Tax Administration: Compliance Measures and Audits of Large Corporations
Need Improvement (Chapter Report, 09/01/94, GAO/GGD-94-70).

Although the nation's 1,700 largest corporations pay billions of dollars
in taxes, do they pay all they owe? To address this matter, the Internal
Revenue Service (IRS) audits these companies under its Coordinated
Examination Program. Of the sizable sums that IRS auditors recommend in
additional taxes, how much is collected after appeals and litigation?
What factors reduce amounts collected? And what is the status of IRS'
ongoing changes to the Program to address those factors? This report
seeks to answer these questions.

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

 REPORTNUM:  GGD-94-70
     TITLE:  Tax Administration: Compliance Measures and Audits of Large 
             Corporations Need Improvement
      DATE:  09/01/94
   SUBJECT:  Tax administration
             Tax law
             Corporations
             Tax return audits
             Federal taxes
             Noncompliance
             Tax nonpayment
             Government collections
             Income taxes
             Appellate procedure
IDENTIFIER:  IRS Coordinated Examination Program
             IRS Industry Specialization Program
             IRS Audit Information Management System
             IRS Business Master File
             IRS Enforcement Revenue Information System
             
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Cover
================================================================ COVER


Report to the Chairman, Permanent Subcommittee on Investigations
Committee on Governmental Affairs
U.S.  Senate

September 1994

TAX ADMINISTRATION - COMPLIANCE
MEASURES AND AUDITS OF LARGE
CORPORATIONS NEED IMPROVEMENT

GAO/GGD-94-70

Corporate Audits


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

  AIMS - Audit Information Management System
  BMF - Business Master File
  CEP - Coordinated Examination Program
  ERIS - Enforcement Revenue Information System
  IDR - information document request
  IRS - Internal Revenue Service
  ISP - Industry Specialization Program
  JCT - Joint Committee on Taxation
  NOL - net operating loss
  ROI - return on investment
  SOI - Statistics of Income Division
  TEI - Tax Executives Institute
  TIN - taxpayer identification number

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


B-254651

September 1, 1994

The Honorable Sam Nunn
Chairman, Permanent Subcommittee
 on Investigations
Committee on Governmental Affairs
United States Senate

Dear Mr.  Chairman: 

This report responds to your request on the Internal Revenue
Service's (IRS) program to audit tax returns of the largest
corporations--the Coordinated Examination Program (CEP).  It makes
recommendations to IRS on improving CEP and the appeals process. 

This report is the third and final phase of our work on CEP.  In
April 1991, we testified on our initial observations.  In April 1992,
we issued our report on trends in CEP audits and a profile of CEP
corporations. 

As agreed with the Committee, unless you publicly release its
contents earlier, we plan no further distribution of this report
until 30 days from the date of this letter.  At that time, we will
send copies to the Commissioner of Internal Revenue; the Chairmen of
the Senate Committee on Finance, the House Committee on Ways and
Means, and the Joint Committee on Taxation; and other interested
parties.  Copies will also be made available to others on request. 

This report was prepared under the direction of Natwar M.  Gandhi,
Associate Director, Tax Policy and Administration Issues.  Other
major contributors are listed in appendix VII.  If you have any
questions about this report, please contact me on (202) 512-5407. 

Sincerely yours,

Jennie S.  Stathis
Director, Tax Policy and
 Administration Issues


EXECUTIVE SUMMARY
============================================================ Chapter 0


   PURPOSE
---------------------------------------------------------- Chapter 0:1

While the nation's 1,700 largest corporations pay billions of dollars
in taxes, do they pay all they owe?  To address this question, the
Internal Revenue Service (IRS) audits these corporations under its
Coordinated Examination Program (CEP).  Of the sizable sums IRS
auditors recommend in additional taxes, how much is collected after
appeals and litigation?  What factors reduce amounts collected?  And
what is the status of IRS' ongoing changes to CEP to address those
factors?  This report, the third in response to a request by the
Chairman of the Permanent Subcommittee on Investigations, Senate
Committee on Governmental Affairs, focuses on these questions. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:2

Taxes paid by CEP corporations play an important role in funding
government programs.  Excluding refunds, these corporations each year
pay income taxes of about $55 billion.  Nevertheless, IRS' revenue
agents annually recommend that they pay billions of dollars of
additional taxes--roughly two-thirds of the total recommended from
all IRS audits.  Thus, it is easy to understand why IRS considers CEP
to be its most important audit program. 

CEP consumes about 20 percent of IRS' total audit resources.  Yet the
1,700 audit staff years devoted to the program are modest compared to
the formidable task of auditing the 1,700 largest, most complex
corporations.  Given this task, CEP audits may not start for several
years after the return is filed and take several more years to be
completed. 

Corporations may challenge the recommended tax assessments in IRS'
Office of Appeals and the courts.  IRS estimates that CEP
corporations appeal 80 to 90 percent of the recommended taxes.  IRS'
Appeals settles almost 90 percent of those amounts, with the
remainder going to court.  These recommended taxes are assessed only
after the corporation agrees to them, the corporation does not
respond to the deficiency notices, or the Tax Court rules on them. 
Because GAO found that these corporations almost always pay what they
are assessed after the appeals process, GAO in this report considers
assessed taxes to be equivalent to collected taxes. 

CEP audits, unlike most other IRS audits, are conducted using a team
approach.  A case manager, at the GS-14 level, may be responsible for
several CEP audits.  An on-site GS-13 or GS-14 team coordinator
supervises one or two revenue agents assigned to the audit.  The team
coordinator may call on engineers, economists, international
specialists, and revenue agents in other districts--all of whom
report separately to their supervisors.  CEP audits are planned,
staffed, and managed at 59 of IRS' 63 district offices.  IRS'
National Office provides overall direction. 

GAO's review included database analyses, surveys, and in-depth case
studies.  GAO computer matched two IRS databases to calculate the
percentage of taxes recommended by CEP teams that was eventually
collected.  One database provided data on taxes recommended from CEP
audits closed in fiscal years 1983 through 1991; the other showed
taxes collected from those audits, after any appeals or litigation,
as of the end of fiscal year 1992.  GAO surveyed 308 IRS and
corporation officials involved in all 108 CEP audits that closed
agreed at audit or appeals levels and recommended at least $30
million of additional taxes in fiscal years 1989 through 1991. 

Using various criteria, GAO judgmentally selected 12 of the 108
audits for case studies.  The 12 audits accounted for $1.5 billion of
the $8.5 billion of recommended taxes in the 108 audits.  For the 12
audits, GAO reviewed documents and interviewed key IRS and
corporation officials.  Overall, GAO interviewed 85 corporation and
IRS officials in 5 regions, 7 districts, and the IRS National Office. 


   RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3

IRS' mission is to collect the proper amount of taxes at the least
cost to the federal government and taxpayers.  However, due to the
complexity of the tax law and the conflicting incentives that IRS
employees face in administering the law, it is impossible to
determine the proper amount of tax that should be collected through
CEP.  GAO computed that, historically, IRS has actually collected 22
percent of the additional taxes that IRS revenue agents have
recommended in CEP audits.  GAO does not know what the proper amount
should be, but believes that it is reasonable to assume that
collecting 22 cents per dollar leaves room for improvement either in
the audit recommendation process or in the appeals process, or both. 

Another avenue for improvement lies with simplifying the tax code. 
Reducing tax law complexity would improve the collection rate while
benefiting both IRS and taxpayers.  Both would have more certainty
about what the proper amount of tax should be, which would reduce
time spent on audits and in appeals.  The complexity and ambiguity of
the tax code causes legitimate differences in interpretation.  This
has resulted in IRS repeatedly auditing some of the same issues and
taxpayers repeatedly disputing IRS' audit findings. 

Neither the appeals process nor litigation have proven effective in
resolving recurring issues.  GAO found that 14 tax code sections
accounted for 45 percent of 12,000 disputed issues facing IRS'
Appeals Office as of September 1992 and for 57 percent of the $99
billion in disputed dollars for those issues.  GAO believes that IRS
should more aggressively seek legislative changes to resolve
recurring disputes. 

The tax system also creates a tension in seeking a proper balance
between the tax administrator's need for information and the
taxpayer's burden in providing information.  Such information often
involved much earlier tax years--sometimes over 10 years prior to the
audit.  Recognizing the tension issue, GAO noted instances in which
CEP audit teams' legitimate needs for taxpayer-provided information
were not met.  GAO also noted instances in which taxpayers were
permitted to introduce information in the appeals process that was
not made available to the CEP audit teams.  GAO believes that IRS
needs better tools for obtaining legitimately needed information to
ensure that audit recommendations for additional taxes are adequately
supported. 

IRS revenue agents and appeals officers face conflicting
measures--measures which create incentives that contribute to the
large gap between taxes recommended and taxes collected after
appeals. 

  IRS agents are charged with protecting the government's revenue. 
     They are instructed to make their audit recommendations without
     deviating from IRS' legal positions or considering the hazards
     of litigation.  A key measure of the work of the Examination
     function as a whole is the amount of additional taxes
     recommended per audit hour. 

  Appeals officers, on the other hand, are charged with resolving tax
     controversies without litigation to the extent possible while
     being fair and impartial to both the government and the
     taxpayer.  They are instructed to consider the hazards of
     litigation and may concede the recommended taxes in part or in
     whole on that basis even if their decision deviates from an IRS
     legal position.  In measuring the Appeals function as a whole,
     IRS focuses on the number of cases settled without litigation. 

GAO recognizes the merit of both objectives but believes that adding
the common measure of dollars collected to the existing measures for
each function would better balance the incentives in the overall
system and contribute to an improved collection rate while permitting
each function to continue pursuing its primary objective. 

GAO also noted opportunities for improvement through changes in the
way IRS allocates and brings CEP resources to bear, trains revenue
agents to enhance their knowledge of the industries they audit, and
controls the coordination between Appeals and other IRS functions. 
These improvements would supplement the 10 changes to CEP that IRS
approved in 1990 and that GAO also views as being needed. 


   GAO'S ANALYSIS
---------------------------------------------------------- Chapter 0:4


   CEP'S COLLECTION RATE WAS LOW
---------------------------------------------------------- Chapter 0:5

An important output measure is the amount of additional taxes
collected as a result of CEP.  CEP corporations voluntarily pay about
$55 billion in income taxes annually.  Because of limitations in IRS'
databases, IRS did not know how much additional revenue was actually
collected as a result of CEP audits. 

GAO worked with IRS' data to compute the collection rate.  GAO's
computer match of taxes recommended in fiscal years 1983 through 1991
showed only a 22 percent collection rate.  Specifically, IRS
collected $7.1 billion of $32.4 billion in recommended taxes. 
Assuming a collection rate of 22 percent for fiscal year 1992, CEP's
$16 billion in recommended taxes would eventually yield $3.5 billion. 
Because IRS' data were incomplete, this 22-percent rate could be too
high or too low.  Accounting for other factors, such as claims for
net operating losses and refunds, would allow IRS to compute a more
accurate collection rate.  (See pp.  30 and 34-35.)

IRS has been developing a system and new measures to track CEP's
results.  While new measures are needed, GAO believes IRS' efforts
will be enhanced if IRS also accurately measures the collection rate
over time.  (See pp.  33-34.)

Although CEP corporations voluntarily pay $55 billion in taxes each
year, no one knows whether this is the full amount owed.  Appeals'
settlements on disputed taxes cannot be used as a measure of the
amount owed by CEP corporations or their ultimate compliance. 
Appeals can settle for a lower amount of taxes if it believes
litigation would be too risky or that the CEP team's recommendations
were not adequately supported--regardless of whether a corporation
complied with the tax laws.  Determining compliance is also
confounded by ambiguities in the tax law.  To fully estimate the
portion of taxes owed but not paid, IRS would have to audit all tax
issues on a sample of CEP tax returns and be assured that it had
properly interpreted the tax law.  IRS does not do this largely
because of time and resource constraints.  (See pp.  35-37.)


   EXAMINATION FACTORS REDUCING
   THE COLLECTION RATE
---------------------------------------------------------- Chapter 0:6


      CEP DIRECTOR DID NOT CONTROL
      FIELD RESOURCES
-------------------------------------------------------- Chapter 0:6.1

The CEP Executive Director did not have authority to control the
budget resources needed for effective CEP audits.  Instead, this
authority resided with the 59 IRS district offices, where CEP
competes with other programs for resources. 

GAO found that this lack of central authority has allowed districts
to redirect resources from CEP, leaving CEP teams ill-equipped to
comprehensively audit enormous corporations that have become more
complex and diversified.  Funds for travel, training, and private
sector experts were insufficient.  (See pp.  45-50.)

Decentralization also limited the impact of the 10 changes IRS
approved in 1990.  The changes focused in better communication,
training, and supervision.  GAO found that IRS had not consistently
implemented the changes in the 59 Districts participating in CEP. 
GAO believes these changes have potential but that such potential
will not be reached if implementation continues to vary across
districts.  (See pp.  43-45.)

A program as large and important as CEP is less likely to succeed
without central control over resources and staff allocation. 
Centralization, however, need not encompass all aspects of CEP cases. 
IRS may choose to leave authority for specific case decisions in the
hands of District officials, who tend to know more about the cases. 


      CEP PRODUCTIVITY MEASURES
      PROVIDED LITTLE INCENTIVE
-------------------------------------------------------- Chapter 0:6.2

IRS mainly measured CEP's productivity by the amount of additional
taxes that audit teams recommended per hour.  This measure encouraged
CEP teams to recommend as many taxes in the shortest time possible,
even if doing so meant bypassing audit steps or not waiting for
missing data.  Relying on this measure has contributed to a low
collection rate, inefficient uses of CEP resources, and unnecessary
burdens on Appeals and corporations. 

Also, focusing on recommended taxes as a measure provided little
incentive for CEP teams to meet with Appeals officials before the
appeals process to explain their audit findings or to meet afterwards
to determine why Appeals did not sustain their recommended taxes. 
Although not required by IRS for all nine appealed cases that GAO
reviewed, only four teams met with Appeals beforehand, and none met
with Appeals after the case was settled.  CEP team members said such
meetings would take time and reduce recommended tax amounts.  (See
pp.  50-53.)


      IRS' METHODS TO OBTAIN
      TAXPAYER DATA DID NOT ALWAYS
      WORK
-------------------------------------------------------- Chapter 0:6.3

CEP teams and corporations may disagree on the types and amount of
information needed for an audit.  Some IRS requests for information
may be overly broad or vague.  Other requests sought information from
many years earlier, which complicated efforts to satisfy the request. 
Recognizing these pitfalls, CEP teams still need a certain amount of
information to determine whether all income is reported and all
deductions and credits are allowable. 

GAO found that two methods CEP teams have to obtain needed taxpayer
information--information document requests and summonses--did not
work well.  For example, 85 percent of CEP team coordinators
responding to GAO's survey reported they did not receive requested
information from corporations in a timely manner; 30 percent said
they had to close audits without receiving all requested information. 
Without such information, CEP teams could not fully support their
recommended taxes, resulting in Appeals ruling in favor of taxpayers'
positions. 

Rather than providing CEP teams with needed data during the audit,
about half of the corporations GAO surveyed said they introduced new
data in Appeals.  For example, in two case studies where this
occurred, Appeals conceded disputed adjustments of about $30 million. 
CEP officials said they would not have recommended some of the taxes
had they received the data during the audit. 

GAO believes that IRS could use better tools to encourage
corporations to provide requested data in a timely manner.  For
example, corporations that do not provide requested data to CEP teams
without reasonable cause could be prohibited from using the data at
Appeals.  (See pp.  53-57.)


      REVENUE AGENTS NEED TO HAVE
      KNOWLEDGE OF THE INDUSTRIES
      THEY AUDIT
-------------------------------------------------------- Chapter 0:6.4

IRS did not encourage CEP revenue agents to specialize in auditing
certain industries.  Instead, IRS rotated them on about a 6-year
schedule to different corporations that often involved different
industries and different accounting standards and issues.  GAO
believes that rotating agents among corporations is necessary to
reduce potential conflicts of interest.  But rotating them to audit
corporations in different industries hindered their ability to fully
develop audit issues that could be sustained in Appeals. 

Over one-quarter of the corporate survey respondents said they were
dissatisfied with the audit team's knowledge of their industry. 
Similarly, 15 of 23 CEP officials from the case studies said revenue
agents often lacked the necessary industry knowledge.  GAO supports
allowing revenue agents to specialize in certain industries but
recognizes that such a policy may increase travel costs and would not
be practical in every district.  (See pp.  57-59.)


   APPEALS FACTORS REDUCING THE
   CEP COLLECTION RATE
---------------------------------------------------------- Chapter 0:7


      MISMATCHED GOALS SET THE
      STAGE FOR A LOW COLLECTION
      RATE
-------------------------------------------------------- Chapter 0:7.1

Appeals' mission is to settle tax disputes without litigation while
being fair and impartial to both the government and the taxpayer. 
CEP teams are charged with protecting the government's revenue and
instructed to make their audit recommendations without considering
the hazards of litigation.  Given complex tax laws, these mismatched
goals laid the foundation for a low collection rate. 

Specifically, IRS' measure for CEP encouraged CEP teams to recommend
more taxes.  Appeals focused on settling cases.  This focus
encouraged appeals officers to negotiate settlements on a portion of
the taxes that CEP teams recommended to avoid the probability of
losing all such taxes in court.  Settlements also avoided overloading
the courts as well as incurring the costs and time of litigation. 

Adding a common measure for both functions, such as the collection
rate, would better balance these incentives.  A common measure would
enhance communication so that CEP teams are less likely to recommend
taxes that Appeals will not sustain, while Appeals would be more
likely to sustain supported tax recommendations.  Applying this
measure only to CEP audit teams would undercut the incentive to
communicate. 

Also, because IRS has litigated few CEP cases, an imbalance seemed to
exist in resolving disputed issues.  Knowing this, corporations could
negotiate settlements in Appeals from a stronger position.  If IRS
were to show more willingness to litigate, its negotiation stance
could improve.  However, GAO recognizes that litigation imposes
burdens and risks, and resource constraints may preclude any
significant increase in litigation. 

Appeals' settlements do not set a precedent for resolving tax
disputes beyond those disputes on which the settlement is reached. 
Without legislative changes that will resolve the disputes or
litigation that sets a precedent, the same disputed issues get
appealed year after year, creating rework for all affected parties. 
As of September 1992, Appeals had 12,000 disputed issues, worth $99
billion in adjustments, waiting to be resolved.  IRS officials did
not know the portion associated with CEP but believed that most were. 
Of the 12,000 disputed issues, GAO found that 5,279 (45 percent)
involved just 14 tax code sections. 

GAO believes that IRS needs to focus more attention on proposing
legislative changes that would stem recurring issues and improve
administration of tax laws as well as the collection rate. 
Legislative solutions to recurring issues could reduce burdens on
corporations and IRS as well as expedite the audit and appeals
processes.  (See pp.  64-69.)


      INTERNAL CONTROL LAPSES IN
      APPEALS GAVE AN EDGE TO CEP
      CORPORATIONS
-------------------------------------------------------- Chapter 0:7.2

Appeals' controls to ensure coordination with other IRS functions did
not always work or exist in the cases GAO reviewed.  Insufficient
coordination gave an edge to CEP corporations and led to inconsistent
settlements.  Specifically, corporations had an advantage during
negotiations whenever Appeals

  used new evidence submitted by corporations after audit without
     letting CEP officials evaluate it and

  settled issues contrary to IRS legal positions without obtaining
     the views of the Office of Chief Counsel. 

More coordination within IRS may raise concerns about Appeals'
independence to settle tax disputes objectively and impartially.  On
the other hand, more coordination does not need to undercut Appeals'
independence and authority.  In fact, coordinating on new facts and
legal interpretations before settling a case, while adding some time,
can be viewed as upholding objectivity.  (See pp.  69-75.)


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 0:8

To better ensure that IRS meets its mission and improves the CEP
collection rate, GAO makes recommendations to the Commissioner of
Internal Revenue in chapters 2, 3, and 4, including the following: 

  Provide the CEP Director with authority over CEP resources in the
     districts. 

  Expand measures in CEP and Appeals to include consideration of a
     common measure, such as the collection rate. 

  Increase revenue agents' knowledge of specific industries in which
     they do CEP audits. 

  Ensure that Appeals seeks CEP teams' evaluation of new information
     from corporations and coordinates with Counsel officials before
     conceding taxes in opposition to IRS legal positions. 

  Propose legislative changes that will permanently resolve more
     recurring tax disputes. 

  Use the 22 percent collection rate, when needed, until IRS has
     corrected the databases for accurately tracking CEP collections. 

  Test ways to measure CEP corporate compliance. 


   COMMENTS
---------------------------------------------------------- Chapter 0:9

In a January 11, 1994, letter, the Commissioner of Internal Revenue
provided comments on a draft of this report. 

The Commissioner agreed to implement some recommendations but not
others.  For example, she opposed using the 22 percent collection
rate when estimating and testing ways to measure corporate
compliance.  She agreed with recommendations on CEP audit teams,
except for giving the CEP Executive Director line and budget
authority.  GAO still recommends this authority for allocating budget
resources but made language changes to clarify its position on line
authority.  GAO did not intend that the CEP Director control all
aspects of CEP, such as specific case decisions. 

Finally, the Commissioner agreed with GAO's recommendations on better
controls and clearer Appeals' summaries as well as resolving
recurring issues by proposing tax law changes.  However, she did not
agree with some suggestions for balancing incentives in the Appeals
process.  GAO still believes that more balance is needed in the
incentives but recognizes that this goal can be achieved through
different means. 

The Commissioner's comments on recommendations and report sections
and GAO's evaluations of these can be found at the end of chapters 2,
3, and 4 of the report.  Appendix VI contains IRS' complete comment
letter and an interspersed point-by-point GAO evaluation. 


INTRODUCTION
============================================================ Chapter 1

The mission of the Internal Revenue Service (IRS) includes collecting
the proper amount of taxes at the least cost.  In doing so, IRS
attempts to minimize the burden on taxpayers.  Driven by this
mission, IRS audits the majority of tax returns filed by about 1,700
of the nation's largest corporations.  Excluding any refunds, these
corporations voluntarily pay about $55 billion in annual income
taxes. 

These relatively few audits, compared to the 1.1 million individual
and corporate audits done annually, account for the majority of IRS'
additional recommended taxes (65 percent in 1992) from all IRS
audits.  But how much of the additional taxes recommended are truly
owed and will be collected after any appeals or litigation? 


   IRS' COMPLIANCE PROGRAM FOR
   LARGE CORPORATE TAXPAYERS
---------------------------------------------------------- Chapter 1:1

In 1966, IRS established the Coordinated Examination Program (CEP) to
audit the nation's largest and most complex corporations, each with
assets usually exceeding $250 million.  IRS established the program
because of the growth in these corporations during the 1950s and
1960s and because of the realization that IRS' traditional "one case,
one agent" approach no longer resulted in effective tax audits of
large businesses. 

IRS' Examination Division is the function responsible for CEP.  IRS
has organized CEP in a decentralized manner with Examination staff
located in 59 district offices.  Examination staff in IRS' National
Office provide program direction and oversight.  Figure 1.1 shows
CEP's decentralized organizational structure.  It shows that the
highest ranking official in CEP--the Executive Director --does not
have line authority over CEP audit teams.  Rather, the district
director and Examination division chief in each district evaluate the
performance of CEP audit team members and control the budget and
staffing resources needed for CEP audits.\1

   Figure 1.1:  CEP Organization
   Chart

   (See figure in printed
   edition.)

Source:  Prepared by GAO on the basis of IRS documents. 

IRS' compliance program for CEP corporations can involve more than
the CEP audits in the Examination Division.  In addition, IRS' Office
of Appeals and Office of Chief Counsel, along with the federal court
system, can affect the additional taxes ultimately collected. 


--------------------
\1 As of March 1994, IRS was considering additional changes to CEP's
organization.  For example, CEP may be expanded to include all
corporations with assets greater than $10 million.  We have not
evaluated these proposed changes. 


      THE CEP AUDIT PROCESS
-------------------------------------------------------- Chapter 1:1.1

To determine which large corporations to select for CEP, IRS scores
income tax returns on various criteria, such as corporate structure,
assets, and income.  Once IRS selects the CEP corporations, it uses a
team to audit each one because of the complexity of the corporations
and their tax returns. 

A CEP audit team usually has an on-site GS-13 or GS-14 team
coordinator, one or more revenue agents, and specialists.  A team
coordinator directs the work of the agents and reports to a GS-14 CEP
case manager, who usually oversees several audits.  Specialists--such
as actuaries, economists, engineers, and international and industry
specialists--work with the team but do not report directly to the
case manager.  Rather, specialists report to their own managers. 

The Industry Specialization Program (ISP) provides technical advice
and information to CEP audit teams.  As of 1993, it had 25 industry
specialists and 7 issue specialists.  They identify tax issues within
major industries having audit potential and help revenue agents treat
tax issues as well as taxpayers consistently.  These specialists,
however, have no line authority over the agents.  ISP specialists
also assist the Office of Chief Counsel in proposing legislative
changes and developing revenue rulings and procedures. 

CEP audit teams usually remain on-site at the corporation's
headquarters for extended periods.  The team generally examines two
or three annual tax returns in a single audit cycle; each audit cycle
takes an average of 2 to 3 years to complete.  Although the time lag
varies, teams generally begin auditing CEP returns 5 to 6 years after
they are filed.  IRS is attempting to reduce the time lag by auditing
more CEP returns over the same audit cycle. 

According to IRS procedures, a CEP team plans its audit by reviewing
the corporation's tax returns, financial statements, historical data
from past audits, and other pertinent documents to identify potential
areas of tax noncompliance.  These areas of potential noncompliance
are referred to as "issues." The team develops the audit plan with
approval from CEP management.  IRS shares the administrative portions
of its audit plan with the taxpayer to facilitate the audit process. 

After identifying the audit issues, CEP teams use information
document requests (IDR) to request documents from taxpayers that
relate to their tax liability.  Generally, the team submits several
IDRs during the audit cycle. 

If IRS has problems getting documents, it may issue a legal summons
to compel taxpayers to provide them.  IRS may issue a summons if
taxpayers do not provide all requested documentation in a reasonable
period without a valid excuse.  When a CEP team cannot determine what
information is available, IRS may issue a summons requiring the
taxpayer to provide information on what records exist and their
location.  The Department of Justice works with IRS to enforce the
summons in court. 

For each issue, if the evidence collected by the audit team does not
support the income or deduction shown on the return, the team is to
recommend adjustments to the return and compute a corrected tax
liability.  IRS presents this information to the taxpayer through a
"Notice of Proposed Deficiency." After receiving the notice, the
taxpayer may (1) agree with the recommendations, (2) provide
additional information, or (3) state why the proposed deficiency
should be reduced or eliminated.  If the taxpayer agrees, the
recommended amount becomes a tax assessment. 


      TAXPAYERS CAN PROTEST AUDIT
      ADJUSTMENTS THROUGH IRS'
      APPEALS FUNCTION OR THE
      COURTS
-------------------------------------------------------- Chapter 1:1.2

At the close of the audit, if the taxpayer does not agree with IRS'
recommended tax adjustments, the taxpayer can (1) file a protest on
some or all of the proposed adjustments with IRS' Office of Appeals,
(2) take the dispute to Tax Court without paying the recommended tax
increase, and/or (3) pay the tax increase and claim a refund in the
U.S.  Court of Federal Claims or a federal district court.  After
these options have been exercised, any additional taxes are assessed
against the taxpayer.  CEP corporations almost always pay the amount
assessed. 

Of these options, IRS has estimated that CEP taxpayers protest 80 to
90 percent of all recommended taxes to IRS Appeals.  All types of
taxpayers appeal billions of dollars in tax adjustments from IRS
audits.  As of September 30, 1992, we reported that Appeals had about
12,000 disputed issues with $99 billion in proposed tax adjustments
waiting to be resolved.\2 IRS' databases did not identify the amounts
that CEP corporations appealed. 


--------------------
\2 Tax Administration:  Recurring Tax Issues Tracked by IRS' Office
of Appeals (GAO/GGD-93-101, May 4, 1993). 


      PROTESTED CEP CASES OFTEN GO
      TO APPEALS' LARGE CASE
      PROGRAM
-------------------------------------------------------- Chapter 1:1.3

Appeals has a special Large Case Program for disputes involving
recommended tax adjustments of $10 million or more.  As of August
1992, the large case inventory had about 2,540 cases.  In fiscal year
1992, Appeals took about 2 years to close a large case.  The number
of protested issues in 1 large case has exceeded 200. 

To take an issue to Appeals, the taxpayer must provide a written
protest outlining the reasons for disagreement.  Before the case is
submitted to Appeals, the CEP team is required to write a rebuttal to
the taxpayer's protest. 

Because of the size and complexity of its large cases, Appeals uses a
team approach.  Each team has a team chief--a senior GS-15 appeals
officer--and two or more appeals officers selected according to the
team's needs.  Team members do not have to work in the same office as
the team chief.  IRS industry specialists may also assist the team. 

After receiving a large case, the team chief arranges a conference
with the CEP taxpayer.  The team chief may hold a preconference
meeting with CEP team members to hear their positions on the facts
and issues.  In all interactions, Appeals' staff are to remain
objective, find a fair and reasonable basis for resolving disputes,
and treat consistently all taxpayers with similar circumstances. 

During an appeal, the Appeals' team reviews the CEP team's report and
workpapers as well as the taxpayer's protest and CEP team's rebuttal. 
A taxpayer may present new information to support its position on a
protested issue.  The team chief is supposed to send that information
to the CEP team for evaluation before settling the dispute. 

To settle a tax dispute, an appeals officer has authority to consider
the hazards of litigation (i.e., the chance of losing in court).  To
do so, an appeals officer is to review the facts of each case,
relevant laws and regulations, and pertinent court cases to judge the
probable result if the case were to be litigated.  The officer is to
evaluate the relative strengths of the taxpayer's and CEP team's
positions, using the documentation submitted by each side and the
results of informal conferences with the taxpayer.  The appeals
officer is then to negotiate mutual concessions in an attempt to
arrive at a settlement that approximates the probable dollar results
if the case were to be litigated.  To facilitate settlement of large
cases, IRS allows team chiefs to approve any final settlement without
higher level approval. 

At the end of a case, the team chief writes a summary to document how
the case was handled.  This summary usually discusses issues raised,
pertinent facts, applicable regulations and rulings, and relative
merits of each side.  If agreement with the taxpayer was reached, it
also includes Appeals' recommendations and reasons for settlement. 
Appeals gives a copy of the summary to the taxpayer and the CEP team. 
If agreement is not reached on the proposed deficiency, Appeals
issues a notice of deficiency, and the taxpayer has 90 days to file a
petition with the Tax Court. 


      TAXPAYERS MAY TAKE DISPUTES
      TO TAX COURT
-------------------------------------------------------- Chapter 1:1.4

Taxpayers have the right to not pay the additional recommended taxes
and instead take protested issues to the Tax Court, either directly
after the audit is closed or if the case is not completely settled in
Appeals.  Cases pending in Tax Court are called docketed cases.  In
fiscal year 1992, 46,600 cases were docketed involving all types of
taxpayers (e.g., individuals and corporations).  The Tax Court has 19
judges who hold court sessions at various locations in the United
States.  In addition, the chief judge can appoint special trial
judges and recall retired judges for a maximum of 90 days each per
year. 

After a case is docketed, IRS District Counsel should transfer the
case to Appeals for possible settlement unless Appeals issued the
notice of deficiency.  Even then, District Counsel still can return
the case but may chose not to do so if settlement seems unlikely. 
Regardless, Appeals has limited jurisdiction to settle a docketed
case independent of District Counsel. 

If a docketed case involves a deficiency of more than $10,000,
Appeals should return the case to District Counsel when (1)
settlement of all or part of the case is not progressing or (2) the
case appears on a trial calendar.  A case with a lower deficiency
should be referred to Appeals for 6 months or until 1 month before
the call of the trial calendar.  At that point, the case returns to
District Counsel unless it and Appeals agree to extend the time for
Appeals' consideration.  While a case is with Appeals or District
Counsel, that office has sole settlement authority.  If District
Counsel requests the case file to prepare for trial, District Counsel
may also agree that Appeals should continue working on a settlement
during this preparation. 

After a trial, Tax Court decisions may be appealed to 1 of 11
regional circuit courts or the Circuit for the District of Columbia. 
Decisions of the circuit courts may be reviewed by the Supreme Court
on a writ of certiorari. 


      TAXPAYERS MAY PAY TAXES AND
      CLAIM REFUNDS THROUGH THE
      COURTS
-------------------------------------------------------- Chapter 1:1.5

A CEP taxpayer may pay all of the recommended taxes and file a claim
for refund unless the taxpayer entered into a closing agreement with
IRS.  The taxpayer must file the claim within 2 years from the date
the taxes were paid.  IRS' audits of claims generally follow the same
pattern as audits of income tax returns.  Revenue agents should
evaluate claims to determine whether the taxpayer is entitled to a
refund.  If agents decide that the taxpayer is entitled to a refund,
IRS will return the overpayment.  If agents decide that the refund
claim is unfounded or excessive, the taxpayer can refer the claim to
Appeals or sue for the refund in a federal district court or the U.S. 
Court of Federal Claims. 

A taxpayer who loses in district court may appeal the decision to the
appropriate circuit court.  Taxpayers may appeal a court of claims
decision to the Court of Appeals for the Federal Circuit. 


   PREVIOUS GAO WORK
---------------------------------------------------------- Chapter 1:2

This report presents the results of the third phase of our work on
CEP.  The first phase was completed in April 1991, when we testified
before the Subcommittee on our initial observations about CEP
management problems that had persisted for many years.\3 These
persistent problems, as identified from various IRS testimony and
internal studies done from 1977 to 1990, included

  lack of reliable data on the amount of CEP-recommended taxes that
     are actually assessed and ultimately collected;

  insufficient training for revenue agents on CEP teams;

  delays in starting CEP audits, which pressures CEP teams to quickly
     audit multiple tax returns filed years earlier-- usually under
     different tax laws;

  insufficient support audits from other IRS districts in which a CEP
     corporation has a major operation;

  poor audit planning, which hampers the ability to audit the most
     significant issues and adequately support any related
     recommended taxes;

  poor use of specialists who can help teams identify and support
     significant audit findings on tax issues; and

  poor coordination among IRS functions in doing the CEP audits. 

The second phase was completed in April 1992, when we issued a
briefing report that provided (1) trends in CEP audit results for
fiscal years 1987 through 1991, (2) CEP audit coverage estimates, and
(3) a profile of CEP taxpayers.\4 We found that CEP involves very
large corporations and generates billions in potential tax revenues. 
Some of our findings were: 

  Total CEP-recommended taxes grew from $7 billion in fiscal year
     1987 to $18 billion in fiscal year 1991, a 157-percent increase. 
     The 1991 figure included one case worth $6.5 billion; excluding
     that case, recommended taxes grew 71 percent over the 5-year
     period.  In fiscal year 1987, IRS recommended $4,372 in
     additional tax per direct examination hour and in fiscal year
     1990, $4,268 per hour--much higher than any other IRS audit
     program.  In fiscal year 1991, the measure increased to $6,875
     per hour because of the effect of the $6.5 billion case. 
     Excluding that case, however, CEP recommendations averaged
     $4,460 per hour in fiscal year 1991--an amount that closely
     parallels the recommended tax per hour for the previous 4 fiscal
     years. 

  Contrary to IRS testimony, IRS does not audit every CEP taxpayer
     every year.  Using IRS' method of calculating audit coverage for
     other groups of taxpayers, we found that CEP audit coverage
     ranged from 66 percent in 1987 to 77 percent in 1991.  This
     coverage included tax returns that were audited solely to
     resolve a single issue that was carried back or forward from
     another tax year.  IRS officials said they do not believe that
     an audit coverage measure is applicable to CEP because every CEP
     return is reviewed for audit potential before being excluded
     from that year's audit inventory. 

  On 1988 corporate income tax returns, CEP taxpayers' reported
     assets averaged $6.5 billion.  They also reported an average of
     about $1.5 billion in total income, $179 million in taxable
     income, and an average income tax of $61 million based on
     taxable income.  After claiming tax credits and other tax
     adjustments, their reported net tax liability averaged $42
     million, or 23 percent of average taxable income. 


--------------------
\3 IRS' Efforts to Ensure Corporate Tax Compliance (GAO/T-GGD-91-21,
Apr.  17, 1991). 

\4 Tax Administration:  IRS Efforts to Improve Corporate Compliance
(GAO/GGD-92-81BR, Apr.  17, 1992). 


   IRS APPROVED CEP CHANGES IN
   1990
---------------------------------------------------------- Chapter 1:3

IRS has been concerned about CEP's effectiveness since the 1970s,
when it began evaluating CEP.  On the basis of recent studies, IRS
announced 10 changes to CEP in July 1990 that were intended to

  relieve taxpayer burden through tax simplification and improved
     systems and procedures,

  resolve most factual issues at the audit level,

  provide proper and timely training and resources to all staff,

  improve the effectiveness and efficiency of audits, and

  substantially improve the currency of audits. 

The 10 changes are briefly described next. 


      NATIONAL POLICY BOARD
-------------------------------------------------------- Chapter 1:3.1

IRS established a national policy board composed of executives from
several of its functions and offices:  Examination, International,
Appeals, and Counsel.  Its charter is to (1) establish policy for
CEP, (2) ensure that CEP is properly focused and managed, and (3)
promote coordination among the functions represented. 


      NATIONAL CEP DIRECTOR AND
      REGIONAL CEP MANAGERS
-------------------------------------------------------- Chapter 1:3.2

IRS filled the position of Executive Director for CEP to provide
program development, oversight, and evaluation.  In addition, CEP
managers were selected in each IRS region to oversee and direct CEP
and to coordinate within the region, among regions, and with the
executive director.  Appeals and Counsel created and filled similar
regional positions with the same expectations. 


      TOP FIELD MANAGEMENT
      INVOLVEMENT IN PLANNING AND
      SUPPORT AUDITS
-------------------------------------------------------- Chapter 1:3.3

IRS decided that district and regional management needed to be more
involved in CEP to improve the planning process and control of
support audits. 


      MORE MANAGERIAL OVERSIGHT TO
      INCREASE TAXPAYER
      COOPERATION
-------------------------------------------------------- Chapter 1:3.4

IRS decided that more top management involvement was needed to
develop a cooperative relationship with CEP taxpayers. 


      MORE INDUSTRY AND ISSUE
      SPECIALIZATION
-------------------------------------------------------- Chapter 1:3.5

IRS concluded that CEP teams needed assistance in addressing the
increasing complexity of corporate tax law and the growth of
international corporate activity.  In response, IRS decided to
establish more industry and issue specialists. 


      MORE CEP TRAINING
-------------------------------------------------------- Chapter 1:3.6

Due to the complex technical and legal issues in CEP cases, IRS
recognized the need to set up a cross-functional training program for
Examination, Appeals, and Chief Counsel personnel involved in CEP
cases.  The training was to ensure a common understanding in
addressing IRS positions and CEP issues. 


      MORE EFFECTIVE COMMUNICATION
      SYSTEMS
-------------------------------------------------------- Chapter 1:3.7

IRS decided it needed to improve communications on industry practices
and other CEP issues to ensure consistent application of the law. 
IRS envisioned creating a tracking system to monitor major issues
arising in CEP and an electronic bulletin board system to communicate
technical information. 


      EXPEDITED LEGAL AND
      TECHNICAL ASSISTANCE
-------------------------------------------------------- Chapter 1:3.8

Due to the complexity of CEP issues and the need for prompt legal and
technical assistance, IRS intended for Counsel to provide that
assistance from the start of CEP audits.  Counsel is to serve as a
legal advisor to the CEP team on matters of law and tax policy as
well as on the development of issues during audits.  Counsel's
purpose is not to prepare for litigation. 


      QUALITY ASSURANCE AND
      MEASUREMENT SYSTEMS
-------------------------------------------------------- Chapter 1:3.9

IRS decided that the overall quality of CEP would be improved by
developing standard measures and goals for Examination,
International, Appeals, and Counsel.  In addition, IRS established a
CEP Quality Peer Review and a CEP Oversight Committee. 


      EARLY SETTLEMENT OFFERS AND
      IMPROVED FUNCTIONAL
      COORDINATION
------------------------------------------------------- Chapter 1:3.10

IRS decided that it needed to (1) facilitate earlier resolution of
audit issues with CEP taxpayers and (2) improve coordination among
Appeals, Counsel, and Examination.  The changes included giving case
managers authority to settle recurring issues previously resolved by
Appeals. 

To offer them more access to Appeals, IRS decided that a CEP team and
Counsel should meet with Appeals before a case is settled to discuss
the team's positions on audit issues.  In addition, Appeals should
meet with a CEP team after the settlement to discuss the resolution
of the issues.  This is intended to help a team to audit later
returns. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
---------------------------------------------------------- Chapter 1:4

Our objectives were to determine (1) the portion of taxes recommended
in CEP audits that are collected after any appeals or litigation; (2)
what factors, if any, reduce the percentage of recommended taxes
ultimately collected; and (3) the status and preliminary results of
IRS' ongoing changes to improve CEP. 


      COMPUTER DATA MATCH USED TO
      CALCULATE COLLECTION RATE
-------------------------------------------------------- Chapter 1:4.1

To determine the portion of audit teams' recommended additional taxes
ultimately paid by CEP corporations (i.e., the CEP collection rate),
we obtained two IRS databases to match corporate income tax return
information.  The first database, IRS' Audit Information Management
System (AIMS), contains information on Examination staff resources
and accomplishments, including taxes recommended from audits closed
during fiscal years 1983 through 1991.  The second database, IRS'
Business Master File (BMF), contains tax return account information
on taxes collected as well as taxable income, tax liability,
penalties, interest, refunds, and audit actions for corporate tax
returns.  To extract the data, we used a list of taxpayer
identification numbers (TIN) for the 1,684 corporations in CEP as of
May 1991. 

Of 16,641 records we extracted from AIMS, we matched 8,874 records
with recommended tax increases to related BMF accounts on the taxes
collected through fiscal year 1992 after all appeals and litigation. 
We could not match the other 7,767 AIMS records to BMF accounts
because (1) the account was no longer available on the BMF or (2) the
account existed, but the collection information was not yet available
on the BMF because the case was still in Appeals or being litigated. 

We also did analyses of our matched data set to determine the
collection rate by industry and by IRS district and for foreign
controlled corporations.  To determine the collection rate of CEP
cases that IRS' Office of Chief Counsel litigated, we obtained and
analyzed a database on the large case disputes closed in litigation
for fiscal years 1988 through 1992.  In addition, we analyzed the BMF
to determine the portion of CEP corporations' income tax payments
that resulted from audits as well as the unpaid balance and the
penalties for CEP tax returns. 


      SURVEYS AND CASE STUDIES
-------------------------------------------------------- Chapter 1:4.2

We used two methods to identify factors that affect the percentage of
CEP-recommended taxes that are collected and the status of IRS' 1990
changes to CEP.  First, we surveyed IRS team coordinators, case
managers, and appeals officers and taxpayer representatives involved
in a universe of 108 closed CEP cases.  Second, we did in-depth case
studies of 12 of the 108 cases. 

Our survey covered 308 IRS and corporate employees involved in 108
CEP audits.  These 108 were IRS' universe of cases that each had $30
million or more in additional taxes recommended and were closed by
agreement at the audit or Appeals levels in fiscal years 1989 through
1991.  We selected the $30 million cut-off point for several reasons: 
(1) the 108 cases accounted for nearly $8.5 billion dollars in
recommended taxes and (2) the universe size was manageable given the
number and complexity of the surveys we used. 

IRS' database originally showed 128 cases meeting our selection
criteria.  We subsequently excluded 20 of these cases from our
analysis when new information showed that the cases did not meet our
selection criteria because, for example, they were still open in
Appeals, involved additional tax recommendations less than $30
million, or involved an audit of a return type other than corporate
income tax.  Similarly, 75 individuals were eliminated from the
relevant survey universes because the designated respondent was no
longer with IRS or the taxpayer.  Results in chapters 3 and 4 are
based on the 308 surveys received from 85 team coordinators, 72 case
managers, 78 appeals officers, and 73 corporations.\5 Table 1.1
summarizes the universe size and response rates for each group. 



                          Table 1.1
           
            Universe and Response Rate Information
                       by Survey Group

                           Team
                     coordinato      Case   Appeals  Taxpaye
                              r   manager   officer        r
-------------------  ----------  --------  --------  -------
Cases meeting               108       108       108      108
 selection criteria
Adjusted universe            89        74        83       96
Surveys received             85        72        78       73
Response rate               96%       97%       94%      76%
------------------------------------------------------------
In the surveys, we asked about factors such as the sufficiency and
quality of IRS staff, training, issue identification and development,
taxpayer cooperation, and case delays.  The team coordinator,
appeals, and taxpayer surveys also had questions on the case's three
largest dollar issues.  All four surveys asked for the respondents'
opinions of recent changes to CEP and Appeals' Large Case Program. 
We also asked respondents whether, in their opinion, the case outcome
would have been different had some recent changes to CEP been in
effect at the time. 

To better understand IRS' processes and the 1990 changes, we did
in-depth case studies of 12 of the 108 cases.  In three cases,
taxpayers fully agreed with CEP audit recommendations; the remaining
nine were closed by Appeals.  The 12 cases accounted for $1.5 billion
(18 percent) of the $8.5 billion of additional taxes recommended in
our universe of 108 cases.  We did three case studies in each of four
IRS districts--Chicago, Houston, Los Angeles, and Manhattan.  These
four districts accounted for about 30 percent of CEP's staff years
and over 40 percent of additional taxes recommended in fiscal year
1991.  The 12 cases also reflected a geographic cross section of the
nation and covered a variety of industries, including financial
services, petroleum, food, construction, and utilities. 

In our 12 cases, CEP teams raised between 50 and 300 issues.  To
narrow our scope, we focused on the three issues having the largest
amounts of additional tax recommended.  Much of our analysis focused
on these 36 issues over the 12 cases. 

For each case, we reviewed up to 13 case documents, including the
audit plan, information document requests, specialist reports, and
the revenue agent report that summarizes the audit findings.  When
applicable, we reviewed up to an additional 11 documents, such as IRS
standard position papers, taxpayer protests, CEP rebuttals, and
Appeals case memoranda and summaries.  Appendix I includes a list of
all 24 documents. 

We interviewed IRS employees and taxpayer representatives who were
involved with each case and IRS district, regional, and National
Office staff responsible for CEP and Appeals management.  These
interviews involved 85 people, including 6 branch chiefs, 8 case
managers, 13 team coordinators, 4 technical specialists, 6 industry
specialists, 11 appeals officers, 11 taxpayer representatives, and 26
others.  Our interviews focused on the effect of (1) CEP policies and
practices about the audits, (2) Appeals policies and practices about
the resolution of disputed issues, (3) the 1990 changes to CEP on
improving the collection rate, (4) IRS' efforts such as task force
studies and process reviews, and (5) other case-specific details that
were not addressed by past or present policies. 

In reviewing IRS' changes to CEP since 1990, we reviewed the Large
Case Policy Board Report, eight CEP task force reports, the CEP
Quality Peer Review for fiscal year 1992, and the Appeals Process
Review for fiscal year 1992. 

IRS National Office and district officials and representatives of CEP
corporations reviewed our surveys and case study methodology before
we began.  They acknowledged the validity of our approach and
reviewed our surveys for comprehensiveness and technical accuracy. 
District office officials told us our selected cases were
representative of typical audits and appeals of CEP corporations in
those districts. 

We obtained written comments from IRS on a draft of our report. 
Appendix VI contains these comments and our evaluation of them.  We
also sent our draft report to three former IRS Commissioners, the Tax
Executives Institute (TEI), and other knowledgeable parties for
review and made changes in the report on the basis of their comments
where appropriate. 

TEI represents tax executives of corporations, including most of
those in CEP.  TEI submitted its comments in a November 12, 1993,
letter.  We are pleased that TEI participated in our review.  In
summary, TEI's president said that TEI agreed with our
recommendations on enhancing training of CEP revenue agents and on
changing the measures of success but opposed others.  TEI also
expressed concerns about the tone and beliefs underlying some of our
conclusions.  We have made changes to better balance the tone and
address concerns about recommendations in chapter 4 on the Appeals
process.  However, we disagree with TEI statements about our
preconceptions and other recommendations.  We have summarized TEI's
comments and our evaluation of them at the end of chapters 2, 3, and
4. 

Overall, we conducted our work at IRS' National Office, 5 regional
offices, and 7 of 59 district offices active in CEP.  Appendix I
provides a detailed description of our methodology.  We did our audit
work from February 1992 to September 1993 in accordance with
generally accepted government auditing standards. 


--------------------
\5 Survey results are reported as percentages of respondents
answering the relevant question.  At times, respondents neglected to
answer a certain question.  As a result, the percentages reported in
the chapters may be based, for example, on 84 rather than 85 team
coordinator responses.  Our text does not report these small
deviations.  However, we do report the number of respondents
answering a question when the question was directed at a subgroup of
respondents (e.g., those with cases that went to appeals). 
Appendixes II through V show the number of responses for each
question on each survey. 


IRS DID NOT KNOW THE COLLECTION OR
COMPLIANCE RATE AMONG CEP
CORPORATIONS
============================================================ Chapter 2

CEP audits consumed over 20 percent (about 1,700 audit staff years)
of Examination's audit resources in fiscal year 1992.  Although this
investment produced additional billions of dollars in recommended
taxes, IRS did not know what portion of the taxes it actually
collected.  We found that IRS assessed and collected 22 percent of
the CEP-recommended taxes.\1

To compute the 22-percent rate, we had to overcome problems with IRS'
databases.  The databases did not show the taxes actually collected
from each CEP audit, excluding the effects of any nonaudit related
factors, such as corporate claims for net operating losses (NOL) and
refunds from other years.  Knowing the taxes collected from audits
can help measure the effectiveness of IRS' enforcement programs and
the large corporation tax gap. 

Even so, our 22 percent collection rate is not a measure of CEP tax
compliance or the CEP tax gap.  Although IRS' mission is to collect
the proper amount of taxes, no one knows what that amount is for CEP
corporations.  For various reasons, IRS cannot compute the total tax
liability for CEP corporations. 


--------------------
\1 CEP corporations in our BMF database had tax assessments of about
$380 billion of which only $348 million (.09 percent) was unpaid.  As
a result, we considered taxes assessed for CEP corporations to be
collected. 


   IRS COLLECTED FEW OF THE TAXES
   RECOMMENDED FROM CEP AUDITS
---------------------------------------------------------- Chapter 2:1

IRS did not have databases that showed the actual amount of
CEP-recommended taxes that it collected.\2 To compute the actual
collection rate we had to merge IRS' AIMS and BMF data.  We found
that IRS collected $7.1 billion, or 22.1 percent, of the $32.4
billion in taxes recommended during fiscal years 1983 through 1991
for large corporations that were still in CEP as of May 1991 and
whose records were closed on both databases through fiscal year 1992. 

No one knows what the current collection rate is, but the 22.1-
percent rate is the only actual computation available.  Until IRS
develops a better, more current collection rate, IRS can use this
22.1-percent rate whenever it wants to estimate the amount of
additional tax revenues that CEP actually produces.  For example, in
fiscal year 1992 CEP audit teams recommended about $16 billion in
taxes.  Given the 22.1-percent rate, these CEP audits could be
expected to eventually generate about $3.5 billion in tax
collections. 


--------------------
\2 IRS has been attempting to collect better data to estimate a
collection rate, particularly for CEP corporations.  IRS officials
briefed us on their new data through its Enforcement Revenue
Information System (ERIS)--which we have not evaluated--in December
1993, after we completed our audit. 


   COLLECTION RATES VARIED WIDELY
   AMONG INDUSTRIES AND DISTRICTS
---------------------------------------------------------- Chapter 2:2

We found that the CEP collection rate varied significantly depending
on industry and district.  Various factors could explain this,
including differences in the cooperation of taxpayers, the complexity
of relevant tax laws, the prevalence of unresolved legal issues in
certain industries or international issues, the quality of CEP
audits, and the practices within and between IRS districts or Appeals
offices.  Chapters 3 and 4 will discuss these and other factors in
more detail. 


      COLLECTION RATE BY INDUSTRY
-------------------------------------------------------- Chapter 2:2.1

Table 2.1 shows collection rates in descending order for the 10
industries with the largest amounts of CEP-recommended taxes. 



                          Table 2.1
           
                10 Industries With the Largest
               Recommended Taxes in Descending
           Collection Rate Order, Fiscal Years 1983
                           to 1991

                    (Dollars in millions)

                               Taxes
                          recommende       Taxes  Collection
                                   d   collected        rate
------------------------  ----------  ----------  ----------
1. Wholesale trade of           $678        $414      61.06%
 motor vehicle equipment
2. Drug manufacturing            873         492       56.36
3. Manufacturing--motor        1,111         443       39.87
 vehicles and equipment
4. Mutual life insurance       1,608         523       32.52
5. Manufacturing--             2,988         570       19.08
 petroleum refining
6. Office, computing,          1,159         198       17.08
 and accounting machines
7. Electric services           1,413         211       14.93
8. Manufacturing--               948          75        7.91
 certain electrical
 equipment
9. Bank holding                2,843         115        4.05
 companies
10. Manufacturing--            1,298          48        3.70
 aircraft, missiles, and
 parts
 Results for top 10      $14,919      $3,089      20.71%
------------------------------------------------------------
Source:  GAO analysis using IRS data. 

For all industries in our database the collection rate ranged from a
positive 114.7 percent for holding and investment companies to a
negative 162 percent for taxpayers in the cement and hydraulic
industries.\3

Collection rates that exceeded 100 percent indicated that appeals
officers collected more taxes than recommended by CEP teams.  This
can occur when the tax liability increases while the case is under
Appeals' jurisdiction.  For example, the liability may increase
because of a carryover adjustment from another audit period that
affects the tax years being appealed or because of an amended return
filed by the taxpayer. 

Negative collection rates occur when the appeals officer not only
concedes all taxes recommended by a CEP team but also gives the
taxpayer a tax refund because the taxpayer filed a claim for a refund
or the reported tax liability was reduced.  For example, the appeals
officer can decrease tax liability because of a computation error in
the dollars recommended or a carryover adjustment from another tax
period to the tax year in Appeals. 


--------------------
\3 This range excludes collection rates exceeding plus or minus 200
percent. 


      COLLECTION RATE BY DISTRICT
-------------------------------------------------------- Chapter 2:2.2

The collection rate also varied among IRS districts.  Table 2.2 shows
collection rates in descending order for the 10 IRS districts with
the largest amount of CEP recommended taxes. 



                          Table 2.2
           
           10 Districts With the Largest Amounts of
             CEP-Recommended Taxes in Descending
            Order of Collection Rate, Fiscal Years
                         1983 to 1991

                    (Dollars in millions)

                               Taxes
                          recommende       Taxes  Collection
District                           d   collected        rate
------------------------  ----------  ----------  ----------
1. Newark                     $1,161        $509      43.84%
2. Detroit                     1,542         595       38.59
3. Boston                      1,087         287       26.40
4. Chicago                     1,418         348       24.54
5. Manhattan                   5,518       1,004       18.19
6. Dallas                      1,121         198       17.66
7. Hartford                    1,184         192       16.22
8. Los Angeles                 2,162         294       13.60
9. Houston                     1,693         223       13.17
10. St. Louis                  1,173         111        9.46
 Result for top 10       $18,059      $3,761      20.83%
------------------------------------------------------------
Source:  GAO analysis using IRS data. 

The collection rate for all IRS districts with CEP audits ranged from
a high of 75.04 percent in Albuquerque, NM, to a low of a negative
52.23 percent in Salt Lake City, UT. 


      FOREIGN VERSUS U.S.-OWNED
      CORPORATIONS
-------------------------------------------------------- Chapter 2:2.3

Our computer match showed that the collection rate for the 144
foreign-owned CEP corporations was 33 percent compared to 21 percent
for 1,124 U.S.-owned corporations.  IRS officials said a possible
reason for this disparity is that foreign-owned corporations often
feel a greater need to quickly resolve tax disputes, diverting
negative public attention from what could be perceived as tax
evasion.  They may fear this attention could result in lower sales or
trigger new restrictive legislation. 


      PROMISING TRENDS IN LARGE
      CORPORATIONS AGREEING TO PAY
      CEP RECOMMENDED TAXES
-------------------------------------------------------- Chapter 2:2.4

IRS is developing new CEP measures and a new management information
system.  CEP officials believe this new system will provide better
information on CEP results.  To the extent it works, the system will
provide the recommended adjustment for each audit issue and the
amount of protected revenue.  A CEP team protects tax revenues
already in the Treasury when it determines that a taxpayer's request
for a tax refund has no merit. 

This new system has produced some data on these new measures.  For
example, IRS data showed an increase in the percent of CEP-
recommended taxes that large corporations agreed to pay (and not
appeal) at the end of the audit.  According to IRS' data, agreed
payments were 5.3 percent in fiscal year 1990, 11.1 percent in 1991,
and 15 percent in 1992.  During these 3 years, the percent of CEP
cases in which corporations agreed with all audit findings were 3
percent, 4.7 percent, and 6 percent, respectively.\4

We believe these trends are promising.  If they continue, IRS and
taxpayers will spend fewer resources settling tax disputes.  In
addition, the collection rate should increase.  However, we did not
analyze the corporate cases leading to these trends.  We do not know
whether these corporations agreed with a greater portion because the
CEP teams better supported their recommended taxes or simply to avoid
the more contentious, complex tax issues. 

Instead of evaluating these new measures and system, our review
focused on computing the collection rate of CEP-recommended taxes. 
We envision the collection rate as an additional CEP measure worth
tracking in this new system.  If the system eventually tracks the
rate, we view that as a positive enhancement.  Even so, we believe
that more changes in CEP are needed, which chapters 3 and 4 discuss. 


--------------------
\4 Because taxpayers may file a claim for refund of taxes after taxes
were paid, agreement rates may need to be lowered. 


   IRS DATABASES SHOULD BE CHANGED
   TO BETTER CAPTURE CEP
   COLLECTIONS
---------------------------------------------------------- Chapter 2:3

We had to make several adjustments to overcome problems in the IRS
databases that we used to compute the collection rate.  The databases
need improvements to track actual CEP results and eliminate the need
to estimate.  Without improvements, the rate will be understated or
overstated, depending on various factors.  Although these factors may
offset each other, IRS and Congress have no way of knowing how much
tax is actually collected from CEP unless the problems are
corrected.\5

The 22 percent collection rate understates the taxes generated from
CEP audits when Appeals subtracts NOL from other tax years.\6
Although the corporation may owe additional taxes as a result of the
CEP audit, BMF records only the net amount instead of the amount
generated from the audits. 

For example, a CEP audit of taxpayer A's 1987 tax return may have
resulted in $100 million in recommended taxes that the taxpayer
appeals.  After appeals, the taxpayer agrees to a liability of $50
million.  However, the taxpayer files a claim with the appeals
officer for a tax refund of $40 million based on an NOL from another
tax year.  BMF will record only a net $10 million payment for audit
related collections.  This understates the contributions of CEP
because the collection rate will appear to be 10 percent rather than
the actual 50 percent.  About 3 percent of the appeals officers we
surveyed said this understatement occurred in their cases. 

On the other hand, the CEP collection rate was overstated when
subsequent events led to refunds of recommended taxes that the
corporation had already paid.  Again, BMF did not record this effect
to allow a truer measure of the CEP collection rate. 

For example, a taxpayer agrees in appeals to pay $40 million of $100
million in recommended taxes--a collection rate of 40 percent.  In
doing so, the taxpayer reserves the right to file a claim on certain
issues involving $20 million because of a pending court decision.  If
the court later rules against IRS, the taxpayer may file the claim
and receive a refund of $20 million.  IRS' databases would record the
$20 million refund but not associate it with an audit.  Instead, IRS'
databases would record the $40 million as an audit result, leading to
a 40 percent collection rate rather than the adjusted rate of 20
percent (the $20 million divided by the $100 million). 


--------------------
\5 Since 1990, IRS has attempted to create a system called ERIS to
track the amount of recommended taxes from all enforcement programs
that IRS eventually collects.  As of December 1993, IRS officials
said they hoped to have reliable collection data in 3 to 5 years.  We
believe our experience may offer ways to expedite the creation of
ERIS. 

\6 An NOL occurs when allowable deductions exceed gross income for a
tax year.  Taxpayers can save and deduct NOLs to reduce taxable
income for up to 15 years or claim a refund of taxes paid in the
preceding 3 years. 


   THE COLLECTION RATE DOES NOT
   MEASURE CORPORATE COMPLIANCE OR
   TAX GAP
---------------------------------------------------------- Chapter 2:4

It is important to recognize what the collection rate does and does
not represent.  In general, the rate measures the portion of
recommended tax assessments that ultimately gets collected.  On the
other hand, the rate does not measure corporate compliance or the tax
gap.  Specifically, the new CEP collection rate does not mean that
CEP corporations paid just 22 percent of their tax liability for
reasons explained in the next section. 

None of IRS' databases contained data for precisely measuring CEP
corporations' tax compliance.  For example, in a separate analysis of
BMF, we found that audited CEP corporations paid $379 billion in
taxes of which $21.5 billion, or 5.7 percent, resulted from CEP
audits.\7 For various reasons, this does not mean that the voluntary
compliance of these CEP corporations was 94.3 percent (100 percent
less 5.7 percent).  The 94.3 percent only represents the voluntary
portion of these corporations' tax payments--not of their total tax
liabilities.  It excludes any additional taxes that may be owed due
to noncompliance that IRS had not identified. 

Currently, IRS' data on CEP audit results only capture the amount of
additional taxes recommended from auditing certain issues on selected
tax returns.  IRS does not know about any additional tax liabilities
from (1) CEP tax returns that are not audited or (2) issues missed on
returns that are audited.  Our April 1992 report stated that IRS does
not audit every CEP return.  Using IRS' method to calculate audit
coverage, we found that IRS audited from 66 percent of CEP returns in
fiscal years 1987 to 77 percent in fiscal year 1991. 

Regarding noncompliance not audited or missed during an audit, we
reported in April 1992 that IRS applied an average of one direct
examination staff year to each CEP return examined for fiscal years
1987 through 1991.\8 This modest level of effort to audit complex
corporations with billions of dollars in assets and income will
undoubtedly miss some noncompliance.  In April 1991, the IRS
Commissioner testified that he believed IRS was not finding all the
issues on CEP tax returns.  Likewise, taxpayers and other IRS
officials have said that IRS is missing audit issues on these
returns. 

Among audited returns, CEP teams may identify noncompliance and
recommend additional taxes.  IRS did not have the data to allow us to
determine the extent to which any recommended taxes from CEP audits
truly represented additional noncompliance.  On one hand, Appeals may
concede some or all of these taxes because the CEP team lacked enough
information to fully support additional taxes.  Or, although the team
supported the additional tax liabilities, Appeals may concede them to
settle disputes.  On the other hand, Appeals may concede some
CEP-recommended taxes that teams raised in error and, as such, do not
represent additional tax liabilities. 

For these reasons, not only is the voluntary compliance rate of CEP
corporations unknown but the tax gap for these corporations cannot be
precisely measured.  The tax gap is the difference between the amount
of income tax owed for a tax year and the amount paid voluntarily. 
For CEP corporations, IRS assumed that the amount of CEP-recommended
taxes equals the tax gap. 

IRS estimated a $23.7 billion tax gap for 1992 among all large
corporations, including those in CEP.  Just as with the voluntary
compliance being understated, IRS' estimate of the tax gap would be
understated to the extent that IRS audits did not account for
additional noncompliance on CEP returns.  Conversely, the tax gap
would be overstated to the extent that the additional tax recommended
did not represent true noncompliance. 

Although not known, the voluntary compliance of CEP corporations may
be decreasing, which increases the tax gap, according to at least one
indicator.  In our April 1992 report on corporate compliance, IRS
officials said trends in recommended taxes can be an indicator of CEP
corporate compliance.  If their compliance increases, IRS officials
said CEP-recommended taxes should decrease to an extent.  Although
factors other than compliance can affect recommended tax amounts,
CEP-recommended taxes increased 47 percent--from $10.9 billion to $16
billion--over fiscal years 1990 to 1992.  No one knew all the reasons
for this increase, including the effect of possible lower voluntary
compliance. 

In the context of the tax gap, IRS officials believed that auditing
the unaudited returns would have little effect.  They said IRS staff
reviews unaudited returns for noncompliance before excluding them. 
Nonetheless, IRS officials said they have not tested their judgment
about the amount of noncompliance on these unaudited returns. 

In the final analysis, IRS' estimates of voluntary compliance and the
tax gap among CEP corporations are rough guesses, not precise
measures.  We believe that IRS could increase the precision of its
voluntary compliance and tax gap estimates if it (1) tested its
judgment to not audit some CEP returns every year and (2) developed a
method for quantifying the noncompliance not detected during CEP
audits. 

As one way to begin to quantify the amount of undetected
noncompliance, IRS could continue auditing CEP taxpayers after the
normal close of the audit.  The CEP team could probe further into
certain (1) corporate subsidiaries that received a cursory review, or
(2) tax return lines that were not audited in depth.  Doing such
probes, however, would increase the costs and burdens on IRS and
corporations. 


--------------------
\7 The number of years covered in this analysis varied for different
taxpayers.  See appendix I for a discussion of this analysis. 

\8 Tax Administration:  IRS Efforts to Improve Corporate Compliance
(GAO/GGD-92-81BR, Apr.  17, 1992). 


   COMPLEXITY AFFECTS MEASUREMENTS
   OF TAX COMPLIANCE AND THE
   COLLECTION RATE
---------------------------------------------------------- Chapter 2:5

Tax law complexity makes measurements of tax compliance and the
collection rate very difficult.  Complex laws provide opportunities
for different interpretations that may lead to different calculations
of corporate liability.  As a result, it is reasonable to assume that
CEP teams are likely to recommend additional taxes and that CEP
corporations are likely to challenge them.  In addition, complexity
can muddle Appeals' determination of tax liability. 

Because disclosure restrictions in section 6103 of the tax code
prohibit a discussion of issues that we reviewed in our cases, we can
only highlight some examples of complexity in laws or regulations
that complicate decisions for CEP teams and taxpayers.  We also
discuss how complexity has resulted in some tax disputes continuing
for over 30 years. 

For example, before the Revenue Reconciliation Act of 1993, taxpayers
could deduct the cost of purchased intangible assets, such as
customer or subscription lists, that had a readily determinable
useful life.  Goodwill was not amortizable because it does not have a
determinable useful life.  Therefore, to amortize an intangible
asset, the taxpayer was required to distinguish the intangible from
goodwill. 

Taxpayers have battled for more than 60 years over amortization of
intangibles.  In the last 20 years, taxpayers have been more
successful in identifying, valuing, and establishing useful lives for
a variety of intangibles.  Recent court cases have been decided on
the taxpayer's ability to prove that the asset exists and is separate
from goodwill.  In 1993, the Supreme Court held that a taxpayer may
depreciate the asset if it can be valued and has a limited useful
life that can be determined with reasonable accuracy. 

In our August 1991 report, we recommended that Congress consider
revising current tax law to allow amortization of purchased
intangibles, including goodwill, over specific statutory recovery
periods.\9 In 1993, legislation was passed to allow 15-year
amortization for many newly purchased intangible assets, including
goodwill and going concern value.\10

Another complex area of law includes provisions existing before the
Tax Reform Act of 1986.  Because many of our cases involved tax years
before the 1986 act, different corporate tax rates applied to
"capital" and "ordinary" income.\11 The tax code defined capital
asset very broadly as "property held by the taxpayer (whether or not
connected with his trade or business)" and excluded five categories
of property from capital asset status. 

While court decisions have set out guidelines for determining whether
an asset is capital or ordinary, those decisions depend on the kind
of asset and whether it fits within an enumerated exception.  Because
the character of the asset may depend on whether the taxpayer
purchased and held it with a business or investment motivation,
classifying assets is often difficult. 

These are just a few examples of the legal ambiguity in cases we
reviewed.  Complexity also arose from extremely detailed statutes and
regulations.  Specifically, the corporate alternative minimum tax and
the uniform capitalization rules have all increased complexity for
corporations. 

An August 1993 IRS contract study surveyed 365 senior tax officers of
CEP corporations on the causes of taxpayer burden.\12

Corporate officials who responded were nearly unanimous in believing
that the Tax Reform Act of 1986 added complexity, resulting in higher
tax compliance costs and less accurate information being provided to
IRS.  Although it was beyond the scope of our review to analyze how
to simplify the tax code, the corporate tax officials suggested
several ideas.  These ideas included using the income shown on a
corporation's financial statement as the basis for assessing taxes
and eliminating the alternative minimum tax. 

Taxpayers deserve a tax system with which they can voluntarily comply
at minimal burden.  Such a system does not exist for CEP
corporations.  We found CEP tax return issues that have been disputed
and remain unresolved after 30 years.  As of October 1992, 56 percent
(11,459) of 20,564 CEP tax returns in our database were unresolved
because of an ongoing activity (audit, litigation, criminal
investigation, or claim for a refund).  The 11,459 unresolved returns
covered various tax years, dating back to 1961, for 1,650 CEP
taxpayers.  (See table 2.3.)



                          Table 2.3
           
             Unresolved CEP Corporate Tax Returns


                 Number
                     of
              unresolve                      Criminal
                      d         Litigatio  investigat  Claim
Tax years       returns  Audit          n         ion      s
------------  ---------  -----  ---------  ----------  -----
1961 to 1969        196     83         93           1    102
1970 to 1979      2,413  1,134        914           5  1,374
1980 to 1989      6,734  6,169      1,149           8  2,451
1990 to 1993      2,116  2,299         53           2    169
============================================================
Total            11,459  9,685      2,209          16  4,096
------------------------------------------------------------
\a Number of activities exceeds number of returns because more than
one activity can occur at the same time.  For example, a taxpayer can
file a claim for refund while the return is being audited. 

Source:  GAO analysis from IRS data. 


--------------------
\9 Tax Administration:  Issues and Policy Proposals Regarding Tax
Treatment of Intangible Assets (GAO/GGD-91-88, Aug.  9, 1991). 

\10 The new rules generally apply to property acquired after August
10, 1993; however, a taxpayer may apply the rules to all property
acquired after July 25, 1991.  On February 9, 1994, IRS announced
that it will offer to settle pending disputes over the tax treatment
of intangible assets acquired on or before July 25, 1991.  Under
guidelines for settling the disputes, taxpayers will generally be
able to reduce the basis of acquired intangible assets for which
amortization was claimed on their returns.  IRS indicated that the
Supreme Court decision in Newark Morning Ledger and changes to the
tax treatment of intangibles in the Omnibus Budget Reconciliation Act
of 1993 (P.L.  103-66) led to its settlement decision. 

\11 It was more advantageous for a taxpayer who has a gain on the
sale of property to argue that the property was a capital asset.  If
a taxpayer realized a loss, it was more beneficial to argue that the
property was not a capital asset. 

\12 "Measuring Taxpayer Burden and Attitudes For Large Corporations,"
by Joel Slemrod, University of Michigan, and Marsha Blumenthal,
University of St.  Thomas. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 2:6

Although not a perfect measure, our 22 percent collection rate is the
only measure of how much IRS actually collects over time from CEP
audits.  Accordingly, until IRS develops better data, we believe IRS
should use this rate whenever it needs to estimate how much it
collects as a result of CEP audits. 

IRS can develop better data to track CEP audit results by improving
its databases.  Specifically, IRS needs to account for factors
causing the rate to be understated or overstated.  Afterwards, IRS
can update the collection rate. 

For various reasons, IRS did not know the extent to which CEP
corporations complied in paying their tax liabilities, much less
their total tax liability.  For example, CEP teams did not (1) audit
all returns or (2) audit all issues on audited returns.  Improved
compliance measurement is possible if IRS tests its assumption on not
auditing CEP tax returns that appear to have little revenue
potential.  For taxpayers who are audited, IRS should test whether
more in-depth audits to detect missed issues would be cost effective. 
Both tests will increase costs and burdens for IRS and corporations. 
However, due to the potential taxes lost if IRS' assumptions are
wrong, we believe limited tests are warranted. 


   RECOMMENDATIONS TO THE
   COMMISSIONER OF INTERNAL
   REVENUE
---------------------------------------------------------- Chapter 2:7

We recommend that the Commissioner of Internal Revenue

  use a 22.1 percent collection rate when estimating the taxes that
     will ultimately be collected from CEP audits until more reliable
     information becomes available;

  correct the factors in IRS' databases that caused the CEP
     collection rate to be understated or overstated (i.e., NOLs and
     refund claims after settlement) and use the corrected results to
     update the collection rate; and

  test the cost-effectiveness and accuracy of measuring CEP corporate
     compliance and the related tax gap by auditing samples of (1)
     unaudited CEP returns and (2) audited CEP returns in greater
     depth. 


   COMMENTS AND OUR EVALUATION
---------------------------------------------------------- Chapter 2:8


      IRS COMMENTS
-------------------------------------------------------- Chapter 2:8.1

In commenting on a draft of this report, the IRS Commissioner did not
agree to use a 22 percent collection rate.  While the Commissioner
agreed that the collection rate concept is useful for estimating
revenue, she believes that the 22-percent rate is too low and that
IRS' new database, ERIS, provides more accurate data.  We disagree on
both points.  We acknowledge in our report various factors (e.g.,
NOLs and refund claims) that could make the collection rate higher or
lower and recommend that IRS correct its databases to account for
these factors.  While we agree that ERIS will be an important data
source for IRS, ERIS will not produce actual collection rate data for
several years.  Until ERIS can produce an actual collection rate, our
22-percent rate is the only computation available. 

The Commissioner also criticized our draft report for using the
collection rate as the sole measurement of CEP effectiveness.  We
disagree; our draft report emphasized that the collection rate should
be used as one of many measures. 

The Commissioner did not specifically agree or disagree with our
recommendation to correct problems with IRS' databases that caused
the CEP collection rate to be understated or overstated.  The
Commissioner did state that the collection rate is a viable concept
for the budget and resource process and that IRS is developing a
baseline voluntary compliance measure using a definition and
methodology "very similar" to ours.  Given this effort, we are
surprised that IRS criticizes our collection rate and we hope that
IRS' methodology incorporates our suggestions for improving the
relevant databases. 

The Commissioner also did not agree to test IRS' assumptions about
auditing more CEP returns and doing fuller audits.  The Commissioner
agreed that such studies would be useful in estimating the tax gap
but raised doubts about the overall benefits of such studies.  Even
so, the Commissioner pointed out that IRS is doing a small-scale
project to evaluate the merits of expanding the scope of CEP audits. 
On the other hand, the Commissioner said doing such projects would be
too costly and burdensome.  We acknowledge IRS' concerns, but we
believe that checking these assumptions is critical given CEP's size
and importance. 


      TEI'S COMMENTS
-------------------------------------------------------- Chapter 2:8.2

TEI took issue with what it characterized as the alleged implication
in the report that tax noncompliance among CEP corporations was
likely to be significant.  TEI rejected the proposition of a single
correct tax liability from which any variance is evidence of
noncompliance.  Our report cites examples of CEP corporations not
complying.  However, before citing these examples, we devoted a major
section in chapter 2 to discuss why no one knows the level of tax
compliance among CEP corporations.  We do not see how this section or
the examples can be construed as evidence of significant
noncompliance among CEP corporations. 

TEI's letter seemingly acknowledged noncompliance by citing our
finding that CEP corporations voluntarily paid 94 percent of taxes
collected from them; the other 6 percent resulted from IRS' CEP
audits.  TEI contended that this 94 percent figure shows that CEP
corporations were among the most compliant taxpayers.  Although this
could be true, we do not view this as evidence of 94-percent
compliance among CEP corporations for various reasons as discussed in
this report. 

Further, TEI suggested that CEP corporations may in fact overpay
their taxes because they do not appeal all additional taxes that CEP
audit teams recommend.  We acknowledge that CEP corporations may not
appeal all tax recommendations that they reasonably could have
appealed.  We do not believe, however, that this means CEP
corporations overpay their taxes.  Our report points out forces, such
as CEP audit teams missing noncompliance or inadequately supporting
their claims of noncompliance, that could result in CEP corporations
underpaying their taxes.  In sum, we reiterate our conclusion--no one
knows the full extent of CEP corporations' tax liabilities. 

TEI also was concerned with what it believed to be our position that
CEP teams audit all tax issues on CEP returns.  TEI said that most
CEP corporations devote considerable time and energy to voluntarily
pay their taxes and already receive heavy IRS scrutiny.  TEI also
stated that this type of audit would create enormous delays and costs
for corporations as well as IRS.  We agree, which is why we did not
recommend this.  Instead, we recommended that IRS audit more issues
on a limited sample of returns in order to test IRS' assumption that
audit teams do not miss issues on CEP tax returns. 


MANY FACTORS RELATED TO THE AUDIT
PROCESS REDUCED CEP'S COLLECTION
RATE
============================================================ Chapter 3

CEP teams audit tax returns as part of IRS' mission to collect the
proper amount of taxes at the least cost to the federal government
and taxpayers.  As a result of these audits, CEP teams recommend
additional taxes that they believe the corporations owe.  Various
problems, attributable to both IRS and corporations, have weakened
the chances that these recommendations will survive.  These problems
also have increased IRS' costs and burdened CEP corporations. 

Although IRS has studied ways to improve CEP since the 1970s, serious
problems remain that reduced the collection rate.  Since 1990, IRS
has made changes to minimize some of these problems.  Our work
indicated that although these changes look promising, they have not
been fully implemented because of the decentralized way in which IRS
organizes its operations.  Even if implemented, the changes may not
be enough to address problems such as inadequate resources and tools
for doing CEP audits.  These changes and problems in the context of
the low collection rate are discussed below. 


   MOST CEP CHANGES HAVE NOT BEEN
   FULLY IMPLEMENTED AND MAY NOT
   BE ENOUGH
---------------------------------------------------------- Chapter 3:1

In 1990, IRS approved and began implementing 10 changes to enhance
CEP audits.  Given such recent approval, we did not attempt to fully
measure the effects of the 10 changes.  However, our case studies,
survey results, and on-site visits and interviews at selected IRS
districts in 1992 and 1993 did allow us to identify the status of the
changes and some preliminary results. 

From our work, we concluded that these changes offer the potential to
improve CEP.  For example, the changes may have contributed, to an
extent, to the recent trend in corporations agreeing to pay more
recommended taxes after audit, as discussed in chapter 2.  We found
that most of the changes have not been fully implemented, suggesting
the need for action.  Table 3.1 summarizes the status of these
changes as well as actions needed.  Chapters 3 and 4 offer
recommendations to address most of the needed actions. 



                                    Table 3.1
                     
                     GAO Evaluation of the Current Status and
                     IRS Actions Needed in Implementing CEP's
                              1990 Approved Changes

1990 approved changes              Status      IRS actions needed
---------------------------------  ----------  ---------------------------------
1. Expedited legal and technical   Ongoing     More consistent district counsel
assistance                                     involvement

2. Expanded ISP to clarify IRS     Complete    Further expansion to improve
positions                                      revenue agents' industry
                                               knowledge

3. Training revenue agents on      Ongoing     More training
issue development

4. Improved communication between  Ongoing     Better incentives for improved
CEP and Appeals                                communications

5. More involvement by IRS field   Ongoing     Managers still need to become
managers to improve (a) taxpayer               more involved for improvements to
cooperation, (b) audit currency,               occur
and (c) issue resolution

6. Field manager involvement in    Ongoing     Managers still need to become
audit planning, support audits,                more involved in these areas
and oversight

7. Better communications for       Ongoing     Districts GAO visited had not
audit teams through laptop                     received funds for laptop
computers and electronic bulletin              computers
board

8. Establish national policy       Complete    None
board to ensure CEP is properly
managed

9. Establish a national CEP        Complete    Has provided overall leadership,
director and CEP managers to                   but lacks authority
provide CEP leadership and
responsibility

10. Develop standards and          Ongoing     Needs revision; see chapter 2
measures for a successful CEP
--------------------------------------------------------------------------------
Source:  IRS documents and GAO analysis. 

On the basis of our surveys and interviews, the two approved changes
to provide more central direction over CEP--establish a national CEP
director and a national policy board--appear to have been fully
implemented.  IRS has also fully implemented its approved expansion
to the Industry Specialization Program (ISP).  Such changes seem to
have improved communication and coordination among the IRS functions
as well as oversight of CEP. 

However, IRS could make these changes even more effective.  We
believe that IRS could do more to improve revenue agents' industry
knowledge.  Further, although IRS established the position of CEP
director to provide development, oversight, and evaluation, the
director has no line authority over CEP revenue agents or resources. 
In March 1994, IRS officials said that they would soon expand the
director's responsibilities beyond the 1,700 CEP corporations.  These
responsibilities would cover IRS' audits (about 50,000) of all
corporations with assets exceeding $10 million but would not cover
the authority over field staff or resources.  The effects of this
expansion on CEP audits and related resources were not known. 

Similarly, the National Large Case Policy Board recently reviewed the
10 changes.\1 The Board's 1993 report noted marked improvement in
many areas, such as the increase in functional cooperation among
Appeals, District Counsel, and CEP.  However, the report identified
the decentralized CEP structure and budget as a key concern.  It
pointed to six CEP areas, which cut across many of the 10 changes,
needing improvement:  (1) a more centralized budget, (2) an improved
measurement system, (3) more issue agreements and case resolutions,
(4) better issue identification, (5) more timely audits, and (6)
accelerated tax collections.  The CEP Executive Director said that
these six areas affect CEP's ability to finish implementing the 1990
changes. 

We found inconsistent and incomplete implementation of the remaining
seven changes.  Our work showed that IRS' decentralized structure
hindered implementation of the seven changes; district offices have
been responsible for implementing most changes.  The CEP Executive
Director said that if he had line authority over CEP teams and a
separate budget, he could have ensured more complete and consistent
implementation of the seven changes. 

IRS' decentralized structure has evolved over time to protect against
concentrated power that could be abused.  In this structure, IRS'
districts acquired the major responsibility for operating various
programs.  Although IRS has been exploring ways to more effectively
operate in a modern environment, its decentralized structure has
become rooted. 

These 10 changes, even if fully implemented, will not solve certain
problems that contribute to CEP-recommended taxes not being
collected.  These problems included the following:  (1) CEP audit
teams lack needed resources, (2) CEP's measures of success skew the
incentives for audit teams in supporting tax recommendations, (3)
CEP's methods for obtaining needed data from corporations do not work
well, and (4) CEP teams lack knowledge about industries covered in
audits. 


--------------------
\1 "The State of the Large Case Program." report of the IRS National
Large Case Policy Board, January 13, 1993. 


   LACK OF BUDGET RESOURCES
   HAMPERED CEP AUDITS
---------------------------------------------------------- Chapter 3:2

IRS considers CEP to be one of its highest priority enforcement
programs.  However, in the four districts we visited, CEP did not
receive a commensurate priority in resource allocation.  The
decentralized structure allowed districts to shift resources to meet
other needs.  Our work showed that CEP teams often lacked funds for
training, traveling to corporate offices to obtain data, and hiring
private sector experts.  Such resource shortfalls hindered CEP teams'
ability to audit large, diverse corporations with operations
scattered worldwide. 


      TRAINING
-------------------------------------------------------- Chapter 3:2.1

Officials in CEP, Appeals, and District Counsel in the four districts
we visited generally said that CEP revenue agents need more training
on how to support recommended taxes.  These officials said that audit
issues were not fully developed, in part, because the agents were not
sure about what documents or expert testimony were needed. 

Only 26 percent of the 85 team coordinators responding to our survey
said they had been trained before being placed in their positions. 
About 33 percent of them reported that they needed more training,
such as on industry tax and accounting issues, to improve their
ability to do audits.  Further, none of the team coordinators in our
12 case studies had received extensive training on the level of
evidence needed to support tax assessment recommendations.  The
advanced corporate training course, which is required for CEP revenue
agents, covered such evidence standards only briefly.  We are
concerned about the lack of training for team coordinators.  As case
managers become responsible for other CEP audits, the team
coordinators continue to receive more responsibility for managing
audits.  (See ch.  1 for a description of CEP staff roles.)

We also found a need for more training on industries that CEP
corporations cover.  About two-thirds of the case managers and team
coordinators responding to our survey had not received training on
industries they audited.  In our survey, a team coordinator who had
specialized in the insurance industry since 1986 had the following
comments about the lack of such training. 

     "From May 1986 until the present time, I have only received
     about 8 days of continuing professional education training in
     insurance (examination of insurance cases is my specialty). 
     This is despite the fact that there were major changes in the
     tax law for life insurance companies in 1984 and property and
     casualty companies in 1986.  We have a number of newer agents
     who have been assigned to the insurance group for more than 1
     year.  These agents have not yet received any formal classroom
     training."

During our work, a revenue agent told us how the lack of industry
training can hurt an audit.  The revenue agent had been rotated from
a CEP team doing audits in one industry to a team in another industry
without any training on the new industry.  This agent erred in
computing an additional tax assessment because he did not know enough
about the tax laws for that industry.  The corporation had to train
the agent on how to compute the tax. 

An appeals officer who had done many CEP audits as a revenue agent
told us the training in Appeals has been much more extensive than
what Examination provided him.  The appeals officer said issue
development and collection rates would be improved if revenue agents
received similar training. 

CEP officials have long known about problems with training.  IRS' CEP
Quality Peer Review Report for 1991 stressed the importance of
training to keep revenue agents updated on tax laws and industry
trends.  The report concluded that a lack of funding had resulted in
revenue agents not receiving the training to do highly competent
work.  The report recommended that IRS develop industry, issue, and
tax law training for all CEP staff. 

A 1992 report by an IRS task force on CEP training concluded that a
lack of training puts revenue agents at a severe disadvantage during
CEP audits.\2 The report recommended that CEP officials develop a
training plan to cover tax law changes and to focus training on
industries being audited as well as other issues commonly raised
during audits. 

This task force also recommended establishing a specific budget for
CEP training.  Accordingly, IRS set aside about $4 million in fiscal
year 1993 for CEP training.  However, we found that three CEP
training courses to be funded through this budget were cancelled as
of May 1993 due to other district office priorities.  The CEP
Executive Director told us that training needs cannot remain unmet
year after year without harming audit quality. 


--------------------
\2 "A Roadmap To Quality CEP Focused Training," National CEP Training
Task Force, Final Report, September 1992. 


      TRAVEL AND SUPPORT AUDITS
-------------------------------------------------------- Chapter 3:2.2

In addition to training, district office decisions to allocate
resources to other areas have limited CEP travel and support audits. 
In one of the four districts in our review, audit teams lacked the
funds to travel to major subsidiaries of large corporations being
audited.  As a result, the teams could not collect information to
fully develop potential audit issues.  One CEP official commented on
the effect of inadequate travel funds on one audit. 

     "The taxpayer suggested a meeting every other month at the
     support site; however, due to lack of travel funds the case
     manager had to reduce these to quarterly meetings.  In addition,
     the case manager recommended that at a minimum the case manager
     and team coordinator travel to the support sites to attend these
     meetings.  Due to district restrictions on travel, only one IRS
     person, the team coordinator, is allowed to travel to these
     meetings.  Therefore, the case manager, who has ultimate
     authority and responsibility for that case and support audit, is
     not allowed to participate in key meetings which will determine
     the success of the examination."

If a district provides insufficient travel funds, its CEP teams
responsible for the audit could have a greater need for audit support
from other districts.  That is, revenue agents in other districts,
where the taxpayer being audited also conducts business, could help
by doing the audit work in their districts. 

In our survey, a team coordinator noted the following problems in
getting support audits when the district budget for CEP was too
limited to allow visits to a taxpayer's subsidiary operations. 

     "My current assignment has a member corporation whose home
     office is in another region.  This corporation has not been
     examined since joining the consolidated group -- at least 10
     years.  Its records for both book and tax are maintained in the
     other region.  Circumstances such as these warrant at least a
     limited scope audit.  I requested a support audit during the
     pre-audit stage of the cycle, and the case manager never
     forwarded the request.  I was told that since the support
     districts no longer receive credit for their work, and with
     budgetary restrictions, they would be reluctant to devote the
     manpower necessary to perform the requested work.  This would
     necessitate our going to the support district and doing the
     audit ourselves, and that wasn't going to happen."

The fiscal year 1992 CEP peer review found completed support audits
in 24 percent of the cases.  The peer review noted that support
audits allow CEP teams to utilize IRS-wide talent to meet audit
needs.  However, case managers and other CEP officials in all four
districts we reviewed were reluctant to request support audits.  They
said resource constraints and differing priorities across districts
meant that agents assigned to do support audits may not be qualified
for the job or be able to do the work when needed.  In summary, they
were not confident that they would receive work of as high quality as
they received when using agents from their own districts. 


      PRIVATE SECTOR EXPERTS
-------------------------------------------------------- Chapter 3:2.3

CEP teams also had difficulty obtaining district office funds for
private sector experts to assist on the audits.  Our work showed that
using experts could help CEP teams support their recommended
assessments.  Appeals officers said they perceived IRS' specialists
as less credible than taxpayers' experts and generally conceded audit
findings developed by IRS specialists.  They added that contracting
private sector experts would help increase the collection rate. 

In our follow-up with survey respondents, 20 percent of 82 team
coordinators told us that they needed but could not obtain a private
sector expert (e.g., an economist) for their cases.  In these cases,
district management did not agree that an expert was needed, given
available IRS specialists and insufficient funds.  Also, district
officials said needed experts were not readily available, and waiting
was impractical. 

CEP teams did not use private sector experts on any of the 36
top-dollar issues in the 12 cases we reviewed.  Of the 11 District
Counsel and Appeals officials who worked on these cases, 10 told us
that CEP needs to hire more experts to develop complex audit issues. 
They said taxpayers' experts have much greater influence in Appeals
and Tax Court than IRS' specialists. 

In one case involving the depreciation of assets, IRS' specialist
alleged that the taxpayer overstated the value of the assets.  The
appeals officer said he conceded most of over $150 million of
recommended adjustments because the courts would be unlikely to
uphold IRS' position when the taxpayer had hired a reputable
appraisal firm.  The appeals officer also said the courts generally
would not perceive IRS' specialists as credible in this case. 

In another example, the appeals officer said the CEP taxpayer hired
famous tax attorneys whose writings on taxation were often cited in
court.  Knowing this, the appeals officer said he felt obligated to
accept the taxpayer's position and conceded over $100 million in
recommended adjustments.  He said the credibility of the taxpayer's
experts exceeded that of IRS' specialists. 

IRS' fiscal year 1992 CEP peer review report found a similar problem. 
CEP used private sector experts in 16 percent of the cases reviewed
compared to 43 percent by the corporations audited.  The report
recommended that CEP teams obtain experts early in the audit to
facilitate information gathering and improve audit quality.  Further,
the report recommended that CEP officials in the National Office seek
additional funds to contract experts. 

IRS has allocated separate funds to CEP for contracting with experts
since fiscal year 1991.  According to National Office officials,
although these funds have helped to alleviate some of the pressures
on the districts when they requested experts, the funds were still
too limited to have a large impact. 

Having a central budget would facilitate the transfer of CEP funds
during the year from one district to another.  In our case studies,
19 of 24 CEP district officials agreed that the National Office
should directly control CEP resources, such as training, travel, and
private sector experts.  They generally supported having a central
CEP budget to deter districts from shifting CEP funds to other
district programs. 

In summary, no IRS program can get all of the resources that it
needs, particularly when budgets are tight.  But our work suggested
that CEP had some serious unmet needs and that resources would be
more certain under a centrally managed CEP budget.  With such
certainty, CEP team members and other IRS staff could be better
developed and utilized.  Although IRS would need to protect against
overcentralizing and thus undercutting other district programs, CEP
would be more likely to meet its mission in auditing large, complex
corporations if resource allocation were more centralized.  One
protection could be to leave the responsibility for specific
decisions about CEP audits and technical aspects at the district
level. 


   CEP PRODUCTIVITY MEASURES NEED
   TO PROVIDE MORE INCENTIVE TO
   REVENUE AGENTS
---------------------------------------------------------- Chapter 3:3

IRS measured CEP's productivity by the amount of additional taxes
that audit teams recommend and the time it takes to complete the
audit.  We agree with the Internal Revenue Service Manual that the
intent of an audit is to determine the true tax liability without
concern about the hazards of litigation.  It is not IRS' manual that
needs to be expanded, but rather its measurement of CEP.  For various
reasons discussed below, we believe that CEP teams also need to
consider the rate at which their recommended taxes are collected. 

Considered separately, we believe that IRS' current two measures have
some validity.  Using recommended taxes as one measure can encourage
revenue agents to identify more areas of potential noncompliance,
especially when complex tax laws make determining the true tax
liability difficult.  Measuring the time to complete audits is likely
to encourage audit teams to use their time effectively. 

On the other hand, we found that these two measures alone did not
provide adequate incentive.  Attempting to generate the most
recommended tax in the shortest amount of time can induce CEP teams
to bypass audit steps and not fully develop support for their
recommended taxes.  Thus, CEP teams had little incentive to review
all areas of tax returns, track down valuable data, or seek feedback
on its audits from Appeals.  We believe this lack of incentive led to
some poorly supported recommended taxes that could not be sustained
in Appeals.  Having the collection rate as another measure could
alter this incentive and result in CEP teams better supporting their
tax recommendations. 


      LITTLE INCENTIVE TO IDENTIFY
      AND FULLY DEVELOP
      RECOMMENDED TAXES
-------------------------------------------------------- Chapter 3:3.1

IRS' measures provided little incentive for CEP audit teams to
adequately identify and develop recommended taxes that can be
sustained after audit.  By focusing on recommended taxes and audit
cycle time, these measures can pressure teams to use the same audit
plan year after year--particularly if the old plan produced high
recommended taxes (regardless of whether Appeals had sustained these
recommended taxes).  CEP teams in 11 of our 12 cases generally
followed the same plan across audit cycles.  Limited time to complete
audits may help explain this tendency. 

We found that following the old audit plan can result in CEP teams
missing issues, overstating recommended taxes, and using resources
ineffectively.  For example, corporate officials told us that the
taxes recommended repeatedly by revenue agents often involved timing
issues that should not be developed in subsequent years once the
adjustment is agreed to and made. 

The most negative aspect of CEP audits cited by both the corporate
and IRS officials surveyed was the revenue agents' failure to
adequately support issues they raised during the audit.  An appeals
officer said:  "To create dollars, Exam (Examination Division) raises
too many weak issues.  This clouds the entire case.  Exam should
focus on solid issues and not be pressured to create tax." Also, a
case manager commented:  "Instead of encouraging agents to fully
develop their issues so that the government can eventually collect
the tax, ROI (return on investment using recommended taxes)
encourages agents to set up big deficiencies.  Finding issues is
probably easier than developing them."


      CEP TEAMS HAD LITTLE
      INCENTIVE TO COORDINATE WITH
      APPEALS
-------------------------------------------------------- Chapter 3:3.2

Measuring success by the amount of recommended taxes per hour also
gave CEP teams little incentive to coordinate with Appeals on how it
settled disputes over recommended taxes.  We found inconsistent
coordination between CEP teams and appeals officers.  Such
coordination could inform CEP teams about the reasons that Appeals
conceded recommended taxes from prior audits.  Without this
knowledge, agents may continue to recommend taxes that are likely to
be conceded. 

One of IRS' 10 changes in 1990 required CEP teams and Appeals to meet
before and after the case is decided by Appeals.  CEP teams can
explain their position on disputed issues and allow Appeals to ask
questions about the team's positions.  The teams may also use this
information to more fully develop their positions in the next audit. 
By May 1991, both functions had changed their procedures to require
these meetings. 

Before IRS required these two functions to meet before and after
settlements, our surveys indicated that communications between
Appeals and CEP teams on settlements were inconsistent.  Although 64
percent of the appeals officers said Appeals provided feedback to CEP
teams on the settlements, only about 40 percent of both the 56 case
managers and 73 team coordinators who had cases that went to Appeals
said Appeals provided feedback.  CEP officials said a possible reason
for the disparity could be that the feedback provided to Examination
was not provided to the CEP teams. 

Our case studies also showed this inconsistency.  For the nine cases
in Appeals we reviewed (most audited and settled before IRS
implemented its CEP changes), four CEP teams did not hold
preconference meetings with Appeals.  In addition, none of the nine
teams met with Appeals after the case was settled to find out why
recommended taxes were not sustained.  Moreover, the revenue agents
working on five of the nine cases said they had neither read the
written Appeals' report on the resolution of past audits of the same
taxpayer nor coordinated with Appeals before or after the audit. 
They said doing so takes time away from current audits and offers
little potential to recommend more taxes. 

In summary, we believe that measuring CEP on taxes collected in
addition to taxes recommended would balance competing incentives and
serve as a control against overstated recommended taxes.  With both
measures, CEP teams should feel less pressure to recommend taxes that
are unlikely to be sustained in Appeals or the courts.  They also
would have more of an incentive to fully develop issues that they do
audit.  As a result, the collection rate should increase from 22
percent. 

A January 1993 report issued by the Treasury Inspector General
illustrates what can happen by emphasizing recommended taxes over
taxes collected--IRS' overall mission.\3 The report described how IRS
managers in the Buffalo district manipulated statistics.  They
shifted recommended taxes from CEP audits to another audit program
that was falling short of its goal.  Because the CEP goal had been
met, they artificially enhanced the other program's results to attain
better performance evaluations and receive merit pay increases.\4
Although IRS prohibits using numerical goals to evaluate individual
performance, IRS holds managers accountable for meeting the program
goals.  The Inspector General concluded that problems he found may
exist throughout IRS. 


--------------------
\3 "Management Inquiry Into the Buffalo District of the Internal
Revenue Service," Department of the Treasury, Inspector General
report, (OIG-OQA-93-003, Jan.  12, 1993). 

\4 Although the Inspector General report did not indicate whether
CEP's collection rate as discussed in chapter 2 would be affected by
this shift in program results, we doubt that our computation of the
rate was affected.  We tracked the taxes recommended for each
specific CEP corporation, which would not be affected by the
manipulation of aggregated results. 


   AUDIT METHODS TO OBTAIN
   TAXPAYER DATA DID NOT WORK
   EFFECTIVELY OR WERE RARELY USED
---------------------------------------------------------- Chapter 3:4

CEP teams need corporate information to determine whether all income
is reported and all deductions and credits are allowable.  But
corporations can have difficulty finding information when IRS'
requests are vague or are for an old tax year.  To the extent that
CEP teams poorly planned the audit, vague requests are more likely. 
Also, the CEP teams and corporations may disagree on the types and
amount of information needed for the audit.  Such disagreements are
the normal product of the tension existing between tax administrators
and taxpayers in a complex tax system that depends on voluntary
compliance. 

We found that the two methods--IDRs and summons authority--that CEP
teams have to obtain needed taxpayer data were not working well. 
IDRs were not effective; and summons authority was seldom used
because of the time required to obtain a summons.  As a result, CEP
teams need more effective tools to use when corporations do not
provide requested information in a timely manner.  Such tools would
help ensure that CEP teams develop supportable recommended taxes that
can be sustained in Appeals. 

In our survey, 85 percent of team coordinators reported they did not
receive requested information in a timely manner, while about 30
percent said they had to close audits without receiving the
information.  Further, 76 percent of the 57 team coordinators and 61
percent of the 55 case managers who reported that their cases closed
later than planned said problems getting information from the
taxpayer caused the delay to a great or very great extent.  One team
coordinator responded to our survey with the following comments. 

     "The taxpayer procrastinated and was able to control the pace of
     the examination.  [IRS] management's decision to close the case
     with undeveloped, unagreed issues was a poor decision.  Exam
     should have fought for the records and issued summonses where
     required to properly develop issues."

Our case studies also showed the difficulty that CEP teams had in
getting information.  Out of the 12 cases, 5 teams extended the time
to complete the audits because the corporation did not provide needed
data.  In all, four teams had not received the data by the time the
audit ended. 

Rather than providing information to CEP teams during the audits,
corporations sometimes provided it only to Appeals.  In our survey,
about half of the 63 corporate respondents whose cases went to
Appeals said they introduced new information only to Appeals.  In the
9 appealed cases we reviewed, the corporations provided new
information to Appeals for 17 of the 27 top-dollar issues.  In two of
these cases, CEP officials told us they would never have recommended
additional taxes if they had received the related information during
the audit.  The information convinced Appeals officials to concede
about $30 million in disputed adjustments to taxable income.  If the
teams had not recommended these adjustments upon receiving the
requested information, the collection rate would have been higher. 

Overall, providing information to Appeals and not to CEP teams
significantly affected the collection rate.  In the 9 appealed case
studies, Appeals sustained almost 70 percent of the recommended taxes
when corporations provided the information to CEP teams compared to
none of those taxes recommended when the corporations provided the
information directly to Appeals. 

The fiscal year 1992 CEP peer review study also found that requested
information was provided by the due date in only one-third of the
requests, even though the team and the taxpayer had agreed on an
acceptable response time.  The peer review report viewed the
efficient exchange of information as essential to a quality audit and
recommended higher management attention. 

When corporations did provide requested information, many case
managers and team coordinators who responded to our survey were not
satisfied with taxpayers' responses.  About 40 percent were
dissatisfied with the completeness of the information.  CEP, Appeals,
and District Counsel officials we interviewed said taxpayers' failure
to provide requested information in the audit resulted in undeveloped
recommended assessments.  Our analysis of the nine case studies
showed that such recommendations were likely to be conceded by
Appeals. 

Both taxpayers and district CEP officials indicated that corporations
encountered difficulties responding to IRS' information requests. 
About 40 percent of the taxpayer respondents reported that they were
dissatisfied with the clarity and conciseness of the teams' requests. 
They believed that the IDRs were too wide-ranging or vague to be
processed quickly and accurately.  According to a report by an
organization whose members include CEP corporations, CEP teams
request irrelevant information when they are "fishing" for issues to
audit. 

IRS officials said while IDRs may be broad and vague, CEP
corporations did not always leave an audit trail that allows CEP
teams to identify the specific documents needed.  On the other hand,
CEP officials in the four districts we visited said they recognized
the corporations' difficulty in responding to IDRs.  They pointed out
that corporations had more difficulty when the requests involved tax
returns from many years ago, particularly if the taxpayers retained
tax information in multiple locations or lacked personnel to find the
information. 

Although the case managers and team coordinators in our survey
expressed dissatisfaction with taxpayers' overall cooperation in
responding to information requests, they rarely issued summons to
obtain the information.  In the survey, only seven case managers and
five team coordinators said they used IRS' summons authority to
obtain needed information.  Instead, they said they relied on
meetings with taxpayers to resolve delays or they reissued the
original request for data. 

We found this same condition in our case studies.  In the nine
protested cases, CEP officials met with the taxpayers to discuss
delays in obtaining requested information.  The CEP teams had not
used their summons authority in any cases, despite their
difficulties.  Most teams did not receive the requested information
in a timely manner, if at all.  In one case, however, a team used a
summons during a subsequent audit cycle when the corporation said the
information requested could not be located.  After receiving the
summons, the corporation located the records overnight.  However,
according to revenue agents in some of the districts we visited, a
summons generally does not provide such immediate results. 

Revenue agents in three of the four districts we visited said they
were reluctant to use the summons authority.  Under pressure to close
audits quickly, they said a summons must be enforced, which can take
from 6 to 24 months.  The agents also said they did not want to harm
good relationships with the corporations.  However, as a District
Counsel noted, agents do not have good relationships when
corporations do not provide requested information. 

We recognize that IRS' IDRs can cross the bounds of what would seem
reasonable to an independent observer.  As a result, we do not
believe that IRS should necessarily be able to obtain all of the
information that it requests. 

However, our case work showed examples in which even reasonable
requests for information were not met in a timely manner or at all. 
Given the practical difficulties of using a summons, the inadequate
corporate responses to IDRs, and the frequency with which
corporations provided new information to Appeals, we believe CEP
teams need more effective tools to gain better access to the
information for which their request is appropriate.  We have
identified the following options that could be used by IRS if a
corporation did not provide requested information without reasonable
cause: 

  Prohibit the corporation from introducing such information during
     appeals or trial.  A similar requirement exists in section 982
     of the Internal Revenue Code for foreign-based documentation. 
     This section can prohibit taxpayers from introducing that
     documentation in a civil tax case. 

  Provide IRS with the authority to assess a penalty for
     noncompliance with a request for certain information.  This
     authority could be similar to section 6038A, which allows
     penalties against certain foreign-owned corporations that fail
     to furnish requested information. 

  Give CEP the authority to impose penalties on corporations that
     willfully fail to produce requested data by the end of the
     audit.  No such penalty exists now.  Under this penalty option,
     Appeals and the courts could rule on whether the corporation had
     reasonable cause for not providing the data to CEP.  If so, the
     penalties imposed by CEP would be abated. 

We have not studied the cost-effectiveness of these three options. 
And IRS may want to examine ways to make the summons authority more
useful, by devising a more timely process or progressive steps
leading to its use.  Any of these approaches may improve IRS' ability
to obtain the necessary information.  Yet, all of them should be
considered as a last resort.  Working cooperatively with taxpayers to
clarify the IDRs and obtain the necessary information should be tried
first.  However, we believe enhancing IRS' tools as we suggest may
increase cooperation so that the new tools would rarely be needed. 


   REVENUE AGENTS WERE NOT
   ADEQUATELY INFORMED ABOUT
   INDUSTRY AUDIT ISSUES
---------------------------------------------------------- Chapter 3:5

We found that CEP revenue agents generally did not specialize in a
particular industry.  IRS policy has long required that agents rotate
from audits of one corporate taxpayer to another about every 6 years. 
We support the concept of rotation as an internal control to
safeguard the integrity of CEP, but whether the current 6-year
standard is appropriate today is another question.  IRS officials
told us that IRS is considering lengthening this period. 

We also believe that rotation is more important among corporations
than among industries.  In rotating among corporations on the 6-year
schedule, IRS' revenue agents have tended to also switch from doing
audits within one industry to audits within another.  Switching
industries, along with corporations, requires agents to learn
different accounting practices and audit issues.  As a result, agents
have more difficulty doing a quality audit under tight time frames. 

District CEP officials in our 12 case studies cited a need for more
industry knowledge.  Of 23 officials, 15 told us CEP revenue agents
often lacked the necessary knowledge of the industry environment, tax
accounting practices, and issues.  They believed this lack of
knowledge hindered revenue agents' ability to develop supportable
audit positions.  These officials said a portion of revenue agents
should specialize in industries to help CEP teams more effectively
audit corporations in the same industry. 

In addition, 11 percent of team coordinators and 27 percent of
taxpayers responding to our survey reported that they were
dissatisfied with the audit team's knowledge of the taxpayer's
industry.  One corporate official we surveyed said that the

     "Technical ability of Examining agents is woefully inadequate. 
     They just don't have the background or expertise to handle
     complex technical issues of CEP taxpayers.  To deal with an
     agent who has `a little knowledge' is a frustrating experience,
     since much time is taken up by responding to irrelevant
     questions."

The 1990 IRS quality improvement team for CEP recognized the need for
more knowledge of industries covered by CEP audits.  The team found
that ISP had not kept pace with the changing corporate world.  ISP
lacked effective communication across IRS districts.  Nor did it
adequately ensure consistency among audit teams in developing
positions on similar industry issues.  The team cited needed
improvements to ISP to deal with multi-industry corporations.  For
example, the team believed that an ISP that relies on each district
to coordinate its industry issues without national management will
not meet its intended purpose.  This team concluded that such an
approach lacked a mechanism to ensure that audit plans and industry
issues are uniformly developed. 

IRS expanded ISP, on the basis of its 1990 change, by having ISP
industry coordinators accumulate and disseminate information on
selected industries as well as IRS' audit positions.  IRS' goal was
to ensure a more consistent treatment of taxpayers.  IRS also created
electronic bulletin boards to improve communications among audit
teams in developing industry issues.  However, IRS did not develop
controls to ensure that revenue agents would use the information as
intended. 

We found ISP had not ensured that CEP teams would raise and develop
coordinated industry issues.  Three of four industry coordinators we
interviewed said their span of responsibility is too vast for them to
be adequately involved in all audits in their industry or to provide
all audit teams with needed assistance.  The industry coordinators
said they rely on audit teams to request their assistance when
problems arise.  However, they acknowledged that audit teams usually
did not have enough industry knowledge to know when to ask for help. 

Not having revenue agents who know about an industry can hamper
audits.  One CEP branch chief said an adequate understanding of the
taxpayer's industry is paramount for effective audits.  In 1 of our
12 cases, the lack of industry knowledge significantly hindered the
audit.  The district assigned three revenue agents to an audit
involving an industry about which they had no knowledge.  The team
coordinator had to spend time coaching the agents on the industry and
its accounting standards.  At the same time, the coordinator was
tasked with developing complex audit issues but lacked enough time to
accomplish this task. 

According to the team coordinator, this audit was inefficient.  The
agents only began to understand the industry and accounting standards
when the audit ended.  As a result, the major issues were poorly
developed and Appeals completely conceded two of the three top-dollar
issues, totaling over $800 million.  The corporation is litigating
the third issue. 

We believe developing industry specialization among revenue agents
would improve their abilities to audit CEP corporations.  IRS is
already developing a program to have agents specialize for non-CEP
audits of businesses.  So far, IRS believes this program has improved
audits.  We believe that this program can provide a road map to help
CEP meet challenges it may encounter through specialization. 
Believing that IRS still should rotate agents among corporations, we
favor a similar type of industry specialization for CEP audits. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 3:6

CEP is IRS' most important audit program given its complexity and
revenue implications.  Since the 1970s, CEP has been plagued by
various problems.  To correct these problems, IRS approved CEP
changes in 1990.  IRS districts, which have the major responsibility
for CEP audits, have not fully implemented all of these changes.  We
believe these changes are positive and need greater support from a
central authority for them to work effectively. 

The decentralized management of CEP has also contributed to these
problems.  This structure has allowed districts to shift CEP
resources to meet other needs.  Having fewer resources, CEP teams are
ill-equipped to do quality audits of large corporations with complex
operations.  In particular, we found that CEP teams needed more
consistent training on industry issues and audit practices.  More
centralized control over budget and staff resources, while balancing
other resource needs in the districts, could improve the audits as
well as the audit team's support for recommended taxes.  To protect
against excessive centralization, authority for making specific case
decisions could be left in District Office hands. 

IRS' measure of CEP--recommended tax increases per hour of audit
time--may encourage CEP teams to recommend tax increases not likely
to be sustained in Appeals.  Contributing factors include time
pressures to close audits and ineffective tools for obtaining needed
information from CEP corporations.  We believe that adding a new
measure--the rate in collecting recommended taxes--could provide
needed balance in discouraging CEP teams from continuing to recommend
taxes that Appeals is likely to concede. 

CEP teams and corporations may disagree on the types and amounts of
information needed for an audit.  While some IRS requests for
information may be overly broad or vague, CEP teams need information
to determine whether all income is reported and all deductions and
credits are allowable.  The CEP teams had problems getting timely and
complete information from taxpayers using IDRs and did not often use
IRS' summons authority--the current two methods of obtaining
information.  While we believe that CEP teams should first try
working cooperatively with taxpayers to clarify data requests and
obtain needed information, we also believe that IRS' tools do not
work well enough when corporations do not provide requested
information in a timely manner. 

Concessions of recommended tax increases in Appeals also arose
because CEP teams lacked knowledge about the industries that their
audits covered.  Our work showed that CEP revenue agents did not know
enough about industry trends and practices.  We believe that having
more such knowledge would improve CEP audits along with the chances
for recommended taxes being upheld in Appeals.  Given increasingly
complex corporations, specialized agents rotated among corporations
in the same industry would improve CEP audits. 

If the IRS changes are successful, CEP teams will be more likely to
improve their audits and recommend tax increases that can be
supported and sustained.  However, we see a need for other changes to
the CEP budget, training, and measures as well as CEP teams' access
to corporate data and their knowledge of industries. 


   RECOMMENDATIONS TO THE
   COMMISSIONER OF INTERNAL
   REVENUE
---------------------------------------------------------- Chapter 3:7

We recommend that the Commissioner of Internal Revenue

  give the CEP Executive Director authority over CEP budget resources
     and staff allocations at the district office level,

  ensure that CEP's revenue agents receive adequate training on the
     industry they specialize in as well as on tax laws and basic
     auditing skills such as standards of evidence,

  expand the measures of CEP productivity to include the percent of
     recommended taxes that is ultimately collected,

  issue regulations or propose legislation to strengthen IRS' ability
     to obtain needed data from CEP corporations during the audit
     after evaluating options for obtaining needed data from
     corporations as discussed on page 56, and

  modify CEP's policy to allow revenue agents to rotate among
     corporations in the same industries to the extent possible. 


   COMMENTS AND OUR EVALUATION
---------------------------------------------------------- Chapter 3:8


      IRS COMMENTS
-------------------------------------------------------- Chapter 3:8.1

The Commissioner agreed with our recommendations on training CEP
revenue agents.  She also agreed to modify CEP policy on rotating
revenue agents to the extent that circumstances and resources permit. 
In addition, she said that in fiscal year 1994, IRS will study the
three options that we suggested to increase IRS' ability to obtain
needed data from corporations during CEP audits. 

The Commissioner did not agree with our recommendation to give line
and budget authority to the CEP Executive Director.  We believe that
IRS assumed our recommendation was similar to ones made by IRS study
groups in 1990, which recommended major centralization.  The intended
scope of our recommendation was not as great.  We agree that full
centralization generates problems as well as benefits.  We clarified
our report recommendation to focus on centralizing authority over
resource allocation, not over CEP cases themselves. 

The Commissioner also did not agree with our recommendation to use
the collection rate as one measure of CEP productivity.  Even so, the
Commissioner said, in commenting on a recommendation in chapter 2,
that IRS is developing a voluntary compliance baseline measure using
a methodology similar to ours.  We continue to believe that this
recommendation is needed and IRS' proposed measure would suffice. 

The Commissioner also said we did not put enough emphasis on changes
that IRS was making to CEP, such as the continual involvement and
control by regional CEP managers and the new measures that IRS was
developing.  We added report language to further acknowledge these
changes and our support for IRS' efforts.  However, neither our
survey of 108 CEP cases nor our work during 1992 and 1993 at IRS
offices in 5 IRS regions provided evidence that regional CEP
managers' involvement had significantly improved the selection of
audit issues or resource allocation. 


      TEI COMMENTS
-------------------------------------------------------- Chapter 3:8.2

TEI raised concerns about whether we would be "jumping the gun" in
suggesting new penalties or sanctions if CEP corporations did not
adequately provide data that CEP teams requested.  TEI pointed to
many problems with these IRS requests, which our report has
discussed.  We also saw evidence of corporations not responding
adequately to reasonable requests. 

We differ slightly with TEI on these points.  In turn, our
recommendations asked IRS to evaluate the various options for
improving CEP teams' ability to obtain needed data.  We do not view
this as "jumping the gun." Our work did not lead us to conclude that
IRS' changes to CEP since 1990 will solve the problem, even though
they may lead to improvements. 

Regarding these ongoing changes to CEP, TEI characterized our report
as "more a historical portrait" of CEP in 1993.  TEI questioned
whether our findings from cases closed a number of years ago would
still be valid because of the many ongoing changes to CEP.  We agree
that much of our work focused on cases audited and settled in Appeals
before IRS approved changes to CEP in 1990.  This fact, however, did
not preclude us from analyzing the status of these changes as well as
the recent state of CEP.  We surveyed various IRS officials as well
as taxpayer officials involved in 108 cases--some settled in Appeals
after 1990.  In all cases, we asked questions about each of IRS'
changes.  Further, we interviewed 85 IRS and corporate officials in
various field locations up through mid-1993.  We drew on all of this
information in reaching our conclusions about the recent state of CEP
as well as IRS' changes. 


APPEALS' MISSION AND CONTROLS
CONTRIBUTED TO A LOWER COLLECTION
RATE AND UNBALANCED INCENTIVES
============================================================ Chapter 4

When corporations disagree with the additional taxes CEP teams
recommend, they usually challenge the taxes in Appeals.  If a CEP
team does not or cannot adequately support its recommended taxes,
Appeals has little choice but to concede these taxes.  Even if
Examination's position is supported, Appeals may concede the taxes in
full or in part on the basis of an assessment of the hazards of
litigating the issue. 

We found that Appeals has been striving to meet its stated mission

     "to resolve tax controversies, without litigation, on a basis
     which is fair and impartial to both the Government and the
     taxpayer and in a manner that will enhance voluntary compliance
     and public confidence in the integrity and efficiency of the
     Service."

While IRS may be meeting its mission to settle disputes without
litigation, we believe that this emphasis along with other factors
contributed to the 22 percent collection rate and challenged Appeals'
ability to meet other parts of its stated mission--to reach
settlements fair to both the government and the taxpayer and to
promote voluntary compliance.  Specifically: 

  Differing interpretations of complex tax laws led to extensive
     rework in resolving disputes year after year, which Appeals'
     settlements generally cannot resolve beyond the years in
     dispute. 

  The inherent conflict between Appeals' mission to settle disputes
     without litigation and Exam's mission to protect the
     government's interest by recommending taxes laid the groundwork
     for a low collection rate. 

  Appeals' controls for coordinating with other IRS offices, such as
     Exam and Counsel, either did not always work or did not exist,
     creating inconsistencies in settling tax disputes. 

Appeals has taken steps to improve the settlement process, such as
requiring opening conferences with CEP teams, sharing its settlement
results and rationales with CEP teams, and initiating an industry
specialization program.  We support such efforts and cite them
throughout this chapter.  Even so, further changes are needed to
balance incentives and tighten controls while allowing Appeals to
stay independent and impartial.  Besides reducing rework, our changes
should help improve the collection rate and consistent application of
tax law.  In sum, IRS should be better able to meet its mission of
collecting the proper amount of tax at the least cost and burden to
IRS and taxpayers. 


   COMPLEX TAX LAWS COMBINED WITH
   APPEALS' MISSION ALLOW TAX
   DISPUTES TO RECUR
---------------------------------------------------------- Chapter 4:1

Both IRS and taxpayers consider the corporate tax code complex and
ambiguous, causing legitimate differences in opinion over how the law
should be interpreted.  As a result, IRS has repeatedly audited the
same issues and corporations have repeatedly disputed IRS' audit
findings.  This cycle has drained IRS and corporate resources without
putting the disputes to rest.  Neither the appeals process nor
litigation are particularly effective means of resolving these
recurring audit issues; a better means may be tax law changes. 

As of September 1992, about 12,000 disputed issues with $99 billion
in proposed adjustments were waiting to be resolved by Appeals.\1 We
found that 14 tax code sections account for 5,279 (45 percent) of
these disputed issues and $56 billion (57 percent) of these proposed
adjustments.  IRS officials said they believed most were appealed by
CEP corporations.\2

Complex, ambiguous laws have created opportunities to characterize
transactions in order to achieve a desired outcome.  This
flexibility, in turn, increases the likelihood of tax disputes. 
Without clear tax laws, resolution of these disputes can get
complicated and can ultimately rely on the negotiating skills of
those persons representing IRS and CEP taxpayers. 

This was illustrated during our review.  We attempted to evaluate
whether Appeals' decisions on the 27 highest-valued issues in our 9
appealed cases were reasonable according to the tax code.  Tax law
ambiguity and complexity combined with Appeals officers' broad
discretion to settle disputes made this attempt inconclusive. 

Our survey results also indicated that ambiguity in the tax code is a
problem in resolving disputes over CEP audit results. 

  Hazards of litigation was the primary reason cited by appeals
     officers for partially or fully conceding issues.  They believed
     that litigation was too risky, given uncertainty over how the
     court would interpret tax laws. 

  About 90 percent of the corporations said they appealed
     CEP-recommended taxes because they disagreed with Examination's
     legal interpretation instead of its presentation of the facts. 

This lingering ambiguity on tax issues reduces CEP's collection rate. 
It also increases IRS' costs as CEP teams continue to raise the same
audit issues--recommending additional taxes--while Appeals continues
to settle disputes over the same issues.  Such rework also increases
corporations' costs.\3 Overall, the effects of complex corporate tax
laws contradict IRS' mission to collect the proper amount of taxes at
the least cost. 

Given the resource drain and burden imposed from reworking tax
disputes, we believe that IRS and Treasury should more actively seek
to permanently resolve these disputes.  We also believe that
proactively pursuing tax law changes, rather than relying on the
appeals process or litigation, is the best means of resolving
recurring issues. 

For example, Appeals' settlements do not produce binding precedents
for resolving similar disputes in future years.  Instead, they
generally resolve tax issues for just the years in dispute.  In
addition, case-by-case settlements have produced dissimilar treatment
for the same tax issue. 

Litigation also does not necessarily establish clear legal precedent. 
Several factors complicate the resolution of disputes through the tax
litigation system.  Because this system involves the Tax Court, Court
of Federal Claims, and federal district courts, conflicts among the
court decisions may arise.  It may take years before the Supreme
Court reviews conflicting decisions, if it ever does.  Litigation,
therefore, may not fully resolve the dispute but will add substantial
time and costs. 

IRS and Treasury already have a process that can be used more
proactively to propose tax law changes to Congress.  IRS annually
generates a list of legislative proposals that the Treasury
Department reviews and approves for the administration's
consideration.  Given the recurrence of many corporate tax disputes,
CEP officials said they annually offer proposals to permanently
resolve disputed tax issues.  The few proposals that survive these
steps are officially submitted to Congress.  We believe that these
proposals must be well supported, clearly presented, and seriously
considered. 


--------------------
\1 Tax Administration:  Recurring Tax Issues Tracked by IRS' Office
of Appeals (GAO/GGD-93-101, May 4, 1993). 

\2 The issues are being appealed by corporations, partnerships,
estates, and individuals.  Because of limitations in IRS' database,
we could not determine how many were appealed by CEP corporations
without doing a time-consuming analysis of all 5,279 open issues. 

\3 An IRS-contracted study by the University of Michigan concluded
that 1,300 CEP corporations together incurred costs totaling $2
billion a year to comply with federal, state, and local tax laws. 


   DIFFERING INCENTIVES LAID
   GROUNDWORK FOR LOW COLLECTION
   RATE AT APPEALS STAGE
---------------------------------------------------------- Chapter 4:2

Appeals' mission to settle disputes without litigation can conflict
with CEP teams' desire to recommend additional taxes.  Given that tax
law is open to interpretation, this difference led to more
recommended taxes that CEP corporations were likely to dispute and
Appeals was likely to concede.  Such differences not only produced
rework but laid the groundwork for the low CEP collection rate. 

Consistent with its mission, Appeals' goal in the mid-1980s was to
settle 85 percent of all types of cases without litigation.  Appeals
dropped this numerical goal in 1988 because its staff strove to
achieve the number instead of reasonable and fair settlements.  Even
without this goal, the settlement rates for CEP cases ranged from 84
to 93 percent in fiscal years 1990 to 1992. 

Such high settlement rates diverged from CEP teams' focus.  As
chapter 3 discusses, a key CEP measure was the amount of additional
taxes recommended per hour.  This measure provided a strong incentive
for CEP teams to recommend additional taxes if they had doubts about
a corporation's liability.  Conversely, Appeals emphasized settling
cases out of court.  This encouraged appeals officers to concede
recommended taxes to settle the case. 

With this imbalance, CEP's focus burdens "downstream" functions like
Appeals.  Similarly, Appeals' focus burdens "upstream" functions like
CEP because Appeals settlements do not set a precedent to follow as
do some court decisions.  A 1992 IRS study discussed the need to
examine its functional organization.\4 It concluded that a functional
organization does not maximize effectiveness.  The study proposed
using a systems approach to find ways to better organize work and
increase cooperation between functions.  It also proposed developing
measures to determine how well IRS meets its overall mission of
collecting the proper amount of tax at the least cost to the public. 

We believe one way IRS could increase cooperation and balance between
CEP and Appeals is to provide a common measure that applies to them
as well as meets IRS' overall mission.  That common measure could be
the collection rate.  If IRS added this measure to both functions,
appeals officers would have more incentive to

  meet with CEP teams before settling cases to better understand the
     audit findings, request any missing data, or provide any new
     taxpayer data; and

  clearly communicate to CEP teams as soon as possible the reasons
     why recommended taxes were not sustained so that the team can
     avoid raising the same issues in the same manner, thus reducing
     taxpayer burden and saving IRS resources. 

National Office Appeals' officials believed that using the collection
rate as a measure could induce some appeals officers to forget about
settling disputes fairly and just focus on collecting the taxes. 
Measures can affect behavior.  That is why they are important. 
However, for various reasons, we expect this added measure to have
overall positive rather than negative effects. 

First, Appeals already measures the portion of recommended tax that
it "recovers" rather than concedes.  As our work showed, this measure
did not induce appeals officers to focus on collection to the
exclusion of their mission.  Our idea of a common measure simply
extends this existing measure in Appeals throughout IRS.  Doing so
would allow IRS to see the total portion of recommended taxes
collected across all stages-- including agreements at the Exam level
as well as Appeals and litigation results. 

Second, National Office Appeals officials raised concerns about
relying on the collection rate measure when separate adjustments to
taxes owed, such as net operating loss carryover or carryback, can
confound settlement amounts for the actual issues being disputed. 
These officials did not know the extent to which these separate
adjustments skew the collection rate.  In chapter 2, we recommend
changes to IRS' databases in order to keep these adjustments from
overstating or understating the collection rate. 

Third, by tracking the collection rate across functions instead of as
a goal within each function, IRS employees would feel less pressure
to ignore their function's mission.  Even if some pressure started to
arise, appeals officers still would be subjected to other measures
and be expected to negotiate fair and objective settlements.  Given
their role of assessing hazards of litigation, the officers may
continue to use their independence to settle for a portion of the
disputed taxes rather than lose them all in court.  The difference
would be that IRS would measure such results overall. 

To the extent that a common measure encourages Appeals to share
taxpayer information with CEP teams and consider their
interpretations, more efficient audits with better supported
recommended taxes would become more likely.  Less rework and burden
on corporations would also be likely if Appeals' enhanced
communication led CEP teams to not recommend taxes that are unlikely
to be sustained due to inadequate support. 

In sum, these forces could better balance the incentives without
detracting from Appeals' independence and impartiality.  In fact,
applying the collection rate only to CEP teams would be unfair to
them and undercut the balance and incentive to communicate. 

Appeals' mission also involved another imbalance.  The pressure to
settle cases without litigation increased the incentive for CEP
taxpayers to appeal and hold out for more favorable settlements,
especially under differing interpretations of law.  Three of four IRS
District Counsel officials we interviewed favored more litigation to
guide IRS' tax positions on selected issues. 

We confirmed that IRS litigation is infrequent, relative to the
number of issues that the 1,700 CEP corporations appeal each year.\5
Counsel records showed that federal Tax, Claims, and District Courts
in fiscal year 1992 decided 46 CEP income tax cases of which 29 were
decided in Tax Court.  During fiscal years 1988 to 1992, Counsel
closed 96 income tax cases from Tax Court. 

However, litigation has a downside.  Neither IRS nor the courts can
handle major increases in litigation.  Litigation also adds costs for
the corporations and IRS as well as time and risk to dispute
resolution.  CEP taxpayers said any IRS willingness to litigate more
will force them to bypass Appeals and go to Tax Court.  Having the
ultimate decision over litigating, taxpayers may tend to litigate if
they see their cases as strong.\6

Resolving disputes at a lower level is preferable--particularly given
limited resources.  However, the propensity to litigate few CEP cases
may put IRS at a disadvantage in its negotiations and increase the
likelihood that CEP corporations will appeal and reach favorable
settlements.  Because litigation adds costs, time, and risks for all
parties, any IRS decision to litigate more disputed issues must
consider these factors. 


--------------------
\4 "The Internal Revenue Service Plan for Improving Customer
Satisfaction and Organizational Performance," Document 9039,
September 24, 1992. 

\5 We did our analysis using a list of taxpayers in CEP as of May
1991. 

\6 Even so, Chief Counsel data on 96 Tax Court cases closed from 1988
to 1992 for CEP corporations we surveyed showed a higher collection
rate, about 35 percent, than our 22-percent rate for a broader
universe of closed CEP cases. 


   APPEALS NEEDS BETTER AND MORE
   CONTROLS TO ENSURE CONSISTENT
   APPLICATION OF TAX LAWS AND A
   LEVEL PLAYING FIELD
---------------------------------------------------------- Chapter 4:3

We found that Appeals did not have sufficient controls to meet its
policies on coordinating with IRS functions.  The controls did not
always work or exist.  Without coordination, IRS is at a disadvantage
when Appeals does not share new information with CEP teams.  Or, if
Appeals' settlements conflict with Counsel's positions, inconsistent
applications of tax laws can arise.  We also found weaknesses in
other internal controls, such as those to prevent conflicts of
interest. 

Officials from Appeals and CEP corporations acknowledged the need for
Appeals to coordinate within IRS.  However, they raised concerns that
more coordination would create the perception that Appeals is less
independent and impartial.  We agree that Appeals must be independent
and impartial.  Before spending money to litigate, corporations need
to be able to contact an objective party at IRS who can review CEP
teams' support for recommended taxes.  However, we do not believe
that Appeals' coordination with other IRS offices will reduce its
independence or authority to objectively settle disputes. 


      IRS CAN IMPROVE CONTROLS TO
      ALLOW CEP TEAMS TO REVIEW
      NEW CORPORATE INFORMATION
      THAT APPEALS RECEIVED
-------------------------------------------------------- Chapter 4:3.1

In May 1991, Appeals formalized its policy to ask CEP teams to
evaluate new, significant information that corporations provide
during the appeals process.  The policy in effect for the cases we
reviewed, however, gave appeals officers the discretion to request
this evaluation.  Not allowing CEP teams to evaluate such information
created the potential for noncompliance to go undetected and for
Appeals to arrive at an incorrect settlement. 

Corporations often provided new information to Appeals.  Our survey
showed that over half of the 63 corporate respondents that appealed
provided new information.  Also, corporations provided new
information on 17 of the top 27 issues in our 9 case studies. 

We found that Appeals frequently did not give new information to the
CEP audit team for evaluation.  In analyzing the 17 issues in which
corporations provided new information, we found that Appeals did not
ask CEP teams to evaluate new information for 8 of the issues. 
District Counsel officials said they believed that corporations,
knowing Appeals usually did not ask for such evaluations, have
withheld information until the Appeals process. 

For example, on one of these eight issues, Appeals received new
evidence to counter an adjustment to taxable income worth more than
$5 million.  The appeals officer told us that he accepts at face
value the information that any corporation provides unless some
reason exists to question it.  CEP officials said that they had not
seen the information and that this corporation has a history of
submitting questionable evidence to support its tax return.  They
believed that Appeals should have provided the new information to
them for verification. 

IRS studies have uncovered similar problems under the current policy. 
A 1992 IRS review found that the policy to send new information to
CEP teams was not followed in over half of 28 Appeals cases
reviewed.\7 In these cases, CEP corporations provided new information
on 25 issues, but Appeals shared the information for just 9 issues
with the CEP teams. 

A 1991 quality review by one district caused it to establish
procedures for sending all new information from corporations to CEP
teams.  An appeals official in that district said this initiative
appears to have given corporations an incentive to cooperate at the
audit level.  In this district, 55 of 63 case managers and revenue
agents perceived that Appeals favored taxpayers.  They had not been
given a chance to rebut new facts and arguments.  On this point, the
report on this quality review stated that some Appeals officers were
reluctant to return cases to CEP teams due to time delays or to
teams' concerns about reworking the case. 

Our work confirmed these reasons.  Team chiefs told us Appeals'
reluctance stems from the increased time to close the case, which can
harm their performance evaluations.  Similarly, a CEP case manager
told us CEP teams may be reluctant to consider new corporate
information if doing so will reduce the additional taxes recommended
and increase their time charges to the case. 

Despite the added time it may take to close the case, we believe IRS'
policy is sound.  CEP teams need to see the new information to round
out their audits.  Given appeals officers' role to settle cases, they
should not have to also audit the new information.  Yet, without
better controls to ensure that CEP teams have a chance to evaluate
new information, taxpayers will have somewhat of an advantage during
the appeals process. 

We considered new controls to ensure that CEP teams not only received
new information but had a chance to comprehensively review it in the
context of Appeals' final settlement.  For example, a control from
other dispute resolution processes would involve having CEP and
corporate officials attend any meeting Appeals holds.  If CEP
officials attended Appeals' meetings, they could evaluate new
information.  They also could react to corporate presentations to
Appeals. 

Although our work indicated a need for CEP officials to react to
corporate presentation of new facts, we decided that requiring CEP
officials to attend all meetings with Appeals and corporate officials
posed problems.  Always having all parties at meetings could cause
lengthier meetings as the two sides argue their positions or prove to
be too burdensome because of numerous meetings. 

Instead, we favored another option.  We concluded that CEP officials
need one last chance to review all new information in the context of
Appeals' settlement--just before it is finalized.  This control would
allow CEP teams to determine whether they received all new
information and learn how appeals officers used it.  While this
control may increase the time necessary to reach settlement, it
should avoid the burdens from having all parties at every meeting. 
It also allows Appeals to retain its independence and may improve its
appearance of impartiality. 


--------------------
\7 National Office Appeals' 1992 Large Case Process Review, January,
15, 1993. 


      IRS CAN IMPROVE ITS CONTROLS
      ON COUNSEL COORDINATION TO
      ENSURE TAX LAW CONSISTENCY
-------------------------------------------------------- Chapter 4:3.2

Appeals also needs to improve a control intended to help ensure
consistent application of tax law.  This control requires, in certain
situations, that Appeals coordinate with Counsel on IRS' standard
legal positions before finalizing any settlement. 

Counsel at the National Office issues various types of guidance about
tax issues.  This guidance includes revenue rulings, private letter
rulings, and technical advice memoranda, which formally set forth
IRS' standard legal position.\8

CEP teams are required to comply with such standard legal positions
in developing issues.  Appeals is not required to do so when settling
the disputed issue unless these positions support the taxpayer, which
can result in inconsistent settlements.  Appeals officials said they
need the flexibility to deviate from standard positions in order to
remain independent. 

IRS has established some limits over Appeals' concessions of audit
issues for which IRS has a standard position.  IRS' manual requires
appeals officers to request and consider the views of the appropriate
Counsel office before completely conceding an audit issue supported
by an IRS standard position but two exceptions exist.  The
requirement does not apply if (1) the concession is less than 100
percent of the recommended tax or (2) the appeals officer believes
that the taxpayer's facts are distinguishable from the facts upon
which IRS' standard position was based. 

An appeals official pointed to a potential internal control weakness
in this manual section.  Team chiefs in the field have broad
discretion in settling disputes.  They can decide both whether their
settlements conflict with IRS' standard positions and whether
coordination is required.  Given their discretion, team chiefs can
justify no coordination in such settlements by, for example,
conceding less than 100 percent of the recommended adjustments.  In
sum, Appeals had no internal control system to track cases with
standard positions and check how chiefs used their discretion in
settling such cases. 

We checked disputed issues that relied on standard positions to see
whether the exceptions to coordination applied.  Of the 27 appealed
issues we reviewed, CEP teams raised 9 issues using such positions. 
Of the nine issues, Appeals fully sustained two issues totaling about
$150 million in adjustments to taxable income.  Appeals conceded at
least 60 percent of the adjustments in each of the seven other issues
involving about $800 million; four issues were conceded 100 percent
and a fifth issue 90 percent. 

Of these seven issues involving IRS' standard positions, Appeals did
not have to coordinate with Counsel on three and did have to
coordinate on two issues that were conceded 100 percent.  Given the
breadth of team chiefs' discretion and the exceptions, we could not
determine whether coordination was required for the last two issues,
both of which were fully conceded. 

  For one of these issues, the CEP team had used revenue rulings from
     earlier years.  Because the rulings did not specifically cover
     this CEP taxpayer, it was difficult to tell whether the rulings'
     examples applied to the actual facts of the disputed issue. 

  In another fully conceded issue, the Appeals team chief conceded
     $20 million contrary to technical advice issued to the taxpayer. 
     The chief said he saw no need to obtain the views of Chief
     Counsel because he believed the facts of the case materially
     differed from those stated in the technical advice.  However,
     Counsel had issued this technical advice to revoke an earlier
     advice when the CEP team illustrated how the taxpayer misstated
     material facts used in the earlier technical advice.  The team
     chief told us that the dispute was over the facts of the case
     and that the CEP team and Counsel were wrong and the taxpayer
     was right.  We disagree that this was just a factual dispute and
     that the legal merits of this case were not an issue. 

To enhance the consistent application of IRS' standard positions, we
generally support coordination with Counsel.  However, such
coordination occurred in only one of seven issues involving these
positions--largely because of the two exceptions to coordinating with
Counsel.  On the basis of our work, we favor changing these
exceptions, particularly for standard positions that rely on
technical advice and private letter rulings. 

In these two types of guidance, the facts apply to a specific
taxpayer and should be agreed to by IRS and the taxpayer before IRS
issues such guidance.  Because of this, the exception for the facts
materially differing should not apply.  Also, concessions for all
seven of the issues reviewed were at least 60 percent.  We believe
that coordination should occur for such substantial concessions
contrary to an IRS standard position.  Further, even if IRS changes
the exceptions, our work indicates the need to track the resolution
of disputes in which technical advice and private letter rulings
apply to the contested issues. 

Appeals officials we interviewed said they were concerned that more
coordination with Counsel would increase the time needed to close
cases.  However, Appeals already has added a coordination step for
its ISP issues.  It recently required appeals officers to seek review
and approval from the ISP coordinator before conceding ISP issues. 
These officials believed that this ISP review will save time because
the appeals officer could consult with a knowledgeable person about
an issue.  We support this new step as a way to ensure consistent
settlements.  We believe that such a coordination step is needed on
IRS' standard positions. 

IRS spends resources to establish standard legal positions and follow
them in audits.  If Appeals disagrees with the positions taken, its
concerns should be communicated to Chief Counsel in order to make
IRS' enforcement consistent.  If Chief Counsel concurs with Appeals,
CEP teams may not need to continue to recommend taxes on issues that
Appeals will concede.  Besides being cost effective and less
burdensome to taxpayers, this outcome should improve the collection
rate. 

One way to communicate concerns about standard positions is through
Appeals' written summary of its case decisions.  In certain cases,
Appeals is required to send this summary to the Joint Committee on
Taxation (JCT) for review.\9

We found that this written summary lacked information that JCT needed
to assess quality.  In the nine issues that CEP teams raised based on
Counsel positions, the summary for eight issues neither referred to
the position nor the reason that the position was not followed.  For
example, one summary made no mention that a CEP team followed a
standard position on a tax issue to adjust taxable income by over
$300 million.\10 Without mentioning this in the summary, future CEP
teams and JCT would not know how Appeals viewed this standard
position for the tax years of our case study. 

IRS requires these written summaries to explain the related tax law
and facts as well as the team chief's rationale for settling an
issue.  This rationale may include references to standard positions. 
However, IRS does not require that these summaries specifically
identify whether standard legal positions existed and were followed. 

These summaries are the only documents received by CEP teams for use
in future audits of the taxpayer and by JCT to evaluate the quality
of Appeals' decisions.  Without discussing the standard positions in
the summary, we believe that JCT, or any reviewer relying on this
summary, does not have all the facts needed to fully evaluate the
quality of the settlement. 


--------------------
\8 A revenue ruling offers IRS' official position on a legal issue. 
A private letter ruling informs a taxpayer how IRS will treat a
specific transaction for tax purposes; it must be honored only for
the taxpayer to whom it is issued.  Technical advice is furnished by
National Office to a District or Appeals office in response to a
question on the interpretation and proper application of tax laws
given the established facts of a specific case.  According to a Chief
Counsel official, it can take from 6 months to 2 years, and sometimes
longer, to issue a revenue ruling or technical advice. 

\9 Congress requires the JCT to review Appeals' settlements for tax
refund cases of $1 million or more and the two largest deficiency
cases closed by each region in a 6-month period. 

\10 Appeals officials said a written summary for prior tax years had
discussed this issue and the applicable technical advice.  We do not
believe that referring to a written summary for earlier tax years is
sufficient notification that CEP had followed a technical advice
memorandum for the current case. 


      APPEALS CAN IMPROVE ITS
      OTHER CONTROLS
-------------------------------------------------------- Chapter 4:3.3

IRS has established other internal controls in Appeals to prevent
collusion between the Appeals team chief and the taxpayer and to
ensure quality settlements.  These controls were that (1) no team
chief was to be assigned to the same taxpayer for more than 6
successive tax years and (2) Appeals' managers were to review the
quality of all settlements made by the team chiefs. 

We found that weaknesses allowed noncompliance with both internal
controls.  Specifically, in one of our nine case studies, the team
chief was assigned to the same taxpayer for 12 successive years, so
the first control was not followed.  This chief told us he was not
aware that any manager had reviewed his settlements since 1980, so
the second control was apparently not followed. 

The January 1993 IRS Large Case study also found that senior appeals
managers were not consistently following this second control by
reviewing the quality of the settlements.  In 14 of 28 large cases
reviewed, team chiefs did "poor" or "fair" in assessing the hazards
of litigation on 1 or more issues (i.e., 24 of 128 issues).  Even so,
6 of the 14 chiefs said they had not received any feedback.  Such
feedback could improve subsequent settlements.  The study recommended
that supervisors provide written feedback during and after the
appeals process. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 4:4

Appeals has been making some positive changes, such as its policy on
sharing its settlements and the bases for them with CEP teams.  But
its mission and controls have contributed to various imbalances that
can grant some advantages to corporations and that have lowered the
collection rate.  IRS' appellate function for settling tax disputes
without litigation where appropriate is crucial, but more changes are
needed to improve the balance as well as the collection rate.  We
believe these changes will allow Appeals to remain independent and do
its job in a fair and impartial manner to the benefit of the affected
parties. 

Our desire to increase the collection rate does not mean that
corporations will always pay more taxes.  They are likely to pay more
taxes if CEP teams have sufficient information and analysis to
support their recommended taxes, making Appeals' concessions less
likely.  They will not pay more taxes when better information leads
CEP teams to no longer recommend taxes that Appeals has repeatedly
conceded.  Thus, IRS and corporations will spend less money reworking
the disputed tax issues. 

Clear tax laws would also play a major role in reducing rework. 
Clarity would make voluntary compliance more likely, reducing the
issues that IRS revenue agents raise and that corporations dispute. 
In the long run, this would ease the burden on CEP corporations of
complying as well as reduce the costs for all parties. 
Unfortunately, certain tax issues continue to be audited and appealed
year after year.  Because Appeals' settlements cannot permanently
resolve the treatment of a tax issue, these tax disputes are likely
to recur.  Clearly, more needs to be done to prevent recurring
issues.  Because litigation can generate high costs and inconsistent
rulings, legislative clarification is the preferred alternative. 
While IRS internally develops some legislative solutions, few are
aggressively pursued and ultimately recommended to Congress. 

Further, the inherent imbalance between the missions of CEP audit
teams and Appeals contributed to rework and a low collection rate. 
Incentives encouraged CEP teams to recommend taxes and CEP
corporations to appeal them--particularly given ambiguities in tax
laws.  Appeals' mission was to settle cases without litigation.  The
imbalance can be mitigated without revamping the appeals process. 
Within the context of Appeals' mission to be fair and independent,
establishing a shared measure such as the collection rate should
improve the balance.  If so, Appeals and CEP teams would be more
likely to communicate.  IRS and corporate costs should decrease as
CEP teams recommend fewer taxes on issues that Appeals has repeatedly
conceded.  Also, CEP teams would be more likely to recommend taxes
that can be supported.  Both effects would improve the collection
rate. 

Better controls would help ensure Appeals' compliance with IRS
policies on (1) sending new corporate information to CEP teams and
(2) asking for Counsel's views before deviating from standard
positions in settling issues.  New controls also would help.  First,
Appeals' written summaries could disclose when standard positions
existed and, if the settlement was contrary to this position, the
reasons why.  Second, a system to track the coordination and
settlement of disputed CEP issues involving technical advice and
private letter rulings that apply to taxpayers would be beneficial. 
Third, Appeals' coordination with CEP officials just before settling
a case would allow the officials to check all new facts, given the
proposed settlement, at one time. 


   RECOMMENDATIONS TO THE
   COMMISSIONER OF INTERNAL
   REVENUE
---------------------------------------------------------- Chapter 4:5

We recommend that the Commissioner of Internal Revenue take the
following actions: 

  More strongly propose legislative changes to resolve more recurring
     CEP tax disputes. 

  Better balance incentives to encourage communication among Appeals,
     CEP teams, and Chief Counsel.  In addition to IRS' current
     program measures, consideration should be given to a
     cross-functional standard measure, such as the collection rate,
     that encourages all units to work toward the overall IRS mission
     to collect the proper amount of tax at the least cost. 

  Improve controls to ensure that Appeals provides CEP teams with (1)
     new information that taxpayers submit and (2) an opportunity to
     comment just prior to settling a case. 

  Improve controls to ensure that Appeals coordinates with Counsel
     before deviating from standard positions on CEP tax issues by
     (1) requiring coordination when Appeals concedes a substantial
     portion, (2) eliminating the exception on facts differing
     materially when Appeals settles an issue contrary to an
     applicable technical advice or private letter ruling, and (3)
     tracking settlements and coordination on disputed issues
     involving technical advice or private letter rulings. 

  Improve communication of settlement decisions and aid quality
     control efforts by requiring Appeals to identify the existence
     and effects of, and any deviations from, standard positions in
     its written summaries on CEP settlements. 


   COMMENTS AND OUR EVALUATION
---------------------------------------------------------- Chapter 4:6


      IRS COMMENTS
-------------------------------------------------------- Chapter 4:6.1

The Commissioner agreed with our recommendation to advocate
legislative changes to help resolve complex tax laws.  She added that
IRS regularly recommends changes to the tax laws with input from
Appeals.  Although we revised our original recommendation that IRS
attempt to litigate more CEP issues, the Commissioner concurred that
litigation may be necessary to resolve disputed interpretations of
the law. 

The Commissioner opposed some of our suggestions in the draft report
for better balancing incentives in Appeals.  Her concern was that
these steps would hamper Appeals' ability to settle cases in a fair
and impartial manner.  We had suggested in the draft report that IRS
measure Appeals by the collection rate and delete the phrase "without
litigation" from Appeals' mission statement.  We continue to believe
that more balance is needed.  We have, however, revised our
recommendation to recognize the need for IRS discretion in how to get
all functions working toward IRS' common goal.  One option could be
to use the collection rate as a common measure for both Appeals and
CEP teams.  Although the Commissioner raised concerns about this
option, she also noted that IRS already is developing and using
similar measures.  Acknowledging IRS' concerns, we also deleted the
suggestion that IRS change Appeals' mission statement. 

The Commissioner agreed with our recommendations on better controls
to ensure that Appeals coordinates with CEP teams on new information
but raised concerns about ways to meet this end.  We no longer
recommend that Appeals invite CEP officials to meetings with
corporate representatives.  Although we believe that such a practice
has merit, we recognize its potential downside, as reflected in IRS'
comments.  Instead, we now recommend that Appeals coordinate with CEP
just before finalizing its settlement to ensure that CEP teams have
seen all new information provided by CEP corporations and how it was
used.  If IRS implements this recommendation and our recommendation
on sharing new information with CEP teams, we no longer see the need
for having all three parties at Appeals' meetings. 

The Commissioner agreed with our recommendation that Appeals
coordinate with Chief Counsel on standard legal positions.  She also
agreed with our recommendation on clarifying Appeals' written
summaries of its settlements to specifically discuss the existence of
standard legal positions. 

However, she did not agree to replace the "full concession" exception
on coordinating with Chief Counsel with a "substantial concession"
exception.  We added language to the report to clarify our bases for
this recommendation.  Coordination does not usurp Appeals' authority
or independence to settle cases.  We believe that Counsel needs to
know when its standard legal positions have not been followed.  Such
knowledge may lead Counsel to change these IRS positions, which CEP
teams must adhere to during their audits. 

The Commissioner also made technical comments about our findings on
Appeals' mission and Appeals' coordination with Chief Counsel when
standard legal positions exist.  We met with Appeals' officials to
discuss these technical questions, and we clarified our report
language where necessary. 


      TEI COMMENTS
-------------------------------------------------------- Chapter 4:6.2

TEI raised major concerns with our conclusions and recommendations
for the appeals process.  TEI believed they would encourage more
litigation.  Although we do not agree with all of TEI's comments, we
have made changes to improve the tone and balance in this chapter. 

TEI interpreted our draft report as implying that Appeals "was giving
away the store." In fact, we pointed out that we could not evaluate
the quality of Appeals' settlements because of its discretion and the
ambiguity of tax law. 

We have made changes to our report to clarify our view on litigation. 
We never viewed litigation as a way to collect more taxes.  Rather,
we viewed litigation as a way, albeit a less desirable one compared
to legislative proposals, to clarify tax law and resolve disputes
over tax issues that recur year after year.  We have expanded our
discussion of its costs and burdens compared to its impact on
negotiating settlements during the appeals process and no longer
recommend more litigation to resolve recurring tax disputes. 

Nor do we still recommend that IRS change Appeals' mission statement
by dropping reference to settling disputes without litigation. 
Although we believe this phrase is redundant--given that settlement
connotes not litigating--we understand TEI's concerns about Appeals'
mission as an impartial, independent forum that taxpayers may use to
administratively resolve disputes. 


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

Our objectives were to determine (1) what portion of taxes
recommended in Coordinated Examination Program (CEP) audits are
collected after any appeals and litigation; (2) what factors, if any,
reduce the percentage of recommended taxes that are collected (i.e.,
the collection rate); and (3) what the status and initial impact are
of the Internal Revenue Service's (IRS) ongoing changes to improve
CEP. 


   COMPUTER DATA MATCH USED TO
   CALCULATE COLLECTION RATE
--------------------------------------------------------- Appendix I:1

To determine the CEP collection rate--the percentage of CEP-
recommended taxes ultimately collected--we did a computer data match
of corporate income tax returns between two IRS databases.  The
first, Audit Information Management System (AIMS), contains
information on audit results, including additional taxes recommended
at the close of an audit.  The second, the Business Master File
(BMF), contains information on taxable income, taxes not yet paid,
tax liability, penalties, interest, payments, refunds, and audit
actions for business tax returns. 

In both systems, each record contains the taxpayer identification
number (TIN), the tax year, and the return type, which for our
purposes is the corporate income tax return.  To make AIMS and BMF
data more compatible, we sorted the information in both databases by
TIN, tax year, and dates of closed audits.\1

Using a list of TIN for 1,684 corporate taxpayers in CEP as of May
1991, we were able to match 1,650 TINs to BMF.  For the 1,650 TINs,
we obtained records for 20,564 corporate tax returns for various tax
years ranging from 1961 to 1993.  The record of a corporate income
tax return generally remains on BMF for 5 years after all tax and
payment disputes are resolved.  We eliminated BMF records of tax
returns that had no audit adjustment code.  We also eliminated all
unnecessary BMF audit transactions that were posted before fiscal
year 1983.  This step was necessary because AIMS data were not
available before 1983. 

To use BMF data, we applied our criterion of a "completed audit
period." We defined this term as the period in which an IRS audit
made at least one tax adjustment, followed by an audit release
indicator.  As the starting point, we used the last day of the
previous audit period or, if not present, the date that IRS posted
the return.  The BMF audit release indicator identified the end of an
audit.  We added 30 calendar days to the audit release date to
identify late posting audit adjustments.  IRS also does this
adjustment on its new Enforcement Revenue Information System (ERIS)
to match tax adjustments to taxes recommended. 

BMF showed more than one audit period for some returns.  Multiple
audit periods can occur when IRS finds it necessary to readjust the
tax liability due to (1) a change in another period that affected the
tax liability, such as a net operating loss (NOL) carryback or a
taxpayer's filing of some other type of claim that was channeled
through the audit process. 

We also obtained complete AIMS records of corporate tax returns for
CEP audits closed by IRS examiners from fiscal years 1983 through
1991, all years for which IRS had complete data tapes as of the end
of fiscal year 1991.  We wanted AIMS records for the earliest year
possible because it generally takes 2 years from the date when a case
is closed on AIMS for it to work its way through the appeals process
to final resolution before the results appear on BMF.  It takes about
6 years for litigated cases. 

AIMS has the recommended tax adjustments for each closed audit.  We
dropped records that showed recommended taxes of $1 because some IRS
districts use this amount if, for some reason, they must close the
case on AIMS for a second time.  As with BMF, AIMS had more than one
record for a tax year for some CEP taxpayers.  Ultimately, our AIMS
database had records of 16,641 audits for 1,572 CEP taxpayers.  IRS
completed these audits from October 1, 1982, to September 30, 1991,
and recommended additional taxes of $60.7 billion. 

We matched the AIMS data to BMF using TINs and tax years, beginning
with our earliest AIMS records.  The BMF audit release indicator date
had to be the same as or later than the AIMS closing date.  We also
matched 8,874 AIMS records having recommended tax increases,
totalling $32.4 billion, to BMF.  This match showed that IRS
collected $7.1 billion of $32.4 billion, a collection rate of 22.08
percent after the appeals process. 


--------------------
\1 We converted dates on BMF and AIMS from calendar dates to
sequential dates for easier matches.  To illustrate, using February
1, 1986, the calendar date is written month/day/year (02/01/86), and
the sequential date shows the numerical position that date occupies
in sequence for a 365-day year and is written year/day (86032). 


      COLLECTION RATE BY INDUSTRY
------------------------------------------------------- Appendix I:1.1

To determine the collection rate by industry, we obtained a
Statistics of Income Division (SOI) tape that provided industry codes
by TIN.  Some taxpayers have no industry code because not all TINs
fit within an SOI industry group.  We matched the industry codes with
those tax returns that had the same codes on AIMS and BMF.  This
match allowed us to allocate 86 percent (about $28 billion) of the
$32.4 billion in tax recommendations and related collections to 141
industries.  Because high tax recommendations have the greatest
impact on the collection rate, we focused on the 10 industries for
which IRS recommended the greatest amount of additional taxes. 


      COLLECTION RATE BY DISTRICT
------------------------------------------------------- Appendix I:1.2

To determine the collection rate by IRS district office, we sorted
the $32.4 billion in recommended taxes (and related collections) by
districts, using the two-digit district codes on related AIMS
records.  Because high tax recommendations have the greatest impact
on the collection rate, we focused on the 10 districts with the
highest tax recommendations. 


      COLLECTION RATE OF
      FOREIGN-CONTROLLED
      CORPORATIONS
------------------------------------------------------- Appendix I:1.3

To determine the collection rate for foreign-controlled corporations
in CEP, we used IRS information that had been manually compiled by
IRS' International Division.  We matched TINs with tax returns that
had the same TINs on AIMS and BMF.  We were able to associate 9
percent of the $32.4 billion with 144 of the 206 CEP
foreign-controlled corporations identified by IRS. 


      COLLECTION RATE OF LITIGATED
      CEP CASES
------------------------------------------------------- Appendix I:1.4

To determine the collection rate of CEP cases that taxpayers pursued
through litigation, we obtained data from IRS' Office of the Chief
Counsel's management information system on large case disputes closed
in litigation for fiscal years 1988 through 1992.  The Chief
Counsel's database showed the amount of taxes and penalties both
before and after litigation.  We matched our database of CEP TINs
with the Chief Counsel's information to develop the collection rate. 


   OTHER ANALYSES OF BMF DATA
--------------------------------------------------------- Appendix I:2

We developed additional information on CEP taxpayers using data from
our BMF database.  The following BMF analyses excluded data on taxes
recommended or any other data from AIMS.  We analyzed

  transaction codes that identified tax payments from all sources to
     determine the percentage of total taxes paid by CEP corporations
     that audits generated;

  transaction codes for audits, litigation, criminal investigations,
     and claims to identify CEP audited returns that were not yet
     resolved;

  taxes due in order to compute the portion of CEP assessments
     unpaid; and

  transaction codes for penalties such as negligence, substantial
     understatement, and fraud to determine the number and amounts of
     enforcement penalties for CEP returns. 


   SURVEYS AND CASE STUDIES
--------------------------------------------------------- Appendix I:3

To determine what factors affected the percent of CEP-recommended
taxes that are collected and the impact of IRS' recent changes to
CEP, we surveyed IRS and taxpayer officials involved in a universe of
108 closed CEP cases and did in-depth case studies of 12 CEP cases, 9
of which had been appealed.  We also interviewed 85 IRS officials in
7 districts and 5 regions. 


      SURVEYS FOR 108 CLOSED CEP
      CASES
------------------------------------------------------- Appendix I:3.1

To identify factors affecting case settlement and the impacts of
recent changes to CEP, we surveyed IRS case managers, team
coordinators, appeals officers, and taxpayer representatives for 108
CEP cases.  Each case had $30 million or more in taxes recommended
and was closed by agreement with the Examination Division or closed
out of Appeals in fiscal years 1989 through 1991.  The threshold of
$30 million in recommended taxes enabled us to focus on the largest
cases with the greatest impact on the collection rate.  The 108 cases
in our universe involved $8.5 billion in taxes recommended by CEP
teams.  The threshold also produced a manageable universe size given
the number and complexity of our four surveys. 

The surveys asked about factors such as the sufficiency and quality
of IRS staff, training, issue identification and development,
taxpayer cooperation, and case delays.  The team coordinator, appeals
officers, and taxpayer representative surveys also asked about each
case's three largest dollar issues.  All four surveys asked for the
respondents' opinions of recent changes to CEP and Appeals' Large
Case Program.  We also asked respondents if the case outcome would
have been different had some recent changes to CEP been in effect at
the time.  To get information on IRS use of outside consultants, we
did a follow-up telephone survey of respondents to our team
coordinator questionnaire. 

IRS' database on closed cases originally gave us a universe of 128
cases that met our criteria.  After mailing the surveys, we received
new information from respondents showing that 20 did not meet our
selection criteria--for example, that cases were still open in
Appeals, were closed before fiscal year 1989, or involved tax
recommendations under $30 million.  We also adjusted the universe
sizes for each survey group when the designated respondent was no
longer with the IRS or was no longer a taxpayer representative.  The
universe included cases closed by agreement at the audit level; by
definition, these cases were excluded from the Appeals survey
universe.  Table I.1 shows the adjusted universe sizes for each of
the four surveys. 



                          Table I.1
           
               Adjusted Universe Sizes for Team
              Coordinator, Case Manager, Appeals
                Officer, and Taxpayer Surveys

                           Team
                     coordinato      Case   Appeals  Taxpaye
                              r   manager   officer        r
-------------------  ----------  --------  --------  -------
Original universe           128       128       128      128
 size
Cases not meeting            20        20        20       20
 universe criteria
Respondents not              19        34        10       12
 available
Cases agreed at the           0         0        15        0
 examination level
============================================================
Total unusable               39        54        45       32
Adjusted universe            89        74        83       96
 size
------------------------------------------------------------
IRS provided the names of the case managers, team coordinators, and
Appeals officers for each case.  We mailed the case manager, team
coordinator, and Appeals officer surveys in April 1992.  We mailed a
second one in May 1992 to those who did not respond initially.  We
asked case managers to send us the name and address of the taxpayer
representative for that audit case.  For cases in which the case
manager was not available, we followed up to identify the taxpayer
contact.  We mailed the taxpayer surveys in August 1992 with a
follow-up mailing in September 1992. 

During October and November 1992, we telephoned taxpayers who still
had not responded to encourage them to do so.  Our response rates,
based on usable responses received by January 1993, ranged from 76
percent for taxpayers to 97 percent for case managers.  Table I.2
summarizes our response rates for each type of survey. 



                          Table I.2
           
            Response Rates for Each Type of Survey

                           Team
                     coordinato      Case   Appeals  Taxpaye
                              r   manager   officer        r
-------------------  ----------  --------  --------  -------
Adjusted universe            89        74        83       96
 size
Surveys received             85        72        78       73
Response rate               96%       97%       94%      76%
------------------------------------------------------------

      CASE STUDIES
------------------------------------------------------- Appendix I:3.2

To better understand the CEP audit and appeals processes and the
factors that affect the collection rate, we did in-depth studies of
12 closed cases.  We judgmentally selected the 12 cases from the
universe of 108 cases that closed by agreement with Examination or
Appeals in fiscal years 1989 to 1991 and that had recommended
additional taxes of $30 million or more. 

We used several criteria to select our cases for detailed review: 
(1) location of the auditing district, (2) availability of case
documents and IRS staff (cases closed from CEP after 1986), (3)
collection rate for the audit, and (4) taxpayer's primary industry. 
On the basis of these criteria, we identified 26 cases available from
which to choose our 12 case studies.  (See table I.3). 



                          Table I.3
           
             Total Number of Cases From the Four
           Districts We Visited, Selection Criteria
                   by Collection Rate Range


                              10 to    40 to
District           0 to 9%      39%      99%    100%   Total
-----------------  -------  -------  -------  ------  ======
Chicago                  0        0        0       5       5
Houston                  1        3        1       0       5
Los Angeles              3        2        0       0       5
Manhattan                8        2        1       0      11
============================================================
Total                   12        7        2       5      26
------------------------------------------------------------
We selected 12 cases from 4 IRS districts--Chicago, IL; Houston, TX;
Los Angeles, CA; and Manhattan, NY.  These four districts accounted
for about 30 percent of the CEP's staff years and over 40 percent of
the taxes recommended in fiscal year 1990.  These cases also provided
a cross section of the nation and industries, including financial
services, food, petroleum, construction, and utilities as well as
conglomerates. 

The 12 cases used an average of 7 CEP audit staff years to complete. 
We could not obtain data on Appeals' staff years for these cases. 
However, the 1992 Appeals Process Review reported that Appeals' large
cases averaged about one-half staff year and 2-1/2 calendar years to
complete.  The 12 cases accounted for $1.5 billion (18 percent) of
the $8.5 billion of additional taxes recommended in our universe of
108 cases. 

As shown in table I.4, our selection covered three of the four ranges
of collection rates.  We selected three cases closed at the
Examination level and nine closed out of Appeals.  Table I.4 shows
the distribution of the 12 cases selected by rate and district. 



                          Table I.4
           
           Collection Rates of GAO-Selected Cases,
                     by District Visited


                              10 to    40 to
District           0 to 9%      39%      99%    100%   Total
-----------------  -------  -------  -------  ------  ======
Chicago                  0        0        0       3       3
Houston                  1        2        0       0       3
Los Angeles              2        1        0       0       3
Manhattan                1        2        0       0       3
============================================================
Total                    4        5        0       3      12
------------------------------------------------------------
In our 12 cases, CEP teams raised at least 70 and as many as 280
issues.  Given so many issues, we focused on the top three issues for
each case in terms of dollars raised.  Specifically, we reviewed
which issues were involved, how they were developed, and how they
were resolved.  We used these 36 issues to structure our review in
analyzing case documents and IRS databases. 

For each case, we reviewed the following case documents: 

  Revenue Agent Report (Form 4549)

  Reasons for Proposed Adjustments (Form 886A)

  Audit Plan (Form 4764A/B)

  CEP Case Status Report (Form 4451)

  Large Case Identity Record (Form 4143)

  Information Document request log, when available

  Examination Closing Record (Form 5344)

  Case Manager's activity log

  Records of opening and closing conferences, when available

  Specialists' reports, when applicable

  Corporate income tax return

  BMF transcripts

When applicable, we reviewed the following additional documents: 

  Request for National Office technical advice

  Technical advice memorandums, Determination Letters, and Private
     Letter Rulings

  Taxpayer protests and Examination's related rebuttals

  Appeals' Audit Statement and Case Memorandum

  Appeals' transmittal letter to Joint Committee on Taxation (JCT)

  Closing agreements

  Examination dissents to Appeals' settlements

Using standard formats, we interviewed IRS and corporate officials
for each case and IRS district, regional, and National Office staff
responsible for CEP and Appeals management.  Our interviews focused
on the impacts of (1) CEP audit policies and practices, (2) Appeals'
policies and practices, (3) the 1990 changes to CEP, (4) IRS' task
force studies and process reviews, and (5) other relevant case
details.  Overall, we interviewed 85 people at least once--including
6 branch chiefs; 8 case managers; 13 team coordinators; 4 technical
specialists; 6 industry specialists; 11 appeals officers; and 26
other IRS district, regional, and national officials as well as 11
taxpayer representatives. 

IRS national and district officials and corporate representatives
reviewed our surveys and case study approach.  They acknowledged the
validity of our approach and surveys.  District officials said our
selected cases were typical of their CEP audits and appeals.  In
addition to IRS, we sent our draft report to three former IRS
Commissioners, the Tax Executive Institute (which represents CEP
taxpayers), and other knowledgeable parties.  We incorporated their
comments in the report where appropriate. 

We did our work at the IRS National Office, 5 regional offices, and 7
of 59 district offices active in CEP.  The five regions included
Midwest, North Atlantic, Southeast, Southwest, and Western; the seven
districts included Boston, Chicago, Houston, Los Angeles, Manhattan,
New Orleans, and St.  Louis. 




(See figure in printed edition.)Appendix II
SURVEY OF CEP TEAM COORDINATORS
=========================================================== Appendix I



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(See figure in printed edition.)Appendix III
SURVEY OF CEP CASE MANAGERS
=========================================================== Appendix I



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(See figure in printed edition.)Appendix IV
SURVEY OF IRS APPEALS OFFICERS
=========================================================== Appendix I



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(See figure in printed edition.)Appendix V
SURVEY OF CEP CORPORATIONS
=========================================================== Appendix I



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(See figure in printed edition.)Appendix VI
COMMENTS FROM THE INTERNAL REVENUE
SERVICE AND OUR EVALUATION
=========================================================== Appendix I

pages 1 through 18 of IRS' general concerns portion of its letter to
facilitate interspersement of GAO comments, which are in boldface
type. 



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MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix VII


   GENERAL GOVERNMENT DIVISION,
   WASHINGTON, D.C. 
------------------------------------------------------- Appendix VII:1

Alan M.  Stapleton, Assistant Director
Tom Short, Assignment Manager
Deborah Parker Junod, Senior Evaluator


   OFFICE OF THE GENERAL COUNSEL,
   WASHINGTON, D.C. 
------------------------------------------------------- Appendix VII:2

Rachel DeMarcus, Assistant General Counsel
Shirley Jones-Clayton, Attorney


   KANSAS CITY REGIONAL OFFICE
------------------------------------------------------- Appendix VII:3

Royce L.  Baker, Evaluator-in-Charge
Kirk R.  Boyer, Site Senior
Yong Meador, Evaluator
Ronda Price, Evaluator
Jerry Hall, Analyst


   CHICAGO REGIONAL OFFICE
------------------------------------------------------- Appendix VII:4

Roger Bothun, Evaluator
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