Tax Administration: IRS' Use of Information Gathering Projects (Letter
Report, 02/05/98, GAO/GGD-98-39).

Pursuant to a congressional request, GAO reviewed the Internal Revenue
Services's (IRS) use of Information Gathering Projects (IGP), focusing
on: (1) the number of IGPs nationwide and in IRS' Georgia District
during fiscal years 1994 through 1996; (2) descriptions and results of
IGPs in Georgia during fiscal years 1994 through 1996; and (3) controls
and procedures IRS has in place for IGPs.

GAO noted that: (1) IRS reported that it had about 1,000 IGPs open
nationwide during both fiscal year (FY) 1995 and FY 1996; (2) data on
the nationwide number of IGPs in FY 1994 were not readily available; (3)
according to IRS officials, nationwide tracking records were discarded
or lost during IRS' reorganization efforts, which involved consolidating
63 districts into 33 and shifting responsibility for IGP records; (4) of
the 76 IGPs that were open in Georgia during fiscal years 1994 through
1996, over half focused on: (a) business taxpayers that potentially
underreported their income or overreported expenses; (b) business
taxpayers that potentially did not properly report or pay taxes, such as
the excise tax on fuels; (c) individual taxpayers who potentially
claimed an improper exemption, filing status, or earned income credit;
and (d) business and individual taxpayers who potentially did not file
required tax returns; (5) of these 76 Georgia IGPs, 41 had closed as of
June 1997; (6) the duration of these closed audits varied from several
months to several years; (7) the audit results, such as additional taxes
recommended plus penalties, also varied, with the additional tax amounts
ranging from $0 to $269 million; (8) for most of these IGPs, IRS audited
relatively few tax returns; (9) IRS closed about three-quarters of these
IGPs after auditing fewer than 50 returns, including 9 that closed
without any audits being done; (10) for years, IRS has had several
controls and procedures designed to limit the vulnerability of IGPs to
misuse as an audit selection technique; (11) IRS has always required
that proposed IGPs undergo review and approval processes at high levels
within the Examination Division in each of the districts; (12) to
oversee IGPs, IRS has a unit at each of its 33 district offices; (13)
these units monitor how returns were selected for audit and whether the
audit results justified continuance of the project; (14) further, IRS
recently has started adding processes to enhance the contribution of
IGPs to compliance research; (15) in 1997, IRS began implementing
compliance initiative proposal processes; and (16) IRS is involving its
Research Division in the processes for approving and overseeing IGPs in
the hope of making IGPs more useful for research purposes.

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

 REPORTNUM:  GGD-98-39
     TITLE:  Tax Administration: IRS' Use of Information Gathering 
             Projects
      DATE:  02/05/98
   SUBJECT:  Tax administration systems
             Tax return audits
             Federal downsizing
             Taxpayers
             Tax nonpayment
             Internal controls
             Statistical methods
IDENTIFIER:  Earned Income Tax Credit
             EIC
             
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Cover
================================================================ COVER


Report to the Honorable
Paul Coverdell, U.S.  Senate

February 1998

TAX ADMINISTRATION - IRS' USE OF
INFORMATION GATHERING PROJECTS

GAO/GGD-98-39

IRS' Use of Information Gathering Projects

(268816)


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

  CIP - compliance initiative proposal
  DIF - discriminant function
  IGP - Information Gathering Project
  IRS - Internal Revenue Service
  MACS - Midwest Automation Compliance System

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


B-277868

February 5, 1998

The Honorable Paul Coverdell
United States Senate

Dear Senator Coverdell: 

As part of its mission, the Internal Revenue Service (IRS) strives to
maintain the highest possible level of tax compliance.  IRS annually
audits a number of tax returns to determine whether taxpayers have
voluntarily complied with the tax laws and paid the proper amounts of
tax.  In selecting returns for audit, IRS' computer assigns a score\1

to each filed return to help find those having audit potential--that
is, those for which an audit would be likely to change the reported
tax because of noncompliance. 

Because such computer-aided selection techniques rely solely on
information on filed returns, IRS' Examination Division collects
information from other sources to identify areas of potential
taxpayer noncompliance.  Information Gathering Projects (IGP) are one
technique that IRS uses to collect information on noncompliance and
to identify returns with audit potential. 

Due to your concerns about IGPs being misused in auditing tax
returns, you asked us to study IRS' use of IGPs in identifying
returns for audit.  This report responds to your request for
information on the (1) number of IGPs nationwide and in IRS' Georgia
District during fiscal years 1994 through 1996, (2) descriptions and
results of IGPs in the state of Georgia during fiscal years 1994
through 1996, and (3) controls and procedures IRS has in place for
IGPs.  We focused on fiscal years 1994-1996 because accurate and
verifiable data for prior years were unavailable. 


--------------------
\1 This computer-generated score is called discriminant function
(DIF).  IRS has computed such a score since the 1960s by using a
formula created from the results of compliance audits of randomly
selected tax returns filed by individuals and other taxpayer
populations.  Through tax year 1988, IRS did these compliance audits
about every 3 years.  Using the score, IRS sorts returns into those
having and not having audit potential.  DIF is IRS' major source for
objectively identifying tax returns to audit. 


   BACKGROUND
------------------------------------------------------------ Letter :1

An IGP is a study or survey undertaken to identify noncompliance with
the tax laws.  IGPs can be proposed at any level--district, regional,
or national--within IRS but are generally initiated at one or more of
IRS' 33 district offices.  IRS staff propose IGPs on the basis of
past audits or studies that have shown noncompliance for selected
taxpayer populations, such as those in a particular occupation,
industry, geographic area, or economic activity, or those claiming a
particular tax exemption, deduction, or credit. 

During an IGP, IRS staff usually audit a limited number of taxpayers
within the selected population.  For IGP audits, IRS staff are to
select tax returns after reviewing information available within IRS
and from non-IRS sources such as banks, licensing and trade
organizations, or other third parties.  IRS believes that IGPs help
IRS staff to select potentially noncompliant tax returns for audit
that would not otherwise be identified as having audit potential.  In
this vein, IGPs have served as 1 of over 30 sources that IRS'
Examination Division uses to identify returns with audit potential. 
In recent years, IGPs have accounted for less than 5 percent of the
total number of returns selected for audit. 

In addition to using IGPs to identify noncompliance and take
enforcement action, IRS also intended to use them to determine the
reasons for noncompliance and recommend ways to reduce it.  However,
IRS has historically used IGPs as tools for enforcing tax laws rather
than as research tools for collecting data about compliance within
taxpayer populations.  Our past work has discussed some of the
problems with attempts to research noncompliance and related
solutions through IGPs.\2 For example, we raised concerns about
whether IGPs (1) focused on taxpayer populations with significant
compliance shortfalls and (2) collected statistically valid data that
could be generalized to a larger population.  As for IRS' management
of IGPs, we pointed to the benefits of enhanced coordination across
IGPs in order to avoid unnecessary duplication and to make fuller use
of IGP results. 

In recent years, IRS has been going through a transition involving
its framework for doing compliance research, including the use of
IGPs as research tools.  Under its 1997 compliance initiative
proposal (CIP), IRS is attempting to link IGPs to a larger research
framework and better manage IGPs to make them more useful for doing
compliance research.  In fact, IRS intends to refer to IGPs as
"compliance initiatives."\3 Recognizing these changes, IRS
Examination officials continue to view IGPs as essential enforcement
tools and sources for data on specific types of noncompliance. 

The revised framework also includes IRS' recent efforts to develop a
more comprehensive and statistically valid approach to compliance
research.  Under this approach, IRS has created new research methods
and tools as well as research units in each district to do compliance
research and to oversee compliance efforts, such as IGPs.  IRS hopes
that this approach will produce valid research data to better
identify significant noncompliance and the reasons for it, as well as
to better test ways to reduce the noncompliance. 


--------------------
\2 Tax Administration:  Profiles of the Major Components of the Tax
Gap (GAO/GGD-90-53BR, Apr.  4, 1990), Tax Administration:  Compliance
2000--A Worthy Idea That Needs Effective Implementation
(GAO/T-GGD-92-48, June 3, 1992), Tax Administration:  IRS Can Better
Pursue Noncompliant Sole Proprietors (GAO/GGD-94-175, Aug.  2, 1994),
and Tax Research:  IRS Has Made Progress but Major Challenges Remain
(GAO/GGD-96-109, June 5, 1996). 

\3 The term "compliance initiative" refers to and replaces all
activities/projects, such as IGPs, to study, measure, or improve tax
compliance. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

IRS reported that it had about 1,000 IGPs open nationwide during both
fiscal year 1995 and fiscal year 1996.  Data on the nationwide number
of IGPs in fiscal year 1994 were not readily available.  According to
IRS officials, nationwide IGP tracking records were discarded or lost
during IRS' reorganization efforts, which involved consolidating 63
districts into 33 and shifting responsibility for IGP records. 

Of the 76 IGPs that were open in Georgia during fiscal years 1994
through 1996, over half focused on (1) business taxpayers that
potentially underreported their income or overreported expenses; (2)
business taxpayers that potentially did not properly report or pay
taxes, such as the excise tax on fuels; (3) individual taxpayers who
potentially claimed an improper exemption, filing status, or earned
income credit; and (4) business and individual taxpayers who
potentially did not file required tax returns.  Of these 76 Georgia
IGPs, 41 had closed as of June 1997.  The duration of these closed
audits varied from several months to several years.  The audit
results, such as additional taxes recommended plus penalties, also
varied, with the additional tax amounts ranging from $0 to $269
million.  For most of these IGPs, IRS audited relatively few tax
returns.  IRS closed about three-quarters of these IGPs after
auditing fewer than 50 returns, including 9 that closed without any
audits being done. 

For years, IRS has had several controls and procedures designed to
limit the vulnerability of IGPs to misuse as an audit selection
technique.  IRS has always required that proposed IGPs undergo review
and approval processes at high levels within the Examination Division
in each of the districts.  To oversee IGPs, IRS has a unit at each of
its 33 district offices.  These units monitor how returns were
selected for audit and whether the audit results justified
continuance of the project. 

Further, IRS recently has started adding processes to enhance the
contribution of IGPs to compliance research.  In 1997, IRS began
implementing CIP processes.  IRS is involving its Research Division
in the processes for approving and overseeing IGPs in the hopes of
making IGPs more useful for research purposes. 


   IGPS NATIONWIDE AND IN GEORGIA
------------------------------------------------------------ Letter :3

IRS Examination staff can run IGPs in IRS' National Office, its 33
district offices, and its 10 service centers.  Table 1 shows the
reported number of IGPs for IRS nationwide and for the Georgia
District. 



                                Table 1
                
                IGPs Open Nationwide and in the Georgia
                   District During Fiscal Years 1994
                              Through 1996

IGP area                                          1994    1995    1996
----------------------------------------------  ------  ------  ------
Nationwide                                          \a   1,097     931
Georgia District                                    53      38      37
----------------------------------------------------------------------
\a IRS could not provide data on the number of IGPs during fiscal
year 1994 because records were discarded or lost during IRS
reorganizing and restructuring. 

Source:  IRS data for fiscal years 1994 through 1996. 

Because most IGPs start in one fiscal year and close in a later year,
the total number of individual IGPs is smaller than the sum of IGPs
for the 3 fiscal years.  For the Georgia District, the total number
of individual IGPs reported was 76, but the sum of the IGPs shown as
open in the 3 fiscal years in table 1 was 128. 


   RECENT IGP RESULTS IN IRS'
   GEORGIA DISTRICT
------------------------------------------------------------ Letter :4

For fiscal years 1994 through 1996, IRS provided information on 76
IGPs that were open at some time during these years in the Georgia
District.  Over half of these IGPs (44) focused on four types of
taxpayers:  (1) businesses that potentially underreported income or
overreported expense deductions; (2) businesses that potentially did
not properly report or pay taxes, such as excise taxes on fuel,
chemicals, or heavy vehicle use; (3) individual taxpayers who
potentially claimed an improper exemption for dependents, a filing
status (e.g., head of household), or earned income credit; and (4)
businesses and individual taxpayers who potentially did not file
required tax returns.  The remaining 32 IGPs dealt with a wide range
of suspected noncompliance involving topics such as the
misclassification of employees as independent contractors, income
from wagering, income from timber sales, and taxable events for
individual partners or shareholders. 

We tracked the duration and audit results of Georgia IGPs that had
closed at the time we did our work.  Of the 76 IGPs, 41 were closed
as of June 1997.  The length of time that these 41 IGPs had remained
open varied from 5 months to several years; more specifically, 23 of
the 41 IGPs lasted 2 or more years.  The audit results for the 41
IGPs also varied widely.  These results included the number of
returns audited, the additional taxes and penalties recommended, and
the percent of audited returns that recommended no tax changes.  For
example: 

  -- The number of returns audited ranged from 0 to 516 but usually
     involved fewer than 50.  Of the 41 closed projects, 32 involved
     audits, and 9 involved no audits.\4 Of the 32 projects involving
     audits, 23 were closed after auditing fewer than 50 returns
     each. 

  -- The additional recommended tax plus penalty amounts per IGP
     ranged from $0 (in the 9 IGPs closed without any audits) to $269
     million; of the 32 IGPs with audits, 11 recommended total
     additional tax amounts that exceeded $500,000, and 7 recommended
     total amounts exceeding $1 million. 

  -- Of the 32 IGPs with audits, 3 closed with a no-change rate that
     exceeded 50 percent, meaning that over half of the audited tax
     returns in these 3 projects were deemed compliant and that the
     audits recommended no tax changes.  Across all 32 IGPs, this
     no-change rate ranged from 0 percent to 60 percent, and the
     median no-change rate was about 20 percent. 

Appendix I to this letter provides specific details on IGPs in
Georgia during fiscal years 1994-1996.  Tables I.1 and I.2 provide
brief descriptions of projects that were not yet closed as well as of
those that were closed as of June 1997.  Table I.3 reports the audit
results of projects that were closed as of June 1997. 


--------------------
\4 An IGP can close without any audits when the information gathering
phase indicates that audits or further study of the selected
population is not warranted. 


   IGP CONTROLS AND PROCEDURES
------------------------------------------------------------ Letter :5

For years, IRS has had various controls and procedures in using IGPs
as audit selection tools, including the approval and review of
proposed projects, independence in the selection of returns, and
limits on the duration of the audit phase.  These controls and
procedures are designed to guard against any improprieties and misuse
of IGPs, as well as to better ensure productive use of audit
resources.  We did not test whether and how well these controls and
procedures have worked.  The following describes what these IGP
controls and procedures have included. 

IRS requires that IGPs be authorized by a district director or higher
level management official for a specified length of time.  According
to IRS officials, the process generally starts out informally when an
IRS employee, usually a revenue agent, discovers an area of potential
noncompliance.  The revenue agent discusses the issue with a manager
and IGP coordinator (who is to oversee and track all IGPs).  If these
parties agree about the potential for noncompliance, an Information
Gathering Project Authorization (Form 6545) is prepared and
forwarded, along with supporting documents, through various
organizational levels for review and approval. 

IRS officials also review IGP proposals to ensure that the project
conforms with Internal Revenue Manual requirements on IGPs.  Among
other things, the officials are to look at the (1) purpose and
objective of the project; (2) data (such as compliance measures) that
support the need for the project; (3) description of the data needed
to do the project, including why and how the data will be used; and
(4) time frames and resources necessary to complete the project.  In
addition, officials are to ensure that the project does not duplicate
other IGPs and that the potential noncompliance, which is the focus
of the project, can meet or exceed the noncompliance that would
otherwise be identified through audits initiated under DIF criteria. 

If approved at each level, the proposal continues to move up the
chain of command.  At a district office, this chain of command
generally includes the

  -- group manager of the revenue agent proposing the IGP;

  -- branch chief for that audit group manager;

  -- the chief of the Examination Division, who is responsible for
     all Examination activity in the district; and

  -- the district director, who is responsible for ultimate approval
     of the IGP as well as various other types of IRS activities
     within the district. 

In addition, other district Examination staff play a role in
reviewing and approving IGPs.  After the branch chief's review, the
IGP coordinator and the chief of the Planning and Special Programs
office (who is to oversee and track various types of Examination
programs) have a role in coordinating any further review and
approval.  Once approved by the chief of the Examination Division,
proposed projects are to be routed through the chief of the District
Office of Research and Analysis, who is either to concur or not
concur.  The District Disclosure Office also reviews each IGP
request.  Following this, the district director reviews the proposal. 
If the director approves, work on the project can begin. 

Approved IGPs normally include an information gathering phase and an
audit phase.  During the information gathering phase, the project
coordinator and/or project team--usually two or more agents
developing the IGP--collect and analyze information on a particular
type of taxpayer, such as child care providers.  Techniques and
sources for collecting information may include interviews with third
parties as well as reviews of internal\5 and external data related to
the IGP.  By analyzing the information, the project coordinator is to
identify whether the apparent noncompliance is significant enough to
warrant audits and, if so, which types of tax returns have audit
potential and should be audited. 

In a 1994 report,\6 we raised two concerns about the selection of
returns to be audited under IGPs.  We found that the controls and
procedures (1) were not adequate to prevent Examination staff from
selectively targeting individual taxpayers for audit, and (2) did not
require a separation of duties between staff who identified the types
of returns to audit and staff who selected the specific returns for
audit.  In July 1995, IRS issued new guidance to address these two
concerns about IGP controls and procedures. 

Under this new guidance, the project coordinator is to work with the
IGP coordinator to identify returns to be audited according to set
criteria, such as the type of tax return, filing status, dollar
threshold, and compliance issue being reviewed.  The IGP coordinator
is responsible for ordering the returns for audit under the project
that meet these criteria.  When the returns are received, the IGP
coordinator (who is located in Planning and Special Programs) is
responsible for getting them manually reviewed to check audit
potential using the criteria selected by the project coordinator. 
Returns with audit potential are assigned for audit according to such
criteria as the location of the taxpayer, grade levels of the agents,
and their knowledge about the issues that are the focus of the IGP. 

The duration of the audit phase for an IGP depends on whether (1) the
project team continues to find tax returns that fit into the defined
category of taxpayers, and (2) the auditors find sufficient levels of
noncompliance on the audited returns.  More specifically, the IGP
audits should find more noncompliance than that uncovered in audits
routinely selected by IRS using the computer-generated score produced
under DIF.  Because of these controls, some IGPs terminate after a
small number of returns are audited, compared to the number ordered
and assigned.  Upon termination of the IGP, IRS requires that a
termination report be submitted to the IGP coordinator to document
audit and other results.\7

In 1997, IRS began implementing additional processes under CIP that
cover all compliance initiatives, including IGPs.  IRS intends for
these processes to introduce more rigor so that the results from IGPs
and other projects can be used for research purposes.  CIP guidelines
require substantially more documentation for proposed compliance
projects than previously required.  The proposals must identify the
methodology to be used and the extent to which the project will
improve compliance within the district.  A district planning
council\8 is to submit the required documentation to the district
director together with its recommendation to approve or disapprove
the proposed project.  Upon completion of an approved project, the
results are to be reported to the planning council, which will make a
recommendation to the district director to either continue, expand,
or terminate the project, or to transform it into a fuller research
project at the local or national level. 


--------------------
\5 A primary internal data source is the Midwest Automation
Compliance System (MACS).  IRS can use MACS to identify returns that
fit the criteria established for the particular type of potential
noncompliance being covered by a specific IGP. 

\6 Tax Administration:  IRS Can Strengthen Its Efforts to See That
Taxpayers Are Treated Properly (GAO/GGD-95-14, Oct.  26, 1994). 

\7 In addition to the audit results, the termination report provides
(1) an assessment as to whether the tax adjustments justified the
time spent on the project, (2) descriptions of procedures and audit
techniques, (3) explanations of difficulties encountered during the
project and how they were resolved, and (4) suggestions for reducing
the specific area of noncompliance in the future. 

\8 The district planning council is a group that oversees district
activities, such as compliance initiatives, to ensure that they are
carefully planned and consistent with IRS' mission. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :6

To accomplish each objective, we interviewed responsible officials at
IRS' National Office, the Atlanta District Office, and the Southeast
Regional Office and collected data relevant to IRS' use of IGPs to
detect noncompliance with the tax laws. 

To identify the number of IGPs open both nationwide and in Georgia in
fiscal years 1994 through 1996, we reviewed available records from
IRS' National Office and Georgia District.  We did not verify the
accuracy of IRS' data on the total number of IGPs conducted
nationwide.  IRS' National Office could not locate data on the total
number of IGPs nationwide during fiscal year 1994.  According to
officials, IRS began a total restructuring in fiscal year 1994 that
reduced the number of district offices from 63 to 33 and shifted the
responsibility for maintaining IGP records.  Officials also told us
that IRS has no requirement to retain records on the number of IGPs. 

To describe the IGPs in the Georgia District and their results, we
collected and reviewed all available IGP authorization and
termination reports for fiscal years 1994 through 1996.  In addition,
we reviewed Examination Division data for individual project results,
such as the number of returns audited, total taxes recommended per
audit hour and per audited return, additional taxes recommended plus
penalty amounts, and the percentage of tax returns for which the
audit recommended no tax change.  We focused our efforts on all IGPs
that were open at any time during fiscal years 1994 through 1996. 

To describe the controls and procedures for IGPs, we collected and
reviewed relevant IRS documents and manuals as well as interviewed
responsible IRS officials in the National Office and the Georgia
District.  These controls and procedures included those established
for the approval of proposed IGPs, the independent selection of tax
returns to be audited, and the duration of the audit phase in an IGP. 
We did not test how well these controls and procedures for IGPs
worked.  Further, we collected documentation and did interviews with
the responsible IRS officials on the new processes being implemented
during 1997 under the CIP guidelines. 

We conducted our review from June to September 1997 in accordance
with generally accepted government auditing standards. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :7

In a letter dated December 12, 1997, IRS' Acting Chief Compliance
Officer commented on a draft of this report (see app.  II).  He said
the report fairly presented the information and he elaborated on
information dealing with IRS' controls over IGP and the new CIP. 


---------------------------------------------------------- Letter :7.1

As we arranged with your office, unless you publicly announce its
contents earlier, we plan no further distribution of this letter
until 30 days from its date of issue.  We will then send copies to
the Commissioner of Internal Revenue and Members of the Georgia
congressional delegation.  We also will make copies available to
others upon request. 

Major contributors to this report are listed in appendix III.  Please
contact me on (202) 512-9110 if you or your staff have any questions
about the report. 

Sincerely yours,

Lynda D.  Willis
Director, Tax Policy and
 Administration Issues


SUMMARY OF IGP ACTIVITY IN THE
GEORGIA DISTRICT, FISCAL YEARS
1994-1996
=========================================================== Appendix I



                                    Table I.1
                     
                      Profile of Georgia District IGPs Open
                      During Fiscal Years 1994-1996 and Not
                            Yet Closed as of June 1997

Project             Start date  Purpose
------------------  ----------  ------------------------------------------------
Auto dealerships      02/14/92  To identify auto dealerships that are diverting
                                 rebates from insurance and warranty contracts
                                 sold to customers. The project also focuses on
                                 (1) overstating inventory (cost-of-goods-sold)
                                 and other expenses due to an error in utilizing
                                 the LIFO (last-in-first-out) inventory method
                                 and (2) underreporting issues stemming from
                                 related finance companies and producer owned
                                 insurance companies.
Construction          03/13/92  To increase contractor and subcontractor
 contractor and                  compliance with (1) income tax filing and
 subcontractor                   reporting requirements and (2) 1099 filing
 compliance                      requirements. This project also focuses on the
                                 issue of contractors building homes and
                                 transferring them to themselves for less than
                                 fair market value, resulting in a significant
                                 dividend.
Scrap and             04/16/92  To determine whether the entities who receive
 recycling dealers               income from selling scrap products (paper,
                                 metal, glass, etc.) to companies dealing in
                                 recycling are reporting the income.
Land condemnation     04/26/92  To determine if taxpayers are properly
 awards                          reflecting land condemnation awards (in which
                                 real estate is acquired under the condemnation)
                                 on their tax returns.
Personal service      05/12/92  To identify personal service corporations that
 corporations                    do not use the required 34-percent tax rate and
                                 to adjust their tax computation accordingly.
Printing industry     05/15/92  To (1) gain knowledge of a very large growth
                                 industry, (2) identify the areas of
                                 noncompliance with the tax laws, and (3)
                                 develop techniques and procedures to deal with
                                 the noncompliance in the industry. Potential
                                 issues include excessive management
                                 compensation and changes in accounting methods
                                 resulting in large adjustments.
Child support         06/17/92  To identify individuals who may be using
 recovery                        improper filing statuses, claiming exemptions
                                 they are not entitled to, and erroneously
                                 receiving Earned Income Credit (EIC). The
                                 project focuses on those individuals making
                                 child support payments and filing incorrect tax
                                 returns in an attempt to receive an income tax
                                 refund.
Earned income         02/04/93  To determine (1) the level of compliance in
 credit (EIC)                    reporting EIC, and (2) whether taxpayers who
                                 filed as single or heads of household and
                                 claimed EIC are actually entitled to the
                                 credit.
Invalid 1120-S        02/04/93  To identify those individual shareholders who
 elections                       claim losses stemming from an 1120-S
 (i.e., corporate                corporation on their return, when the
 returns)                        corporation either has not filed the Form 2553
                                 (Request for 1120-S status) or has been denied
                                 1120-S status. The project also focuses on
                                 taxpayers' returns where the 1120-S election
                                 was approved for a subsequent year, but the
                                 loss was taken in the current year, for which
                                 the 1120-S status was not granted.
Wagering              02/10/93  To identify those individuals engaged in
                                 gambling activities and to determine their
                                 compliance with the tax laws.
Tax return            02/24/93  To determine whether individuals who own tax
 preparers                       return preparation businesses are filing their
                                 own individual income tax returns. This project
                                 also focuses on preparers who have claimed
                                 losses from their tax return preparation
                                 businesses.
Illegal income        03/04/93  To identify individuals who fail to report
                                 income from drug-trafficking activities. A
                                 potential issue is that substantial amounts of
                                 money and assets are connected with drug-
                                 trafficking activities and that individuals
                                 involved do not report their income.
Nonfilers             03/25/93  To develop cases on taxpayers who have not filed
 identified by the               tax returns for at least 1 year. The project
 Criminal                        focuses on those taxpayers identified by the
 Investigation                   Criminal Investigation Branch of the Atlanta
 Branch                          Service Center.
Heavy vehicle         05/24/93  To determine the degree of compliance of Georgia
 use tax                         taxpayers with the reporting and paying of
                                 heavy vehicle use tax.
Duplicate address     06/10/93  To determine which taxpayer is actually entitled
 returns                         to the head of household filing status and the
                                 related tax exemptions when the same mailing
                                 address is duplicated by several taxpayers all
                                 claiming the same filing status and exemptions.
Contract nurses       06/17/93  To identify nurses or respiratory therapists who
                                 work as subcontractors through placement
                                 agencies. A potential issue is that a number of
                                 these nurses and therapists do not file tax
                                 returns or claim erroneous expenses.
Excessive             07/15/93  To identify potential areas of abuse and
 deductions                      noncompliance by taxpayers filing at the
                                 Atlanta Service Center. The project focuses on
                                 individuals who may be taking excessive
                                 deductions on their income tax returns.
Unreported tip        08/14/93  To determine the extent of compliance in tip
 income                          reporting by employees and employers of large
                                 food and beverage establishments.
Tow trucks and        09/09/93  To identify individuals and corporations in the
 wreckers                        vehicle towing industry that are substantially
                                 underreporting gross receipts. The project
                                 focuses on three different types of towing
                                 services in which taxpayers are known to be the
                                 most noncompliant: (1) contract wrecker
                                 services for the government, ( 2) private
                                 impounding services for the government and
                                 private property owners, and (3) private towing
                                 services for individuals and businesses.
Bars and              02/01/94  To gain knowledge of the restaurant industry,
 restaurants                     identify areas of noncompliance with the tax
                                 laws, and develop techniques and procedures to
                                 properly audit the industry.
Fuel excise tax       02/20/94  To determine the extent to which taxpayers are
                                 claiming allowable fuel excise tax credits on
                                 form 4136 and whether individuals are filing
                                 correct income tax returns and complying with
                                 the fuel excise tax laws.
Corporate used        06/14/94  To determine whether corporate used auto dealers
 auto sales                      are properly reporting the income and finance
                                 charges (from financed sales) on the accrual
                                 basis and properly accounting for their ending
                                 inventory.
Voluntary Employee    07/10/94  To identify employers who utilize a VEBA to pay
 Beneficiary                     employee fringe benefits in a manner that
 Association                     results in significant tax deductions. These
 (VEBA)                          deductions are not in compliance with tax laws.
Healthcare            08/18/94  To determine whether (1) technical issues
 industry                        present in the Coordinated Examination Program
                                 (CEP) returns are present in the returns of
                                 health care providers not included in the CEP,
                                 and (2) fraudulent physician compensation
                                 issues are present in the returns filed by
                                 exempt, for-profit providers.
Alimony               02/09/95  To determine whether taxpayers who are (1)
                                 paying alimony are properly deducting it and
                                 (2) receiving alimony are properly reporting
                                 the income as required by tax laws.
Plumbing, heating,    02/20/95  To determine whether plumbing, heating, and air
 and air                         conditioning contractors and subcontractors are
 conditioning                    correctly reporting income and using the proper
                                 method of accounting. A potential issue is that
                                 this industry widely operates on a cash basis
                                 and uses inventory as a significant income-
                                 producing factor.
Form 8300             04/15/95  To (1) determine the level of compliance by
 compliance                      taxpayers in filing Form 8300 and (2) identify
                                 fraud where the nonfiling of form 8300 is
                                 deliberate. Tax law requires all cash payments
                                 received in a trade or business in excess of
                                 $10,000 to be reported on a form 8300.
Schedule C            06/21/95  To identify truckers who have claimed excessive
 truckers                        deductions for repairs and maintenance on their
                                 Schedule C. The goal is to have truckers deduct
                                 only necessary repairs paid in the tax year and
                                 to depreciate any capital expenditures.
Automotive            07/18/95  To determine whether individuals in the
 industry--                      automotive industry are filing correct income
 District Office                 tax returns and complying with the tax laws.
 of Research and                 The project focuses on those who appear to be
 Analysis Study                  filing questionable returns because they report
                                 (1) less than $25,000 in gross receipts on
                                 their Schedule C and (2) insufficient income
                                 over multiple years to support the expenses.
Real estate           08/25/95  To increase compliance with tax law requirements
 partnerships                    for subchapter K partnerships (distributions
                                 and transfers of interest) in the construction
                                 and real estate industry.
Adult                 12/05/95  To identify those adult entertainment clubs that
 entertainment                   classify their dancers as independent
                                 contractors, instead of as employees, and have
                                 set up a payment arrangement that avoids any
                                 type of form 1099 or W-2 reporting
                                 requirements. The project also focuses on tax
                                 compliance, nonfiler, and underreporting
                                 issues.
Chemical tax          05/16/96  To determine the level of compliance in
                                 reporting excise tax on chemicals and whether
                                 individuals are filing correct income tax
                                 returns and complying with the tax laws.
Reclassification      06/19/96  To determine whether 1120-S shareholders are
 of 1120-S                       receiving salary in the form of distributions,
 distributions to                instead of wages, to avoid the payment of
 wages                           Social Security and Medicare taxes and the
                                 withholding of income tax.
Lump-sum timber       06/28/96  To determine whether land owners who cut or sell
 sales to                        timber are accurately reporting timber sales,
 individuals                     using form T, filing form 1099, and computing
                                 basis. (Form T is the form used for lump-sum
                                 contract sales and retained pay-as-you-cut
                                 interest contracts.)
Schedule C filers     07/15/96  To identify Schedule C filers who underreport
 qualifying for                  their net Schedule C income to qualify for EIC
 EIC                             and receive an income tax refund. Potential
                                 issues include questionable situations
                                 involving Schedule Cs and EIC. In these cases,
                                 the taxpayer underreports business income and
                                 overreports business expenses to get the
                                 maximum amount of EIC and therefore generate a
                                 refund.
--------------------------------------------------------------------------------
Source:  IRS data for 1994-96. 



                                    Table I.2
                     
                      Profile of Georgia District IGPs That
                             Were Closed by June 1997

Project                  Dates        Purpose
------------------  ----------------  ------------------------------------------
Bail bond            01/17/92 -01/    To promote compliance in the bail bond
 companies               13/95         industry and determine whether bondsmen
                                       were correctly reporting income from
                                       deferrals and cooperative arrangements.
                                       Potential issues included whether some
                                       bond companies deferred income on monies
                                       received from clients whose bonds were
                                       bound over to state court. Also, bondsmen
                                       often cooperated with bondsmen in other
                                       cities in writing bonds for their clients
                                       but underreported income received under
                                       the cooperative agreement.
Automobile dealers   02/14/92 -03/    To determine whether automobile dealers
                         01/97         overstated their inventory (cost of goods
                                       sold) due to an error in the inventory
                                       method utilized.
Corporate employee   03/03/92 -04/    To determine whether corporate employees
 embezzlement            30/94         who embezzled funds reported the income.
Construction         03/13/92 -01/    To conduct a follow-up review of the
 revisited               31/95         construction industry. A prior project
                                       was run in 1987 to determine the level of
                                       compliance in the construction industry
                                       with reporting and paying income taxes.
Timber sales         03/16/92 -12/    To determine whether individuals who sold
                         31/93         timber were reporting the income from
                                       such sales. Form 1099s were not required
                                       to be issued to payees by purchasers of
                                       timber.
Construction of      03/16/92 -03/    To determine the level of compliance in
 personal                31/95         reporting correct income and expenses of
 residence                             taxpayers who constructed their personal
                                       residences at a cost of over $100,000.
Child care           03/26/92 -04/    To determine whether child care providers
 providers               05/94         were complying with tax laws. Potential
                                       issues include whether some providers
                                       cared for many more children than that
                                       allowed by the state, but only reported
                                       money earned from the "state allowed"
                                       number. Another issue was that the
                                       providers who qualified for food
                                       reimbursement from the state failed to
                                       report it on their tax return.
Poultry industry     04/16/92 -10/    To determine whether the industry was in
                         27/93         compliance with the income reporting
                                       requirements of the tax law.
Hazardous waste      04/16/92 -01/    To determine the degree of compliance in
 sites                   23/95         the industry, including whether companies
                                       assessed fines or penalties for
                                       environmental law violations deducted
                                       such penalties on their tax returns.
Customizing shops    04/23/92 -03/    To determine whether automobile
 (vans and cars)         24/94         customizing shop owners were complying
                                       with tax laws and filing income tax
                                       returns. The project also focused on
                                       individuals and customers who frequent
                                       these businesses and spend large amounts
                                       of cash on customizing their cars, vans,
                                       etc.
Advertising          06/15/92 -05/    To determine the degree to which the
 industry                22/95         advertising industry was in compliance
                                       with the income reporting requirements
                                       under tax law. Issues included cash
                                       versus accrual method accounting and
                                       inventory costs associated with the
                                       production activities of an advertising
                                       agency.
Casino report        06/15/92 -05/    To identify those individuals who gambled
                         31/96         at various casinos, purchased large
                                       amounts of chips in cash, and were either
                                       not filing or filing fraudulent income
                                       tax returns.
Ozone depleting      06/17/92 -12/    To determine whether taxpayers were filing
 chemicals               30/93         correct income tax returns and complying
                                       with the excise tax laws on chemicals.
Fraud referral       06/17/92 -03/    To determine whether taxpayers who had
 follow-up               31/94         been referred for fraud penalties in
                                       prior years were complying with the tax
                                       laws.
Self-prepared        06/22/92 -12/    To determine whether the complexity of the
 business returns        31/93         Internal Revenue Code contributed to the
                                       level of noncompliance among business
                                       taxpayers who prepared their own tax
                                       returns.
Nude dancers         06/29/92 -04/    To determine whether nude dancers complied
                         01/94         with tax laws and filed income tax
                                       returns. A potential issue identified
                                       from a televised news report was that
                                       many dancers reportedly earned $50,000
                                       and up annually and never filed tax
                                       returns.
Asbestos removal     08/03/92 -10/    To determine whether taxpayers who removed
                         31/94         asbestos from properties they own were in
                                       compliance with tax law. A potential
                                       issue was that asbestos removal costs
                                       were deducted instead of capitalized. Tax
                                       law prohibits the deduction of costs
                                       associated with permanent improvements
                                       that increase the value of any property.
                                       Asbestos removal enhances market value.
Auto salvage         08/06/92 -10/    To increase compliance in filed tax
 auctions                03/94         returns and reported income from the sale
                                       of salvage automobiles by used car
                                       dealers and repair shops.
Unmatched            08/31/92 -06/    To determine whether amounts that were
 information             30/95         reflected on mismatched information
 returns                               returns were reported by the taxpayer.
Accounting and       09/10/92 -09/    To determine whether individuals in the
 legal professions       30/95         accounting and legal professions were
                                       filing correct income tax returns and
                                       complying with the tax laws.
Laundromats          10/10/92 -02/    To identify those laundromats that
                         06/96         understated cash sales. Potential issues
                                       included whether the understatement was
                                       due to incomplete or fraudulent records
                                       of daily cash receipts. The project also
                                       focused on unreported income,
                                       nondeductible expenses, gains and losses
                                       in connection with the sale of
                                       laundromats, loans to and from
                                       shareholders, and unfilled income tax
                                       returns.
Livestock sold by    11/02/92 -05/    To identify gentlemen farmers who failed
 gentlemen farmers       02/94         to report income from the sale of
                                       livestock through stockyards.
Original issue       11/04/92 -12/    To determine whether taxpayers who were
 discount (OID)          31/96         holders of bonds issued by a certain
 exclusions on                         corporation were correctly reporting
 bonds                                 income. IRS found that some taxpayers
                                       included OID income as taxable interest
                                       income on their returns but then backed
                                       out the same income as an ordinary loss
                                       from unpaid accrued interest thus
                                       excluding the income. The taxpayers
                                       claimed that the corporation became
                                       insolvent and was incapable of paying the
                                       interest.
Medical              11/24/92 -06/    To increase compliance among individuals
 transportation          30/96         who generated income by furnishing
                                       medical transportation to Medicaid
                                       patients. A potential issue was that
                                       these individuals substantially
                                       overstated their business expenses or
                                       claimed expenditures of a personal nature
                                       as business expenses.
Peanut and other     02/09/93 -07/    To increase compliance among individuals
 crop quotas             31/94         who failed to report or underreported
                                       income from the sale of crop quotas for
                                       peanuts, tobacco, and other products. The
                                       project also focused on those individuals
                                       who improperly treated crop quotas as
                                       depreciable or amortizable assets. Crop
                                       quotas that may be sold can be obtained
                                       from the Agricultural Stabilization and
                                       Conservation Service.
Water                02/24/93 -12/    To determine (1) the level of compliance
 transportation          31/93         in the water transportation industry and
 companies                             (2) whether these companies were bona
                                       fide companies, tax shelters, or hobby
                                       losses.
Employee versus      05/12/93 -09/    To determine whether securities firms
 independent             30/94         treated their salespersons as employees
 contractor                            or as independent contractors. According
 (registered                           to IRS, the Securities and Exchange
 representative)                       Commission has a regulatory interest in
                                       assuring that all broker-dealers maintain
                                       the control and supervision required
                                       under the Securities and Exchange Act.
                                       The control required would indicate that
                                       the salesmen should be considered
                                       employees.
Video stores         05/24/93 -09/    To determine whether video stores were
                         30/95         correctly following tax law requirements,
                                       which state that video cassettes should
                                       be depreciated using either the straight-
                                       line or income forecast method of
                                       depreciation.
Financial products   06/01/93 -09/    To identify taxpayers who were involved in
                         30/94         the use of financial products (options,
                                       swaps, futures contracts, etc.) and
                                       determine whether proper characterization
                                       of gains or losses was made in accordance
                                       with tax laws.
Discharge of         09/02/93 -08/    To determine whether taxpayers properly
 indebtedness            31/94         included their discharge of indebtedness
                                       in income. A potential issue was that
                                       taxpayers had mortgages secured by bonds
                                       issued by their counties. When the bonds
                                       were paid off early, the county notified
                                       the mortgage company and the remaining
                                       mortgage was forgiven. Tax laws require
                                       that taxpayers include this discharge of
                                       debt in income in the year the discharge
                                       occurs.
Timber sales         11/02/93 -11/    To determine whether individuals who sold
                         18/94         timber were reporting income from such
                                       sales. Form 1099s are not required to be
                                       issued to payees by purchasers of timber.
Nonfiler             12/02/93 -12/    To encourage all partnership entities that
 partnerships            31/95         had ceased filing tax returns to file
                                       income tax returns and comply with the
                                       tax laws.
Lottery businesses   12/14/93 -06/    To determine whether business owners were
                         22/94         filing correct income tax returns and
                                       complying with the tax laws. The project
                                       focused on those business owners who
                                       filed applications with the state to sell
                                       lottery tickets but were refused
                                       permission to sell the tickets as a
                                       result of their failing to meet state
                                       criteria.
Georgia nonfilers    02/01/94 -01/    To determine whether Georgia taxpayers
                         31/96         were filing federal income tax returns.
                                       The project focused on three different
                                       segments of Georgia taxpayers who were
                                       potential federal nonfilers: (1)
                                       taxpayers who filed under the Georgia
                                       Amnesty program, (2) taxpayers who
                                       applied for licenses to sell lottery
                                       tickets, and (3) taxpayers identified
                                       with state sales tax information.
Farm credit          02/04/94 -09/    To determine whether farmers who did
 association             30/94         business with farm credit associations,
 members                               and who submitted crop checks as payment
                                       on their loan accounts, complied with the
                                       tax law requirements of reporting
                                       receipts as part of gross income.
Title VII            03/14/94 -03/    To determine whether taxpayers who
 discrimination          10/95         received awards based on a discrimination
 settlements                           complaint were including the correct
                                       amount in income.
Vaccine floor        04/20/94 -04/    To determine the level of compliance in
 stock compliance        30/96         reporting the vaccine floor stock tax
                                       that was due 2/28/94. This was a one-
                                       time tax.
Mortuaries and       04/20/94 -05/    To determine the degree to which the
 funeral homes           31/96         funeral home industry was in compliance
                                       with federal tax law requirements for
                                       funeral home income and information
                                       return (forms W-2 and 1099) reporting and
                                       proper matching of income with expenses.
Underground          05/04/94 -10/    To identify noncompliance with the tax
 storage tank            13/94         treatment of underground storage tank
 cleanup costs                         cleanup costs (capital versus current
                                       expenses).
Depreciation on      07/14/94 -07/    To ensure depreciation compliance by
 tax-exempt bonds        27/95         taxpayers who received private tax-
                                       exempt activity industrial development
                                       bonds. A potential issue was that
                                       taxpayers often used the other-method and
                                       life depreciation methods instead of the
                                       straight-line alternative and required-
                                       life depreciation methods that are
                                       required by tax law.
Debenture            07/14/94 -07/    To determine whether income (gains) from
 conversions             31/95         the conversion of debentures was reported
                                       in accordance with the tax law
                                       requirements.
--------------------------------------------------------------------------------
Source:  IRS data for 1994-96. 



                                    Table I.3
                     
                     Results of Georgia District IGPs Closed
                                   by June 1997

                                                                          Percen
                                   Tax        Tax                           t of
                      Return    amount     amount                             no
                           s       per        per                         change
                      audite     audit    audited  Total amount of taxes  return
Project                    d      hour     return     plus penalties           s
--------------------  ------  --------  ---------  ---------------------  ------
Bail bond companies      142      $578    $10,874       $1,544,105           22%
Automobile dealers       516    16,363    521,320       269,001,321           12
Corporate employee        18     6,662    154,342        2,778,147             0
 embezzlement
Construction             105       848     12,605        1,323,563             8
 revisited
Timber sales               9       240      1,441         12,969              33
Construction of           25       540     18,934         473,351             12
 personal residence
Child care providers      24       957      3,826         91,824              13
Poultry industry           7         8        164          1,148              57
Hazardous waste           27       589     18,379         496,222             22
 sites
Customizing shops          5        81      2,045         10,226              60
 (vans and cars)
Advertising industry      46       720     15,833         728,318             23
Casino report             80       497     18,887        1,510,960            20
Ozone depleting           90     1,096      1,096         98,640               1
 chemicals
Fraud referral            21       519      4,031         84,658              19
 follow-up
Self-prepared             24       418     14,704         352,899             20
 business returns
Nude dancers               0       n/a        n/a           n/a              n/a
Asbestos removal          \a        \a         \a           \a                \a
Auto salvage              21       768     30,702         644,742             23
 auctions
Unmatched                 25     1,957     12,210         305,250              0
 Information returns
Accounting and legal      19       609     13,694         260,180             37
 professions
Laundromats              139       206      4,023         559,254             25
Livestock sold by          6        78      1,400          8,400              33
 gentlemen farmers
Original issue            60     6,975    153,440        9,206,400            13
 discount (OID)
 exclusions on bonds
Medical                   53       930     12,332         653,573              0
 transportation
Peanut and other           0       n/a        n/a           n/a              n/a
 crop quotas
Water transportation       0       n/a        n/a           n/a              n/a
 companies
Employee versus           \a        \a         \a           \a                \a
 independent
 contractor
 (registered
 representative)
Video stores              21       576      8,554         179,628             14
Financial products        16       705     13,309         212,946             31
Discharge of               0       n/a        n/a           n/a              n/a
 indebtedness
Timber sales              21       265      2,118         44,478              24
Nonfiler                   0       n/a        n/a           n/a              n/a
 partnerships
Lottery businesses         0       n/a        n/a           n/a              n/a
Georgia nonfilers        234     1,036      6,218        1,455,012             0
Farm credit                0       n/a        n/a           n/a              n/a
 association members
Title VII                  0       n/a        n/a           n/a              n/a
 discrimination
 settlements
Vaccine floor stock       10     1,463     11,701         117,010             60
 compliance
Mortuaries and            31       335      7,527         233,325             23
 funeral homes
Underground storage       14     1,228     13,506         189,090              7
 tank cleanup costs
Depreciation on tax-      \a        \a         \a           \a                \a
 exempt bonds
Debenture                  0       n/a        n/a           n/a              n/a
 conversions
--------------------------------------------------------------------------------
Note 1:  All tax amounts are the taxes recommended in the audits and
may include some penalties, if any. 

Note 2:  As reflected by the zeros in the table above, IRS auditors
may sometimes find during the information gathering phase of the IGP
that initial data indicate a smaller/lesser compliance problem than
originally expected or that data collected do not warrant further
study of the taxpayer group.  As a result, the IGP is terminated
without any returns audited. 

Note 3:  n/a = not applicable. 

\a IRS disclosure rules preclude us from revealing audit information
when fewer than four taxpayers are involved. 

Source:  GAO analysis of IRS data. 




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


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix III

GENERAL GOVERNMENT DIVISION,
WASHINGTON, D.C. 

Tom Short, Assistant Director
Elwood D.  White, Evaluator

ATLANTA FIELD OFFICE

Michelle E.  Bowsky, Evaluator-in-Charge
H.  Dean Perkins, Evaluator


*** End of document. ***