Tax Administration: Taxpayer Rights and Burdens During Audits of Their
Tax Returns (Testimony, 09/26/97, GAO/T-GGD-97-186).
GAO discussed the rights of taxpayers and their treatment during audits
of their tax returns by the Internal Revenue Service (IRS).
GAO noted that: (1) IRS has limited data on both the treatment of
taxpayers and the burdens imposed on them during audits; (2) IRS
recently created a system to track taxpayers' complaints about improper
treatment but IRS does not solicit input on all improper treatment; (3)
similarly, IRS has no comprehensive definition of, and little data on,
the burden its audits impose on taxpayers; (4) IRS has recently
developed a survey that will ask individual taxpayers about their
satisfaction with various parts of the audit process but results will
not be available until 1998; (5) IRS has various indicators and
standards on audit performance; (6) one measure of audit performance is
how much additional tax is recommended; (7) IRS does not have a
corresponding measure on how much of the recommended tax is ultimately
collected after taxpayer appeals; (8) without an indicator to balance
taxes recommended against those collected, IRS auditors could have an
incentive to recommend taxes that would be unlikely to withstand a
taxpayer challenge; (9) IRS has nine audit standards; (10) GAO's work on
one set of IRS audit techniques--those used in analyzing taxpayers'
financial status to identify unreported income--showed that IRS used
these techniques in less than a quarter of the audits completed in the
time periods covered by GAO's review; (11) in about one-quarter of the
audits in which financial status techniques were used, IRS did not have
to contact the taxpayer to obtain information on the taxpayer's
financial status beyond what was reported on the tax return; (12) GAO
also found that IRS' use of financial status techniques has not
increased in recent years; (13) regarding revenue impact, GAO found that
in about 16 percent of the cases where they were used, these techniques
did help to identify significant amounts of unreported income--$10,000
or more; (14) IRS is concerned that its ability to target the
potentially most noncompliant taxpayers for audits is deteriorating;
(15) IRS' concern arises because it has not been able to rely on its
past approach for developing statistically valid research data that
allowed IRS to create and periodically update formulas to target the
returns with the most potential for noncompliance; (16) IRS last
collected these data through audits of a random sample of taxpayers for
tax year 1988; and (17) IRS subsequently abandoned that approach due to
concerns about its costs and to concerns from the public and Congress
about the taxpayer burden involved with those audits.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: T-GGD-97-186
TITLE: Tax Administration: Taxpayer Rights and Burdens During
Audits of Their Tax Returns
DATE: 09/26/97
SUBJECT: Taxpayers
Tax return audits
Auditing procedures
Auditing standards
Tax administration systems
Customer service
Data integrity
Auditors
Tax nonpayment
Financial records
IDENTIFIER: IRS Taxpayer Compliance Measurement Program
******************************************************************
** This file contains an ASCII representation of the text of a **
** GAO report. Delineations within the text indicating chapter **
** titles, headings, and bullets are preserved. Major **
** divisions and subdivisions of the text, such as Chapters, **
** Sections, and Appendixes, are identified by double and **
** single lines. The numbers on the right end of these lines **
** indicate the position of each of the subsections in the **
** document outline. These numbers do NOT correspond with the **
** page numbers of the printed product. **
** **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced. Tables are included, but **
** may not resemble those in the printed version. **
** **
** Please see the PDF (Portable Document Format) file, when **
** available, for a complete electronic file of the printed **
** document's contents. **
** **
** A printed copy of this report may be obtained from the GAO **
** Document Distribution Center. For further details, please **
** send an e-mail message to: **
** **
** **
** **
** with the message 'info' in the body. **
******************************************************************
Cover
================================================================ COVER
Before the Subcommittee on Oversight, House Committee on Ways and
Means
For Release
on Delivery
Expected at
10:00 a.m. EDT
Friday,
September 26, 1997
TAX ADMINISTRATION - TAXPAYER
RIGHTS AND BURDENS DURING AUDITS
OF THEIR TAX RETURNS
Statement of James White, Associate Director, Tax Policy and
Administration Issues, General Government Division
GAO/T-GGD-97-186
GAO/GGD-97-186T
(268819)
Abbreviations
=============================================================== ABBREV
CEP - Coordinated Examination Program
DIF - discriminant function
EQMS - Examination Quality Measurement System
IRS - Internal Revenue Service
TCMP - Taxpayer Compliance Measurement Program
TAX ADMINISTRATION: TAXPAYER
RIGHTS AND BURDENS DURING AUDITS
OF THEIR TAX RETURNS
====================================================== Chapter SUMMARY
Taxpayers and Congress have expressed concerns with how the Internal
Revenue Service (IRS) treats taxpayers in audits and whether audits
are too burdensome. Based on its ongoing and previous work, GAO
makes the following points on these issues:
-- IRS has limited data on both the treatment of taxpayers and the
burdens imposed on them during audits. IRS recently created a
system to track taxpayers' complaints about improper treatment
but IRS does not solicit input on all improper treatment.
Similarly, IRS has no comprehensive definition of, and little
data on, the burden its audits impose on taxpayers. IRS has
recently developed a survey that will ask individual taxpayers
about their satisfaction with various parts of the audit process
but results will not be available until 1998.
-- IRS has various indicators and standards on audit performance.
One measure of audit performance is how much additional tax is
recommended. IRS does not have a corresponding measure on how
much of the recommended tax is ultimately collected after
taxpayer appeals. Without an indicator to balance taxes
recommended against those collected, IRS auditors could have an
incentive to recommend taxes that would be unlikely to withstand
a taxpayer challenge. IRS has nine audit standards. The
standards focus on the efficient use of auditors' time and not
on when they should use particular audit techniques. To ensure
adherence to the standards, IRS relies on oversight by the
auditors' managers. However, their workload limits their time
for doing oversight.
-- GAO's work on one set of IRS audit techniques--those used in
analyzing taxpayers' financial status to identify unreported
income--showed that IRS used these techniques in less than a
quarter of the audits completed in the time periods covered by
GAO's review. In about one-quarter of the audits in which
financial status techniques were used, IRS did not have to
contact the taxpayer to obtain information on the taxpayer's
financial status beyond what was reported on the tax return.
GAO also found that IRS' use of financial status techniques has
not increased in recent years. Regarding revenue impact, GAO
found that in about 16 percent of the cases where they were
used, these techniques did help to identify significant amounts
of unreported income--$10,000 or more. However, in over
three-quarters of the total audits in which these techniques
were used, no changes resulting from the use of these techniques
were made to the income reported. Most of the audits did result
in some tax change for other reasons. Data are not available to
permit GAO or IRS to determine the additional burden imposed on
taxpayers from the use of the techniques in audits.
-- IRS is concerned that its ability to target the potentially most
noncompliant taxpayers for audits is deteriorating. IRS'
concern arises because it has not been able to rely on its past
approach for developing statistically valid research data that
allowed IRS to create and periodically update formulas to target
the returns with the most potential for noncompliance. IRS last
collected these data through audits of a random sample of
taxpayers for tax year 1988. IRS subsequently abandoned that
approach due to concerns about its costs and to concerns from
the public and Congress about the taxpayer burden involved with
those audits.
TAX ADMINISTRATION: TAXPAYER
RIGHTS AND BURDENS DURING AUDITS
OF THEIR TAX RETURNS
==================================================== Chapter STATEMENT
Madam Chairman and Members of the Subcommittee:
We are pleased to be here today to assist the Subcommittee in its
inquiry into the rights of taxpayers and their treatment during
audits of their tax returns by the Internal Revenue Service (IRS).
Recently, taxpayers, tax professionals, and Congress have expressed
concerns about how IRS treats taxpayers during audits and whether
audits are overly burdensome. You asked us to discuss IRS' data on
taxpayer complaints and the burden imposed on taxpayers as well as
IRS' indicators for measuring audit performance. You also asked us
to discuss our ongoing work for the Chairman of the House Committee
on Ways and Means on IRS' use of a particular audit
technique--reviews of taxpayers' financial status (i.e., their flow
of income and expenses)--and IRS' methodology for selecting tax
returns for audit.
Today, I would like to make four points taken from this ongoing work
as well as from previous reports and testimonies.
-- First, IRS has limited data on both the treatment of taxpayers
and the burdens imposed on them during audits. IRS recently
created a system to track taxpayers' complaints about improper
treatment but IRS does not solicit input on all improper
treatment. Similarly, IRS has no comprehensive definition of,
and little data on, the burden its audits impose on taxpayers.
IRS has recently developed a survey that will ask individual
taxpayers about their satisfaction with various parts of the
audit process but results will not be available until 1998.
While recognizing the difficulties in collecting data from
taxpayers about treatment and burden, we believe that this
survey may have the potential to provide better information than
presently exists.
-- Second, IRS' Examination Division has various indicators and
standards on audit performance. One measure IRS uses for audit
performance is how much additional tax is recommended. IRS does
not have a corresponding measure on how much of the recommended
tax is ultimately collected after taxpayer appeals. Without an
indicator to balance taxes recommended against those collected,
IRS auditors could have an incentive to recommend taxes that
would be unlikely to withstand a taxpayer challenge. IRS has
nine audit standards. The standards focus on the efficient use
of auditors' time and not on when they should use particular
audit techniques. To ensure adherence to the standards, IRS
relies on oversight by the auditors' managers. However, their
workload limits their time for doing oversight.
-- Third, our work on one set of audit techniques--those used in
analyzing taxpayers' financial status to identify any unreported
income--provided several interesting statistics. We estimated
that IRS auditors used these techniques in less than a quarter
of the audits completed in the time periods covered by our
review. When used, financial status techniques were always part
of an audit that included other techniques or methodologies. In
about one-quarter of the audits in which financial status
techniques were used, IRS did not have to contact the taxpayer
to obtain information on the taxpayer's financial status beyond
what was reported on the tax return. We also found that the use
of financial status techniques has not increased in recent
years. Regarding revenue impact, we found that in about 16
percent of the cases where they were used, these techniques did
help to identify significant amounts of unreported
income--$10,000 or more. However, of the total audits in which
these techniques were used, in over three-quarters no changes
resulting from the use of these techniques were made to the
income reported, although most of the audits resulted in some
tax change for other reasons. Data are not available to permit
either us or IRS to determine the additional burden imposed on
taxpayers from the use of financial status techniques in audits.
-- Fourth, IRS is concerned that its ability to target the
potentially most noncompliant taxpayers for audits is
deteriorating. IRS' concern arises because it has not been able
to rely on its past approach for developing statistically valid
research data that allowed IRS to create and periodically update
formulas to target the returns with the most potential for
noncompliance. IRS last collected these data through audits of
a random sample of taxpayers for tax year 1988. IRS
subsequently abandoned that approach due to concerns about its
costs and to concerns from the public and Congress about the
taxpayer burden involved with those audits. For context, we
note that from the 1960s, when IRS first created its
research-based audit formulas until it stopped gathering that
research data after 1988, it had reduced the rate to which its
audits made no recommended tax change from more than 40 percent
to around 10 to 15 percent, depending on the type of return and
the year of the audit.
I would like to discuss each of these points in more detail after
providing an overview on why IRS audits tax returns and how IRS is
supposed to do the audits.
OVERVIEW OF IRS AUDITS OF TAX
RETURNS
-------------------------------------------------- Chapter STATEMENT:1
IRS' Examination Division audits tax returns to ensure that taxpayers
report and pay the amount of tax they owe. Because our tax system is
based on self-assessment, IRS also does audits to induce taxpayer
compliance and promote public confidence in the tax system.\1
The income tax gap--the difference between taxes owed and taxes paid
voluntarily and on time--is one reason why IRS seeks to provide an
audit presence. Under IRS' most recent estimate, the 1992 income tax
gap for individuals exceeds $90 billion, of which about two-thirds
can be attributed to individuals not reporting income on their tax
returns.
In recent years, IRS has been auditing about one to two percent of
the 100-million plus income tax returns filed annually by individual
taxpayers.\2 IRS' policies and procedures are generally directed at
selecting returns that appear to be most noncompliant. After
selecting the returns, IRS audits them either (1) through 1 of its 33
district offices by meeting with taxpayers or their representatives
or (2) through 1 of its 10 service centers by corresponding with the
taxpayers. Since fiscal year 1992, these audits have been
recommending between $5 billion to $8 billion in additional taxes
each year. Appendix I of my statement summarizes selected audit
statistics since fiscal year 1992.
IRS auditors are instructed to not only verify the eligibility and
amounts for various types of tax deductions, credits, and exemptions,
but to also look for any indications of unreported income. If
auditors find such indications, they are to exercise their judgment
in deciding whether to do further probes in an effort to determine
whether the taxpayer underreported income.
To guide auditors, IRS manuals and publications have identified the
rights of taxpayers during audits and the manner in which auditors
should treat taxpayers. For example, IRS documents say that
taxpayers have the right, among others, to know why IRS is asking for
information about the tax return and to authorize another person to
represent them during the audit. Through its documents and training
programs, IRS instructs its audit staff to explain these rights to
the audited taxpayer and to protect those rights. In addition, audit
staff are instructed to protect taxpayers' privacy as well as treat
them with professionalism and courtesy.
--------------------
\1 IRS also induces compliance through taxpayer assistance,
third-party reporting to IRS of payments (such as wages and interest)
made to taxpayers, computer matching of tax returns to third-party
data, income tax withholding, and penalties for noncompliance.
\2 IRS also annually audits tens of thousands of income tax returns
filed by corporations and partnerships as well as thousands of other
types of returns such as those filed to report estate tax, gift tax,
employment tax, and excise tax.
IRS DATA ON AUDIT BURDEN AND
TAXPAYER COMPLAINTS ABOUT
TREATMENT
-------------------------------------------------- Chapter STATEMENT:2
Recently, taxpayers, tax professionals, and Congress have criticized
IRS for treating taxpayers improperly and imposing unnecessary
burdens during audits. At a general level, these criticisms have
asserted that auditors lacked sufficient experience, training,
motivation, or competence. Specific criticisms have focused on a
range of asserted IRS behaviors, including:
-- subjecting compliant taxpayers to unnecessary audits, resulting
in no change to the tax liability reported on the tax returns;
-- wasting taxpayers' time during the audit by asking for
irrelevant documentation or by delving into issues that are
minor or personal; and
-- treating taxpayers unprofessionally or abusively, regardless of
whether they underpaid their taxes, by lying, making threats,
applying pressure, and the like.
IRS has limited data for use in responding to such assertions. With
respect to unprofessional or improper treatment, in 1994 and 1996, we
reported that IRS lacked comprehensive data on the nature and
magnitude of the complaints as well as their resolutions.\3 Nor did
IRS have clear definitions that allowed it to determine whether these
complaints indicated auditor behaviors that were "abusive" or
"unnecessary."
Since our 1996 report, IRS has developed a definition and tracking
system for complaints about improper treatment. IRS defines a
complaint as an allegation by taxpayers or their representatives that
an IRS employee violated the law, regulation, or IRS rules of conduct
or used inappropriate behavior (e.g., rude, overzealous,
discriminatory, intimidating) or that an IRS system failed to
function properly or within the prescribed time frame.
IRS' complaint tracking system does not systematically solicit input
from taxpayers on their treatment during audits; rather, it records
only those complaints initiated by taxpayers. As a result, neither
we nor IRS have representative data on the extent to which auditors
treat taxpayers improperly across the roughly 2 million audits.
Nevertheless, IRS does report the data the system collects on
taxpayer complaints. For the first quarter of fiscal year 1997, IRS
reported that taxpayers initiated 1,203 complaints, of which 290 (25
percent) involved audit staff. Of the 290 audit-related complaints,
almost half involved assertions of inappropriate behavior by an
auditor and about one-quarter of these complaints were addressed
through counseling or administrative action or through the employee
leaving IRS; for the remaining three-quarters of the complaints, IRS
concluded that the employee's behavior was appropriate or that
information provided by the taxpayer was not complete enough to take
disciplinary action against the employee.
With respect to taxpayer burden, IRS has limited data on the
burden--whether necessary or not--imposed by audits. For example, in
fiscal year 1996, IRS tax auditors made no changes to 14 percent of
the individual tax returns. However, IRS does not know the amount of
burden imposed by these or other audits.
Data on burden can be difficult to collect for various reasons.
Neither IRS nor its stakeholders have clear definitions or agreement
on what constitutes audit burden as well as unnecessary burden.
Further, our work has shown that taxpayers do not keep records on the
amount of audit burden in terms of time or money.\4
IRS has recently developed a survey that will ask individual
taxpayers about their satisfaction with the audit process. Results
will not be available until 1998. Recognizing the difficulties in
collecting data about treatment and burden, we believe that this
survey may begin to provide better information about taxpayer
treatment and burden but its usefulness will need to be evaluated.
--------------------
\3 Tax Administration: IRS Can Strengthen Its Efforts to See That
Taxpayers Are Treated Properly (GAO/GGD-95-14, Oct. 26, 1994), and
Tax Administration: IRS Is Improving Its Controls for Ensuring That
Taxpayers Are Treated Properly (GAO/GGD-96-176, Aug. 30, 1996).
\4 Tax System: Issues in Tax Compliance Burden, (GAO/T-GGD-96-100,
Apr. 3, 1996) and Tax System Burden: Tax Compliance Burden Faced by
Business Taxpayers, (GAO/T-GGD-95-42, Dec. 9, 1994).
IRS' INDICATORS TO MEASURE THE
IMPACTS OF AUDITS
-------------------------------------------------- Chapter STATEMENT:3
IRS has established some indicators for measuring its audit
performance. However, existing indicators primarily focus on interim
results without also considering final results from the audits.
Similarly, IRS has established nine audit standards to guide its
auditors. However, the standards do not provide objective criteria
on when to use particular audit techniques.
IRS' Examination Division has used additional tax recommended as an
important indicator of audit performance (see app. II for the fiscal
year 1997 indicators).\5 We expressed concerns in previous work that
overreliance on additional taxes recommended as an indicator of
performance could create undesirable incentives for auditors (and
other Examination staff) to recommend taxes that would be unlikely to
withstand a taxpayer challenge.\6 While we recognize the complexity
of the Internal Revenue Code and the difficulties faced by both IRS
and the taxpayer in determining the "correct tax," the fact remains
that audit recommendations that do not withstand such a challenge may
have imposed an unnecessary burden on the taxpayer. For this reason,
in our previous work, we supported the need to measure taxes
recommended but advocated balancing that indicator with others such
as taxes ultimately collected.
Our work also pointed out that developing an indicator of taxes
ultimately collected from audits would be challenging. For example,
the time lag between an audit and the ultimate tax collected makes
linking the two problematic. IRS is working on developing a way of
determining the ultimate taxes collected.
In addition to indicators of audit performance, IRS also has nine
audit standards to provide guidance to auditors on minimizing the
time spent on an audit, checking large and unusual claims on tax
returns, probing for unreported income, and preparing adequate audit
workpapers (see app. III for all nine standards). These nine
standards do not address the proper treatment of taxpayers. Further,
although the standards provide guidance on the proper depth and
breadth of audits given the time available, they provide little
objective guidance to auditors on when to use particular audit
techniques such as those related to an analysis of a taxpayer's
financial status.
To ensure adherence to the standards, IRS relies on managers'
oversight of auditors. However, according to IRS officials, these
managers cannot review all audits because their workloads limit the
time available for review. As audits close throughout the year,
separate groups of IRS staff supplement the managerial review process
by reviewing a small sample of audits to measure adherence to the
nine standards (see appendix III for measurement results in fiscal
years 1992 through 1996).
--------------------
\5 Taxpayers do not necessarily have to pay the recommended taxes.
Taxpayers may challenge them through administrative channels within
IRS or the courts. If they win the challenge, the recommended taxes
will not be assessed as owed. If they lose or raise no challenge,
the recommended taxes are assessed.
\6 Tax Administration: Compliance Measures and Audits of Large
Corporations Need Improvement (GAO/GGD-94-70, Sept. 1, 1994) and Tax
Administration: Factors Affecting Results From Audits of Large
Corporations (GAO/GGD 97-62, Apr. 17, 1997).
IRS' USE OF FINANCIAL STATUS
TECHNIQUES
-------------------------------------------------- Chapter STATEMENT:4
Given recent complaints about the asserted burdens and intrusions
associated with IRS' financial status audit techniques, the Chairman
of the House Committee on Ways and Means asked us to report on the
frequency and results of IRS' use of these techniques. IRS uses
these techniques to identify unreported income. During our analyses
of audits done in 1992-93 and 1995-96, we found that IRS relied
primarily on two financial status techniques:\7
1)Cash transaction analysis (or cash-T), in which the auditor uses
the tax return and other sources to ensure that adequate income has
been reported on the return to cover expenses. In deciding to use
this technique, auditors may first do a preliminary cash-T. It
differs from the regular cash-T in that the auditor does it before
meeting with taxpayers, relying on information reported on tax
returns.
2)Bank deposit analysis, in which the auditor verifies that the
taxpayer's bank deposits are consistent with the income reported on
the tax return.
To do our work, we randomly sampled from the universe of audits
closed in IRS districts in which IRS scheduled meetings with
taxpayers to review their records. These samples covered 1992-93 and
1995-96 and were both projectable to universes of about a half
million audits.
On the basis of our analysis of these two samples, we estimate that
the use of financial status techniques had not increased over the
time frames we reviewed--the techniques were used in about
one-quarter of the audits in each of our two universes. Financial
status techniques were never used alone; they were always part of
audits that included other audit techniques to explore issues other
than unreported income, such as overstated deductions.
These techniques imposed no or little additional burden on taxpayers
in some of the audits where they were used. For example, IRS
auditors used just the preliminary cash-T in 23 percent of the
1995-96 audits that used financial status techniques. The
preliminary cash-T technique imposes no additional burden on the
taxpayer because the auditor relies on the information on the tax
return and does not have to contact the taxpayer to obtain additional
information or explanations to complete this technique.
We found that use of the financial status techniques in some cases
helped to identify significant amounts of unreported income--$10,000
or more--that IRS would not have otherwise found. However, over
three-quarters of the audits in which these techniques were used
resulted in no changes that were directly attributable to the use of
these techniques, even though IRS did find noncompliance in most of
these audits through other techniques.
While neither we nor IRS know the actual burden imposed on taxpayers,
our review of IRS' workpapers illustrated some conditions under which
use of certain techniques may impose additional burdens. For
example, a bank deposit analysis can be very burdensome if the
auditor asks for records on many bank accounts and asks many
questions about the deposits in those accounts. A regular cash-T may
or may not be very burdensome, depending on the number of contacts
with taxpayers to request information and the amount of information
requested.
--------------------
\7 Other techniques include an analysis of (1) a taxpayer's net worth
and (2) a business taxpayer's reported cost of goods sold and data on
average markups within the specific business to estimate gross
receipts generated by that taxpayer.
BARRIERS TO SELECTING THE MOST
NONCOMPLIANT TAX RETURNS FOR
AUDIT
-------------------------------------------------- Chapter STATEMENT:5
As discussed in previous reports, IRS is concerned about its ability
to objectively select tax returns so that it focuses on the most
noncompliant taxpayers.\8 IRS' concerns arise because it has not been
able to rely on its past approach for developing statistically valid
research data that allowed IRS to create and periodically update
formulas to target the returns with the most potential for
noncompliance. IRS refers to these as discriminant function (DIF)
formulas, which have served as the major method for selecting returns
for audit.\9 IRS fears that its DIF formulas have become imprecise
because the formulas use outdated statistical data.
In past years, IRS collected the statistically valid research data
under its Taxpayer Compliance Measurement Program (TCMP). TCMP
involved full-scale audits of a random sample of tax returns--
usually for about 50,000 individual taxpayers every 3 years. In
1995, IRS abandoned this approach due to concerns about its costs and
to concerns from the public and Congress about the taxpayer burden
involved with those audits. As a result, IRS' last TCMP covered tax
year 1988.
In a 1996 report, we discussed IRS' need for compliance data that are
statistically valid and more current.\10 IRS needs the data not only
to update its DIF formulas but also to support most of its compliance
programs. Accordingly, we recommended that IRS develop a
cost-effective, long-term strategy to ensure the continued
availability of such compliance data.
Since IRS started to use DIF in the 1960s to better target its audits
through fiscal year 1996, IRS has reduced the rate at which its
auditors made no tax changes from more than 40 percent of the audited
returns to around 10 to 15 percent, depending on the type of return
and the year of the audit. IRS is concerned that as time passes,
DIF's precision in identifying noncompliant returns may decrease
unless IRS updates the formulas with valid data, and that as a
result, more and more compliant taxpayers will be unnecessarily
burdened with an audit. We are now designing a study of this issue
at the request of the Chairman of the House Committee on Ways and
Means.
--------------------
\8 Tax Research: IRS Has Made Progress But Major Challenges Remain,
(GAO/GGD-96-109, June 5, 1996); Tax Administration: Alternative
Strategies to Obtain Compliance Data (GAO/GGD-96-89, Apr. 26, 1996);
Tax Gap: Many Actions Taken, But a Cohesive Compliance Strategy
Needed (GAO/GGD-94-123, May 11, 1994); and Tax Administration: IRS'
Plans to Measure Tax Compliance Can Be Improved (GAO/GGD-93-52, Apr.
5, 1993).
\9 Tax Administration: Audit Trends and Results for Individual
Taxpayers (GAO/GGD-96-91, Apr. 26, 1996). IRS has up to 40 methods
for identifying returns to audit. Appendix IV summarizes the number
of audits selected by the major methods for fiscal years 1992 through
1996.
\10 Tax Administration: Alternative Strategies to Obtain Compliance
Data (GAO/GGD-96-89, Apr. 26, 1996).
------------------------------------------------ Chapter STATEMENT:5.1
Madam Chairman, this concludes my testimony. I would be pleased to
answer any questions you or other members of the Subcommittee may
have.
SELECTED INFORMATION ABOUT THE
RETURNS FILED AND EXAMINED AND
RECOMMENDED ADDITIONAL TAXES
(FISCAL YEARS 1992-96)
=========================================================== Appendix I
Descriptio
n 1992 1993 1994 1995 1996
---------- ------------ ------------ ------------ ------------ ------------
Number of returns
--------------------------------------------------------------------------------
Filed 152,031,900 153,453,600 152,732,800 154,293,700 155,279,600
Examined 1,452,009 1,300,230 1,426,573 2,100,144 2,136,819
Percent .96 .85 .93 1.36 1.38
coverage
Recommende $26.9 $23.1 $23.9 $27.8 $28.1
d
additiona
l tax and
penalties
(in
billions)
Individual 6.3 5.7 6.2 7.8 $7.6
returns
Corporate 18.1 14.7 15.1 17.7 $18.0
returns
All 2.5 2.7 2.6 2.3 $2.5
other\a
Average tax and penalty per return examined by
--------------------------------------------------------------------------------
Revenue $25,161 $24,704 $18,177 $21,237 $24,407
agent for
non-
CEP\b
Revenue 3,940,148 2,700,352 3,279,298 4,032,528 3,998,409
agent for
CEP
Tax 2,280 2,625 3,113 3,497 3,051
auditor
Service 2,541 2,934 1,945 1,427 1,733
center
--------------------------------------------------------------------------------
\a Other includes fiduciary, estate, gift, employment, excise,
windfall profit, and miscellaneous taxes.
\b CEP = Coordinated Examination Program, under which IRS audits the
largest corporations.
IRS EXAMINATION DIVISION MEASURES
FOR 1997
========================================================== Appendix II
Basic measures across Examination activities include
1.Amount of additional tax and penalties recommended.
2.Percentage of additional recommended amounts plus interest amounts
that were collected before IRS issued the second notice on the
amounts that were assessed.
3.Average number of days that an audit case remains open.
4.Amount of additional tax and penalty recommended as well as the
amount of tax protected in audits divided by the total
full-time-equivalent staffing invested.
For the Coordinated Examination Program (CEP), additional measures
include
1.Average number of tax years for tax returns filed by a CEP taxpayer
that have not yet been audited.
2.Amount of additional tax and penalty recommendations that CEP
taxpayers agreed to pay minus amount overassessed divided by the
total full-time-equivalent staffing invested.
3.Amount of total adjusted revenues divided by the total
full-time-equivalent staffing invested.
IRS' EXAMINATION QUALITY
MEASUREMENT SYSTEM
========================================================= Appendix III
The Office of Compliance Specialization, within IRS' Examination
Division, has responsibility for Quality Measurement Staff operations
and the Examination Quality Measurement System (EQMS). Among other
uses, EQMS measures the quality of closed audits against nine IRS
audit standards. The standards address the scope, audit techniques,
technical conclusions, workpaper preparation, reports, and time
management of an audit. Each standard includes additional key
elements describing specific components of a quality audit. Table
III.1 summarizes the standards and the associated key elements.
Table III.1
Summary of IRS' Examination Quality
Measurement System (EQMS) Auditing
Standards (as of October 1996)
No. Standard Key elements Purpose Overview
-------- ------------ ----------------- ----------------- ------------------
1 Considered A.Balance sheet Measures whether This standard
large, and Schedule M consideration was encompasses, but
unusual, or considered given to the is not limited to,
questionable B.Income, large, unusual, the following
items deduction, and or questionable fundamental
credit items items in both the considerations:
considered precontact stage absolute dollar
C.Scope of and during the value, relative
examination was course of the dollar value,
appropriate examination. multiyear
comparisons,
intent to mislead,
industry/business
practices,
compliance impact,
and so forth.
2 Probes for A.Consideration Measures whether Gross receipts
unreported of internal the steps taken were probed during
income controls for all verified that the the course of
business returns proper amount of examination,
B.Consideration income was regardless of
of books and reported. whether the
records taxpayer
C.Consideration maintained a
of financial double entry set
status of books.
D.Appropriate use Consideration was
of indirect given to responses
methods to interview
questions, the
financial status
analysis, tax
return
information, and
the books and
records in probing
for unreported
income.
3 Required A.Consideration Measures whether Required filing
filing of prior and consideration was checks consist of
checks subsequent year given to filing the analysis of
tax returns and examination return information
B.Consideration potential of all and, when
of related returns required warranted, the
returns by the taxpayer, pick-up of
C.Compliance including those related, prior,
items considered entities in and subsequent
taxpayer's sphere year returns. In
of influence/ accordance with
responsibility. Internal Revenue
Manual 4034,
examinations
should include
checks for filing
information
returns.
4 Examination A.Adequate Measures whether The depth of the
depth and interviews the issues examination was
records conducted examined were determined through
examined B.Adequate exam completed to the inspection,
techniques used extent necessary inquiry,
C.Fraud to provide interviews,
adequately sufficient observation, and
considered and information to analysis of
developed determine appropriate
D.Issues substantially documents,
sufficiently correct tax. ledgers, journals,
developed oral testimony,
third-party
records, etc., to
ensure full
development of
relevant facts
concerning the
issues of merit.
Interviews
provided
information not
available from
documents to
obtain an
understanding of
the taxpayer's
financial history,
business
operations, and
accounting records
in order to
evaluate the
accuracy of books
or records.
Specialists
provided expertise
to ensure proper
development of
unique or complex
issues.
5 Findings A.Correct Measures whether This standard
supported by technical or the conclusions includes
law factual reached were consideration of
conclusions based on a applicable law,
reached correct regulations, court
application of cases, revenue
tax law. rulings, etc., to
support technical
or factual
conclusions.
6 Penalties A.Recognized, Measures whether Consideration of
properly considered, and applicable the application of
considered applied penalties were appropriate
correctly considered and penalties during
B.Penalties applied all examination is
computed correctly. required.
correctly
7 Workpapers A.Fully disclose Measures the Workpapers
support audit trail and documentation of provided the
conclusions techniques the examination's principal support
B.Legible and audit trail and for the examiner's
organized techniques used. report and
C.Adjustments in documented the
workpapers agree procedures
with 4318, 4700, applied, tests
and reports performed,
D.Activity record information
adequately obtained, and the
documents exam conclusions
activities reached in the
E.Disclosure examination.
8 Report A.Applicable Measures the Addresses the
writing report writing presentation of written
procedures procedures the audit presentation of
followed followed findings in terms audit findings in
B.Correct tax of content, terms of content,
computation format, and format, and
accuracy. accuracy. All
necessary
information is
contained in the
report, so that
there is a clear
understanding of
the adjustments
made and the
reasons for those
adjustments.
9 Time span or A.Examination Measures the Time is an
time charged time utilization of essential element
commensurate time as it of the auditing
B.Exam relates to the standards and is a
initiation complete audit proper
C.Examination process. consideration in
activities analyses of the
D.Case closing examination
process. The
process is
considered as a
whole and at
examination
initiation,
examination
activities, and
case-closing
stages.
--------------------------------------------------------------------------------
Source: IRS data.
STANDARD SUCCESS RATE
------------------------------------------------------- Appendix III:1
EQMS quality reviewers use the key element definitions to determine
whether an audit adhered to the standard. Thus, adherence to audit
quality is measured by the presence or absence of associated key
elements. For a standard to be rated as having been met, each of the
associated key elements must also be rated as met or not applicable.
If the audit does not demonstrate the characteristics described by
one of the key elements, then the standard is rated as not met.
One measure that IRS uses to evaluate the audit quality is the
standard success rate. It measures the percentage of cases for which
all the underlying key elements of each standard are rated as having
been met. According to IRS, this measure is useful for determining
whether a case is flawed and in what area. Figures III.1 and III.2
show the standard success rates for each of the standards for fiscal
years 1992-96 for office and field audits, respectively.
Figure III.1: Standard Success
Rates for Office Audits (Fiscal
Years 1992-96)
(See figure in printed
edition.)
Source: IRS data.
Figure III.2: Standard Success
Rates for Field Audits (Fiscal
Years 1992-96)
(See figure in printed
edition.)
Source: IRS data.
KEY ELEMENT PASS RATE
------------------------------------------------------- Appendix III:2
IRS also uses the key element pass rate as a measure of audit
quality. This measure computes the percentage of audits
demonstrating the characteristics defined by the key element.
According to IRS, the key element pass rate is the most sensitive
measurement and is useful when describing how an audit is flawed,
establishing a baseline for improvement, and identifying systemic
changes. Figures III.3 and III.4 show the pass rates for the key
elements of standard 2 for fiscal years 1992 through 1996 for office
and field audits, respectively.
Figure III.3: Key Element Pass
Rates for Key Elements of
Standard 2 for Office Audits
(Fiscal Years 1992-96)
(See figure in printed
edition.)
Source: IRS data.
Figure III.4: Key Element Pass
Rates for Key Elements of
Standard 2 for Field Audits
(Fiscal Years 1992-96)
(See figure in printed
edition.)
IRS data.
NUMBER AND PERCENT OF INDIVIDUAL
RETURNS AUDITED BY AUDIT SOURCE
(FISCAL YEARS 1992-96)
========================================================== Appendix IV
Fiscal year 1992 Fiscal year 1993 Fiscal year 1994 Fiscal year 1995 Fiscal year 1996
---------------------------- --------------------- --------------------- --------------------- --------------------
Audit sources Number Percent Number Percent Number Percent Number Percent Number Percent
---------------------------- ------------- ------------- ---------- --------- ---------- --------- ---------- --------- --------- ---------
DIF/DIF related 452,445 38% 372,116 35% 239,557 20% 263,200 14% 351,867 18%
Nonfilers 119,865 10 190,809 18 402,435 33 410,612 21 212,226 11
Tax shelter related 101,453 8 48,070 5 29,687 2 27,473 1 20,300 1
Self-employment tax 71,126 6 46,310 4 43,032 4 48,578 3 40,601 2
Regular classification 52,528 4 50,709 5 47,170 4 46,637 2 48,534 3
State information 48,418 4 3,564 0 4,573 0 3,210 0 71,582 4
Service center studies and 43,333 4 20,059 2 22,825 2 25,026 1 18,684 1
tests
Compliance projects 40,403 3 44,267 4 41,959 3 38,624 2 45,680 2
Claims for refund 33,163 3 37,203 4 26,412 2 23,175 1 31,495 2
Return preparers 27,706 2 28,231 3 27,708 2 26,542 1 33,637 2
Non-DIF multiyear 26,866 2 29,373 3 26,742 2 24,926 1 29,927 2
Unallowable items 13,117 1 12,099 1 134,007 11 761,886 40 824,721 42
Other sources 175,596 15 176,156 16 179,600 15 219,548 11 212,306 11
=====================================================================================================================================================
Total 1,206,019 100% 1,058,966 100% 1,225,707 100% 1,919,437 100% 1,941,560 100%
-----------------------------------------------------------------------------------------------------------------------------------------------------
Note 1: For this table, we used the format from our 1996 report on
audit trends (GAO/GGD-96-91, Apr. 1996). That format listed the top
10 sources for each of the fiscal years 1992 through 1994. Using
that format, we updated the numbers and percentages for those
categories for fiscal years 1995 and 1996.
Note 2: See next page for definitions of terms used in this table.
Note 3: Percentages are the percent of total audits for the year and
have been rounded to the nearest whole percent.
Source: GAO analysis of IRS data.
DEFINITIONS OF AUDIT SOURCES
=========================================================== Appendix V
CLAIMS FOR REFUND
------------------------------------------------------- Appendix V:0.1
Ammended returns audited because of taxpayers' claims for refunds.
COMPLIANCE PROJECTS
------------------------------------------------------- Appendix V:0.2
Returns identified through IRS' information gathering projects.
DIF/DIF RELATED
------------------------------------------------------- Appendix V:0.3
Returns selected on the basis of a computer-generated score (the
scoring is based on an analysis technique known as discriminant
function). Also included are related returns identified during an
audit of a DIF-source return and related returns from prior or
subsequent years for the same taxpayer.
NON-DIF MULTIYEAR
------------------------------------------------------- Appendix V:0.4
Related returns from prior or subsequent years for the same taxpayer,
when the initial source was other than a DIF-source return.
NONFILERS
------------------------------------------------------- Appendix V:0.5
Audits initiated against known taxpayers who did not file a return
with IRS.
OTHER SOURCES
------------------------------------------------------- Appendix V:0.6
Over 25 other audit sources, such as referrals from other IRS
Divisions, which were not one of the 10 largest sources during the
period of our review.
REGULAR CLASSIFICATION
------------------------------------------------------- Appendix V:0.7
Manually selected returns for audit that do not result from other
specified audit sources.
RETURN PREPARERS
------------------------------------------------------- Appendix V:0.8
Returns identified for audit due to questionable tax preparers.
SELF-EMPLOYMENT TAX
------------------------------------------------------- Appendix V:0.9
Returns involving self-employment tax issues identified by IRS
service center examination staff.
SERVICE CENTER STUDIES AND
TESTS
------------------------------------------------------ Appendix V:0.10
Returns identified through service center projects initiated by the
IRS National Office.
STATE INFORMATION
------------------------------------------------------ Appendix V:0.11
Returns identified from various state sources, generally under
exchange agreements between IRS and the states.
TAX SHELTER RELATED
------------------------------------------------------ Appendix V:0.12
Related returns of partners, grantors, beneficiaries, and
shareholders identified during audits of either partnerships,
fiduciaries, or Subchapter S corporations involving potential tax
shelter issues.
UNALLOWABLE ITEMS
------------------------------------------------------ Appendix V:0.13
Returns involving refundable credits and dependency exemptions, such
as the Earned Income Tax Credit, identified by service center
examination staff.
*** End of document. ***