax 
Year 2006 individual income reporting compliance study. 
* Updated workload selection models for tax year 2006 using data from 
prior compliance studies, enabling the IRS to better leverage limited 
enforcement resources and reduce the burden on compliant taxpayers. 
* Issued new regulations dealing with transactions of interest 
(transactions that have potential for abuse but lack sufficient 
information to be designated specifically as tax avoidance 
transactions) and clarified rules relating to disclosure of reportable 
transactions allowing IRS more flexibility in quickly addressing 
potential tax shelter issues. 
* Targeted preparers whose tax work indicated questionable return 
preparation practices and assessed over $62 million in penalties.
Admissions of these regrettable behaviors received significant 
publicity. 

Individuals and Businesses, Actions Planned or Underway for FY 2008 and 
Beyond: 
* IRSï¿½s FY 2008 budget request includes funding to support multiple 
reporting compliance studies for additional taxpayer segments such as 
corporate income taxpayers, partnerships, S corporations, and employment
taxpayers. 
* Implement provisions contained in the report on the federal tax gap. 

Tax Exempt and Government Entities, Actions Taken: 
* Increased enforcement presence through a 5% increase in examinations 
and 12% in overall compliance contacts, including conducting reviews of
executive compensation practices among tax-exempt organizations. 
* Developed web-based tools such as [hyperlink, 
http://www.stayexempt.org], a popular website that helps tax exempt 
entities understand their federal tax requirements. 
* Developed workshops to assist remote tribal villages in understanding
federal and state employment tax and other reporting requirements. 

Tax Exempt and Government Entities, Actions Planned or Underway for FY 
2008 and Beyond: 
* Continue to focus efforts on tax shelter schemes and abusive 
transactions. 
* Continue compliance initiatives to address tribal gaming and banking
issues. 
* Develop risk-based models to improve examination case selection. 

Challenge/Issue: Security of the Internal Revenue Service: 
Strengthening the security infrastructure and the applications that
guard sensitive data. 
Actions Taken: 
* Established new offices including the Office of Privacy, Information
Protection, and Data Security to provide direction and oversight 
regarding the security and protection of sensitive information. 
* Established an Associate Chief Information Officer position to manage 
the IRS-wide Information Technology Security Program. 
* Developed an integrated Information Technology Security Schedule and
Plan, and a comprehensive IRS security strategy, which defined areas for
improvement in the security posture of the IRS. 
* Encrypted all laptop data and tapes used in electronic data exchange. 
* Implemented an enterprise anti-virus Internet gateway solution to 
detect and quarantine malicious content from invading systems. 
* Updated IRS mandatory employee training to reflect recent policy 
guidance and reinforced employee responsibilities related to the 
protection of sensitive information and the use of encryption tools. 

Actions Planned or Underway for FY 2008 and Beyond: 
* Upgrade core security infrastructure components, including firewalls 
and network intrusion detections systems. 
* Implement a security solution that facilitates the recovery and 
preservation of evidence from remote systems involved in security 
incidents. 
* Assess the vulnerability of critical systems across all business 
operations, including identification of new on-line computer fraud 
schemes. 

Challenge/Issue: Providing Quality Taxpayer Service Operations: 
Providing top quality service to every taxpayer in every transaction is 
an integral part of the IRSï¿½s strategic and modernization plans. 
Actions Taken: 
* Completed the Taxpayer Assistance Blueprint (TAB), the most extensive
research effort on the needs, preferences, and behaviors of taxpayers 
and partners who assist them in complying with the tax laws. 
* Provided assistance to millions of taxpayers through toll-free call 
centers, the IRS.gov website, the 401 Taxpayer Assistance Centers, and 
at more than 11,922 Volunteer Income Tax Assistance and Tax Counseling 
for the Elderly sites. 
* Created key messages and publicized split refund capability and the
Telephone Excise Tax Refund (TETR) through a network of more than 300
partner coalitions and more than 11,000 sites. 
* Provided free tax assistance to the elderly, disabled and limited 
English proficient individuals, filing approximately 2.63 million 
returns through its Volunteer Income Tax and Tax Counseling for the 
Elderly sites (a 14% increase over FY 2006). 
* Increased the number of partnerships with community-based 
organizations assisting taxpayers with financial literacy, return 
preparation, and tax return filing. These efforts resulted in an 
increase in outreach efforts by 15% and return preparation by 18% over 
FY 2006. 
* Held a National EITC Day, a single-day nationwide media campaign to
increase awareness of EITC among eligible taxpayers. 

Actions Planned or Underway for FY 2008 and Beyond: 
* Implement TAB service improvement initiatives through the IRS planning
and budget process. 
* Deliver Spanish interactive tax applications, including the Spanish 
version of ï¿½Whereï¿½s My Refund?ï¿½ and hyperlinked applications. 
* Continue efforts utilizing IRS partners to disseminate information, 
simplify forms, and tax filing processes. 

Challenge/Issue: Complexity of the Tax Law: 
Simplifying the tax process within current laws while at the same time 
modernize IRS systems and processes to reduce tax complexity for 
individual and business taxpayers. 
Actions Taken: 
* Redesigned the Request for Innocent Spouse Relief, Form 8857, which is
expected to eliminate 30,000 follow-up letters annually, reducing 
taxpayer burden. 
* Designed a ï¿½1040 Centralï¿½ page which contains new releases, fact 
sheets, and tax tips to keep taxpayers informed of changes when they 
happen. 
* Tested a streamlined Form 1040 that moves lesser-used lines for 
certain income, deductions, and credits from the Form 1040 to a new 
Schedule O, reducing burden for approximately 95% of individual 
taxpayers. 
* Created an internet version of a popular tax compliance workshop for 
small to mid-sized exempt organizations, including charities and 
churches, which received positive media coverage and an enthusiastic 
reaction from practitioners and stakeholders. 
* Developed a three-point plan that expanded EITC outreach initiatives 
and outlined effort to improve forms and various media for EITC filers. 

Actions Planned or Underway for FY 2008 and Beyond: 
* Contingent on funding, implement the streamlined Form 1040 with a new
Schedule O, in conjunction with Modernized e-File Form 1040 for cost
efficiency. 
* Complete the Study of Universal Use of Advanced Payment of EITC. 
* Continue to develop guidance in response to The Pension Protection 
Act of 2006. 
* Develop a simplified employee plan application process for small
employers. 
* Finalize and present correction workshops to employers and plan
representatives unfamiliar with employee benefits practice. 
* Address potential compliance issues for small businesses and 
individuals with limited English proficiency through the translation of 
chapters in Publication 17, ï¿½Your Federal Income Tax,ï¿½ and Publication 
334, ï¿½Tax Guide for Businesses.ï¿½ 

Challenge/Issue: Using Performance and Financial Information for 
Program and Budget Decisions: 
The absence of accurate and complete management information hinders the 
IRSï¿½s ability to produce timely, accurate and useful information needed 
for day-to-day decisions. 
Actions Taken: 
* Expanded the capabilities of the Custodial Detail Database (CDDB) to
provide the IRS with the means to trace payments and refunds at the
point of receipt providing the data necessary to quickly trace missing
payments and missing refund information. 
* Completed a second release for CDDB which provided weekly updates
for unpaid trust fund assessments, allowing for the tracing of multiple
and duplicate transactions. 
* Improved the accuracy and reliability of IRSï¿½s property and equipment
accounting records by making enhancements to accounting code
definitions used to select proper accounting codes for recording a
transaction, improving the coordination among units, and streamlining
the analysis of transactions most susceptible to misclassification. 
* Issued a cost accounting policy to provide guidance to the business
units on allocating and reporting costs. Additional initiatives 
supporting cost accounting included performing analysis of cost data 
from the Integrated Financial System in support of business unit 
decision making. 

Actions Planned or Underway for FY 2008 and Beyond: 
* Develop the redesign of the Interim Revenue Account Control System
to provide new functionality and move the existing system into general
ledger compliance. 
* Complete the development and implementation of additional CDDB 
releases that add other revenue receipt transactions (Federal Tax 
Deposits, Lockbox remittances) and create a refund transactions 
subsidiary ledger. 

Challenge/Issue: Erroneous and Improper Payments: 
Reduce improper payments that include base compliance activities and 
redesign efforts. 
Actions Taken: 
* Met all of the Improper Payments Information Act of 2002 requirements
for EITC by providing a current estimate of error, an explanation of the
methodology, and an action plan to reduce error. 
* Protected about $2.6 billion in revenue EITC enforcement efforts, 
which included the examination of 500,000 returns claiming EITC, 390,000
document matching reviews, and 500,000 math error process corrections. 
* Identified more than 169,000 potentially fraudulent returns claiming 
over $1.3 billion in refunds, stopped over $1 billion in fraudulent 
claims using the Electronic Fraud Detection System and referred more 
than 131,000 returns for civil investigations. 
* Completed the second phase of the return preparersï¿½ compliance study
and, through due diligence visits, reduced erroneous refunds by
assessing 8,554 due diligence penalties against 219 of the preparers
visited. 
* Developed and implemented a robust enterprise research strategy in
partnership with internal and external organizations to support the IRS
goals of reducing erroneous claims and increasing participation of EITC
eligible taxpayers. 

Actions Planned or Underway for FY 2008 and Beyond: 
* Identify opportunities to reduce the number of erroneous and improper
payments by analyzing the results from the first year of the multi-year
National Research Program study. The study is designed to provide an
annual update of the EITC error rate and will enable the IRS to more
quickly explore research-based, cost-effective approaches to improve
EITC participation and minimize errors. 
* Continue to identify and investigate high-impact fraud and tax scheme
promoters. 
* Actively explore research-based cost-effective approaches to improve
EITC participation and minimize errors. 
* Complete development of a new Concept of Operations, a multi-year
vision that will drive development of expanded and new EITC Program
strategic initiatives, including a paid preparer strategy. 

Challenge/Issue: Taxpayer Protection and Rights: 
The IRS has made significant progress in complying with the Internal 
Revenue Service Restructuring and Reform Act of 1998, and most 
provisions pertaining to taxpayer protection and rights have been 
implemented. Significant management attention is still required to 
ensure that remaining issues have been addressed. 

Actions Taken: 
* Through quarterly managerial and annual independent reviews, IRS
continued to monitor compliance with the taxpayer rights provisions of
Section 1204 of the Internal Revenue Restructuring and Reform Act of
1998 which prohibits the use of Records of Tax Enforcement Results to
evaluate, impose or suggest production goals and quotas with respect
to such employees. 
* Provided aggressive oversight of Private Collection Agencies to ensure
taxpayer rights were protected as accounts were migrated. 
* Implemented additional controls to ensure taxpayers are properly
informed of potential action prior to generating a levy. 

Actions Planned or Underway for FY 2008 and Beyond: 
* Complete the Federal Tax Levy Payment Program (FLPP) research
project to determine the best approach for ensuring that levies
processed through the FLPP against Social Security and Railroad
Retirement Board benefits do not result in hardship for low-income
taxpayers. 
* Continue efforts to protect taxpayer rights through established 
reviews and safeguards. 
* Complete the development of an updated Concept of Operations to
address paid preparer non-compliance and establish treatment
alternatives that align intensity of the efforts with the level of paid 
preparer behaviors. 
* Establish a new enterprise approach to examine questionable claims
and protect revenue prior to issuing refunds, focusing on identifying 
and releasing legitimate claims quickly. 

Challenge/Issue: Processing Returns and Implementing Tax Law Changes 
During the Filing Season: 
The filing season remains a critical IRS program that impacts every
American taxpayer. Many programs, activities and resources have to be
planned and managed effectively for the filing season to be successful. 

Actions Taken: 
* Delivered a successful filing season with more than 139.7 million
individual returns processed, and more than 105.5 million refunds
issued totaling $261 billion. 
* Increased electronic filing to 57.1% for individuals and 19.1% for
business returns, increases of 5% and 15%, respectively, over FY
2006. 
* Delivered an integrated approach to TETR enabling filing of over 94
million 2006 federal income tax returns which claimed more than $4.81
billion in credits or refunds. 
* Implemented processing procedures to accommodate TETR and split
refunds, which impacted all of the 1040 series of returns by adding line
items. Developed new forms, publications, and employee training
materials, as well as the programming of 38 major filing systems. 
* Implemented an extensive communication strategy for TETR which
included release of information in over 4,000 articles in magazines and
newspapers, 22 news releases, and 8 ï¿½Tax Tipsï¿½ for an estimated media 
reach of more than 88 million people along with delivery of the message 
on IRS.gov viewed by more than 4.5 million people. 
* Prevented more than $40 million in erroneous refunds through in-depth
analysis of TETR claims and split refund requests. 

Actions Planned or Underway for FY 2008 and Beyond: 
* Ensure filing season readiness through executive plan oversight. 
* Continue to include TETR information in the individual income tax
packages for TY 2007, advising eligible taxpayers who did not claim the
TETR credit on their original TY 2006 returns to file amended returns. 

Challenge/Issue: Human Capital: 
The IRSï¿½s ability to meet expectations outlined by the Presidentï¿½s
Management Agenda in personnel management area, such as recruiting,
training, and retaining employees. 

Actions Taken: 
* Continued to hire and train candidates to fill mission critical
occupations, meeting or exceeding the targets in four key enforcement
occupations. 
* Achieved 99.1% of filing season hiring commitments and 100% in 6 out
of 10 campus locations. 
* Developed a Human Capital Strategy which included the establishment
of a Center of Excellence Office, development of training and 
recruitment strategy and hiring of a cadre of employees to support 
project development efforts. 
* Created and began utilizing a Succession Management Program for the
identification and recruitment of talented leaders. 
* Delivered the $2.8 million multi-media advertising and marketing plan
that supported national recruitment events and partnerships with
national advocacy and support groups. 
* Offered the newly authorized incentives to attract applicants who will
help IRS meet mission critical goals. 
* Expanded external and rolling out internal recruitment modules (Career
Connector), addressing more than 100 occupations. 
* Completed workforce planning and benchmarking study and developed a 
business case for IRS workforce framework implementation. 

Actions Planned or Underway for FY 2008 and Beyond: 
* Complete strategic analysis of turnover rates, costs, and drivers. 
* Development of a cost-index model to quantify turnover, with rollout 
to all business units. 
* Simplification of the application process and the use of hiring 
incentives. 
* Continue efforts to quickly replace key leaders lost to retirement by
expanding the Succession Management Program and expanding use of the 
Leadership Succession Review tool to levels below the senior executive. 

[End of appendix] 

Financial Statements: 

Principal Financial Statements: 

The principal financial statements have been prepared to report the 
financial position and results of operations of the Internal Revenue 
Service (IRS), pursuant to the requirements of the Chief Financial 
Officers Act of 1990 (P.L. 101-576), the Government Management Reform 
Act of 1994 and the Office of Management and Budgetï¿½s (OMB) Circular 
No. A-136, revised June 29, 2007, Financial Reporting Requirements. The 
responsibility for the integrity of the financial information included 
in these statements rests with the management of the IRS. The audit of
IRSï¿½s principal financial statements was performed by the Government 
Accountability Office (GAO). The auditorsï¿½ report accompanies the 
principal statements. 

IRSï¿½s principal financial statements for fiscal years 2007 and 2006 are 
as follows: 

* The Balance Sheet describes the assets, liabilities and net position 
components of IRS. 

* The Statement of Net Cost presents the net cost of operations by 
program. It includes the gross costs less any exchange revenue earned 
from activities. 

* The Statement of Changes in Net Position presents the change in IRSï¿½s 
net position resulting from the net cost of operations, budgetary 
financing sources other than exchange revenues, and other financing 
sources. 

* The Statement of Budgetary Resources presents the budgetary 
resources; the status of those resources; the change in obligated 
balances during the year; and the outlays. Additional detail by major 
budget accounts is available in the Required Supplementary
Information section. 

* The Statement of Custodial Activities presents the sources and 
disposition of nonexchange federal tax revenues collected and accrued 
by the IRS. 

Table: 
Internal Revenue Service Balance Sheet As of September 30, 2007 and 2006
(In Millions): 

Assets: Intragovernmental: Fund balance with Treasury (Note 2); 
2007: $2,074; 
2006: $2,066. 

Assets: Intragovernmental: Due from Treasury (Note 6); 
2007: 1,675; 
2006: 1,695. 

Assets: Intragovernmental: Other assets (Note 3); 
2007: 187; 
2006: 205. 

Assets: Total Intragovernmental; 
2007: 3,936; 
2006: 2,966. 

Assets: Cash and other monetary assets (Note 4, 6);
2007: 165; 
2006: 52. 

Assets: Federal taxes receivable, net (Notes 5, 6);
2007: 26,000; 
2006: 21,000. 

Assets: Property and equipment, net (Note 7); 
2007: 1,194; 
2006: 1,280. 

Assets: Other assets (Note 3); 
2007: 14; 
2006: 15. 

Total Assets: 
2007: 31,309; 
2006: 26,313. 

Liabilities: Intragovernmental, Due to Treasury (Note 5); 
2007: 26,000; 
2006: 21,000. 

Liabilities: Intragovernmental, Other liabilities (Note 8); 
2007: 176; 
2006: 178. 

Liabilities: Total Intragovernmental; 
2007: 26,176; 
2006: 21,178. 

Liabilities: Federal tax refunds payable; 
2007: 1,675; 
2006: 1,695. 

Liabilities: Other liabilities (Notes 8, 9, 10); 
2007: 1,692; 
2006: 1,541. 

Total Liabilities: 
2007: 29,543; 
2006: 24,414. 

Net Position: Unexpended Appropriations; 
2007: 1,482; 
2006: 1,575. 

Net Position: Cumulative Results of Operations; 
2007: 284; 
2006: 324. 

Total Net Position: 
2007: 1,766; 
2006: 1,899. 

Total Liabilities and Net Position: 
2007: 31,309; 
2006: 26,313. 

The accompanying notes are an integral part of these statements. 

[End of table] 

Table: 
Internal Revenue Service Statement of Net Cost For the Years Ended 
September 30, 2007 and 2006 (In Millions): 

Program: Taxpayer Assistance and Education, Gross cost; 
2007: $479
2006: $407. 

Program: Taxpayer Assistance and Education, Earned revenue: 
2007: (3); 
2006: (55). 

Program: Taxpayer Assistance and Education, Net cost of program: 
2007: 476; 
2006: 352. 

Program: Filing and Account Services, Gross cost: 
2007: 3,640; 
2006: 3,690. 

Program: Filing and Account Services, Earned revenue: 
2007: (43); 
2006: (33). 

Program: Filing and Account Services, Net cost of program: 
2007: 3,5597; 
2006: 3,657. 

Program: Compliance, Gross cost: 
2007: 7,702; 
2006: 7,409. 

Program: Compliance, Earned revenue: 
2007: (231); 
2006: (125). 

Program: Compliance, Net cost of program: 
2007: 7,471; 
2006: 7,284. 

Administration of Tax Credit Programs, Gross cost: 
2007: 192; 
2006: 192. 

Administration of Tax Credit Programs, Earned revenue: 
2007: [Empty]; 
2006: [Empty]. 

Administration of Tax Credit Programs, Net cost of program: 
2007: 192; 
2006: 192. 

Net Cost of Operations (Note 11): 
2007: 11,735; 
2006: 11,485. 

The accompanying notes are an integral part of these statements. 

[End of table] 

Internal Revenue Service Statement of Changes in Net Position For the 
Years Ended September 30, 2007 and 2006 (in millions): 

Beginning Balances: 
2007: Cumulative Results of Operations: $324; 
2007: Unexpended Appropriations: $1,575; 
2006: Cumulative Results of Operations: $355; 
2006: Unexpended Appropriations: $1,528. 

Budgetary Financing Sources, Appropriations received: 
2007: Cumulative Results of Operations: [Empty}; 
2007: Unexpended Appropriations: 10,596; 
2006: Cumulative Results of Operations: [Empty]; 
2006: Unexpended Appropriations: 10,681. 

Budgetary Financing Sources, Appropriations transferred in/out: 
2007: Cumulative Results of Operations: [Empty]; 
2007: Unexpended Appropriations: 4; 
2006: Cumulative Results of Operations: [Empty]; 
2006: Unexpended Appropriations: [Empty]. 

Budgetary Financing Sources, Other Adjustments: 
2007: Cumulative Results of Operations: [Empty];
2007: Unexpended Appropriations: (73); 
2006: Cumulative Results of Operations: [Empty];
2006: Unexpended Appropriations: (227). 

Budgetary Financing Sources, Appropriations used: 
2007: Cumulative Results of Operations: 10,621; 
2007: Unexpended Appropriations: (10,621); 
2006: Cumulative Results of Operations: 10,417; 
2006: Unexpended Appropriations: (10,417). 

Budgetary Financing Sources, Non-exchange revenue - Earmarked Funds 
(Note 13): 
2007: Cumulative Results of Operations: 11; 
2007: Unexpended Appropriations: [Empty];
2006: Cumulative Results of Operations: [Empty];
2006: Unexpended Appropriations: [Empty]. 

Other Financing Sources, Imputed financing: 
2007: Cumulative Results of Operations: 1,094; 
2007: Unexpended Appropriations: [Empty];
2006: Cumulative Results of Operations: 1,060; 
2006: Unexpended Appropriations: [Empty]. 

Other Financing Sources, Transfers in/out without reimbursement: 
2007: Cumulative Results of Operations: 13; 
2007: Unexpended Appropriations: [Empty]; 
2006: Cumulative Results of Operations: 18; 
2006: Unexpended Appropriations: [Empty]. 

Other Financing Sources, Transfers to General Fund: 
2007: Cumulative Results of Operations: (44); 
2007: Unexpended Appropriations: [Empty]; 
2006: Cumulative Results of Operations: (41); 
2006: Unexpended Appropriations: [Empty]. 

Total Financing Sources: 
2007: Cumulative Results of Operations: 11,695; 
2007: Unexpended Appropriations: (93); 
2006: Cumulative Results of Operations: 11,454; 
2006: Unexpended Appropriations: 37. 

Net Cost of Operations: 
2007: Cumulative Results of Operations: (11,735); 
2007: Unexpended Appropriations: [Empty]; 
2006: Cumulative Results of Operations: (11,485); 
2006: Unexpended Appropriations: [Empty]. 

Net Change: 
2007: Cumulative Results of Operations: (40); 
2007: Unexpended Appropriations: (93); 
2006: Cumulative Results of Operations: (31); 
2006: Unexpended Appropriations: 37. 

Ending Balances: 
2007: Cumulative Results of Operations: $284; 
2007: Unexpended Appropriations: $1,482; 
2006: Cumulative Results of Operations: $324; 
2006: Unexpended Appropriations: $1,575. 

The accompanying notes are an integral part of these statements. 

[End of table] 

Internal Revenue Service Statement of Budgetary Resources For the Years 
Ended September 30, 2007 and 2006 (In Millions): 

Budgetary Resources, Unobligated balance, beginning of period: 
2007: $552; 
2006: $488. 

Budgetary Resources, Recoveries of prior year unpaid obligations: 
2007: 183; 
2006: 127. 

Budgetary Resources, Budget authority, Appropriations: 
2007: 10,776; 
2006: 10,782. 

Budgetary Resources, Budget authority, Spending authority from 
offsetting collections: 
2007: 119; 
2006: 104. 

Budgetary Resources, Nonexpenditure transfers, net: 
2007: 4; 
2006: [Empty]. 

Budgetary Resources, Permanently not available: 
2007: (73); 
2006: (227). 

Total Budgetary Resources: 
2007: 11,561; 
2006: 11,274. 

Status of Budgetary Resources, Obligations incurred (Note 12): 
2007: 10,897; 
2006: 10,722. 

Status of Budgetary Resources, Unobligated balance ï¿½ available (Note 
2): 
2007: 171; 
2006: 192. 

Status of Budgetary Resources, Unobligated balance ï¿½ not available 
(Note 2): 
2007: 493; 
2006: 360. 

Total Status of Budgetary Resources: 
2007: 11,561; 
2006: 11,274. 

Change in Obligated Balance, Obligated balance, net, beginning of 
period: 
2007: 1,522; 
2006: 1,511. 


Change in Obligated Balance, Obligations incurred (Note 12): 
2007: 10,897; 
2006: 10,722. 

Change in Obligated Balance, Gross Outlays: 
2007: (10,800); 
2006: (10,586); 

Change in Obligated Balance, Recoveries of prior year unpaid 
obligations, actual: 
2007: (183); 
2006: (127(. 

Change in Obligated Balance, Change in uncollected customer payments 
from Federal sources: 
2007: (9); 
2006: 2. 

Obligated balance, net, end of period (Note 12): 
2007: 1,427; 
2006: 1,522. 

Net Outlays, Gross Outlays: 
2007: 10,800; 
2006: 10,586. 

Net Outlays, Offsetting collections: 
2007: (110); 
2006: (106). 

Net Outlays, Distributed Offsetting receipts: 
2007: (164); 
2006: (106). 

Net Outlays: 
2007: 10,526; 
2006: 10,374. 

The accompanying notes are an integral part of these statements. 

[End of table] 

Internal Revenue Service Statement of Custodial Activity For the Years 
Ended September 30, 2007 and 2006 (In Billions): 

Revenue Activity, Collections of Federal Tax Revenue (Note 14), 
Individual income, FICA/SECA, and other: 
2007: 2,202; 
2006: 2,035. 

Revenue Activity, Collections of Federal Tax Revenue (Note 14), 
Corporate income: 
2007: 395; 
2006: 380. 

Revenue Activity, Collections of Federal Tax Revenue (Note 14), Excise: 
2007: 53; 
2006: 58. 

Revenue Activity, Collections of Federal Tax Revenue (Note 14), Estate 
and gift: 
2007: 27; 
2006: 29. 

Revenue Activity, Collections of Federal Tax Revenue (Note 14), 
Railroad retirement: 
2007: 5; 
2006: 5. 

Revenue Activity, Collections of Federal Tax Revenue (Note 14), Federal 
unemployment: 
2007: 7; 
2006: 7. 

Total Collections of Federal Tax Revenue: 
2007: 2,689; 
2006: 2,514. 

Increase/(Decrease) in federal taxes receivable, net: 
2007: 5; 
2006: [Empty]. 

Total Federal Tax Revenue: 
2007: 2,694; 
2006: 2,514. 

Distribution of Federal Tax Revenue to Treasury: 
2007: 2,689; 
2006: 2,514. 

Increase/(Decrease) in amount due to Treasury: 
2007: 5; 
2006: [Empty]. 

Total Disposition of Federal Tax Revenue: 
2007: 2,694; 
2006: 2,514. 

Net Federal Revenue Activity: 
2007: [Empty]; 
2006: [Empty]. 

Federal Tax Refund Activity, Total Refunds of Federal Taxes Note 15): 
2007: 292; 
2006: 277. 

Federal Tax Refund Activity, Appropriations Used for Refund of Federal 
Taxes: 
2007: (292); 
2006: (277). 

Net Federal Tax Refund Activity: 
2007: [Empty]; 
2006: [Empty]. 

The accompanying notes are an integral part of these statements. 

[End of table] 

Internal Revenue Service: 
Notes to the Financial Statements: 
For the Years Ended September 30, 2007 and 2006: 

Note 1. Summary of Significant Accounting Policies: 

A. Reporting Entity: 

The Internal Revenue Service (IRS) is a bureau of the U.S. Department 
of the Treasury (Treasury). The IRS originated in 1862, when Congress 
established the Office of the Commissioner of the Internal Revenue. In 
1952, the Bureau was reorganized by Congress and became the Internal 
Revenue Service in 1953. 

The mission of the IRS is to provide Americaï¿½s taxpayers with top-
quality service by helping them understand and meet their tax 
responsibilities and by applying the tax law with integrity and 
fairness to all. 

The organizational structure of the IRS consists of organizations and 
major programs which administer the tax laws and collects 95 percent of 
the revenues funding the Federal government. 

Organizations: 
* Operating Divisions; 
* National Headquarters; 
* Functional Support Divisions; 
* Cross-Servicing Organizations. 

There are four operating divisions. Wage and Investment (W&I) is 
responsible for individuals with wage and investment income only. In 
addition, W&I manages submission processing for all taxpayers.
Small Business and Self-Employed (SBSE) administers compliance 
activities with respect to small businesses, self-employed individuals 
and others with income from sources other than wages. Tax-Exempt and 
Government Entities (TEGE) is in charge of employee plans, tax exempt 
organizations, and government entities. Large and Mid-Size Business 
(LMSB) is responsible for corporations, sub-chapter S corporations, and 
partnerships with assets greater than $10 million. 

The functional support divisions are Appeals, Criminal Investigation, 
Taxpayer Advocate and Chief Counsel. They are independent of the 
operating divisions and other units of the IRS. Taxpayer Advocate 
reports directly to Congress and Chief Counsel reports to the Secretary 
of the Treasury. 

National Headquarters fills the role of setting broad policy, providing 
executive oversight, reviewing plans and goals of the operating units, 
and developing major improvement initiatives. 

Two cross-servicing organizations, Modernization and Information 
Technology Services (MITS) and Agency Wide Shared Services (AWSS), 
provide central support to all areas of the IRS. 

Major Programs: 
* Taxpayer Assistance and Education; 
* Compliance; 
* Filing and Account Services; 
* Tax Credit Programs. 

The major programs are discussed in Note 1. J., Program Costs. 

B. Basis of Accounting and Presentation: 

The financial statements have been prepared from the accounting records 
of the IRS in conformity with accounting principles generally accepted 
in the United States and in accordance with the Office of Management 
and Budget (OMB) Circular No. A-136, revised June 29, 2007, Financial 
Reporting Requirements. Accounting principles generally accepted for 
Federal entities are the standards prescribed by the Federal Accounting 
Standards Advisory Board (FASAB). FASAB is recognized by the American 
Institute of Certified Public Accountants as the official accounting 
standards-setting body of the Federal government. 

These comparative financial statements and related notes consist of the 
Balance Sheet, the Statement of Net Cost, the Statement of Changes in 
Net Position, the Statement of Budgetary Resources, and the Statement 
of Custodial Activity. 

The accounting structure of Federal agencies is designed to reflect 
both accrual and budgetary accounting transactions. Under the accrual 
method of accounting, revenues are recognized when earned and expenses 
are recognized when incurred, without regard to receipt or payment of 
cash. Budgetary accounting facilitates compliance with legal 
constraints and controls over the use of Federal funds. The Statement 
of Custodial Activity is presented on the modified cash basis of 
accounting. Cash collections and disbursements to Treasury are reported 
on a cash basis and the change in Federal tax receivables and refunds 
payable are reported on an accrual basis. 

Certain assets, liabilities, earned revenues and costs have been 
classified as intragovernmental throughout the financial statements and 
notes. Intragovernmental is defined as exchange transactions made 
between two reporting entities within the Federal government. 

C. Fund Balance with Treasury: 

The Fund Balance with Treasury is the aggregate of funds in the IRSï¿½s 
accounts, primarily appropriated funds, from which the IRS is 
authorized to make expenditures and pay liabilities. Fund Balance with
Treasury is offset in the budgetary accounts, for the most part, by 
obligated and unobligated balances. 

Obligated balances not yet disbursed include accounts payable and other 
accrued liabilities net of receivables, and undelivered orders. 
Unobligated balances may be further broken into available and 
unavailable components. Available unobligated balances represent 
amounts in unexpired appropriations as of the end of the current fiscal 
year. Unavailable unobligated balances represent amounts in expired 
appropriations and amounts not apportioned for obligation as of the end 
of the current fiscal year. 

D. Other Assets: 

Accounts receivable consist of amounts due to the IRS from the public 
and Federal agencies. Accounts receivable are recorded and reimbursable 
revenues are recognized as the services are performed and costs are 
incurred. The allowance for uncollectible accounts is based on an 
annual review of groups of accounts by age for accounts receivable 
balances older than one year. 

Advances to government agencies primarily represent funds paid to the 
Treasury Working Capital Fund (WCF) and the Department of Interior 
GovWorks (GovWorks). Centralized services funded through the WCF 
consist primarily of telecommunications services, payroll processing, 
and depreciation of property and equipment owned by the WCF. Activities 
funded through GovWorks consist of the acquisition of systems 
furniture. Advances to the public are cash outlays for criminal 
investigations and employee travel. 

Forfeited property held for sale is acquired as a result of forfeiture 
proceedings or foreclosure sales to satisfy a tax liability. The 
Federal Tax Lien revolving fund is used to redeem real property 
foreclosed upon by a holder of a lien. The IRS may sell the property, 
reimburse the revolving fund and apply the net proceeds to the 
outstanding tax obligation. 

E. Cash and Other Monetary Assets: 

Imprest funds are maintained by Headquarters and field offices in 
commercial bank accounts. Other monetary assets consist primarily of 
offers in compromise, voluntary deposits received from taxpayers
pending application of the funds to unpaid tax assessments and seized 
monies of less than $1 million pending the results of criminal 
investigations. 

F. Federal Taxes Receivable, Net and Due to Treasury: 

Federal taxes receivable, net and the corresponding liability, Due to 
Treasury, are not accrued until related tax returns are filed or 
assessments are made by the IRS and agreed to by either the taxpayer or
the court. Additionally, the prepayments are netted against 
liabilities. Accruals are made to reflect penalties and interest on 
taxes receivable through the balance sheet date. 

Taxes receivable consist of unpaid assessments (taxes and associated 
penalties and interest) due from taxpayers. The existence of a 
receivable is supported by a taxpayer agreement, such as filing of a tax
return without sufficient payment, or a court ruling in favor of the 
IRS. The allowance for doubtful accounts reflects an estimate of the 
portion of total taxes receivable deemed to be uncollectible. 

Compliance assessments are unpaid assessments neither the taxpayer nor 
a court has affirmed the taxpayer owes to the Federal government. 
Examples include assessments resulting from an IRS audit or
examination in which the taxpayer does not agree with the results. 
Write-offs consist of unpaid assessments for which the IRS does not 
expect further collections due to factors such as taxpayersï¿½ 
bankruptcy, insolvency, or death. Compliance assessments and write-offs 
are not reported on the balance sheet. Statutory provisions require the 
accounts to be maintained until the statute for collection expires. 

Tax Assessments and Abatements: 

Under the Internal Revenue Code (26 USC) Section 6201, the Secretary of 
the Treasury is authorized and required to make inquiries, 
determinations, and assessments of all taxes imposed and accruing under 
any internal revenue law but have not been duly paid including 
interest, additions to the tax, and assessable penalties. The Secretary 
has delegated this authority to the Commissioner of the IRS. Unpaid 
assessments result from taxpayers filing returns without sufficient 
payments and from the IRSï¿½s enforcement programs, such as examination, 
under-reporter, substitute for return, and combined annual wage 
reporting. 

Under the Internal Revenue Code (26 USC) Section 6404, the Commissioner 
of the IRS has authority to abate the paid or unpaid portion of an 
assessed tax, interest, and penalty. Abatements occur for a number of 
reasons and are a normal part of the tax administration process: 

* May be allowed for a qualifying corporation claiming a net operating 
loss which created a credit. The credit can be carried back to reduce a 
prior yearï¿½s tax liability and amend tax returns. Additionally, the 
credit can correct an assessment from an enforcement program, taxes
discharged in bankruptcy, accepted offers in compromise, penalty 
abatements for reasonable cause, contested assessments made due to 
mathematical or clerical errors and assessments contested after the 
liability has been satisfied. 

* May result in claims for refunds or a reduction of the unpaid 
assessed amount. 

G. Property and Equipment: 

Property and equipment is recorded at historical cost. It consists of 
tangible assets and software. The IRS depreciates property and 
equipment on a straight line basis over its estimated useful life. In 
the first and final years, one-half year depreciation is taken. 
Disposals are recorded when deemed material. 

The IRS capitalization policy for property and equipment is presented 
by asset class and capitalization threshold. 

Asset Class: ADP equipment; 
Capitalization Threshold: Capitalized regardless of acquisition cost. 

Asset Class: Non-ADP equipment; 
Capitalization Threshold: Individual asset cost of $5 thousand or 
greater. 

Asset Class: Furniture; 
Capitalization Threshold: Individual asset cost of $5 thousand or 
greater. 

Asset Class: Investigative equipment; 
Capitalization Threshold: Individual asset cost of $5 thousand or 
greater. 

Asset Class: Vehicles; 
Capitalization Threshold: Capitalized regardless of acquisition cost. 

Asset Class: Major systems; 
Capitalization Threshold: Projects with costs of $20 million or 
greater. 

Asset Class: Internal Use Software; 
Capitalization Threshold: Major business systems modernization projects 
independent of cost. 

Asset Class: Leasehold Improvements; 
Capitalization Threshold: Capitalized regardless of acquisition cost. 

Asset Class: Assets under capital lease; 
Capitalization Threshold: Assets with bulk cost of $50 thousand or 
greater. 

ADP Equipment includes related commercial off-the-shelf software. Major 
systems were a category for large-scale computer systems prior to 
Statement of Federal Financial Accounting Standards No. 10 (SFFAS No. 
10), Accounting for Internal Use Software. 

Internal Use Software captures the costs of major Business Systems 
Modernization projects in accordance with SFFAS No. 10. It encompasses 
software design, development and testing of projects adding significant 
new functionality and long-term benefits. Costs for developing internal 
use software are accumulated in work in process until a project is 
placed into service, and testing and final acceptance are successfully 
completed. Once completed, the costs are transferred to depreciable
property. 

H. Federal Tax Refunds Payable and Due from Treasury: 

Federal Tax Refunds Payable is a fully funded liability and is offset 
with a corresponding asset Due from Treasury. IRS records Due from 
Treasury to designate approved funding to pay year-end tax refund 
liabilities. The liability account represents the Federal tax refunds 
to taxpayers. 

I. Financing Sources and Revenues: 

Appropriations Received: 
IRS receives the majority of its funding through annual, multi-year, 
and no-year appropriations available for use within statutory limits 
for operating and capital expenditures. Appropriations are recognized 
as budgetary financing sources when the related expenses are incurred.
In FY 2007, Congress implemented a new appropriations structure which 
realigned resources from three of IRSï¿½s major operating appropriations. 
The main significance was to create a separate appropriation for 
Operations Support, encompassing headquarters, shared services and 
information technology. Formerly, headquarters and shared services were 
combined with tax return processing, while information technology had 
its own appropriation. 

Appropriations: 
* Taxpayer Services; 
* Operations Support; 
* Enforcement; 
* Other Appropriations. 

Taxpayer Services provides funds for the direct costs of the Taxpayer 
Assistance and Education and the Filing and Account Services Programs 
discussed in Note 1. J., Program Costs. 

Enforcement provides resources for the direct costs of the Compliance 
Program discussed in Note 1. J., Program Costs. Additionally, it funds 
the direct costs of administration of the Earned Income Tax Credit 
Program. 

Operations Support funds the indirect costs of all programs. Activities 
include executive planning and direction; shared service support for 
facilities, rent, utilities and security; procurement, printing and
postage; headquarters activities such as strategic planning, finance, 
human resources and Equal Employment Opportunity; research and 
statistics of income; and information systems, data processing and 
telecommunication. 

Other Appropriations include Business Systems Modernization (BSM), the 
largest of these funds, and Health and Insurance Tax Credit 
Administration. BSM provides resources for the planning and capital
asset acquisition of information technology to modernize IRSï¿½s business 
systems. Additionally, BSM is obligated pursuant to an expenditure plan 
approved by Congress. Health and Insurance Tax Credit Administration 
provides funding for health insurance and refundable tax credits to 
qualified individuals. 

Exchange Revenues: 
Exchange revenues recognized by IRS represent reimbursements and user 
fees. Reimbursements are recognized as the result of costs incurred for 
services performed for Federal agencies or the public under 
reimbursable agreements. User fees are derived from transactions with 
the public and are recognized when the fees are collected. 

Non-exchange Revenues ï¿½ Earmarked Funds: 
Non-exchange revenues represent amounts retained from tax collections 
for payments to private collection agencies (PCAs) and for enforcement 
activities. The Private Collection Agent Program authorizes contracts 
with PCAs to collect delinquent taxes on behalf of IRS not to exceed 25 
percent of the total taxes collected. Additionally, IRS retains 25 
percent of the total taxes collected to fund enforcement activities. 

Imputed Financing Sources: 
Other financing sources include imputed financing sources to offset the 
imputed costs recognized for goods or services received from other 
Federal agencies without reimbursement from IRS. The imputed costs are 
pension and other retirement benefit costs administered by the Office 
of Personnel Management, costs of processing payments and collections 
by the Financial Management Service and legal judgments paid by the 
Treasury Judgment Fund. 

J. Program Costs: 

Taxpayer Assistance and Education provides services to taxpayers to 
assist them in preparing correct returns. Primary activities include 
tax forms and instructions; tax publications and information; taxpayer 
education and outreach programs; walk-in taxpayer assistance; and the 
National Distribution Center to process orders for forms and 
publications. Earned revenues are primarily from enrolled agents fees. 

Filing and Account Services perform functions of processing tax 
returns, recording tax payments, issuing refunds, and maintaining 
taxpayer accounts. Program activities include submission processing;
operating taxpayer assistance call centers and websites; and Taxpayer 
Advocate. Earned revenues are primarily from the Tax Refund Offset 
Program and tax return copying and verification. 

Compliance manages activities to identify and correct possible errors 
or underpayments. This program includes pre-filing agreements, letter 
rulings and determinations; exam functions of document matching, desk 
and field exams; collection functions of notices, Automated Collection 
Systems and field collections; criminal investigations of tax, money 
laundering and illegal drug activities; and Appeals and Chief Counsel. 
Earned revenues are primarily from the Treasury Forfeiture Fund,
Financial Crimes Enforcement Network, installment agreement fees, 
offers in compromise and letter rulings and determinations. 

Administration of Tax Credit Programs oversees the Earned Income Tax 
Credit (EITC) and Health Coverage Tax Credit (HCTC) programs. EITC 
performs expanded customer service, public outreach, enforcement, and 
research efforts to reduce claims and erroneous filings associated with 
the program. EITC comprises the full spectrum of taxpayer services and 
compliance activities. However, EITC payments actually refunded to 
individuals or credited against other tax liabilities are not included 
in program costs. 

HCTC activities are focused on implementing the health insurance tax 
credit program set out in the Trade Adjustment Assistance Reform Act of 
2002 (Trade Act of 2002). These costs do not encompass payments made to 
health insurance carriers on behalf of participants or tax credits 
refunded to qualifying individuals. 

K. Custodial Activity: 

Non-exchange Revenues: 
IRS collects custodial non-exchange revenues for taxes levied against 
taxpayers for: individual and corporate income; Federal Insurance 
Contributions Act (FICA) and Self-Employment Contribution Act (SECA); 
excise, estate, gift, railroad retirement and Federal unemployment 
taxes. These collections are not available to IRS for obligation or 
expenditure and are recognized as custodial revenues when collected. 
The disposition of these revenues are reported on the Statement of 
Custodial Activity and as distribution of Federal tax revenue to the 
general fund of the U.S. Treasury. 

Permanent Indefinite Appropriations: 
IRS was granted permanent and indefinite budgetary authority through 
legislation to disburse tax refund principle and related interest as 
they become due. The permanent and indefinite appropriations are not
subject to budgetary ceilings set by Congress during the annual 
appropriation process. Refunds due to taxpayers are reported as Federal 
Tax Refunds Payable on the Balance Sheet. IRS records an offsetting 
asset, Due from Treasury, to reflect the year-end budget authority to 
pay this liability. 

Disbursements for tax refunds and related interest, reported on the 
Statement of Custodial Activity, are offset by Appropriations Used for 
Refunds. Disbursements for refunds are not a cost of IRS, but rather
a cost of the government as a whole. 

L. Earmarked Funds: 

Earmarked funds are financed by specifically identified revenues which 
remain available over time. These specifically identified revenues are 
required by statute to be used for designated activities, benefits or 
purposes and must be accounted for separately from the Federal 
governmentï¿½s general revenues. 

The Informant Payments program was further amended by the Tax Relief 
and Health Care Act of 2006 (P.L.109-432), to authorize IRS to make 
payments to individuals for information leading to the collection of 
underpayment of taxes. 

The Federal Tax Lien Revolving Fund was established pursuant to section 
112(a) of the Federal Tax Lien Act of 1966, to serve as the source of 
financing the redemption of real property by the United States. 

The Private Collection Agent Program was established under the American 
Jobs Creation Act of 2004 and authorizes IRS to enter into contracts 
with private collection agencies (PCAs) to assist in the collection of 
delinquent Federal tax liabilities. A portion of the collections are 
retained by IRS to pay the PCAs and fund enforcement activities. 

Other earmarked funds have a variety of purposes and include: Gifts to 
the United States to reduce the Public Debt, Presidential Election 
Campaign Fund and Reimbursement to State and Local Law Enforcement 
Agency. 

M. Allocation Transfer: 

IRS is a party to allocation transfers from the Department of 
Transportationï¿½s Federal Highway Administration as a receiving entity. 
Obligations and outlays incurred by IRS are charged to the allocation 
account as it executes the delegated activity on behalf of 
Transportation. Financial activity for the allocations transfers are 
reported in the financial statements of Transportation. 

N. Reclassifications: 

Certain prior year amounts have been reclassified to conform to current 
year presentation in the disclosures. 

O. Change in Presentation of a Principal Financial Statement: 

In the revised OMB Circular No. A-136, dated June 29, 2007, the 
statement of Financing is not required to be presented as a principal 
financial statement. The Statement of Financing reconciled the net cost 
of operations with the obligation of budgetary resources and non-
budgetary resources. In FY 2007, the statement presentation has been 
changed to a required disclosure, Reconciliation of Net Cost of 
Operations to Budget, as presented in Note 16. 

Note 2. Fund Balance with Treasury (In Millions): 

General Funds: 
2007: $1,937; 
2006: $1,962. 

Special Funds: 
2007: 136; 
2006: 99. 

Revolving Funds: 
2007: 6; 
2006: 4. 

Other Funds: 
2007: (5); 
2006: 1. 

Fund Balance with Treasury: 
2007: 2,074; 
2006: 2,066. 

Unobligated balances, Available: 
2007: 171; 
2006: 192. 

Unobligated balances, Unavailable: 
2007: 493; 
2006: 360. 

Obligated balances not yet disbursed: 
2007: 1,427; 
2006: 1,520. 

Non-Budgetary FBWT: 
2007: (17); 
2006: (6). 

Status of Fund Balance with Treasury: 
2007: 2,074; 
2006: 2,066. 

[End of table] 

Note 3. Other Assets: 

Advances: 
2007, Intragovernmental: 162; 
2007, With the Public: 8; 
2006, Intragovernmental: 187; 
2006, With the Public: 9. 

Accounts receivable, net: 
2007, Intragovernmental: 17; 
2007, With the Public: 7; 
2006, Intragovernmental: 14; 
2006, With the Public: 7. 

Forfeited property held for sale: 
2007, Intragovernmental: [Empty}; 
2007, With the Public: 2; 
2006, Intragovernmental: [Empty}; 
2006, With the Public: 4. 

Suspense: 
2007, Intragovernmental: 8; 
2007, With the Public: (3); 
2006, Intragovernmental: 3; 
2006, With the Public: (5). 

Other Assets: 
2007, Intragovernmental: 187; 
2007, With the Public: 14; 
2006, Intragovernmental: 205; 
2006, With the Public: 15. 

[End of table] 

Note 4. Cash and Other Monetary Assets, (In Millions): 

Imprest funds: 
2007: 4; 
2006: 4; 

Other monetary assets: 
2007: 161; 
2006: 48; 

Cash and Other Monetary Assets: 
2007: 165; 
2006: 52. 

Note 5. Federal Taxes Receivable, Net and Due to Treasury, (In 
Billions): 

Gross Federal taxes receivable: 
2007: 98; 
2006: 91. 

Allowance for doubtful accounts: 
2007: (72); 
2006: (70). 

Federal taxes receivable, net and Due to Treasury: 
2007: 26; 
2006: 21. 

[End of table] 

Federal taxes receivable consists of tax assessments, penalties and 
interest not paid or abated which were agreed to by the taxpayer and 
IRS or upheld by the courts. Federal taxes receivable, net is the
portion of gross Federal taxes receivable estimated to be collectible. 
It is based on projections of collectibility from a statistical sample 
of taxes receivable. The allowance for doubtful accounts was 
established for the difference between the gross Federal taxes 
receivable and the portion estimated to be collectible. Due to Treasury 
is the offsetting liability to Federal taxes receivable, net, and 
represents amounts to be transferred to Treasury when collected. 

Note 6. Non-entity Assets: 

Due from Treasury: 
2007, Intra-Governmental: 1,675; 
2007: With the Public: [Empty}];
2006, Intra-Governmental: 1,695; 
2006: With the Public: [Empty]. 

Federal taxes receivable, net: 
2007, Intra-Governmental: [Empty] 
2007: With the Public: 26,000; 
2006, Intra-Governmental:[Empty] 
2006: With the Public: 21,000. 

Other Monetary Assets: 
2007, Intra-Governmental: [Empty]; 
2007: With the Public: 161; 
2006, Intra-Governmental: [Empty]; 
2006: With the Public: 48. 

Non-Entity Assets: 
2007, Intra-Governmental: 1,675; 
2007: With the Public: 26,161;
2006, Intra-Governmental: 1,695; 
2006: With the Public: 21,048. 

Non-entity assets are not available for IRSï¿½s use. The IRS collects 
Federal taxes receivable for the U.S. Government but does not have the 
authority to spend them. 

[End of table] 

Note 7. Property and Equipment: 

ADP assets: 
Useful Life (Years): 3 to 7; 
Cost: $1,777; 
Accumulated Depreciation: $(1,336); 
2007 Net Book Value: $441; 
2006 Net Book Value: $499. 

Internal use software: 
Useful Life (Years): 7 to 17; 
Cost: 773; 
Accumulated Depreciation: (335); 
2007 Net Book Value: 438; 
2006 Net Book Value: 479. 

Leasehold improvements: 
Useful Life (Years): 10; 
Cost: 475; 
Accumulated Depreciation: (310):
2007 Net Book Value: 165; 
2006 Net Book Value: 179. 

Major systems: 
Useful Life (Years): 7; 
Cost: 422; 
Accumulated Depreciation: (420); 
2007 Net Book Value: 2; 
2006 Net Book Value: 32. 

Internal use software ï¿½ work in process
Useful Life (Years): [Empty];
Cost: 99; 
Accumulated Depreciation: [Empty]; 
2007 Net Book Value: 99; 
2006 Net Book Value: 41. 

Vehicles: 
Useful Life (Years): 5; 
Cost: 82; 
Accumulated Depreciation: (55); 
2007 Net Book Value: 27; 
2006 Net Book Value: 18. 

Furniture and non-ADP equipment: 
Useful Life (Years): 8 to 10; 
Cost: 64; 
Accumulated Depreciation: (52); 
2007 Net Book Value: 12; 
2006 Net Book Value: 15. 

Assets Under Capital Lease: 
Useful Life (Years): 4 to 10; 
Cost: 20; 
Accumulated Depreciation: (11); 
2007 Net Book Value: 9; 
2006 Net Book Value: 15. 

Investigative equipment: 
Useful Life (Years): 10; 
Cost: 9; 
Accumulated Depreciation: (8); 
2007 Net Book Value: 1; 
2006 Net Book Value: 2. 

Property and Equipment: 
Useful Life (Years): [Empty]; 
Cost: $3,721; 
Accumulated Depreciation: $(2,527); 
2007 Net Book Value: $1,194; 
2006 Net Book Value: $1,280. 

The Cost column represents the historical cost of property and 
equipment, net of disposals. The cost basis for FY 2007 and FY 2006 is 
$3,721 million and $3,529 million, respectively. Accumulated
depreciation for FY 2007 and FY 2006 is $2,527 million and $2,249 
million, respectively. 

The IRS has 13 internal use software projects, including deployed and 
work in process. 

* Modernized E-File is an electronic filing system for tax returns. 
* Customer Account Data Engine (CADE) is a project to replace IRSï¿½s 
master files for taxpayer accounts. 
* Account Management Services (AMS) will support users with CADE access 
and query capabilities. 
* Integrated Financial System (IFS) is an administrative financial 
system. 
* E-Services is a system of web-based products and services for tax 
practitioners and the public. 
* Enterprise Systems Management (ESM) and Security and Technology 
Infrastructure Release (STIR) create new information technology 
security infrastructure. 
* Filing & Payment Compliance provides functionality to enable private 
debt collection and manage delinquent tax cases. 
* Customer Communications is a customer service telephone system. 
* Internet Refund Fact of Filing allows taxpayers to review the status 
of their refund. 
* Examination Desktop Support System (EDSS) is new examination software 
to be used by revenue agents, tax compliance officers and tax examiners 
in the SBSE division. 
* Correspondence Exam Automated Support (CEAS) will centralize and 
automate the processing of examination correspondence. 
* The Custodial Detail Database (CDDB) provides the functionality 
needed for custodial financial management reporting. 

Table: Deployed Internal Use Software (In Millions): 

Modernized E-File: 
Cost: $165; 
Accumulated Depreciation: $(62); 
2007 Net Book Value: $103; 
2006 Net Book Value: $102. 

CADE: 
Cost: 148; 
Accumulated Depreciation: (47); 
2007 Net Book Value: 101; 
2006 Net Book Value: 105. 

Integrated Financial System: 
Cost: 147; 
Accumulated Depreciation: (52); 
2007 Net Book Value: 95; 
2006 Net Book Value: 115. 

E-Services: 
Cost: 141; 
Accumulated Depreciation: (71); 
2007 Net Book Value: 70; 
2006 Net Book Value: 91. 

STIR: 
Cost: 76; 
Accumulated Depreciation: (49); 
2007 Net Book Value: 27; 
2006 Net Book Value: 38. 

Filing and Payment Compliance: 
Cost: 28; 
Accumulated Depreciation: (3); 
2007 Net Book Value: 25; 
2006 Net Book Value: 3. 

Customer Communications: 
Cost: 25; 
Accumulated Depreciation: (22); 
2007 Net Book Value: 3; 
2006 Net Book Value: 7. 

Enterprise Systems Management: 
Cost: 16; 
Accumulated Depreciation: (10); 
2007 Net Book Value: 6; 
2006 Net Book Value: 8. 

Internet Refund Fact of Filing: 
Cost: 15; 
Accumulated Depreciation: (9); 
2007 Net Book Value: 6; 
2006 Net Book Value: 8. 

Other: 
Cost: 12; 
Accumulated Depreciation: (10); 
2007 Net Book Value: 2; 
2006 Net Book Value: 2. 

Deployed Internal Use Software: 
Cost: $773; 
Accumulated Depreciation: $(335); 
2007 Net Book Value: $438; 
2006 Net Book Value: $479. 

[End of table] 

Work in Process Internal Use Software (In Millions): 

CADE: 
2007: $57; 
2006: $10. 

AMS: 
2007: $23; 
2006: [Empty]. 

Modernized E-File: 
2007: $7; 
2006: $16. 

EDSS: 
2007: $6; 
2006: [Empty[. 

CEAS: 
2007: $4; 
2006: [Empty]. 

CDDB: 
2007: $2; 
2006: [Empty]. 

Filing & Payment Compliance: 
2007: [Empty]; 
2006: $15. 

Work in Process Internal Use Software: 
2007: $99; 
2006: $41. 

[End of table] 

Note 8. Other Liabilities (In Millions): 

Intragovernmental: Accrued expenses; 
2007, Current: $23; 
2007, Non-Current: [Empty]; 
2007: Total: $23. 

Intragovernmental: Accrued payroll and benefits; 
2007, Current: 55; 
2007, Non-Current: [Empty]; 
2007: Total: 55. 

Intragovernmental: Accrued FECA liability; 
2007, Current: 43; 
2007, Non-Current: 55; 
2007: Total: 98. 

Intragovernmental: Other Liabilities; 
2007, Current: 121; 
2007, Non-Current: 55; 
2007: Total: 176. 

With the Public: Accounts payable; 
2007, Current: 86; 
2007, Non-Current: [Empty]; 
2007: Total: 86. 

With the Public: Accrued expenses; 
2007, Current: 208; 
2007, Non-Current: [Empty]; 
2007: Total: 208. 

With the Public: Accrued payroll and benefits; 
2007, Current: 281; 
2007, Non-Current: [Empty]; 
2007: Total: 281. 

With the Public: Actuarial FECA liability; 
2007, Current: [Empty]; 
2007, Non-Current: 465; 
2007: Total: 465. 

With the Public: Accrued annual leave; 
2007, Current: 480; 
2007, Non-Current: [Empty]; 
2007: Total: 480. 

With the Public: Other custodial liabilities; 
2007, Current: 161; 
2007, Non-Current: {Empty]; 
2007: Total: 161. 

With the Public: Net Capital lease liability (Note 9); 
2007, Current: [Empty]; 
2007, Non-Current: 3; 
2007: Total: 3. 

With the Public: Installment agreement liability; 
2007, Current: 8; 
2007, Non-Current: [Empty]; 
2007: Total: 8. 

With the Public: Other Liabilities; 
2007, Current: $1,224; 
2007, Non-Current: $468; 
2007: Total: $1,692. 

Intragovernmental: Accrued expenses; 
2006, Current: $30; 
2006, Non-Current: [Empty]; 
2006: Total: $30. 

Intragovernmental: Accrued payroll and benefits; 
2006, Current: 51; 
2006, Non-Current: [Empty]; 
2006: Total: 51. 

Intragovernmental: Accrued FECA liability; 
2006, Current: 41; 
2006, Non-Current: 55; 
2006: Total: 96. 

Intragovernmental: Net Capital lease liability (Note 9); 
2006, Current: 1; 
2006, Non-Current: [Empty]; 
2006: Total: 1. 

Intragovernmental: Other Liabilities; 
2006, Current: 123; 
2006, Non-Current: 55; 
2006: Total: 178. 

With the Public: Accounts payable; 
2006, Current: 99; 
2006, Non-Current: [Empty]; 
2006: Total: 99. 

With the Public: Accrued expenses; 
2006, Current: 208; 
2006, Non-Current: [Empty]; 
2006: Total: 208. 

With the Public: Accrued payroll and benefits; 
2007, Current: 193; 
2007, Non-Current: [Empty]; 
2007: Total: 193. 

With the Public: Actuarial FECA liability; 
2006, Current: [Empty]; 
2006, Non-Current: 487; 
2006: Total: 487. 

With the Public: Accrued annual leave; 
2006, Current: 478; 
2006, Non-Current: [Empty]; 
2006: Total: 478. 

With the Public: Other custodial liabilities; 
2006, Current: 48; 
2006, Non-Current: {Empty]; 
2006: Total: 48. 

With the Public: Net Capital lease liability (Note 9); 
2006, Current: 1; 
2006, Non-Current: 3; 
2006: Total: 4. 

With the Public: Contingent liabilities; 
2006, Current: 2; 
2006, Non-Current: [Empty]; 
2006: Total: 2. 

With the Public: Other Liabilities; 
2006, Current: $1,051; 
2006, Non-Current: $490; 
2006: Total: $1,541. 

[End of table] 

Liabilities Not Covered by Budgetary Resources (In Millions): 

Actuarial FECA liability: 
2007 Intra-Governmental: [Empty]; 
2007 With the Public: $465; 
2006 Intra-Governmental: [Empty]; 
2006 With the Public: $487. 

Accrued annual leave: 
2007 Intra-Governmental: [Empty]; 
2007 With the Public: 480; 
2006 Intra-Governmental: [Empty]; 
2006 With the Public: 478. 

Accrued FECA liability: 
2007 Intra-Governmental: 98; 
2007 With the Public: [Empty]; 
2006 Intra-Governmental: 96; 
2006 With the Public: [Empty]. 

Installment agreement liability: 
2007 Intra-Governmental: [Empty];
2007 With the Public: [Empty];
2006 Intra-Governmental: 8; 
2006 With the Public: [Empty]. 

Contingent liabilities: 
2007 Intra-Governmental: [Empty];
2007 With the Public: [Empty];
2006 Intra-Governmental: [Empty];
2006 With the Public: 2. 

Liabilities Not Covered by Budgetary Resources: 
2007 Intra-Governmental: 98; 
2007 With the Public: 953; 
2006 Intra-Governmental: 96; 
2006 With the Public: 967. 

Liabilities not covered by budgetary resources include liabilities for 
which congressional action is needed before budgetary resources can be 
provided. Although future appropriations to fund these liabilities are 
likely, it is not certain appropriations will be enacted to fund these 
liabilities. 

[End of table] 

Note 9. Leases (In Millions): 

ADP Equipment: 
Total: $6; 
Future Payments Due, 2008: $3; 
Future Payments Due, 2009: $3. 

Future Lease Payments: 
Total: 6; 
Future Payments Due, 2008: 3; 
Future Payments Due, 2009: 3. 

Imputed Interest: 
Total: (1); 
Future Payments Due, 2008: (1); 
Future Payments Due, 2009: [Empty]. 

Executory costs: 
Total: (2); 
Future Payments Due, 2008: (2); 
Future Payments Due, 2009: [Empty]. 

Net Capital Lease Liability: 
Total: $3; 
Future Payments Due, 2008: [Empty]; 
Future Payments Due, 2009: $3. 

The capital lease liability is covered by budgetary resources. As of 
September 30, 2007 and 2006, capital lease liability was $3 million and 
$5 million, respectively. 

IRS leases office space, vehicles and equipment under annual operating 
leases. These leases are cancelable or renewable on an annual basis at 
the option of the IRS. They do not impose binding commitments on the 
IRS for future rental payments on leases with terms longer than one 
year. 

[End of table] 

Note 10. Commitments and Contingencies: 

The IRS is a party to legal actions in whose outcome, if unfavorable, 
could materially effect the financial statements. Management and legal 
counsel have determined, for some of these actions, it is probable the 
outcome will be unfavorable and losses will result. As of September 30, 
2007, there was no estimated contingent liability arising from these 
actions. The estimated contingent liability as of September 30, 2006 
was $2 million. 

For some of the legal actions to which IRS is a party, management and 
legal counsel cannot determine the likelihood of an unfavorable outcome 
nor can any related loss be reasonably estimated. As of September 30, 
2007 and 2006, there were two cases and three cases, respectively for 
which management and legal counsel are unable to determine the 
likelihood of an unfavorable outcome or establish a range of potential 
losses. 

As of September 30, 2007 and 2006, the IRS does not have contractual 
commitments for payments on obligations related to canceled 
appropriations. 

Note 11. Cost and Earned Revenue by Programs (In Millions): 

Intragovernmental Gross Cost: 
2007, Taxpayer Assistance and Education: $75; 
2007, Filing and Account Services: $1,497; 
2007, Compliance: $2,353; 
2007, Administration of Tax Credit Programs: $41; 
2007, Total: $3,966. 

Gross Costs with the Public: 
2007, Taxpayer Assistance and Education: 404; 
2007, Filing and Account Services: 2,143; 
2007, Compliance: 5,349; 
2007, Administration of Tax Credit Programs: 150; 
2007, Total: 8,046. 

Program Costs: 
2007, Taxpayer Assistance and Education: 479; 
2007, Filing and Account Services: 3,640; 
2007, Compliance: 7,702; 
2007, Administration of Tax Credit Programs: 191; 
2007, Total: 12,012. 

Intragovernmental Earned Revenue: 
2007, Taxpayer Assistance and Education: (1); 
2007, Filing and Account Services: (8); 
2007, Compliance: (41); 
2007, Administration of Tax Credit Programs: [Empty]; 
2007, Total: (50). 

Earned Revenue from the Public: 
2007, Taxpayer Assistance and Education: (2); 
2007, Filing and Account Services: (35); 
2007, Compliance: (190); 
2007, Administration of Tax Credit Programs: [Empty]; 
2007, Total: (227). 

Program Revenue: 
2007, Taxpayer Assistance and Education: (3); 
2007, Filing and Account Services: (43); 
2007, Compliance: (231); 
2007, Administration of Tax Credit Programs: [Empty]; 
2007, Total: (277). 

Net Cost of Operations: 
2007, Taxpayer Assistance and Education: 476; 
2007, Filing and Account Services: 3,597; 
2007, Compliance: 7,471; 
2007, Administration of Tax Credit Programs: 191; 
2007, Total: 11,735. 

Intragovernmental Gross Cost: 
2006, Taxpayer Assistance and Education: $106; 
2006, Filing and Account Services: $1,459; 
2006, Compliance: $2,219; 
2006, Administration of Tax Credit Programs: $45; 
2006, Total: $3,829. 

Gross Costs with the Public: 
2006, Taxpayer Assistance and Education: 301; 
2006, Filing and Account Services: 2,231; 
2006, Compliance: 5,190; 
2006, Administration of Tax Credit Programs: 147; 
2006, Total: 7,869. 

Program Costs: 
2006, Taxpayer Assistance and Education: 407; 
2006, Filing and Account Services: 3,690; 
2006, Compliance: 7,409; 
2006, Administration of Tax Credit Programs: 192; 
2006, Total: 11,698. 

Intragovernmental Earned Revenue: 
2006, Taxpayer Assistance and Education: [Empty]; 
2006, Filing and Account Services: (15); 
2006, Compliance: (32); 
2006, Administration of Tax Credit Programs: [Empty]; 
2006, Total: (47). 

Earned Revenue from the Public: 
2006, Taxpayer Assistance and Education: (55); 
2006, Filing and Account Services: (18); 
2006, Compliance: (93); 
2006, Administration of Tax Credit Programs: [Empty]; 
2006, Total: (166). 

Program Revenue: 
2006, Taxpayer Assistance and Education: (55); 
2006, Filing and Account Services: (33); 
2006, Compliance: (125); 
2006, Administration of Tax Credit Programs: [Empty]; 
2006, Total: (231). 

Net Cost of Operations: 
2006, Taxpayer Assistance and Education: 352; 
2006, Filing and Account Services: 3,657; 
2006, Compliance: 7,284; 
2006, Administration of Tax Credit Programs: 192; 
2006, Total: 11,485. 

The new appropriation structure, discussed in Note 1. I., Financing 
Sources and Revenues, realigned funding of the IRS program costs. In FY 
2006, exchange revenues derived primarily from letter rulings
and determinations were reported with their related program costs in 
Taxpayer Assistance and Education. In FY 2007, these exchange revenues 
were reported with their related program costs in Compliance. 

[End of table] 

Note 12. Statement of Budgetary Resources: 

Obligations Incurred (In Millions): 

Direct - Category B: 
2007: $10,808; 
2006: $10,634. 

Reimbursable - Category B: 
2007: 89; 
2006: 88. 

Obligations Incurred: 
2007: 10,897; 
2006: 10,722. 

Category B apportionments distribute budgetary resources by activities 
or programs and are restricted by purpose for which obligations can be 
incurred. 

[End of table] 

Comparison of Statement of Budgetary Resources (SBR) and the 
Presidentï¿½s Budget (In Millions): 

Statement of Budgetary Resources: 
Budgetary Resources: $11,274; 
Obligations Incurred: $10,722; 
Distributed Offsetting Receipts: $106; 
Net Outlays: $10,374. 

Included on SBR, not in President's Budget, Expired Funds: 
Budgetary Resources: (277); 
Obligations Incurred: (16); 
Distributed Offsetting Receipts: [Empty]; 
Net Outlays: [Empty]. 

Included on SBR, not in President's Budget, IRS Miscellaneous Retained 
Fees: 
Budgetary Resources: (99); 
Obligations Incurred: [Empty]; 
Distributed Offsetting Receipts: [Empty]; 
Net Outlays: [Empty]. 

Included on SBR, not in President's Budget, Distributed Offsetting 
Receipts: 
Budgetary Resources: [Empty];
Obligations Incurred: [Empty];
Distributed Offsetting Receipts: (106); 
Net Outlays: 106. 

Included on SBR, not in President's Budget, Other: 
Budgetary Resources: 2; 
Obligations Incurred: 1; 
Distributed Offsetting Receipts: [Empty]; 
Net Outlays: 2. 

Included in President's Budget, not on SBR, Tax credits and interest 
refunds to taxpayers: 
Budgetary Resources: 55,905; 
Obligations Incurred: 55,905; 
Distributed Offsetting Receipts: [Empty]; 
Net Outlays: 55,905. 

Included in President's Budget, not on SBR, Payments to informants: 
Budgetary Resources: 25; 
Obligations Incurred: 25; 
Distributed Offsetting Receipts: [Empty]; 
Net Outlays: 25. 

Budget of the United States Government: 
Budgetary Resources: $66,830; 
Obligations Incurred: $66,637; 
Distributed Offsetting Receipts: [Empty]; 
Net Outlays: $66,412. 

[End of table] 

The FY 2009 Budget of the United States Government (Presidentï¿½s Budget) 
presenting the actual amounts for the year ended September 30, 2007 has 
not been published as of the issue date of these financial statements. 
The FY 2009 Presidentï¿½s Budget is scheduled for publication in February 
2008. A reconciliation of the FY 2006 column on the Statement of 
Budgetary Resources (SBR) to the actual amounts for FY 2006 in the FY 
2008 Presidentï¿½s Budget for budgetary resources, obligations incurred,
distributed offsetting receipts, and net outlays is presented above. 

The Presidentï¿½s Budget includes appropriations for EITC, Child Tax 
Credit, HCTC, interest relating to taxpayer refunds and informant 
payments totaling $56 billion. The majority of the appropriations
represent budgetary resources and outlays of payments to taxpayers for 
credits that exceed the taxpayerï¿½s income tax liability and interest 
paid on refunds of collections. 

There are no material differences for unobligated available balances 
between the SBR and the Presidentï¿½s Budget. 

Obligated Balances, net, End of Period (In Millions): 

Undelivered orders-unpaid: 
2007: $798; 
2006: $932. 

Budgetary accounts payable: 
2007: 653; 
2006: 605. 

Budgetary accounts receivable: 
2007: (24); 
2006: (15). 

Obligated Balance, net, End of Period: 
2007: $1,427; 
2006: $1,522. 

[End of table] 

Note 13. Earmarked Funds: 

The IRS is responsible for the operation of certain earmarked funds. 
The Private Collection Agent Program and the Federal Tax Lien Revolving 
Fund are discussed in Note 1. L., Earmarked Funds. 

Balance Sheet, Assets: Fund Balance with Treasury; 
2007, Private Collection Agent Program: $6; 
2007, Federal Tax Lien Revolving Fund: $6; 
2007, Total: $12. 

Balance Sheet, Assets: Other Assets; 
2007, Private Collection Agent Program: [Empty]; 
2007, Federal Tax Lien Revolving Fund: 2; 
2007, Total: 2. 

Balance Sheet, Total Assets: 
2007, Private Collection Agent Program: $6; 
2007, Federal Tax Lien Revolving Fund: $8; 
2007, Total: $14. 

Liabilities and Net Position, Net Position, Unexpended Appropriations: 
2007, Private Collection Agent Program: [Empty]; 
2007, Federal Tax Lien Revolving Fund: 6; 
2007, Total: 6. 

Liabilities and Net Position, Net Position, Cumulative Results of 
Operations: 
2007, Private Collection Agent Program: 6; 
2007, Federal Tax Lien Revolving Fund: 2; 
2007, Total: 8. 

Total Liabilities and Net Position: 
2007, Private Collection Agent Program: 6; 
2007, Federal Tax Lien Revolving Fund: 8; 
2007, Total: 14. 

Statement of Net Cost, Gross Cost: 
2007, Private Collection Agent Program: 5; 
2007, Federal Tax Lien Revolving Fund: [Empty]; 
2007, Total: 5. 

Statement of Net Cost, Net Cost of Operations: 
2007, Private Collection Agent Program: 5; 
2007, Federal Tax Lien Revolving Fund: [Empty]; 
2007, Total: 5. 

Statement of Changes in Net Position, Net Position Beginning of 
Period: 
2007, Private Collection Agent Program: [Empty]; 
2007, Federal Tax Lien Revolving Fund: 8; 
2007, Total: 8. 

Statement of Changes in Net Position, Net Costs of Operations: 
2007, Private Collection Agent Program: (5); 
2007, Federal Tax Lien Revolving Fund: [Empty]; 
2007, Total: (5). 

Statement of Changes in Net Position, Non-Exchange Revenue: 
2007, Private Collection Agent Program: 11; 
2007, Federal Tax Lien Revolving Fund: [Empty]; 
2007, Total: 11. 

Statement of Changes in Net Position, Net Position End of Period: 
2007, Private Collection Agent Program: 6; 
2007, Federal Tax Lien Revolving Fund: 8; 
2007, Total: 14. 

[End of table] 

Note 14. Collections of Federal Tax Revenue (In Billions): 

Individual income, FICA/SECA, and other: 
Tax Year 2007: $1,409*; 
Tax Year 2006: $751; 
Tax Year 2005: $24; 
Prior Years: $18; 
Collections Received, FY 2007: $2,202; 
Collections Received, FY 2006: $2,035. 

Corporate income: 
Tax Year 2007: 253**; 
Tax Year 2006: 116; 
Tax Year 2005: 3; 
Prior Years: 23; 
Collections Received, FY 2007: 395; 
Collections Received, FY 2006: 380. 

Excise: 
Tax Year 2007: 39; 
Tax Year 2006: 14; 
Tax Year 2005: [Empty]; 
Prior Years: [Empty]; 
Collections Received, FY 2007: 53; 
Collections Received, FY 2006: 58. 

Estate and gift: 
Tax Year 2007: [Empty[; 
Tax Year 2006: 16; 
Tax Year 2005: 2; 
Prior Years: 9; 
Collections Received, FY 2007: 27; 
Collections Received, FY 2006: 29. 

Railroad retirement: 
Tax Year 2007: 4; 
Tax Year 2006: 1; 
Tax Year 2005: [Empty]; 
Prior Years: [Empty]; 
Collections Received, FY 2007: 5; 
Collections Received, FY 2006: 5. 

Federal unemployment: 
Tax Year 2007: 5; 
Tax Year 2006: 2; 
Tax Year 2005: [Empty]; 
Prior Years: [Empty]; 
Collections Received, FY 2007: 7; 
Collections Received, FY 2006: 7. 

Total: 
Tax Year 2007: $1,710 (64%); 
Tax Year 2006: $900 (33%); 
Tax Year 2005: $29 (1%); 
Prior Years: $50 (2%); 
Collections Received, FY 2007: $2,689 (100%); 
Collections Received, FY 2006: $2,514. 

* Includes other collections of $491 million. 
** Includes tax year 2008 corporate income tax receipts of $10 billion. 

In FY 2007, individual income, FICA/SECA, and other taxes include $74 
billion in payroll taxes collected from other Federal agencies. Of this 
amount, $12 billion represents the portion paid by the employers. 

[End of table] 

Note 15. Federal Tax Refund Activity: 

Individual income, FICA/SECA, and other: 
Tax Year 2007: $2; 
Tax Year 2006: $235; 
Tax Year 2005: $18; 
Prior Years:$6; 
Disbursed, FY 2007: $261; 
Disbursed, FY 2006: $246. 

Corporate income: 
Tax Year 2007: 1; 
Tax Year 2006: 8; 
Tax Year 2005: 4; 
Prior Years: 15; 
Disbursed, FY 2007: 28; 
Disbursed, FY 2006: 31. 

Excise: 
Tax Year 2007: [Empty]; 
Tax Year 2006: 1; 
Tax Year 2005: [Empty]; 
Prior Years: 1; 
Disbursed, FY 2007: 2; 
Disbursed, FY 2006: [Empty]. 

Estate and gift: 
Tax Year 2007: [Empty];
Tax Year 2006: [Empty];
Tax Year 2005: 1; 
Prior Years: [Empty];
Disbursed, FY 2007: 1; 
Disbursed, FY 2006: [Empty]. 

Federal Tax Refund Activity: 
Tax Year 2007: $3 (1%); 
Tax Year 2006: $244 (83%); 
Tax Year 2005: $23 (8%); 
Prior Years: $22 (8%); 
Disbursed, FY 2007: $292 (100%); 
Disbursed, FY 2006: $277. 

Individual income, FICA/SECA, and other refund amounts include EITC and 
child tax credit refunds. 

[End of table] 

Note 16. Reconciliation of Net Cost of Operations to Budget (In 
Millions): 

Resources used to finance activities: Obligations Incurred; 
2007: $10,897; 
2006: $10,722. 

Resources used to finance activities: Spending Authority from 
offsetting collections and recoveries; 
2007: (302); 
2006: (231). 

Resources used to finance activities: Offsetting receipts; 
2007: (164); 
2006: (106). 

Resources used to finance activities: Other exchange revenues not in 
budget; 
2007: (40); 
2006: (37). 

Resources used to finance activities: Imputed financing; 
2007: 1,094; 
2006: 1,060. 

Resources used to finance activities: Transfers in/out without 
reimbursement; 
2007: 13; 
2006: 18. 

Resources used to finance activities: Total; 
2007: 11,498; 
2006: 11,426. 

Resources that do not fund net cost of operations: Change in goods, 
services and benefits ordered but not yet received or provided; 
2007: 167; 
2006: (50). 

Resources that do not fund net cost of operations: Costs capitalized on 
the balance sheet; 
2007: (292); 
2006: (268). 

Resources that do not fund net cost of operations: Total; 
2007: (125); 
2006: (318). 

Costs that do not require resources in current period: Depreciation and 
amortization; 
2007: 370; 
2006: 377. 

Costs that do not require resources in current period: Decrease in 
unfunded liabilities; 
2007: (21); 
2006: (11). 

Costs that do not require resources in current period: Revaluation of 
assets or liabilities; 
2007: 9; 
2006: 11. 

Costs that do not require resources in current period: Other; 
2007: 4; 
2006: [Empty]. 

Costs that do not require resources in current period: Total; 
2007: 362; 
2006: 377. 

Net Cost of Operations: 
2007: $11,735; 
2006: $11,485. 

In accordance with Statement of Federal Financial Accounting Standards 
No. 7 (SFFAS No. 7), Accounting for Revenue and Other Financing Sources 
and Concepts for Reconciling Budgetary and Financial Accounting, a 
reconciliation is required for the relationship between the budgetary 
resources obligated during the period for IRSï¿½s programs and operations 
to the net cost of operations. The budgetary accounting reports the 
obligations and outlays of financial resources to acquire or provide
goods and services and the accrual basis of financial accounting 
reports the net cost of resources used. 

[End of table] 

[End of Notes] 

Internal Revenue Service: 
Required Supplementary Information - Unaudited: 
For the Years Ended September 30, 2007 and 2006: 

Schedule of Budgetary Resources by Major Budget Accounts (In Millions): 

In FY 2007, Congress implemented a new appropriations structure for IRS 
which realigned resources from its major operating appropriations into 
new budget accounts. As a result of this realignment, the FY 2006 
Schedule of Budgetary Resources by Major Budget Accounts is not 
comparable and is not presented. 

Budgetary Resources: Unobligated balance ï¿½ beginning of period; 
Fiscal Year 2007, Taxpayer Services: $154; 
Fiscal Year 2007, Enforcement: $85; 
Fiscal Year 2007, Operations Support: $91; 
Fiscal Year 2007, Other Appropriations: $222; 
Fiscal Year 2007, Total: $552. 

Budgetary Resources: Recoveries of prior year unpaid obligations; 
Fiscal Year 2007, Taxpayer Services: 89; 
Fiscal Year 2007, Enforcement: 36; 
Fiscal Year 2007, Operations Support: 44; 
Fiscal Year 2007, Other Appropriations: 14; 
Fiscal Year 2007, Total: 183. 

Budgetary Resources: Budgetary appropriations; 
Fiscal Year 2007, Taxpayer Services: 2,157; 
Fiscal Year 2007, Enforcement: 4,742; 
Fiscal Year 2007, Operations Support: 3,471; 
Fiscal Year 2007, Other Appropriations: 406; 
Fiscal Year 2007, Total: 10,776. 

Budgetary Resources: Spending authority from offsetting collections; 
Fiscal Year 2007, Taxpayer Services: 30; 
Fiscal Year 2007, Enforcement: 48; 
Fiscal Year 2007, Operations Support: 31; 
Fiscal Year 2007, Other Appropriations: 10; 
Fiscal Year 2007, Total: 119. 

Budgetary Resources: Non-expenditure transfers, net; 
Fiscal Year 2007, Taxpayer Services: 53; 
Fiscal Year 2007, Enforcement: (82); 
Fiscal Year 2007, Operations Support: 170; 
Fiscal Year 2007, Other Appropriations: (137); 
Fiscal Year 2007, Total: 4. 

Budgetary Resources: Permanently not available; 
Fiscal Year 2007, Taxpayer Services: (33); 
Fiscal Year 2007, Enforcement: (13); 
Fiscal Year 2007, Operations Support: (23); 
Fiscal Year 2007, Other Appropriations: (4); 
Fiscal Year 2007, Total: (73). 

Budgetary Resources: Total; 
Fiscal Year 2007, Taxpayer Services: $2,450; 
Fiscal Year 2007, Enforcement: $4,816; 
Fiscal Year 2007, Operations Support: $3,784; 
Fiscal Year 2007, Other Appropriations: $511; 
Fiscal Year 2007, Total: $11,561. 

Status of Budgetary Resources: Obligations incurred; 
Fiscal Year 2007, Taxpayer Services: 2,267; 
Fiscal Year 2007, Enforcement: 4,715; 
Fiscal Year 2007, Operations Support: 3,6650; 
Fiscal Year 2007, Other Appropriations: 265; 
Fiscal Year 2007, Total: 10,897. 

Status of Budgetary Resources: Unobligated balance ï¿½ available; 
Fiscal Year 2007, Taxpayer Services: 11; 
Fiscal Year 2007, Enforcement: 16; 
Fiscal Year 2007, Operations Support: 54; 
Fiscal Year 2007, Other Appropriations: 90; 
Fiscal Year 2007, Total: 171. 

Status of Budgetary Resources: Unobligated balance ï¿½ not available; 
Fiscal Year 2007, Taxpayer Services: 172; 
Fiscal Year 2007, Enforcement: 85; 
Fiscal Year 2007, Operations Support: 80; 
Fiscal Year 2007, Other Appropriations: 156; 
Fiscal Year 2007, Total: 493. 

Status of Budgetary Resources: Total; 
Fiscal Year 2007, Taxpayer Services: $2,450; 
Fiscal Year 2007, Enforcement: $4,816; 
Fiscal Year 2007, Operations Support: $3,784; 
Fiscal Year 2007, Other Appropriations: $511; 
Fiscal Year 2007, Total: $11,561. 

Change in Obligated Balance: Obligated balance, net, beginning of 
period; 
Fiscal Year 2007, Taxpayer Services: 448; 
Fiscal Year 2007, Enforcement: 324; 
Fiscal Year 2007, Operations Support: 572; 
Fiscal Year 2007, Other Appropriations: 178; 
Fiscal Year 2007, Total: 1,522. 

Change in Obligated Balance: Obligations incurred; 
Fiscal Year 2007, Taxpayer Services: 2,267; 
Fiscal Year 2007, Enforcement: 4,715; 
Fiscal Year 2007, Operations Support: 3,650; 
Fiscal Year 2007, Other Appropriations: 265; 
Fiscal Year 2007, Total: 10,897. 

Change in Obligated Balance: Gross Outlays; 
Fiscal Year 2007, Taxpayer Services: (2,391); 
Fiscal Year 2007, Enforcement: (4,709); 
Fiscal Year 2007, Operations Support: (3,416); 
Fiscal Year 2007, Other Appropriations: (287); 
Fiscal Year 2007, Total: (10,800). 

Change in Obligated Balance: Recoveries of prior year unpaid 
obligations, actual; 
Fiscal Year 2007, Taxpayer Services: (89); 
Fiscal Year 2007, Enforcement: (36); 
Fiscal Year 2007, Operations Support: (44); 
Fiscal Year 2007, Other Appropriations: (14); 
Fiscal Year 2007, Total: (183). 

Change in Obligated Balance: Change in uncollected customer payments 
from Federal sources; 
Fiscal Year 2007, Taxpayer Services: [Empty]; 
Fiscal Year 2007, Enforcement: (1); 
Fiscal Year 2007, Operations Support: (8); 
Fiscal Year 2007, Other Appropriations: [Empty]; 
Fiscal Year 2007, Total: (9). 

Obligated balance, net, end of period: 
Fiscal Year 2007, Taxpayer Services: 235; 
Fiscal Year 2007, Enforcement: 296; 
Fiscal Year 2007, Operations Support: 754; 
Fiscal Year 2007, Other Appropriations: 142; 
Fiscal Year 2007, Total: 1,427. 

Net Outlays: Gross Outlays; 
Fiscal Year 2007, Taxpayer Services: 2,391; 
Fiscal Year 2007, Enforcement: 4,706; 
Fiscal Year 2007, Operations Support: 3,416; 
Fiscal Year 2007, Other Appropriations: 287; 
Fiscal Year 2007, Total: 10,800. 

Net Outlays: Offsetting collections; 
Fiscal Year 2007, Taxpayer Services: (30); 
Fiscal Year 2007, Enforcement: (46); 
Fiscal Year 2007, Operations Support: (23); 
Fiscal Year 2007, Other Appropriations: (11); 
Fiscal Year 2007, Total: (110). 

Net Outlays: Distributed Offsetting receipts; 
Fiscal Year 2007, Taxpayer Services: [Empty]; 
Fiscal Year 2007, Enforcement: [Empty]; 
Fiscal Year 2007, Operations Support: [Empty]; 
Fiscal Year 2007, Other Appropriations: (164); 
Fiscal Year 2007, Total: (164). 

Net Outlays: Total; 
Fiscal Year 2007, Taxpayer Services: $2,361; 
Fiscal Year 2007, Enforcement: $4,660; 
Fiscal Year 2007, Operations Support: $3,393; 
Fiscal Year 2007, Other Appropriations: $112; 
Fiscal Year 2007, Total: $10,526. 

[End of table] 

Other Claims for Refunds: 

Management has estimated amounts which may be paid out as other claims 
for tax refunds. This estimate represents an amount (principal and 
interest) which may be paid for claims pending judicial review by the
Federal courts or, internally, by Appeals. In FY 2007, the total 
estimated payout (including principal and interest) for claims pending 
judicial review by the Federal courts is $8.8 billion and by Appeals is
$5.9 billion. In FY 2006, the total estimated payout (including 
principal and interest) for claims pending judicial review by the 
Federal courts was $14.8 billion and by Appeals was $7.1 billion. To 
the extent judgments against the government in these cases prompt other 
similarly situated taxpayers to file similar refund claims, these 
amounts could become significantly greater. 

Federal Taxes Receivable, Net: 

In accordance with SFFAS No. 7, some unpaid assessments do not meet the 
criteria for financial statement recognition as discussed in Note 1. 
F., Federal Taxes Receivable, Net and Due to Treasury. Although 
compliance assessments and write-offs are not considered receivables 
under Federal accounting standards, they represent legally enforceable 
claims of IRS acting on behalf of the Federal government. There is, 
however, a significant difference in the collection potential of these 
categories. 

The components of the total unpaid assessments and derivation of net 
Federal taxes receivable were as follows (in billions): 

Total unpaid assessments: 
2007: $263; 
2006: $245. 

Compliance assessments: 
2007: (65); 
2006: (57). 

Write-offs: 
2007: (100); 
2006: (97). 

Gross Federal taxes receivable: 
2007: $98; 
2006: $91. 

Allowance for doubtful accounts: 
2007: (72); 
2006: (70). 

Federal taxes receivable, net: 
2007: $26; 
2006: $21. 

[End of table] 

IRS cannot reasonably estimate the amount of allowance for doubtful 
accounts pertaining to its compliance assessments, and thus cannot 
determine their net realizable value or the value of the preassessment
work-in-process. 

To eliminate double-counting, the compliance assessments reported above 
exclude trust fund recovery penalties, totaling $6 billion as of 
September 30, 2007 and $9 billion as of September 30, 2006, that were 
assessed against officers and directors of businesses who were involved 
in the non-remittance of Federal taxes withheld from their employees. 
The related unpaid assessments of those businesses are reported as
taxes receivable or write-offs, but IRS may also recover portions of 
those businessesï¿½ unpaid assessments from any and all individual 
officers and directors against whom a trust fund recovery penalty is 
assessed. 

Internal Revenue Service: 
Other Accompanying Information - Unaudited: 
For the Years Ended September 30, 2007 and 2006: 

Statement of Net Cost by Responsibility Segment (In Millions): 

Operating divisions: WAGE; 
2007: 3,048; 
2006: 2,911. 

Operating divisions: SBSE; 
2007: 2,548; 
2006: 2,491. 

Operating divisions: LMSB; 
2007: 821; 
2006: 800. 

Operating divisions: TEGE; 
2007: 267; 
2006: 268. 

Operating divisions: Total; 
2007: 6,684; 
2006: 6,470. 

Functional support: Appeals; 
2007: 211; 
2006: 209. 

Functional support: Chief Counsel; 
2007: 319; 
2006: 322. 

Functional support: Criminal Investigation; 
2007: 604; 
2006: 619. 

Functional support: Taxpayer Advocate; 
2007: 192; 
2006: 186. 

Functional support: Communications; 
2007: 26; 
2006: 24. 

Functional support: Total; 
2007: 1,352; 
2006: 1,360. 

Operating Net Cost: 
2007: $8,036; 
2006: $7,830. 

General and Administration: 
2007: 1,555; 
2006: 1,721. 
Information Technology: 
2007: 1,766; 
2006: 1,546. 

Depreciation/Loss on Disposal: 
2007: 378; 
2006: 388. 

Total Net Cost: 
2007: $11,735; 
2006: $11,485. 

[End of table] 

Child Tax Credit: 

The child tax credit provided under Internal Revenue Code (26 USC) 
Section 24 was originally authorized by the Taxpayer Relief Act of 1997 
(Public Law 105-34). The child tax credit is a special credit for 
taxpayers who work, whose earnings fall below the established allowance 
ceiling, and who have a qualifying child. In FY 2007, IRS issued $16 
billion in child tax credit refunds. An additional $31 billion of child 
tax credits were applied to reduce taxpayer liability. In FY 2006, IRS 
issued $15 billion in child tax credit refunds. An additional $32 
billion of child tax credits were applied to reduce taxpayer liability. 

Earned Income Tax Credit: 

The EITC is a special credit for employed taxpayers whose earnings fall 
below the established allowance ceiling. In FY 2007, IRS issued $38 
billion in EITC refunds. In FY 2006, IRS issued $36 billion in EITC
refunds. An additional $5.1 billion and $5.4 billion of the EITC was 
applied to reduce taxpayer liability for FY 2007 and FY 2006, 
respectively. 

Social Security and Medicare Taxes: 

The Federal Insurance Contributions Act (FICA) provides for a Federal 
system of old-age, survivors, disability, and hospital insurance 
benefits. Payments to trust funds established for these programs are
financed by payroll taxes on employee wages and tips, employersï¿½ 
matching payments, and a tax on selfemployment income. 

A portion of FICA benefits involves old-age, survivors, and disability 
payments. These benefits are funded by the ï¿½social security taxï¿½ which 
is currently 6.2% of wages and tips up to $97,500 and an employer 
matching amount of 6.2% bringing the total rate to 12.4%. These 
benefits are also funded by a self-employment tax of 12.4% on self 
employment income up to $97,500 for calendar year 2007. The income 
ceiling for both wages and tips and self-employment income was $94,200 
for calendar year 2006. Remaining benefits under FICA pertain to 
hospital benefits (referred to as ï¿½Medicareï¿½) and are funded by a 
separate 1.45% tax on all wages and tips (there is no wage limit) and 
the employer matching contribution of 1.45% bringing the total rate to 
2.9%. Self-employed individuals pay a Medicare tax of 2.9% on all self 
employment income. Social Security taxes collected by IRS were 
estimated to be approximately $664 billion and $614 billion in FY 2007 
and FY 2006, respectively. Medicare taxes collected by IRS were 
estimated to be approximately $193 billion and $178 billion in FY 2007 
and FY 2006, respectively. Social Security taxes and Medicare taxes are 
included in individual income, FICA/SECA and other on the Statement of 
Custodial Activity. 

Tax Gap: 

The tax gap is the difference between the amount of tax imposed by law 
and what taxpayers actually pay on time. The tax gap arises from the 
three types of noncompliance: not filing required tax returns on time 
or at all (the nonfiling gap), underreporting the correct amount of tax 
on timely filed returns (the underreporting gap), and not paying on 
time the full amount reported on timely filed returns (the underpayment 
gap). Of these three components, only the underpayment gap is observed; 
the nonfiling gap and the underreporting gap must be estimated. The tax 
gap, estimated to be about $345 billion for Tax Year 2001, represents 
the amount of noncompliance with the tax laws. Underreporting of tax
liability accounts for 82 percent of the gap, with the remainder almost 
evenly divided between nonfiling (eight percent) and underpaying (ten 
percent). Part of the estimate is based on data from a study of 
individual returns filed for tax year 2001. It does not include any 
taxes that should have been paid on income from illegal activities. 
Each instance of noncompliance by a taxpayer contributes to the tax gap,
whether or not the IRS detects it, and whether or not the taxpayer is 
even aware of the noncompliance. Some of the tax gap arises from 
intentional (willful) noncompliance, and some of it arises from
unintentional mistakes. 

The collection gap is the cumulative amount of tax, penalties, and 
interest that has been assessed over many years, but has not been paid 
by a certain point in time, and which the IRS expects to remain 
uncollectible. In essence, it represents the difference between the 
total balance of unpaid assessments and the net taxes receivable 
reported on IRSï¿½s balance sheet. The tax gap and the collection gap are 
related and overlapping concepts, but they have significant 
differences. The collection gap is a cumulative balance sheet concept 
for a particular point in time, while the tax gap is like an income 
statement item for a single year. Moreover, the tax gap estimates 
include all noncompliance, while the collection gap includes only 
amounts that have been assessed (a small portion of all noncompliance). 
Also, the tax gap includes only tax, while the collection gap includes 
tax, penalties, and interest. 

Tax Burden and Tax Expenditures: 

The Internal Revenue Code provides for progressive rates of tax, 
whereby higher incomes are generally subject to higher rates of tax. 
The following graphs and charts present the latest available 
information on income tax and adjusted gross income (AGI) for 
individuals by AGI level and for corporations by size of assets. For 
individuals, the information illustrates, in percentage terms, the tax 
burden borne by varying AGI levels. For corporations, the information 
illustrates, in percentage terms, the tax burden borne by these 
entities by various sizes of their total assets. The graphs are only 
representative of more detailed data and analysis available from the 
Statistics of Income (SOI) office. 

Total tax expenditures are the foregone Federal revenue resulting from 
deductions and credits provided in the Internal Revenue Code. Since tax 
expenditures directly affect funds available from government 
operations, decisions to forego Federal revenue are as important as 
decisions to spend Federal revenue. 

Average Individual Income Tax Liability And Average Adjusted Gross 
Income (AGI), Tax Year 2005: 

[See PDF for image] 

(All figures are estimates and based on samples provided by the 
Statistics of Income (SOI) Office): 

This figure is a line graph with lines depicting Average AGI and 
Average income tax. The vertical axis of the graph represents 
Thousands, from 0 to 600. The horizontal axis of the graph represents 
amounts from under $15,000 to $200,000 or more. 

Individual Income Tax Liability As A Percentage Of AGI, Tax Year 2005: 

[See PDF for image] 

(All figures are estimates and based on samples provided by the 
Statistics of Income (SOI) Office): 

This figure is a line graph depicting Adjusted Gross Income (AGI)The 
vertical axis of the graph represents percentage, from 0 to 30. The 
horizontal axis of the graph represents amounts from under $15,000 to 
$200,000 or more. 

The data depicted in both graphs is represented in the following table: 

Adjusted gross income (AGI): Under $15,000; 
Number of taxable returns (1) (in thousands): 36,889; 
AGI (in millions): 197,723; 
Total income tax (in millions): 3,239; 
Average AGI per return (in whole dollars): 5,360; 
Average Income tax per return (in whole dollars): 88; 
Income tax as a percentage of AGI: 1.6%. 

Adjusted gross income (AGI): $15,000 under $30,000; 
Number of taxable returns (1) (in thousands): 29,739; 
AGI (in millions): 655,562; 
Total income tax (in millions): 23,308; 
Average AGI per return (in whole dollars): 22,044; 
Average Income tax per return (in whole dollars): 784; 
Income tax as a percentage of AGI: 3.6%. 

Adjusted gross income (AGI): $30,000 under $50,000; 
Number of taxable returns (1) (in thousands): 24,596; 
AGI (in millions): 961,071; 
Total income tax (in millions): 60,187; 
Average AGI per return (in whole dollars): 39,075; 
Average Income tax per return (in whole dollars): 2,447; 
Income tax as a percentage of AGI: 6.3%. 

Adjusted gross income (AGI): $50,000 under $100,000; 
Number of taxable returns (1) (in thousands): 28,867; 
AGI (in millions): 2,033,408; 
Total income tax (in millions): 179,382; 
Average AGI per return (in whole dollars): 70,441; 
Average Income tax per return (in whole dollars): 6,214; 
Income tax as a percentage of AGI: 8.8%. 

Adjusted gross income (AGI): $100,000 under $200,000; 
Number of taxable returns (1) (in thousands): 10,831; 
AGI (in millions): 1,434,585; 
Total income tax (in millions): 190,599; 
Average AGI per return (in whole dollars): 132,452; 
Average Income tax per return (in whole dollars): 17,598; 
Income tax as a percentage of AGI: 13.3%. 

Adjusted gross income (AGI): $200,000 or more; 
Number of taxable returns (1) (in thousands): 3,541; 
AGI (in millions): 2,081,299; 
Total income tax (in millions): 471,549; 
Average AGI per return (in whole dollars): 587,772; 
Average Income tax per return (in whole dollars): 133,168; 
Income tax as a percentage of AGI: 22.7% 

Adjusted gross income (AGI): Total;
Number of taxable returns (1) (in thousands): 134,463; 
AGI (in millions): 7,363,648; 
Total income tax (in millions): 928,264; 
Average AGI per return (in whole dollars): [Empty]; 
Average Income tax per return (in whole dollars): [Empty];
Income tax as a percentage of AGI: [Empty]. 

[End of table] 

Corporation Tax Liability As A Percentage Of Taxable Income Tax Year 
2004 Data: 

[See PDF for image] 

(All figures are estimates and based on samples provided by the 
Statistics of Income (SOI) Office): 

This figure is a line graph depicting Size of Assets. The vertical axis 
represents percentage from 0 to 40. The horizontal axis represents size 
of assets from zero to $250,000 or more. The data depicted in the graph 
is represented in the following table: 

Total Assets (in thousands): Zero Assets; 
Income subject to tax (in millions): 15,385; 
Total income tax after credits (in millions): 4,076; 
Percentage of income tax after credits to taxable income: 26.5%. 

Total Assets (in thousands): $1 under $500; 
Income subject to tax (in millions): 8,436; 
Total income tax after credits (in millions): 1,536; 
Percentage of income tax after credits to taxable income: 18.2%. 

Total Assets (in thousands): $500 under $1,000; 
Income subject to tax (in millions): 4,081; 
Total income tax after credits (in millions): 960; 
Percentage of income tax after credits to taxable income: 23.5%. 

Total Assets (in thousands): $1,000 under $5,000; 
Income subject to tax (in millions): 12,215; 
Total income tax after credits (in millions): 3,519; 
Percentage of income tax after credits to taxable income: 28.8%. 

Total Assets (in thousands): $5,000 under $10,000; 
Income subject to tax (in millions): 7,562; 
Total income tax after credits (in millions): 2,446; 
Percentage of income tax after credits to taxable income: 32.3%. 

Total Assets (in thousands): $10,000 under $25,000; 
Income subject to tax (in millions): 10,694; 
Total income tax after credits (in millions): 3,511; 
Percentage of income tax after credits to taxable income: 32.8%. 

Total Assets (in thousands): $25,000 under $50,000; 
Income subject to tax (in millions): 10,076; 
Total income tax after credits (in millions): 3,282; 
Percentage of income tax after credits to taxable income: 32.6%. 

Total Assets (in thousands): $50,000 under $100,000; 
Income subject to tax (in millions): 12,037; 
Total income tax after credits (in millions): 3,918; 
Percentage of income tax after credits to taxable income: 32.5%. 

Total Assets (in thousands): $100,000 under $250,000; 
Income subject to tax (in millions): 23,779; 
Total income tax after credits (in millions): 7,529; 
Percentage of income tax after credits to taxable income: 31.7%. 

Total Assets (in thousands): $250,000 or more; 
Income subject to tax (in millions): 753,124; 
Total income tax after credits (in millions): 193,658; 
Percentage of income tax after credits to taxable income: 25.7%. 

Total Assets (in thousands): Total; 
Income subject to tax (in millions): 857,389; 
Total income tax after credits (in millions): 224,435; 
Percentage of income tax after credits to taxable income: 26.2%. 

[End of table] 

[End of section] 

Appendix I: Material Weaknesses, Significant Deficiency, and Compliance 
Issues: 

Material Weaknesses: 

During our audits of the Internal Revenue Service's (IRS) fiscal years 
2007 and 2006 financial statements, we continued to identify four 
material weaknesses in internal controls. These material weaknesses 
have given rise to significant management challenges that have (1) 
impaired management's ability to prepare financial statements and other 
financial information without extensive compensating procedures, (2) 
limited the availability of reliable information to assist management 
in effectively managing operations on an ongoing basis, (3) reduced 
IRS's effectiveness in enforcing the Internal Revenue Code, (4) 
resulted in errors in taxpayer accounts, (5) increased taxpayer burden, 
and (6) reduced assurance that data processed by IRS's information 
systems are reliable and appropriately protected. The issues that we 
have identified and discuss in this report relate to IRS's controls 
over (1) financial reporting, (2) unpaid tax assessments, (3) tax 
revenue and refunds, and (4) information security. We reported on each 
of these issues last year[Footnote 20] and in prior audits. We 
highlight these issues and a significant deficiency related to hard-
copy tax receipts and taxpayer information in the following sections. 
Less significant weaknesses we identified in IRS's system of internal 
controls and its operations will be reported to IRS separately. 

In previous years, we reported, as a component of the material weakness 
in financial reporting, that IRS did not separately report the amounts 
of revenue it collected for three of the federal government's three 
largest revenue sources--Social Security, hospital insurance, and 
individual income taxes. Additionally, we reported that IRS was unable 
to determine, at the time of payment of excise taxes, to which trust 
funds the excise tax receipts are attributable. This resulted in the 
federal government depending on a complex, multistep process that is 
susceptible to error to distribute excise taxes to the recipient trust 
funds. IRS has taken action to address both of these issues. During 
fiscal year 2007, IRS disclosed information relating to Social Security 
and hospital insurance revenue sources as other accompanying 
information to its financial statements, and also began presenting the 
most recent available information on the amount of excise tax receipts 
certified to the Airport and Airways, Black Lung Disability, and 
Highway Trust Funds in its Management Discussion and Analysis. 
Including more specific information on the federal government's major 
revenue sources and disclosing information on excise tax distributions 
enhances the usefulness of the information being reported. In addition, 
in fiscal year 2007, IRS began to accelerate the timing of its 
certification of excise tax receipts to recipient trust funds.[Footnote 
21] Specifically, in fiscal year 2007, IRS was able to certify as 
accurate 9 months of the fiscal year's excise tax receipt distributions 
to the trust funds, as opposed to only 6 months of receipt 
distributions as was previously the case. This, in turn, reduces the 
risk to the recipient trust funds that they may not receive the 
appropriate distribution of excise tax revenues within a given fiscal 
year. Based on IRS's actions, we no longer consider these issues to 
represent internal control deficiencies. 

Financial Reporting: 

In fiscal year 2007, as in prior years, IRS did not have financial 
management systems adequate to enable it to accurately generate and 
report, in a timely manner, the information needed to both prepare 
financial statements and manage operations on an ongoing basis. To 
overcome these systemic deficiencies with respect to preparation of its 
annual financial statements, IRS was compelled to employ extensive 
compensating procedures. During fiscal year 2007, IRS (1) did not have 
an adequate general ledger system for tax-related transactions, and (2) 
was unable to readily determine the costs of its activities and 
programs and did not have cost-based performance information to assist 
in making or justifying resource allocation decisions. Although 
reliance on compensating procedures resulted in financial statements 
that were fairly stated as of September 30, 2007, and 2006, they do not 
afford real-time data needed to assist in managing operations on a day-
to-day basis and to provide an informed basis for making or justifying 
resource allocation decisions. 

Similar to our findings discussed in last year's report,[Footnote 22] 
during fiscal year 2007, IRS's core general ledger system for tax-
administration-related transactions was not supported by adequate audit 
trails for any of its material balances, including tax revenue, tax 
refunds, and taxes receivable. Financial data related to tax revenue 
and tax refund transactions were posted to IRS's core general ledger 
for administration of tax activities (the Interim Revenue Accounting 
Control System, or IRACS) at a summary level, and were not traceable to 
source documents for individual transactions to appropriately document, 
and to allow independent verification, that transactions were recorded 
in conformance with the posting requirements of the U.S. Government 
Standard General Ledger (SGL). In addition, IRS's reported balance for 
net federal taxes receivable, which comprised over 83 percent of IRS's 
total assets as reported on its fiscal year 2007 balance sheet, was not 
posted to IRACS.[Footnote 23] This was because it was the product of a 
complex statistical estimation process rather than the traditional 
posting of individual transactions. Hence, it also was not traceable to 
underlying transaction detail. Consequently, IRACS does not 
substantially comply with the (1) SGL at the transaction level; (2) 
Federal Financial Management Systems Requirements (FFMSR) embodied in 
Office of Management and Budget (OMB) Circular No. A-127, Financial 
Management Systems;[Footnote 24] or (3) requirements of the Federal 
Financial Management Improvement Act of 1996 (FFMIA). 

As detailed in our discussion of the material weakness in IRS's 
management of unpaid tax assessments which follows, IRS is in the 
process of implementing the Custodial Detail Data Base (CDDB), which is 
ultimately intended to provide appropriate detail transaction 
traceability for all tax-related transactions. However, while IRS 
continued to make progress on CDDB in fiscal year 2007, IRS expects it 
will be several years before CDDB will fully achieve this objective. 
Also, IRS uses two separate general ledgers, one to account for its tax 
administration activities and another to capture the funding for, and 
costs of conducting, those activities. This greatly complicates efforts 
to measure the cost of IRS's tax administration efforts. It remains 
unclear how IRS will overcome this additional obstacle to reliably 
measure the costs and benefits of its tax administration activities to 
permit informed management decision making and more effectively support 
related requests to Congress for resources. 

During fiscal year 2006, we reported that IRS improved its cost 
accounting capabilities by developing and implementing a methodology 
for allocating its costs of operations to its business units. However, 
we also reported that IRS was unable to either readily determine the 
costs of activities and programs that involve activities in multiple 
business units, such as the Automated Underreporter Program, or 
segregate the costs for each activity in cases where multiple 
activities are performed by a single business unit, such as the 
processing of different types of tax returns. 

During fiscal year 2007, IRS continued to make progress in improving 
its cost accounting capabilities. Specifically, IRS issued its first 
cost accounting policy in August 2007, which provides guidance on the 
concepts and requirements for managerial cost accounting within IRS. 
The purpose of this policy is to outline a clear set of guidelines for 
IRS to use to accumulate and report on the full costs of its programs, 
activities, and associated outputs to allow for better decision making. 
In addition, IRS is conducting cost pilots in an effort to establish 
the relationship between its costs and its products and services. IRS 
does not anticipate the results of these pilots to be available until 
the last quarter of fiscal year 2008. These pilots, when completed, 
could help IRS to develop a practical approach to use cost information 
within the Integrated Financial System (IFS) to systemically produce 
managerial cost accounting data that are defensible, reliable, and 
consistent. While these are positive steps, IRS at present remains 
unable to readily determine the full costs of specific activities and 
programs. It will likely require several years and further analysis of 
the relationship between IRS's costs and its products and services 
before the full potential of its cost accounting capabilities will be 
realized. 

Despite progress made during fiscal year 2007, the continued existence 
of these financial reporting weaknesses once again compelled IRS to 
expend more time and effort to maintain its accounting records and 
generate financial management information than would otherwise have 
been necessary. Further, despite these monumental efforts, IRS 
continued to lack reliable and timely financial information to assist 
in managing operations throughout fiscal year 2007. Addressing the 
financial reporting deficiencies discussed above would enhance this 
process by providing management the reliable and timely information 
that it needs to support informed decision making without having to 
resort to costly and time-consuming procedures to compensate for 
information system deficiencies. 

Unpaid Tax Assessments: 

During fiscal year 2007, we continued to find serious internal control 
issues that affected IRS's management of unpaid tax assessments. 
Specifically, we continued to find (1) IRS lacked a subsidiary ledger 
for unpaid tax assessments that would allow it to produce accurate, 
useful, and timely information with which to manage and report 
externally, and (2) errors and delays in recording taxpayer 
information, payments, and other activities. While IRS is making 
progress in addressing these issues, these conditions nevertheless 
continued to hinder IRS's ability to effectively manage its unpaid tax 
assessments.[Footnote 25] 

IRS continues to lack a detailed listing, or subsidiary ledger, that 
tracks and accumulates unpaid tax assessments and their status on an 
ongoing basis for external reporting. IRS recognizes the seriousness of 
this deficiency and is working to address this matter. In fiscal year 
2006, IRS began a phased-in implementation of CDDB. One of the key 
objectives of CDDB is to ultimately serve as a subsidiary ledger for 
IRS's tax administration activities, including tax revenue receipts, 
tax refund disbursements, and unpaid tax debt, by linking account 
information in IRS's master files[Footnote 26] with IRACS. The first 
phase of CDDB primarily consisted of implementing computer programs 
that analyze and classify related taxpayer accounts from IRS's master 
file that are associated with unpaid payroll taxes. However, these 
programs only had the capability to process less complex accounts 
recorded after August 2001. During fiscal year 2007, IRS enhanced CDDB 
to analyze and classify a larger percentage of unpaid payroll tax 
accounts, though it is still unable to process all such accounts. 
Additionally, IRS enhanced CDDB to begin journalizing tax debt 
information from its master files to its general ledger weekly. This is 
a significant step in establishing CDDB's capability to serve as a 
subsidiary ledger for unpaid tax debt. However, IRS is presently unable 
to use CDDB as its subsidiary ledger for posting tax debt information 
to its general ledger in a manner that ensures reliable external 
reporting. 

Specifically, to report balances for taxes receivable and other unpaid 
tax assessments in its financial statements and required supplemental 
information, IRS must continue to apply statistical sampling and 
estimation techniques to master file data processed through CDDB at 
year-end. Even though CDDB is capable of analyzing master file data 
weekly to produce tax debt information classified into the various 
financial reporting categories (taxes receivable, compliance 
assessments, and write-offs), this information contains material 
inaccuracies. For example, through its use of its statistical sampling 
and estimation techniques, IRS identified errors necessitating over $20 
billion in adjustments to the year-end gross taxes receivable balance 
produced by CDDB. Thus, while the use of CDDB has refined this process, 
it continued to take IRS several months to complete, required 
multibillion-dollar adjustments, and produced amounts that after 
adjustments were still only reliable as of the last day of the fiscal 
year. Consequently, the lack of a fully functioning subsidiary ledger 
continues to inhibit IRS's ability to develop reliable and timely 
financial management reports useful for ongoing management decisions 
and external reporting. Full operational capability of CDDB is still 
several years away and depends on the successful implementation of 
future system releases planned through 2009. 

IRS's management of unpaid tax assessments also continued to be 
hindered by inaccurate tax records. We continued to find errors and 
omissions in taxpayer records resulting from IRS's failure to record 
information accurately and timely. Such errors directly affect the 
accuracy of the classified tax debt information produced by CDDB. 
Additionally, such errors in IRS records can cause frustration to 
taxpayers who either do not owe the debt or owe significantly lower 
amounts. 

For example, during our audit we found that IRS erroneously created a 
second account for the same taxpayer when it recorded the taxpayer's 
$24 million estate tax assessment into an account with an invalid 
taxpayer identification number. The taxpayer had previously made 
payments to fully pay the amount of the estate tax. However, because 
IRS erroneously recorded the tax assessment into this second account, 
it created a balance due, which triggered a notice for taxes due being 
sent to the taxpayer with related penalties and interest for over $32 
million. IRS identified this error when it selected the taxpayer's 
account as part of its statistical sampling and estimation process for 
deriving the balances of net taxes receivable and other unpaid tax 
assessments for year-end financial reporting. In another example, IRS 
assessed almost $5 million in penalties against a business for failing 
to provide a required supporting schedule along with its quarterly 
payroll tax return. When IRS subsequently examined the taxpayer's 
return, it determined that the required schedule was in fact attached 
to the return. In both of these cases, IRS subsequently identified and 
corrected its error, but not before inconveniencing the taxpayers. 
Additionally, IRS had to make multimillion-dollar adjustments to the 
account balances because these errors were in IRS's master file records 
at the point in time that IRS extracted the account information to 
estimate and record its balance of taxes receivable and other unpaid 
tax assessments for year-end financial reporting. 

As in prior years,[Footnote 27] we continued to find errors involving 
IRS's failure to properly record payments to all related taxpayer 
accounts associated with unpaid payroll taxes.[Footnote 28] IRS's 

current systems continued to be unable to automatically link each of 
the multiple tax assessments made for the one tax liability. 
Consequently, if the business or any officer of that business paid some 
or all of the outstanding taxes, IRS's systems were unable to 
automatically reflect the payment as a reduction in the amounts owed on 
any related accounts. Over the past several years, IRS has taken 
several steps to compensate for the lack of an automated link between 
related accounts. For example, IRS manually inputs a code in each 
account that cross-references it to other related accounts. In 
addition, since August 2001, IRS has established procedures to more 
clearly link each penalty assessment against an officer to a specific 
tax period of the business account. In July 2003, IRS also began 
phasing 
in the use of an automated trust fund recovery penalty system that is 
intended to properly cross-reference payments received and thus 
eliminate the opportunity for errors that plague the current manual 
process. 

Although IRS is making improvements in its processes for recording 
trust fund recovery penalties, our work in fiscal year 2007 continued 
to find deficiencies in this process, leading to errors in taxpayers' 
accounts. In our testing of 76 statistically selected payments recorded 
on trust fund recovery penalty accounts established since August 2001, 
we found 9 instances in which IRS did not properly record payments 
received on all related taxpayer accounts. Based on our testing, we 
estimate that about 12 percent of trust fund recovery penalty payment 
transactions posted to accounts established since August 2001 could 
contain inaccuracies.[Footnote 29] 

IRS processing errors or delays also contribute to inaccurate tax 
records and result in IRS having to make adjustments as part of its 
process for estimating the balances of net taxes receivable and other 
unpaid tax assessments, which IRS reports on its balance sheet and the 
required supplemental information to its financial statements, 
respectively. During our audit, we found a case where a taxpayer signed 
a document in November 2006 agreeing to $1.4 million of additional 
taxes owed. However, as of July 2007, IRS had not recorded this tax 
assessment on the taxpayer's master file account. Since this was a 
valid tax assessment agreed to by the taxpayer and established during 
fiscal year 2007, IRS had to make a $1.4 million adjustment to the 
balance in the taxpayer's account. 

Furthermore, such processing errors and delays contribute to IRS's 
inability to timely release federal tax liens against taxpayers once 
taxpayers have fully satisfied or are otherwise relieved of their tax 
liability. As with the other issue previously described, delays by IRS 
in recording bankruptcy discharges and in researching and applying 
taxpayer payments that cover multiple tax periods result not only in 
inaccurate tax records but delays in IRS's release of federal tax 
liens. This, in turn, causes undue hardship and burden to taxpayers who 
are attempting to sell property or apply for commercial 
credit.[Footnote 30] 

The progress IRS has made to date with CDDB is an important step in 
moving toward a subsidiary ledger that links account information in 
IRS's master files with its general ledger for tax administration 
activities. However, IRS must still address the issues that prevent it 
from using unadjusted CDDB information to support the general ledger 
for external reporting. This will require further enhancements to CDDB 
to enable it to more accurately distinguish between the three 
categories of unpaid tax assessments--taxes receivable, compliance 
assessments, and write-offs--so that balances are ultimately recorded 
in the proper general ledger accounts. Also, in order to ensure 
accurate financial reporting and to minimize undue burden on taxpayers, 
IRS faces a continuing challenge to address the factors that cause 
inaccuracies in taxpayer account records and to maintain the integrity 
of the account information going forward. 

Tax Revenue and Refunds: 

During fiscal year 2007, we continued to find that IRS's internal 
controls were not fully effective in ensuring that it is maximizing the 
federal government's ability to collect tax revenues owed and 
minimizing the risk of paying improper tax refunds. IRS has a broad 
array of operational management information available to it and has 
used innovative approaches to develop and apply this information to 
increase tax collections and reduce improper tax refunds. However, IRS 
does not, at present, have agencywide cost-benefit information, related 
cost-based performance measures, or a systematic process for ensuring 
it is using its resources to maximize its ability to collect what is 
owed and minimize the disbursements of improper tax refunds in the 
context of its overall mission and responsibilities. These deficiencies 
inhibit IRS's ability to appropriately assess and routinely monitor the 
relative merits of its various initiatives and adjust its strategies as 
needed. This, in turn, can significantly affect both the level of tax 
revenue collected and the magnitude of improper refunds paid. 

As of September 30, 2007, IRS's inventory of cumulative unpaid tax 
assessments totaled $263 billion. Of this amount, $26 billion, about 10 
percent, is estimated to be collectible.[Footnote 31] In addition, 
based on data accumulated during a study of individual tax returns 
filed in 2001, IRS estimated that taxes totaling about $345 billion 
were not paid to the federal government. Of this amount, IRS estimates 
that its enforcement efforts will eventually recover about $55 billion, 
leaving a net $290 billion uncollected. With respect to improper tax 
refunds, IRS successfully stopped over: 

$3.1 billion in potential improper tax refund payments from 2002 
through 2005.[Footnote 32] However, the magnitude of total improper tax 
refunds that are not prevented and are thus paid each year is unknown. 
IRS has done some targeted studies of improper refunds related to the 
Earned Income Tax Credit (EITC)[Footnote 33] program, which constituted 
$38 billion of the $292 billion (about 13 percent) in total refunds 
paid during fiscal year 2007. Based on a study conducted of EITC claims 
filed for tax year 2001, IRS estimated that at least $10 billion in 
improper EITC tax refunds may have been disbursed in fiscal year 
2007.[Footnote 34] However, IRS has not estimated the magnitude of 
improper refunds not related to EITC, and thus the magnitude of total 
improper tax refunds disbursed each year is unknown. Because of these 
and other issues, we have designated enforcement of tax laws as a high-
risk area in the federal government.[Footnote 35] 

In its efforts to identify and pursue the correct amount of taxes owed 
and to ensure that only proper tax refunds are disbursed, IRS faces 
numerous challenges, many of which are beyond its control. These 
include the complexity of the tax code, the timeliness of corroborative 
information, time constraints on issuing refunds, and resource 
constraints. For example, the amounts of both tax liabilities due the 
federal government and tax refunds due to taxpayers are based on 
taxpayer interpretations of the requirements of the very complex and 
frequently changing tax laws, and are submitted to IRS on tax returns 
that encompass largely unsubstantiated assertions that IRS has a 
limited capacity to verify. In addition, taxpayers do not always file 
the required tax returns, or properly calculate and report their 
taxable income. Some third-party information, such as the data provided 
by taxpayers with their tax returns on W-2s[Footnote 36] and IRS 1099 
forms,[Footnote 37] is also later transmitted to IRS electronically and 
in that form can be used by IRS to help corroborate the amount of wages 
and income reported by taxpayers. However, the electronic version of 
this information is not required to be filed until after the start of 
the tax filing season. Consequently, the utility of the comparison of 
this information with tax return data as a tool to address improper 
refunds is problematic because IRS does not have time to prepare third-
party data for matching prior to the payment of tax refund claims 
related to these data. Additionally, the time available to IRS to 
verify the information on tax returns claiming refunds before it must 
make payment is limited by statutory requirements that tax refunds be 
paid within set time constraints or be subject to interest 
charges.[Footnote 38] Consequently, many of IRS's efforts have 
traditionally been focused on detective controls, such as examinations 
and automated matching of tax returns with third-party data to identify 
for collection under reported taxes and improper tax refunds. However, 
these efforts are not undertaken until months after the tax returns 
have been filed and, consequently, in the case of tax returns claiming 
tax refunds, do not prevent improper tax refunds from being disbursed. 

While IRS faces a number of constraints that are largely beyond its 
control, effectively deploying its resources should be within its 
control. Like other agencies, IRS has limited resources to deploy to a 
wide range of programs and activities. These programs and activities 
are not only focused on enforcement of the tax law, but also on 
providing various services to taxpayers, including processing tax 
returns. In this context, IRS must weigh its options in terms of 
deployment of its limited resources to these and other responsibilities 
critical to the day-to-day operations of the agency. Additionally, 
while IRS should strive to maximize collections of tax revenue and 
minimize payment of improper tax refunds, we recognize that it has a 
responsibility to ensure it is applying the tax code fairly. Having 
agencywide cost-benefit information and cost-based performance data, 
and a systematic process for using this information, would improve 
IRS's ability to ensure it is, in fact, deploying its resources to most 
effectively address its core mission and responsibilities. We have been 
reporting on the need for IRS to have good cost benefit information for 
its various collection and enforcement programs to assist in resource 
allocation decision making since our fiscal year 1999 financial audit, 
and have made several recommendations which remain open as of the date 
of this report.[Footnote 39] 

IRS has recognized the need to have sound cost-benefit data with which 
to make better informed resource allocation decisions. As discussed in 
the material weakness over financial reporting section, IRS has 
initiated a number of cost pilots in an effort to establish a 
relationship between its costs and its various activities. IRS also 
recognizes that it will likely take several years before it can fully 
use this information as an agencywide resource planning tool. In the 
interim, IRS has undertaken initiatives to make more effective use of 
existing information to better target its enforcement efforts. 

For example, as we have reported in prior years, IRS does not pursue 
collection action against all tax debt owed to the federal government. 
IRS has "shelved" billions of dollars of the tax debt cases due to lack 
of resources, and billions more are in a queue of cases that are not 
being actively pursued while they wait to be assigned to a collection 
official. Over the past 3 years, IRS has employed various approaches, 
including sophisticated computer modeling and risk assessment 
techniques, to assist it in more effectively identifying the tax debt 
cases with the greatest collection potential, and to facilitate 
prioritizing of these cases for collection. IRS has also employed these 
techniques to identify the most effective collection approach to take 
for the various types of outstanding tax debt. IRS has estimated that 
several billion dollars in additional tax collections have been 
realized through the use of these techniques. Although these efforts 
have significantly helped IRS target cases for collection, its ability 
to assess the relative merits of these efforts is hampered by its 
inability to reliably measure how much it collects as a result of these 
efforts, compared to their associated costs. Additionally, these 
efforts are primarily focused on only one of IRS's operating divisions; 
thus, they do not presently represent an agencywide, systematic 
approach to managing the collection of unpaid taxes across the scope of 
IRS's activities. IRS has additional projects under way to enhance its 
management of tax collection cases; however, these projects are not 
scheduled to be fully implemented until 2009. Thus, their full 
potential is unknown. 

IRS has a number of methods for identifying those taxpayers that 
potentially under report their income or overstate their deductions. 
For 
example, IRS uses its Automated Underreporter Program (AUR) to perform 
automated matches between information reported on tax returns and 
related information provided electronically by third parties. Based on 
these comparisons, IRS identifies thousands of potential cases of 
under reported taxes every year. However, due to constraints in the 
level of resources allocated to the AUR function, IRS only investigates 
a portion of these cases. In deciding which cases to pursue, IRS 
conducts an analysis to identify the types of cases that have 
historically resulted in the largest additional tax assessments when 
investigated further. This approach has yielded notable progress; for 
tax year 2005,[Footnote 40] the cases IRS investigated accounted for 
about 87 percent of the total dollars of potential unreported taxes 
identified through these matches. This represents a substantial 
increase over 2002, when IRS investigated about 48 percent of the total 
dollars of potential unreported taxes. However, at present, decisions 
made by AUR personnel on which cases to pursue for assessment are not 
routinely linked to decisions made by collection personnel as to which 
types of cases that are not immediately paid by the taxpayer will be 
pursued for collection. We recognize the need for IRS to consider other 
factors, such as ensuring appropriate coverage of varying types of 
potential underreporter cases, in determining which ones to 
investigate. However, knowledge of the collection potential of such 
cases, and the costs associated with pursuing them, are also important 
factors to consider in case selection. Absent this information, it is 
difficult for IRS to assess fully the most appropriate level of 
resources to devote to this program, or to compare it with other 
various compliance initiatives in terms of cost-effectiveness. 

IRS has also made significant strides in applying the information it 
does have available to address the problem of improper tax refunds as 
it relates to the EITC program. Specifically, by using the management 
information available to it, IRS was able to identify sources of EITC 
taxpayer errors and develop methods to combat abusive and fraudulent 
activity that contribute to improper tax refunds. For example, an IRS 
task force study found that the leading cause of errors resulting in 
improper tax refunds associated with the EITC program was taxpayers 
claiming nonqualified children. IRS tested the potential for reducing 
the amount of improper tax refunds issued as a result of this type of 
error by requiring that when filing their tax returns, selected 
taxpayers document that their qualifying child lived with them for more 
than half the tax year.[Footnote 41] According to IRS, the test results 
suggested that the certification requirement reduced improper EITC 
claims; IRS estimated that for the 25,000 taxpayers in the study, it 
deterred from $5.8 million to $6.8 million in improper claims. 

IRS has also begun to establish performance measures to better enable 
it to assess the effectiveness of its various EITC compliance 
initiatives. For example, in 2004, IRS established the Percentage of 
EITC Claims Paid in Error as one of its long-term measures for the EITC 
program. During fiscal years 2006 and 2007, IRS also established 
measures for specific functions within the EITC program, including the 
(1) EITC assessment rate from post-refund treatment program, which is 
the rate of EITC dollars assessed from examination and document-
matching programs, and (2) EITC improper payment rate, which is an 
estimate of the percentage of ineligible claims that are paid and not 
recovered. Establishing these and other related performance measures 
represents a major step forward in IRS's management of EITC compliance 
and, if effectively used, could provide management with important tools 
to better assess the effectiveness of its various EITC initiatives and 
enable IRS to institute appropriate adjustments over time. However, IRS 
has not yet implemented all the measures it established and those that 
have been implemented are relatively new. Consequently, it is too early 
to tell whether they will be effective tools to assist IRS in reducing 
the rate of improper tax refunds as it relates to EITC. 

We commend the studies and initiatives IRS has undertaken to address 
aspects of this material weakness and believe important progress has 
been made. However, IRS has not yet institutionalized these activities 
to cover the totality of unpaid taxes and potential improper tax 
refunds. Additionally, the absence of agencywide cost-benefit 
information and related cost-based performance measures continues to 
hamper IRS's ability to formulate a focused, effective, and efficient 
strategy for the collection of unpaid taxes and prevention of improper 
tax refunds. 

Given the environment in which it operates, IRS cannot be expected to 
collect all taxes owed or prevent all improper tax refunds claimed from 
being disbursed through enhancements to its internal controls alone. As 
noted earlier, the level of uncollected taxes and improper refunds is 
affected by many factors beyond IRS's control. Also, in deploying its 
resources to its various programs and activities, IRS must consider 
other factors besides maximizing revenue collections, minimizing 
improper refund payments, and minimizing costs incurred, such as 
ensuring it is applying the tax code fairly and improving overall 
compliance. Nevertheless, it is incumbent upon IRS to make optimum use 
of its available resources and to be able to credibly demonstrate it is 
doing so to Congress and the public. In fiscal year 2007, the continued 
lack of reliable and timely agencywide cost-benefit information and 
related cost-based performance measures, coupled with the lack of an 
agencywide strategy to employ these tools, inhibited IRS's ability to 
meet these objectives. 

Information Security: 

To effectively fulfill its tax processing responsibility, IRS relies 
extensively on computerized systems to support its financial and 
mission-related operations. Effective information system controls are 
essential to ensuring that taxpayer and financial information is 
adequately protected from inadvertent or deliberate misuse, fraudulent 
use, improper disclosure, or destruction. Ineffective system controls 
can impair the accuracy, completeness, and timeliness of information 
used by management and, in the absence of effective compensating 
procedures, increase the potential for undetected material 
misstatements in the agency's financial statements. 

Significant weaknesses in information security controls continue to 
threaten the confidentiality, integrity, and availability of IRS's 
financial processing systems and information. In fiscal year 2007, we 
identified further weaknesses in controls for protecting access to 
systems and information, as well as other information security controls 
that affect key financial systems--particularly IFS and IRACS. For 
example, sensitive information, including user IDs, passwords, and 
software code for mission-critical applications, was accessible on an 
internal Web site to anyone who could connect to IRS's internal 
network--without having to log in to the network. The information 
gained through this access could be used to alter data flowing to and 
from IFS. In addition, configuration flaws in the mainframe allowed 
users unrestricted access to all programs and data on the mainframe, 
including IRACS. Because this access was not controlled by the security 
system, no security violation logs would be created, reducing IRS's 
ability to detect unauthorized access. Weaknesses also existed in other 
areas, such as protecting against unauthorized physical access to 
sensitive computer resources and patching servers to protect against 
known vulnerabilities. 

IRS has made limited progress in resolving previously reported security 
weaknesses in the controls for its financial and tax processing systems 
and information. To its credit, IRS implemented controls for user IDs 
on certain critical servers, improved physical protection for its 
procurement system, developed a security plan for IRACS, and upgraded 
servers that had been using obsolete operating systems. However, IRS 
has not completed corrective actions for other previously reported 
weaknesses. About 70 percent of the 98 weaknesses we previously 
identified that remained unresolved at the end of our fiscal year 2006 
audit had not been corrected at the end of our fiscal year 2007 audit. 
These weaknesses included having passwords that were not complex enough 
to avoid being guessed or cracked, not physically protecting sensitive 
computer resources, and not encrypting sensitive information, such as 
user IDs and passwords, as it is transferred across the network. The 
agency's procurement system was particularly at risk, with issues such 
as not (1) appropriately restricting access to sensitive programs, (2) 
logging security-relevant events to provide audit trails, and (3) 
applying vendor-supplied system patches in a timely manner to protect 
against known vulnerabilities. These outstanding weaknesses, along with 
the new weaknesses identified during our fiscal year 2007 financial 
audit, increase the risk that data processed by the agency's financial 
management systems are not reliable. 

A key reason for the presence of these information security weaknesses 
in IRS's financial systems was that it has not yet fully implemented a 
security program[Footnote 42] to ensure that controls are effectively 
established and maintained. Although IRS continues to make important 
progress in implementing such a program, it has not fully or 
consistently implemented program requirements for key information 
systems. For example, policies for monitoring security-relevant 
activities on the mainframe were not adequate to ensure that critical 
system changes were identified and authorized. In addition, IRS had not 
updated contingency plans for key general support systems, or 
documented that those plans were tested annually. Furthermore, the 
plans did not identify essential IRS business processes required to be 
restored if normal operations were disrupted. Until IRS takes 
additional steps to fully implement key elements of its information 
security program, its facilities, computing resources, and information 
will remain vulnerable to inappropriate use, modification, or 
disclosure, and agency management will have limited assurance of the 
integrity and reliability of its financial and taxpayer information. 

The newly identified deficiencies in fiscal year 2007 and the 
unresolved deficiencies from prior audits represent a material weakness 
in IRS's internal controls over its financial systems. Collectively, 
these deficiencies reduce IRS's ability to secure its financial and 
sensitive taxpayer information and, in the absence of effective 
compensating procedures, increase the potential for undetected material 
misstatements in the agency's financial statements. We plan to issue a 
separate report on the newly identified deficiencies and the status of 
previously identified IRS information security deficiencies. 

Significant Deficiency: 

In addition to the material weaknesses previously discussed, we 
identified a significant deficiency concerning weaknesses in IRS's 
internal controls over hard-copy tax receipts and taxpayer information. 

Hard-Copy Tax Receipts and Taxpayer Information: 

IRS manually processes hundreds of billions of dollars of hard-copy 
taxpayer receipts and related taxpayer information at its service 
center campuses, field office taxpayer assistance centers, other field 
office units, and commercial lockbox banks.[Footnote 43] In previous 
audits, we have reported that weaknesses in IRS's controls designed to 
safeguard these taxpayer receipts and information increase the risk 
that receipts in the form of checks, cash, and the like could be 
misappropriated or that the information could be compromised.[Footnote 
44] During our fiscal year 2007 audit, we identified improved controls 
relating to courier security, processing of high-dollar receipts, and 
control of restricted areas, which mitigated some of these weaknesses. 
For example, we found that at the sites we visited, couriers 
transporting taxpayer deposits to depository institutions (1) were 
always on approved lists authorizing them access to taxpayer receipts 
and information, (2) always returned deposit slips by the next business 
day, and (3) never transported taxpayer receipts with related 
individuals. In addition, we found that IRS employees followed proper 
procedures when identifying high-dollar taxpayer receipts during the 
extraction and candling processes.[Footnote 45] Finally, we found that 
IRS strictly enforced its prohibition against bringing personal 
belongings into restricted receipt processing areas. 

Despite these improvements at its various processing facilities, IRS's 
controls over hard-copy taxpayer receipts and related information were 
not adequate to sufficiently limit the risk of theft, loss, or misuse 
of these funds and information. Specifically, we found the following: 

* Weaknesses in physical security controls designed to prevent 
unauthorized access to IRS's receipt processing facilities. For 
example, during our fiscal year 2007 audit, we observed that (1) 
critical utilities, such as telephone and electrical feeds, were 
vulnerable to unauthorized access and tampering (at one taxpayer 
assistance center and two lockbox banks); (2) guards did not respond 
timely to alarms (at two service center campuses); (3) security cameras 
did not provide unobstructed 360 degree coverage of the building 
exterior or the facility's external perimeter (at three service center 
campuses and one lockbox bank); and (4) newly hired IRS employees were 
allowed to access facilities that process taxpayer receipts and 
information before proper fingerprint check results were received (53 
IRS employees hired during the period October 1, 2006, through April 
30, 2007). 

* Weaknesses in procedural safeguards and controls designed to account 
for, control, and protect taxpayer receipts. For example, during our 
fiscal year 2007 audit, we found that IRS (1) was not always aware when 
contractors entered taxpayer assistance centers during nonoperating 
hours (at four taxpayer assistance centers), (2) was unable to provide 
evidence indicating that janitorial contractors with unescorted access 
to IRS facilities received favorable background investigations before 
being granted access (at three taxpayer assistance centers and three 
field office locations),[Footnote 46] (3) was unable to provide 
evidence that contractor employees who participated in shredding 
federal taxpayer information at off-site facilities received favorable 
background investigations before being granted access to the 
information (at five taxpayer assistance centers and three field office 
locations), and (4) did not always ensure that employees receiving 
taxpayer payments had adequate system access restrictions to prevent 
improper recording of the payments received (at four taxpayer 
assistance centers). 

* Weaknesses in transfer security controls designed to safeguard hard-
copy taxpayer receipts and related taxpayer information during 
transport between IRS business units and to or from third parties, such 
as depository institutions and post offices. For example, during our 
fiscal year 2007 audit, we found that (1) there was no evidence that 
IRS employees sending packages containing taxpayer receipts and 
information followed up with responsible parties at the recipient 
location when document transmittal forms, which are used to 
specifically identify the contents of the packages shipped, remained 
unacknowledged by the recipient (at one service center campus, two 
taxpayer assistance centers, and five field office locations); (2) 
personally identifiable information, including federal taxpayer 
information, that is sent off-site was not encrypted (at four lockbox 
banks); and (3) there was no evidence documenting managerial review of 
transfer-related documents[Footnote 47] (at one service center campus, 
seven taxpayer assistance centers, and one field office location). 

IRS's progress in addressing these issues has been hampered by a lack 
of effective communication on newly implemented guidance and policies. 
Although IRS issued new guidance or revised existing requirements 
during fiscal year 2006 to address previously identified weaknesses, we 
often continued to find the same or similar weaknesses in fiscal year 
2007 because IRS staff were unaware of the recent changes. For example, 
we found that most IRS employment office staff did not follow new 
juvenile hiring policies and requirements; taxpayer assistance center 
employees did not perform required payment and processing reviews; and, 
at one service center campus, a security analyst used an incorrect and 
outdated version of a security audit management checklist when 
performing a review. These internal control weaknesses increase IRS's 
vulnerability to theft or loss and expose taxpayers to increased risk 
of losses from financial crimes committed by individuals who 
inappropriately gain access to taxpayer receipts and confidential 
information entrusted to IRS. 

Compliance Issues: 

Our work on compliance with selected provisions of laws and regulations 
disclosed one instance of noncompliance that is reportable under U.S. 
generally accepted government auditing standards and OMB guidance. This 
instance relates to the release of federal tax liens against taxpayers' 
property. We also found that IRS's financial management systems do not 
substantially comply with the requirements of FFMIA. 

Release of Federal Tax Liens: 

The Internal Revenue Code grants IRS the power to file a lien against 
the property of any taxpayer who neglects or refuses to pay all 
assessed federal taxes. The lien becomes effective when it is filed 
with a designated office, such as a courthouse in the county where the 
taxpayer's property is located.[Footnote 48] The lien serves to protect 
the interest of the federal government and as a public notice to 
current and potential creditors of the government's interest in the 
taxpayer's property. For example, federal tax liens are disclosed in 
credit reports of individuals. Under section 6325 of the Internal 
Revenue Code, IRS is required to release federal tax liens within 30 
days after the date the tax liability is satisfied or has become 
legally unenforceable or the Secretary of the Treasury has accepted a 
bond for the assessed tax. 

In our prior audits, we found that IRS did not always release the 
applicable federal tax lien within 30 days of the tax liability being 
either paid off or abated, as required by the Internal Revenue 
Code.[Footnote 49] In response, IRS has taken a number of actions over 
the past several years to improve its lien processing. For example, IRS 
centralized all lien processing at its Cincinnati Service Center Campus 
in 2005. In addition, in July 2006, IRS enhanced various lien 
processing-related exception reports to include a cumulative list of 
unresolved lien releases, allowing it to more readily track the release 
status and take corrective action. 

Despite the actions IRS has taken to date to improve its lien release 
process, our work in fiscal year 2007 continued to find that IRS did 
not always timely release all tax liens. In prior audits, we tested a 
statistical sample of tax cases with liens in which the taxpayers' 
total outstanding tax liabilities were either paid off or abated during 
the fiscal year under audit. Beginning in fiscal year 2006, IRS began 
performing its own test of the effectiveness of its lien release 
process as part of implementing the requirements of the revised OMB 
Circular No. A-123[Footnote 50] and we reviewed its test results. For 
fiscal year 2007, we once again reviewed and validated IRS's test 
results. 

In its testing of 59 statistically selected tax cases with liens in 
which the taxpayers' total outstanding tax liabilities were either paid 
off or abated during fiscal year 2007, IRS found 7 instances in which 
it did not release the applicable federal tax lien within the 
statutorily mandated 30 days. The time between satisfaction of the 
liability and release of the lien ranged from 35 days to 135 days. 
Based on its sample, IRS estimated that for about 12 percent of unpaid 
tax assessment cases in which it had filed a tax lien that were 
resolved in fiscal year 2007, it did not release the lien within 30 
days.[Footnote 51] 

Various processing delays resulted in IRS not releasing these liens 
timely. In two of these cases, IRS received the taxpayers' satisfying 
payment just prior to recording the lien in its automated systems. Due 
to the processing time it takes for IRS to record information into the 
taxpayers' master file accounts, the payments did not post to the 
taxpayers' account until after IRS recorded the filing of the liens. 
Because IRS recorded the actual receipt date of the payment, which was 
prior to the date it recorded the lien filing, IRS's systems did not 
recognize that the payment had fully satisfied the outstanding tax 
liability. Consequently, its systems did not initiate the lien release 
process. In both cases, IRS released the liens only after it identified 
that they had not been released during its A-123 testing. In another 
case, IRS did not properly credit all of the taxpayer's outstanding 
accounts when the taxpayer sent in one payment to satisfy the tax 
liability of multiple tax accounts. Consequently, one of the taxpayer's 
accounts remained open, even though the taxpayer satisfied the total 
tax liability. This, in turn, prevented the initiation of the lien 
release process for this taxpayer. In another case, IRS did not timely 
update the taxpayer's account to reflect that the taxpayer had been 
discharged of the taxes in bankruptcy court. In yet another case, IRS 
failed to timely resolve issues with the account when it showed up on 
an exception report. In the two remaining cases, IRS received the 
taxpayers' satisfying payments just prior to, or during, the annual 3 
week period when IRS was scheduled to perform maintenance on its master 
files. During this period, IRS could not record the payment in the 
taxpayers' master file accounts, which delayed the initiation of the 
lien release process. This delay, in turn, resulted in IRS releasing 
the liens more than 30 days after receipt of the satisfying payments. 
However, the delays in these two cases exceeded the 30 day limit by 
only a few days. 

These issues are similar to those we reported in prior audits.[Footnote 
52] We issued reports in January 2005 and May 2007 that discussed the 
factors contributing to IRS's failure to timely release federal tax 
liens, along with our recommendations to address those issues.[Footnote 
53] The continued failure to promptly release tax liens could cause 
undue hardship and burden to taxpayers who are attempting to sell 
property or apply for commercial credit. 

Financial Management Systems' Noncompliance With FFMIA: 

In fiscal year 2007, we continued to find that IRS's financial 
management systems did not substantially comply with the requirements 
of FFMIA. Specifically, IRS's systems did not substantially comply with 
FFMSR, federal accounting standards (U.S. generally accepted accounting 
principles), and the SGL at the transaction level. We found that IRS 
cannot rely solely on information from its general ledger to prepare 
its financial statements because the reported balance for taxes 
receivable, which accounted for over 83 percent of the assets reported 
by IRS on its balance sheet as of September 30, 2007, is the product of 
a complex statistical estimation process and is not supported by 
transaction detail or entered into IRACS. In addition, IRS (1) does not 
have an adequate audit trail from IRACS back to detailed records and 
transaction source documents for any of its material tax-related 
balances--tax revenues, tax refunds, and taxes receivable--and (2) 
cannot produce managerial cost information consistent with Statement of 
Federal Financial Accounting Standards No 4, Managerial Cost Accounting 
Standards. 

IRS's implementation of the first release of IFS represented a major 
step forward and has provided significant benefits, such as enhanced 
audit trails for nontax amounts and a cost module. However, IRS 
continues to rely on obsolete systems to process tax revenues, tax 
refunds, and unpaid tax assessments, including taxes receivable. IRS 
will need to address the limitations of these tax administration 
systems if it is to fully resolve many of its long-standing financial 
management challenges. In addition, since these systems do not 
interface with IFS--which accounts for and reports only IRS's nontax 
administrative activities--IRS will also need to determine how to 
overcome this separation to successfully apply the cost information in 
IFS to its tax-related transactions. As discussed earlier, IRS has 
initiated several pilot projects intended to explore ways of addressing 
this issue, but the ultimate solution remains unclear. 

This noncompliance with FFMIA is a result of the material weaknesses 
discussed earlier in this report related to the inability of IRS's 
financial management systems to produce auditable financial statements 
and related disclosures that conform to U.S. generally accepted 
accounting principles without substantial compensating processes and 
significant adjustments, as well as IRS's continued inability to 
routinely accumulate and report the full cost of its activities. Since 
IRS's systems do not substantially comply with FFMSR, U.S. generally 
accepted accounting principles, and the SGL, they also do not comply 
with OMB Circular No. A-127, Financial Management Systems (revised Dec. 
1, 2004). In its Federal Managers' Financial Integrity Act of 1982 
assurance statement to Treasury, IRS reported that its financial 
management systems did not substantially comply with the requirements 
of FFMIA in fiscal year 2007. 

IRS has established a remediation plan to address the conditions 
affecting its systems' inability to substantially comply with the 
requirements of FFMIA. This plan outlines the actions to be taken to 
resolve these issues, but because of the long-term nature of IRS's 
systems modernization efforts, which IRS expects will resolve many of 
the most serious issues, many of the planned time frames exceed the 3-
year resolution period specified in FFMIA. OMB concurred with 
Treasury's determination that IRS could not bring its systems into 
substantial compliance within 3 years, and OMB monitors IRS's progress 
in remediating its systems deficiencies on an ongoing basis.[Footnote 
54] 

[End of section] 

Appendix II: Details on Audit Methodology: 

To fulfill our responsibilities as the auditor of IRS's financial 
statements, we did the following: 

* We examined, on a test basis, evidence supporting the amounts and 
disclosures in the financial statements. This included selecting 
statistical samples of unpaid assessment, revenue, refund, accrued 
expenses, payroll, nonpayroll, property and equipment, accounts 
payable, and undelivered order transactions. These statistical samples 
were selected primarily to substantiate balances and activities 
reported in IRS's financial statements. Consequently, dollar errors or 
amounts can and have been statistically projected to the population of 
transactions from which they were selected. In testing some of these 
samples, certain attributes were identified that indicated deficiencies 
in the design or operation of internal control. These attributes, where 
applicable, can be and have been statistically projected to the 
appropriate populations. 

* We assessed the accounting principles used and significant estimates 
made by management. 

* We evaluated the overall presentation of the financial statements. 

* We obtained an understanding of internal controls related to 
financial reporting (including safeguarding assets) and compliance with 
laws and regulations (including the execution of transactions in 
accordance with budget authority). 

* We obtained an understanding of the design of the internal controls 
relating to the existence and completeness assertions related to the 
performance measures reported in IRS's Management Discussion and 
Analysis, and determined that they have been placed in operation. 

* We tested relevant internal controls over financial reporting 
(including safeguarding assets) and compliance, and evaluated the 
design and operating effectiveness of internal controls. 

* We considered IRS's process for evaluating and reporting on internal 
controls and financial management systems under 31 U.S.C. ï¿½ 3512 (c), 
(d), commonly referred to as the Federal Managers' Financial Integrity 
Act of 1982, and OMB Circular No. A-123, Management's Responsibility 
for Internal Control. 

* We tested compliance with selected provisions of the following laws 
and regulations: Anti-Deficiency Act, as amended (31 U.S.C. ï¿½ 
1341(a)(1) and 31 U.S.C. ï¿½ 1517(a)); Purpose Statute (31 U.S.C. ï¿½ 
1301); Release of lien or discharge of property (26 U.S.C. ï¿½ 6325); 
Interest on underpayment, nonpayment, or extensions of time for payment 
of tax (26 U.S.C. ï¿½ 6601); Interest on overpayments (26 U.S.C. ï¿½ 6611); 
Determination of rate of interest (26 U.S.C. ï¿½ 6621); Failure to file 
tax return or to pay tax (26 U.S.C. ï¿½ 6651); Failure by individual to 
pay estimated income tax (26 U.S.C. ï¿½ 6654); Failure by corporation to 
pay estimated income tax (26 U.S.C. ï¿½ 6655); Prompt Payment Act (31 
U.S.C. ï¿½ 3902(a), (b), and (f) and 31 U.S.C. ï¿½ 3904); Pay and Allowance 
System for Civilian Employees (5 U.S.C. ï¿½ï¿½ 5332 and 5343, and 29 U.S.C. 
ï¿½ 206); Federal Employees' Retirement System Act of 1986, as amended (5 
U.S.C. ï¿½ï¿½ 8422, 8423, and 8432); Social Security Act, as amended (26 
U.S.C. ï¿½ï¿½ 3101 and 3121 and 42 U.S.C. ï¿½ 430); Federal Employees Health 
Benefits Act of 1959, as amended (5 U.S.C. ï¿½ï¿½ 8905, 8906, and 8909); 
Revised Continuing Appropriations Resolution, 2007, Pub. L. No. 110-5, 
ï¿½ï¿½ 101, 103, 104, 21050, 21053, 121 Stat. 8, 9, 54 (Feb. 15, 2007), 
which incorporates by reference certain provisions in the Department of 
the Treasury Appropriations Act, 2006, Pub. L. No. 109-115, div. A, 
tit. II, 119 Stat. 2432, 2436-7 (Nov. 30, 2005); and Revised Continuing 
Appropriations Resolution, 2007, Pub. L. No. 110-5, ï¿½ï¿½ 21051, 21052, 
121 Stat. 8, 54 (Feb. 15, 2007), which incorporates by reference 
certain provisions in Title II of H.R. 5576 (109TH Congress, June 14, 
2006); Department of the Treasury Appropriations Act, 2006, Pub. L. No. 
109-115, div. A, tit. II, 119, Stat. 2396, 2432 (Nov. 30, 2005). 

* We tested whether IRS's financial management systems substantially 
comply with the three requirements of the Federal Financial Management 
Improvement Act of 1996 (Pub. L. No. 104-208, div. A, ï¿½ 101(f), tit. 
VIII, 110 Stat. 3009, 3009-389 (Sept. 30, 1996). 

[End of section] 

Appendix III: Comments from the Internal Revenue Service: 

Department Of The Treasury: 
Deputy Commissioner: 
Internal Revenue Service: 
Washington, D.C. 20224: 

November 5, 2007: 

Mr. David M. Walker: 
Comptroller General: 
U.S. Government Accountability Office: 
441 G Street, N.W.: 
Washington, D.C. 20548: 

Dear Mr. Walker: 

Thank you for the opportunity to comment on the draft report titled, 
Financial Audit: IRS's Fiscal Years 2007 and 2006 Financial Statements. 
We are pleased that the Internal Revenue Service (IRS) received an 
unqualified opinion on the combined financial statements for the eighth 
consecutive year. The unqualified opinion demonstrates that the IRS 
accurately accounts for approximately $2.7 trillion in tax revenue 
receipts, $292 billion in tax refunds, and $11 billion in IRS 
appropriated funds. 

The report recognizes the significant accomplishments the IRS made this 
year in addressing outstanding audit issues. It is also noteworthy that 
we implemented another phase of the Custodial Detail Data Base (CDDB) 
that created the interface between CDDB and Interim Revenue Accounting 
Control System (IRACS) for posting to IRACS summary unpaid assessment 
and accrual data. 

We are dedicated to continuing to improve financial management at the 
IRS, as evidenced by the following additional FY 2007 achievements: 

* Conducted A-123 activities by testing transaction processes material 
to Treasury's Consolidated Financial Statements, including 29 
administrative processes related to $10 billion in administrative 
transactions and 6 custodial tax processes related to $2 trillion in 
tax revenues; 

* Completed required Federal Information Security Management Act 
activities, including contingency plan testing on 260 applications and 
systems and live disaster recovery testing for all major applications; 

* Improved the timely release of liens to 88 percent, a 19 percentage 
point increase from the 69 percent timeliness rate in FY 2006; 

* Achieved a 21 percent improvement in the Trust Fund Recovery Penalty 
accuracy rate through the use of CDDB to resolve issues; 

* Issued first published cost accounting policy; 

* Improved capability to capitalize or expense assets and properly 
account for Business System Modernization costs in internal use 
software; 

* Established the Custodial Financial Requirements Board to ensure that 
custodial financial requirements are included in Business System 
Modernization projects. 

Improving information security continues to be a priority for the IRS. 
The IRS established the Office of Privacy, Information Protection, and 
Data Security to provide direction and oversight of the security and 
protection of sensitive information. We also developed an integrated 
Information Technology Security Schedule and Plan and a comprehensive 
IRS security strategy. We encrypted all laptop data and tapes used in 
electronic data exchange and implemented an enterprise anti-virus 
Internet gateway solution to detect and quarantine malicious content 
from invading systems. 

I want to recognize the Government Accountability Office's support 
throughout the audit. While challenges remain, the IRS has established 
its ability to consistently produce accurate and reliable financial 
statements. We have a solid management team dedicated to promoting the 
highest standard of financial management, and we continue to increase 
the focus on information security and internal controls while improving 
financial reporting. 

Sincerely, 

Signed by: 

Richard A. Spires 

[End of section] 

Footnotes: 

[1] GAO, High-Risk Series: An Overview, GAO/HR-95-1 (Washington, D.C.: 
February 1995). 

[2] GAO, High-Risk Series: An Update, GAO-07-310 (Washington, D.C.: 
January 2007). 

[3] GAO-07-310. 

[4] An S-corporation is a corporation with a limited number of 
stockholders (100 or fewer) that elects not to be taxed as a regular 
corporation and meets certain other requirements. 

[5] CFO Act of 1990, Pub. L. No. 101-576, 104 Stat. 2838 (Nov. 15, 
1990); Government Management Reform Act of 1994, Pub. L. No. 103-356, 
108 Stat. 3410 (Oct. 13, 1994). 

[6] IRS includes an estimate of the tax gap in its Management 
Discussion and Analysis and in the other accompanying information to 
the financial statements. This estimate is based on a study conducted 
to measure the compliance rate of individual filers based on an 
examination of a statistical sample of tax returns filed for tax year 
2001. 

[7] Tax expenditures are revenue losses--the amount of revenue that the 
government forgoes--resulting from federal tax law provisions that (1) 
allow a special exclusion, exemption, or deduction from gross income, 
or (2) provide a special credit, preferential rate, or deferred tax 
liability. Under U.S. generally accepted accounting principles, tax 
expenditure amounts are not required to be disclosed as part of federal 
agencies' financial statements, but certain information on tax 
expenditures can be included as other accompanying information to the 
financial statements. 

[8] GAO, Financial Audit: Examination of IRS' Fiscal Year 1992 
Financial Statements, GAO/AIMD-93-2 (Washington, D.C.: June 30, 1993). 

[9] IRS's master files contain detailed records of taxpayer accounts. 
However, the master files do not contain all the details necessary to 
properly classify or estimate collectibility for unpaid tax assessment 
accounts. There are several master files, the most significant of which 
are the individual master file, which contains tax records of 
individual taxpayers, and the business master file, which contains tax 
records of corporations and other businesses. 

[10] When a company does not pay the taxes it withholds from employees' 
wages, such as Social Security or individual income tax withholdings, 
IRS has the authority to assess all responsible officers individually 
for the taxes withheld from employees. Although assessed to multiple 
parties, the liability need only be paid once. Thus, IRS may record tax 
assessments against each of several individuals for the employee-
withholding component of the payroll tax liability of a given business 
in an effort to collect the total tax liability of the business. The 
tax assessments made against business officers are known as trust fund 
recovery penalties. See 26 U.S.C. ï¿½ 6672 and implementing IRS guidance 
in the Internal Revenue Manual at ï¿½ 4.23.9.13, Trust Fund Recovery 
Penalty (Mar. 1, 2003). 

[11] Unpaid tax assessments consist of (1) federal taxes receivable, 
which are taxes due from taxpayers for which IRS can support the 
existence of a receivable through taxpayer agreement or a favorable 
court ruling; (2) compliance assessments where neither the taxpayer nor 
the court has affirmed that the amounts are owed; and (3) write-offs, 
which represent unpaid tax assessments for which IRS does not expect 
further collections because of factors such as the taxpayer's death, 
bankruptcy, or insolvency. Of these three classifications of unpaid tax 
assessments, only net federal taxes receivable are reported on the 
principal financial statements. 

[12] A material weakness is a significant deficiency, or a combination 
of significant deficiencies, that result in more than a remote 
likelihood that a material misstatement of the financial statements 
will not be prevented or detected. A significant deficiency is a 
control deficiency, or combination of control deficiencies, that 
adversely affects the entity's ability to initiate, authorize, record, 
process, or report financial data reliably in accordance with generally 
accepted accounting principles such that there is more than a remote 
likelihood that a misstatement of the entity's financial statements 
that is more than inconsequential will not be prevented or detected. 

[13] We reported this issue as a reportable condition in fiscal year 
2006 and in prior years. Reportable conditions involved matters coming 
to the auditor's attention that, in the auditor's judgment, should be 
communicated because they represent significant deficiencies in the 
design or operation of internal control, and could adversely affect an 
agency's ability to meet key control objectives. In May 2006, the 
American Institute of Certified Public Accountants issued Statement on 
Auditing Standards (SAS) 112, and subsequently made conforming changes 
to the Statements on Standards for Attestation Engagements (AT 501). AT 
501 eliminated the term reportable condition and it is no longer used. 
AT 501 also established standards related to a new definition for the 
terms significant deficiency and material weakness, and the auditor's 
responsibilities for identifying, evaluating, and communicating 
matters related to an entity's internal control over financial 
reporting. Under these new standards, the auditor is required to 
communicate control deficiencies that are considered to be significant 
deficiencies or material weaknesses in internal controls. 

[14] GAO, Internal Revenue Service: Status of GAO Financial Audit and 
Related Financial Management Report Recommendations, GAO-07-629 
(Washington, D.C.: June 7, 2007). 

[15] Tax law requires IRS to release a federal tax lien within 30 days 
after the date the tax liability is satisfied or has become legally 
unenforceable, or the Secretary of the Treasury has accepted a bond for 
the assessed tax. 26 U.S.C. ï¿½ 6325 (a). 

[16] Pub. L. No. 104-208, div. A, ï¿½ 101(f), title VIII, 110 Stat. 3009, 
3009-389 (Sept. 30, 1996). 

[17] Office of Management and Budget, Circular No. A-127, Financial 
Management Systems (Washington, D.C.: Dec. 1, 2004). FFMSR require 
application of the SGL at the transaction level and state that 
conformance requires, among other items, that transaction detail for 
SGL accounts be readily available in the financial management systems 
and directly traceable to specific SGL account codes. 

[18] JFMIP was originally formed under the authority of the Budget and 
Accounting Procedures Act of 1950 as a cooperative undertaking of the 
OMB, the Treasury, the Office of Personnel Management, and GAO, working 
in cooperation with each other and with operating agencies to improve 
financial management practices in the federal government. On December 
1, 2004, JFMIP ceased to exist as a separate organization, with OMB's 
Office of Federal Financial Management assuming many JFMIP functions. 

[19] In addition to the 30 measures, data to estimate the Earned Income 
Tax Credit will not be available until after the 2007 calendar year. 
The two Cost and Schedule Variance measures are based on +/- 10 percent 
and are reported on several project releases/subreleases. 

[20] GAO, Financial Audit: IRS's Fiscal Years 2006 and 2005 Financial 
Statements, GAO-07-136 (Washington, D.C.: Nov. 9, 2006). 

[21] Payers of excise taxes are generally required to make semimonthly 
deposits to cover their quarterly tax liability. When making tax 
deposits, taxpayers identify them as excise taxes, but are not required 
to provide the related specific tax-type information. Consequently, IRS 
cannot classify the deposit amounts by tax type or trust fund until the 
related excise tax returns are submitted. Based on information later 
reported on the excise tax returns, IRS quarterly certifies excise tax 
receipts to be distributed to trust funds based on the type and amount 
of taxes paid and the amount of tax assessed. Because of the delay 
between the end of the quarter and the receipt of the tax returns, IRS 
certifies distributions of excise tax receipts to the trust funds 4-1/
2 months after the end of the tax quarter. 

[22] GAO-07-136. 

[23] IRS reports federal taxes receivable on its balance sheet, net of 
an allowance for amounts considered uncollectible. 

[24] Office of Management and Budget, Circular No. A-127, Financial 
Management Systems (Washington, D.C.: Dec. 1, 2004). FFMSR require 
application of the SGL at the transaction level and state that 
conformance requires, among other items, that transaction detail for 
SGL accounts be readily available in the financial management system 
and traceable to specific SGL account codes. 

[25] Unpaid tax assessments consist of (1) federal taxes receivable, 
which are taxes due from taxpayers for which IRS can support the 
existence of a receivable through taxpayer agreement or a favorable 
court ruling; (2) compliance assessments where neither the taxpayer nor 
the court has affirmed that the amounts are owed; and (3) write-offs, 
which represent unpaid tax assessments for which IRS does not expect 
further collections because of factors such as the taxpayer's death, 
bankruptcy, or insolvency. Of these three classifications of unpaid tax 
assessments, only net federal taxes receivable are reported on the 
principal financial statements. 

[26] IRS's master files contain detailed records of taxpayer accounts. 
However, the master files do not contain all the details necessary to 
properly classify or estimate collectibility for unpaid tax assessment 
accounts. 

[27] GAO-07-136. 

[28] When a company does not pay the taxes it withholds from employees' 
wages, such as Social Security or individual income tax withholdings, 
IRS has the authority to assess all responsible officers individually 
for the taxes withheld from employees. Although assessed to multiple 
parties, the liability need only be paid once. Thus, IRS may record tax 
assessments against each of several individuals for the employee-
withholding component of the payroll tax liability of a given business 
in an effort to collect the total tax liability of the business. The 
tax assessments made against business officers are known as trust fund 
recovery penalties. See 26 U.S.C. ï¿½ 6672 and implementing IRS guidance 
in the Internal Revenue Manual at ï¿½ 4.23.9.13, Trust Fund Recovery 
Penalty (Mar. 1, 2003). 

[29] We are 95 percent confident that the error rate does not exceed 20 
percent. 

[30] This issue is discussed further in the Compliance Issues section 
of this report. 

[31] The $26 billion represents those unpaid tax assessments that meet 
the definition of federal taxes receivable under federal accounting 
standards and which IRS expects to collect. 

[32] Treasury Inspector General for Tax Administration: The Electronic 
Fraud Detection System Redesign Failure Resulted in Fraudulent Returns 
and Refunds Not Being Identified, 2006-20-108 (Washington, D.C.; Aug. 
9, 2006). 

[33] Enacted in 1975, EITC was originally intended to offset the burden 
of Social Security taxes and provide a work incentive for low-income 
taxpayers. The EITC, which has been modified by subsequent laws and is 
codified at 26 U.S.C. ï¿½ 32, is a refundable tax credit, meaning that 
qualifying working taxpayers may receive a refund greater than the 
amount of income tax they paid for the year. 

[34] In Appendix C of OMB Circular No. A-123, which sets out guidance 
implementing the Improper Payments Information Act of 2002 (IPIA), OMB 
assessed the EITC program as ineffective because of the significant 
level of noncompliance, and identified it as a program subject to the 
reporting requirements of IPIA (Pub. L. No. 107-300, 116 Stat. 2350 
(Nov. 26, 2002)), until Treasury can document a minimum of 2 
consecutive years of improper payments at less than $10 million 
annually. Additionally, IRS has reported EITC noncompliance as a 
material weakness in its 2007 Federal Managers' Financial Integrity Act 
of 1982 (FIA) assurance statement to the Treasury. 

[35] GAO, High-Risk Series: An Update, GAO-07-310 (Washington, D.C.: 
January 2007). 

[36] IRS Form W-2 is the Wage and Tax statement, which is provided to 
taxpayers by their employers and provides a record of their salary and 
deductions for amounts withheld for taxes and other purposes. 

[37] IRS 1099 forms are used by third parties, such as financial 
institutions, to report taxpayers' interest income, dividend 
distributions, and other miscellaneous income. 

[38] By statute, IRS must pay interest on tax refunds not paid within 
45 days of receipt or due date, whichever is later. 26 U.S.C. ï¿½ 6611. 

[39] GAO, Financial Audit: IRS' Fiscal Year 1999 Financial Statements, 
GAO/AIMD-00-76 (Washington, D.C.: Feb. 29, 2000), and Internal Revenue 
Service: Recommendations to Improve Financial and Operational 
Management, GAO/01-42 (Washington, D.C.: Nov. 17, 2000); and, Internal 
Revenue Service: Status of GAO Financial Audit and Related Financial 
Management Report Recommendations, GAO-07-629 (Washington, D.C.: June 
7, 2007). 

[40] The most recent year for which complete Automated Underreporter 
Program results are available. 

[41] IRS rules require that the qualifying child live with the taxpayer 
for more than half the tax year, but only requires the taxpayer to 
substantiate residency if the taxpayer is audited by IRS. 

[42] In December 2002, Congress enacted the Federal Information 
Security Management Act of 2002 (FISMA), which requires agencies to 
develop, document, and implement an information security program. FISMA 
was enacted as title III of the E-Government Act of 2002 (Pub. L. No. 
107-347, 116 Stat. 2946) (Dec. 17, 2002). This requirement was codified 
at 44 U.S.C. ï¿½ 3544(b). 

[43] IRS's receipt processing facilities include service center 
campuses, which process tax returns and payments submitted by taxpayers 
and deposit tax payments in depository institutions; taxpayer 
assistance centers, which accept payments from and provide assistance 
directly to taxpayers; commercial lockbox banks that operate under 
contract with Treasury's Financial Management Service to provide tax 
receipt processing and deposit services on behalf of IRS; and other 
business operating divisions that provide taxpayer audit and assistance 
centers. Other business operating divisions are organized along the 
following business lines: Large and Mid-Size Businesses, Small-
Business/Self-Employed, and Tax Exempt/Government Entities. 

[44] See GAO-07-136; GAO, Management Report: Improvements Needed in 
IRS's Internal Controls, GAO-07-689R (Washington, D.C.: May 11, 2007); 
and Internal Revenue Service: Status of GAO Financial Audit and Related 
Financial Management Report Recommendations, GAO-07-629 (Washington, 
D.C.: June 7, 2007). 

[45] In the extraction process, IRS opens the taxpayer mail it receives 
and removes (1) any correspondence for appropriate follow-up, (2) tax 
returns for posting to IRS records, and (3) remittances, such as 
checks, money orders, and cash, for deposit in financial institutions. 
Subsequent to extraction, the envelopes in which the taxpayer mail was 
received are subject to further inspection known as candling, to verify 
that no remittances or other taxpayer information has been overlooked. 
Once candling is complete, the empty envelopes are shredded. 

[46] IRS field offices can include such units as Small Business/Self-
Employed, Large and Mid-Sized Businesses, and Tax-Exempt/Government 
Entities. 

[47] Transfer-related documents include courier, mail, and deposit logs 
and Forms 795 and 3210, which accompany taxpayer receipts and other 
information shipped to other IRS locations. 

[48] 26 U.S.C. ï¿½ï¿½ 6321, 6323. 

[49] GAO-07-136. 

[50] OMB's revised Circular No. A-123, Management's Responsibility for 
Internal Control, became effective on October 1, 2005. Circular No. A-
123 provides updated internal control guidance and new requirements for 
executive branch agencies to follow in conducting management's 
assessment of the effectiveness of internal control over financial 
reporting. Based on this assessment, agency management is required to 
prepare an assurance statement on the effectiveness of internal 
controls over financial reporting to be included in its performance and 
accountability report. These requirements are applicable to the 24 
Chief Financial Officers Act agencies, including Treasury, of which IRS 
is a significant component. 

[51] IRS is 95 percent confident that the percentage of cases in which 
the lien was not released within 30 days does not exceed 21 percent. 

[52] GAO-07-136. 

[53] GAO, Opportunities to Improve Timeliness of IRS Lien Releases, 
GAO-05-26R (Washington, D.C.: Jan. 10, 2005), and Management Report: 
Improvements Needed in IRS's Internal Controls, GAO-07-689R 
(Washington, D.C.: May 11, 2007). 

[54] Section 803(c)(4) of FFMIA requires that Treasury, with the 
concurrence of the Director of OMB, specify the most feasible date for 
binging its systems into substantial compliance with the three FFMIA 
system requirements and designate a Treasury official who shall be 
responsible for bringing its systems into substantial compliance by 
that date. 

[End of section] 

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