[Final Audit Report on Internal Revenue Taxes, Bureau of Internal Revenue, Government of the Virgin Islands]
[From the U.S. Government Printing Office, www.gpo.gov]

Report No. 98-I-188

Title: Final Audit Report on Internal Revenue Taxes, Bureau of
       Internal Revenue, Government of the Virgin Islands

Date: December 30, 1997

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V-IN-VIS-001-96

United States Department of the Interior

OFFICE OF INSPECTOR GENERAL
   Washington, D.C. 20240

Honorable Roy L. Schneider
Governor of the Virgin Islands
No. 21 Kongens Gade
Charlotte Amalie, Virgin Islands 00802

Subject: Final Audit Report on Internal Revenue Taxes, Bureau of Internal Revenue,
Government of the Virgin Islands (No. 98-I-188) 

Dear Governor Schneider:

This report presents the results of our review of the internal revenue taxes administered by
the Bureau of Internal Revenue of the Government of the Virgin Islands. The objective of
the audit was to evaluate: (1) the impact of the Bureau's automation project on revenue
collection; (2) the work load and staffing of the Revenue Officers and Revenue Agents; and
(3) the Bureau's efforts to identify delinquent taxpayers and nonfilers and to enforce the
collection of amounts owed. The scope of the audit included Bureau operations that occurred
during fiscal years 1995 and 1996 (through April 1996).

Despite disruptions caused by the Bureau's move to new office space and the occurrence of
Hurricane Marilyn during the period covered by the audit, the Bureau implemented a new
mainframe computer system that allowed for more efficient tax administration. However, we
found that further improvements could be made in computer operations and that more
aggressive enforcement was needed in the areas of delinquent accounts and returns and audits
of taxes. Specifically, we found that:

- The Bureau did not realize all potential revenue collections because it could not access
a taxpayer's complete and accurate payment history for all classes of taxes from a single
computer system. We also found that: (1) payments were not reversed from taxpayer
accounts as paid amounts if the checks were not honored by banks and returned; (2) the
Bureau's Code and Edit Unit did not correct mathematical and data entry errors in order to
process tax returns in a timely manner; and (3) data produced by the Computer Operations
Branch to detect and prevent nonfilers and filers of duplicate dependent claims were not made
' available to the Audit Enforcement Branch in a consistent and timely manner. As a result,
taxes of about $700,000 were owed by taxpayers whose payment checks were not honored
by the banks; approximately 11,200 returns for tax years 1994 and 1995 had not been
processed as of November 1996; and the Audit Enforcement Branch did not have access to
information that could have been used to detect nonfilers and filers of duplicate dependent
claims.

 
- The Delinquent Accounts and Returns Branch did not effectively use collection
practices and tools to enforce the collection of amounts owed by taxpayers. Specifically, the
Branch did not: (1) follow up with delinquent taxpayers or make reasonable efforts to collect
amounts owed before the statute of limitations on collections expired; (2) file liens and levies
to serve as the Government's claim on delinquent taxpayers' property; and (3) provide
required supporting documentation for tax penalty waivers. As a result, the Bureau did not
collect $10.1 million from 1,760 taxpayer cases totaling $15.2 million; did not collect tax
revenues of approximately $324,000 because the statute of limitations had expired and could
lose an additional $940,000 within the next 2 years unless collection actions are undertaken;
and granted penalty waivers totaling $795,000 without the required documentation.

- The Audit Enforcement Branch did not implement adequate internal controls to
effectively administer its audit function. Specifically, the Branch did not: (1) use computer
printouts produced by the Computer Operations Branch to detect and prevent nonfilers;
(2) begin audits of the casualty loss claims filed as a result of Hurricane Marilyn; (3) conduct
a sufficient number of audits of corporations and high-income taxpayers; (4) document
changes made to Revenue Agent findings; (5) mail statutory notices (90.day letters) of audit
results to taxpayers in a timely manner; and (6) transmit closed cases to the Processing
Branch in a timely manner for assessment. As a result, the Audits Branch did not conduct
audits of 4,600 taxpayers who received Forms 1099,MISC (miscellaneous income) and
2 1,625 taxpayers who received Forms W-2 ("Wage and Tax Statement") for tax year 1992
but who either did not report the income on filed tax returns or did not file a tax return, and
it did not have adequate control over assigned tax audit cases.

On August 12, 1997, we transmitted a draft of this report to you requesting your comments
by September 12, 1997, and extended that date until October 3 1, 1997. However, a response
to the draft report has not been provided. Therefore, since this report is being issued without
the benefit of your response, all of the recommendations are considered to be unresolved (see
Appendix 2).

The Inspector General Act, Public Law 95-452, Section 5(a)(3), as amended, requires
semiannual reporting to the U.S. Congress on all audit reports issued, the monetary impact
of audit findings (Appendix 1), actions taken to implement audit recommendations, and
identification of each significant recommendation on which corrective action has not been
taken. -

In view of the above, please provide a response, as required by Public Law 95-357, to this
report by January 30, 1998. The response should be addressed to our Caribbean Regional
Office, Federal Building, Room 207, St. Thomas, Virgin Islands 00802. The response should
include the information requested in Appendix 2.

 
We appreciate the assistance of Bureau of Internal Revenue personnel in the conduct of our
audit.

Inspector General

cc: Mr. Joseph Aubain, Director,
  Virgin Islands Bureau of Internal Revenue

 
CONTENTS

Page

APPENDICES

1 .  CLASSIFICATION OF MONETARY AMOUNTS . . . . . . . . . . . . . . . . . . . 23
2 .  STATUS OF AUDIT REPORT RECOMMENDATIONS . . . . . . . . . . . . . . 24

 
INTRODUCTION

BACKGROUND

The Virgin Islands Bureau of Internal Revenue was established under Title 33, Chapter 20,
of the Virgin Islands Code to administer and enforce the laws imposing the following taxes:
corporate and individual income, gross receipts, trade and excise, hotel occupancy, highway
users, production, gift, inheritance, and fuel.

Corporate and individual income taxes are classified as Federal taxes, and all other taxes are
classified as local taxes. The taxing authority for Federal taxes is contained in the Internal
Revenue Code of 1986 and the Naval Service Appropriations Act of 1922. The Naval
Service Appropriations Act established the principle that the Internal Revenue Code applied
in the Virgin Islands under a "mirror system," in which the words "Virgin Islands" were
substituted for "United States" wherever necessary so that the Internal Revenue Code would
have the same effect in the Virgin Islands as in the United States. Further, the Naval Service
Appropriations Act stated, "The income tax laws in force in the United States of America and
those which may hereafter be enacted shall be held to be likewise in force in the Virgin Islands
of the United States, except that proceeds of such taxes shall be paid into the treasuries of
said islands." Therefore, according to these guidelines, the income tax provisions of the
Internal Revenue Code, the Treasury Regulations, and the Revenue Rulings and Revenue
Procedures issued by the Internal Revenue Service are generally applicable in the Virgin
Islands. The taxing authority for local taxes is contained in the Virgin Islands Code.

The Bureau comprises five major divisions: the Director's Office, the Processing Accounts
and Returns Branch, the Delinquent Accounts and Returns Branch, the Audit Enforcement
Branch, and the Computer Operations Branch. The Bureau has o&es on St. Thomas and
St. Croix and has a staff of approximately 140 persons. Beginning in February 1995, the
Bureau implemented a comprehensive training program for Bureau staff that has included
training in income tax return preparation and the U.S. Internal Revenue Service's formal
training for Revenue Officers and Revenue Agents.

During fiscal years 1995 and 1996 (through April), the Bureau collected tax revenues totaling
about $515 million, with about 90 percent of the collections representing income and gross
receipts taxes. As of July 1996, there were 12,410 income taxpayer delinquent accounts,
totaling $82.4 million, for tax years 1978 to 1995 and 15,875 gross receipts taxpayer
delinquent accounts, totaling $9.6 million, for tax years 1994 and 1995. In addition, as of
October 1996, there were approximately 44,000 tax returns (excluding casualty loss claims
filed as a result of Hurricane Marilyn), totaling $68.4 million (excluding interest), of unpaid
income tax refunds for tax years 1994 and 1995.

During the period covered by our audit (October 1,1994, through April 30,1996), Bureau
operations were disrupted, primarily on St. Thomas, for two reasons: (1) in August 1995, the
Bureau's St. Thomas operations were moved to its present location in the Havensight area
of St. Thomas, and (2) in September 1995, Hurricane Marilyn struck the Virgin Islands.

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These events affected the normal cycle of tax return filings and significantly increased the
number of casualty loss claims. Despite these factors, the Bureau implemented a new
mainframe computer system by March 1996.

OBJECTIVE AND SCOPE

The objective of the audit was to evaluate: (1) the impact of the Bureau's automation project
on revenue collection; (2) the work load and staffing of the Revenue Officers and Revenue
Agents; and (3) the Bureau's efforts to identify delinquent taxpayers and nonfilers and to
enforce the collection of amounts owed.

The scope of the audit included Bureau operations that occurred during fiscal years 1995 and
1996 (through April) and the policies and procedures in effect at the time of the audit. For
certain tests, we expanded the scope of our audit to November 1996 because some of the
computer printouts that we requested were not produced until that time.  The audit was
conducted at the Bureau of Internal Revenue and the Department of Finance.

In June 1996, during the survey fieldwork phase, the Bureau's Director denied us access to
taxpayer records based on the disclosure restrictions contained in the Internal Revenue Code.
Based on information compiled by the Internal Revenue Service's Disclosure Officer (in
Washington, D.C.) and research conducted by the Office of Inspector General's General
Counsel, the Virgin Islands Attorney General rendered an opinion that the audit authority
given the Office of Inspector General by the Insular Areas Act of 1982 provided an exception
to the disclosure restrictions in the Internal Revenue Code. Upon notification of the opinion
in July 1996, the Bureau's Director did provide access to taxpayer records at the Bureau.
During our review, we did not disclose confidential taxpayer information, in accordance with
the requirements for confidentiality and restricted disclosure of income tax return and return
information, as stated in Section 6103 of the Internal Revenue Code of 1986, which applies
to the Virgin Islands.

Our review was made in accordance with the "Government Auditing Standards," issued by
the Comptroller General of the United States. Accordingly, we included such tests of records
and other auditing procedures that were considered necessary under the circumstances.

We included an evaluation of internal controls over Bureau operations to the extent we
considered necessary to accomplish the audit objective. The internal control weaknesses
identified were related to activities in the Computer Operations, Delinquent Accounts and
Returns, and Audit Enforcement Branches. The weaknesses are discussed in the Findings and
Recommendations section of this report. The recommendations, if implemented, should
improve the internal controls in these areas.

PRIOR AUDIT COVERAGE

The Office of Inspector General has not conducted any audits of the Bureau during the past
5 years. However, between 1985 and 1988, the Office of Inspector General issued four audit
reports on taxes as follows: the administration, enforcement, and collection of gross receipts

2

 
taxes (1985); hotel occupancy taxes (1985); excise taxes (1987); and income taxes (1988).
Additionally, in May 1991, the Office of Inspector General issued the audit report entitled
"Followup of Recommendations Regarding Gross Receipts, Hotel Occupancy, Excise, and
Income Taxes, Government of the Virgin Islands" (No. 9l-I-791), which stated that the
Bureau did not implement 34 of the 47 recommendations made in the four prior audit reports.
The May 1991 report stated that 2 of the 34 outstanding recommendations were withdrawn
because changed conditions had made the recommendations invalid. Although additional
documentation provided by the Bureau in September 1991 subsequently allowed us to
consider the 32 remaining recommendations resolved and implemented, our current review
found that some of the deficiencies in the areas of the administration, enforcement, and
collection of taxes disclosed in the prior reports still existed, as discussed in the Findings and
Recommendations section of this report.

 
FINDINGS AND FUWOMMENDATIONS

A. COMPUTER OPERATIONS

Although the Bureau of Internal Revenue purchased a new mainframe computer system that
increased data storage capacity and computer processing capabilities, the Bureau could not
access a taxpayer's complete and accurate payment history for all classes of taxes from a
single computer system to determine a taxpayer's total outstanding amount. In addition,
reversing entries were not made to taxpayer accounts if the checks for tax payments were not
honored by banks and were subsequently returned, the Code and Edit Unit did not correct
mathematical and data entry errors to process tax returns in a timely manner, and data
produced by the Computer Operations Branch to detect and prevent nonfilers and filers of
duplicate dependent claims were not made available to the Audit Enforcement Branch in a
consistent and timely manner. Title 33, Chapter 20, of the Virgin Islands Code contains
criteria applicable to the administration and enforcement of the laws that impose income and
other taxes, and Chapter 200 of the Internal Revenue Manual contains criteria applicable to
providing quality customer service to taxpayers in an efficient and expeditious manner. We
found that the deficiencies existed because the Computer Branch did not: (1) integrate all
classes of taxes onto one computer system; (2) provide sufficient training to the Tax
Examiners in the Code and Edit Unit on how to interpret and take action on the computer
printouts which listed errors in tax return information entered into the computer system; and
(3) make it a priority to compile information on nonfilers and filers of duplicate dependent
claims because it was "labor intensive." As a result, several computer systems had to be
queried to determine a taxpayer's total outstanding amount; reversing accounting entries were
not made to taxpayers' accounts for tax payments totaling $700,000 that were paid with
checks that had not been honored by banks; approximately 11,200 returns for tax years 1994
and 1995 had not been processed; and the Computer Branch did not produce reports of
nonfilers and filers of duplicate dependent claims for tax years subsequent to 1992 that could
be used for tax enforcement purposes.

Computer Operations Branch

The Computer Operations Branch was responsible for the automated processing of all tax
information. In that regard, the Computer Branch processed bills for outstanding tax
liabilities, compiled schedules of taxpayer refunds, and maintained the Bureau's management
information systems. As of May 1996, the Computer Branch had 11 employees: 1 Chief of
Computer Operations, 1 Systems Analyst, and 8 Programmers on St. Thomas and 1 Systems
Monitor on St. Croix.

Mainframe Computer. In order to improve revenue collection at the Bureau and to
increase data storage capacity and computer processing capabilities, the Bureau sought
funding through the Department of the Interior's Office of Insular Affairs to purchase a new
mainframe computer system. The Bureau obtained approximately $1.4 million between
August 1995 and August 1996 to purchase the computer system, related computer terminals
and printers, and network software and tools. As of September 1996, about $800,000 was

 
used to purchase the computer system. Bureau officials said that they anticipated using the
remaining funds to purchase approximately 90 computer terminals for the St. Thomas and
St. Croix offices and related network software to bring the St. Croix office on-line with
St. Thomas.

Computer Integration. Although the computer system became operational in March
1996, the Tax Information Processing System on the system contained only the income and
gross receipts tax modules, a wage information module, and a database query module. The
withholding. hotel occupancy, and excise tax modules had not been integrated onto the
computer system, although the system was capable of processing information for all classes
of taxes as of December 1996. Instead, these tax modules were accessed from separate
personal computer (PC)-based systems that did not interact with the computer system.

Moreover, the information pertaining to tax years prior to 1993 was archived and was not

maintained on-line.

Bureau officials said that they anticipated integrating the remaining

modules onto the computer system by the end of fiscal year 1998. Based on our review, we

concluded that it will be more difficult for the Bureau to significantly increase its revenue
collections until it is capable of accessing a taxpayer's entire tax profile, including all tax
liabilities, payment history, and filing information, from a single computer system.

Checks Not Honored. We found that the Computer Branch maintained a listing of
taxpayers who made payments with checks that were not honored by the banks on a PC-based
system that was not on-line with the operational tax modules. We found that entries for
payments made with checks were posted to taxpayer accounts in the mainfiame computer and
the PC-based system as payments but were not reversed upon notification from the
Department of Finance that the checks were not honored by the banks. Accordingly, taxpayer
accounts receivable records were understated. We believe that this listing should be
integrated onto the mafiame computer so that taxpayer accounts can be adjusted to reflect
checks that were not honored and the correct payment due balances. Based on a listing
produced by the Computer Branch in November 1996, we found 921 checks, totaling
$700,000, that were not honored. These payments were not reversed in the taxpayer
accounts; thus taxpayer accounts receivable records were understated by $700,000.

Computerized Income Tax Processing

The Bureau processed about 60,000 income tax returns during fiscal year 1994. The
Bureau's Processing Accounts and Returns Branch is responsible for processing all tax
returns and depositing all revenues received by the Bureau into the Government's General
Fund (except for hotel occupancy taxes, which are deposited into the Tourism Advertising
Fund). To process the tax returns, the Branch's Code and Edit Unit and Data Entry Unit
examine tax returns and enter tax return information into the computer. Tax returns that
cannot be processed because of mathematical errors by the taxpayer, insufficient data
submitted by the taxpayer, or errors by a Data Entry Unit Clerk were identified by the
Computer Branch on weekly printouts. We found that the Code and Edit Unit did not
examine and correct the errors in a timely manner.

5

 
Error Registers. The Computer Branch produced a detailed error register for a
taxpayer's return and indicated the location of the error by an asterisk next to the appropriate
line of the tax return. The error registers were transmitted to the Processing Branch's Code
and Edit Unit for correction of the errors. Based on our review of three computer printouts
produced by the Computer Branch in November 1996 that summarized the error registers for
tax years 1994 and 1995, we found approximately 6,300 tax returns which contained either
mathematical errors made by the taxpayer or data entry errors made by a Data Entry Unit
clerk and approximately 1,500 tax returns which could not be processed because necessary
taxpayer information was not included on the tax return. In addition, as a result of a physical

inspection that we conducted in November 1996, we found 3,400 unprocessed tax returns for

tax years 1993 to 1995, which were transmitted to the Code and
October 1996. Accordingly, as of November 1996, the
approximately 11,200 tax returns that needed to be processed.

Edit Unit between May and
Code and Edit Unit had

At the beginning of our audit fieldwork in May 1996, the Code and Edit Unit had four Tax

Examiners and five temporary employees who worked at the Bureau from April 22 to July 2,
1996. By the end of our audit fieldwork in December 1996, the Code and Edit Unit had only
three Tax Examiners, which we believe was insufficient staffing to effectively conduct initial
examinations of tax returns and to correct errors on tax returns entered into the computer
system in a timely manner. However, during our March 4, 1997, meeting on the preliminary
draft of this report, the Bureau Director told us that the Bureau had a "very positive
experience" with the temporary employees and planned to use the same number of temporary
employees in the future to meet the Unit's work load requirements during the peak income
tax filing period.

During the audit, the Supervisor of the Code and Edit Unit told us that the Computer Branch
did not: (1) transmit the error registers to the Code and Edit Unit in a timely manner;
(2) provide training to the Tax Examiners on how to interpret the error registers; and
(3) provide the Tax Examiners with sufficient computer access to clear the tax returns for
forwarding to the file room for filing. However, at our March 4, 1997, meeting, the Bureau's
Director and Deputy Director said that: (1) the Computer Branch produced the error registers
on a weekly basis for tax returns processed during that week and could produce consolidated
error registers when requested by the Code and Edit Unit; (2) the Tax Examiners received at
was expected to provide on-the-job training to the staff; and (3) the Tax Examiners had the
level of computer access which the Director believed was appropriate for them to carry out
their job responsibilities without compromising the confidentiality of taxpayer information.

Title 33, Chapter 20, Section 68 1, of the Virgin Islands Code gives the Bureau the authority
"to restructure and create, in accordance with existing law, such divisions and units within the
Bureau as the Director deems necessary for the proper administration of the Bureau." In
addition, Chapter 200 of the Internal Revenue Manual states that the work load should be
handled "as expeditiously as possible" while effectively providing service to customers. Based

`We determined that the training included interpreting error registers.

6

 
on these criteria, we believe that the Director should assess the staffing, training, and
computer access issues identified during our review and take appropriate action to ensure that
the Code and Edit Unit has the resources, training, and supervisory oversight necessary to
process income tax returns efficiently and expeditiously.

Nonfilers

The Computer Branch had the capability of producing printouts that aided in the prevention
and detection of nonfilers and filers of duplicate dependent claims.  In order to detect
nonfilers, compilation reports, which compared information on Forms 1099.MISC
(miscellaneous income) and Forms W-2 ("Wage and Tax Statement") with the financial data
filed by a taxpayer, were produced by the Computer Branch. Further, the Computer Branch
devised a program to detect duplicate social security numbers claimed on more than one tax
return to detect individuals who filed duplicate dependent claims. Computer Branch officials
said that they produced this information for the benefit of the Audit Enforcement Branch to
aid in the selection of tax returns for audit examination. Computer Branch records indicated
that in June and July 1995, listings of nonfilers for Forms 1099~MISC and Forms W-2 income
were produced for tax year `1992 information and that a similar printout was produced for a
tax year prior to 1992 for duplicate dependent claims.  However, Branch officials said that
they made no further efforts to produce the reports of nonfilers and filers of duplicate
dependent claims for successive tax years because the information was "labor intensive" to
produce.

We also found that the Computer Branch had the capability to compare businesses' sales with
gross receipts taxes paid. However, the Branch did not produce a printout highlighting this

comparrson.

We believe that identifying potential nonfilers and filers of duplicate dependent claims and
providing comparisons between businesses' reported sales and gross receipts taxes paid
would assist the Audit Enforcement Branch in selecting returns for examination. (Additional
information regarding the Audit Enforcement Branch's use of the computer printouts is
presented in Finding C.)

Recommendations

We recommend that the Director of the Virgin Islands Bureau of Internal Revenue:

1. Develop a detailed action plan which outlines the Bureau's implementation schedule
for integrating the withholding, hotel occupancy, and excise taxes modules onto the
mainframe computer so that this project is completed by the Bureau's September 1998 target
date.

  2. Ensure that entries for tax payments made with checks that have not been honored by
a bank are reversed from taxpayer accounts as paid amounts within a reasonable time (such
as 30 days) after the date that they were presented in payment of the accounts. Also,

7

 
consideration should be given to integrating the listing of checks not honored onto the
mainframe computer and developing a program to allow interaction between the listing and
the payment posting process.

3. Assess the causes for the delays in clearing income tax error registers and ensure that
the Code and Edit Unit has sufficient staff resources, training, and computer access to process
tax returns expeditiously.

  4. Require the Computer Branch to produce printouts of nonfilers, filers of duplicate
dependent claims, and comparisons of businesses' sales and gross receipts taxes paid on an
annual basis and to provide the results to the Audit Enforcement Branch.

Governor of the Virgin Islands Response and Office of Inspector General
Reply

The Governor of the Virgin Islands did not provide a response to the draft report. Therefore,
the recommendations are considered unresolved (see Appendix 2).

 
B. DELINQUENT ACCOUNTS AND RETURNS

The Delinquent Accounts and Returns Branch did not effectively use collection practices or
tools to enforce the collection of amounts owed. Specifically, the Delinquent Accounts
Branch did not: (1) perform followup collection activities on taxpayers whose accounts were
delinquent or make reasonable efforts to protect the Government's interests before the
statute of limitations on collections expired; (2) file liens and levies to serve as the
Government's claim on a delinquent taxpayer's property; and (3) provide required supporting
documentation for tax penalty waivers. The Internal Revenue Code and the Internal Revenue
Manual contain criteria applicable to the collection of Federal taxes, and the Virgin Islands
Code contains criteria applicable to the collection of local taxes. The deficiencies existed
because the Revenue Officers in the Delinquent Accounts Branch did not: (1) effectively
manage their caseloads; (2) document collection efforts in taxpayer case history files;
(3) maintain a master inventory listing of the taxpayer cases assigned to them; and
(4) comply with Federal and local guidelines for filing liens and levies and granting penalty
waivers. As a result, the Bureau: (1) did not collect $10.1 million from 1,750 taxpayer cases
totaling $15.2 million; (2) did not collect approximately $324,000 in tax revenues because the
statute of limitations had expired and could lose an additional $940,000 within the
next 2 years unless collection actions are taken; and (3) granted penalty waivers totaling
$795,000 without the required supporting documentation.

Delinquent Accounts and Returns Branch

The Delinquent Accounts and Returns Branch was responsible for collecting unpaid taxes
administered by the Bureau. The Delinquent Accounts Branch had 24 employees as of May
1996 as follows: 1 Chief on St. Thomas, 1 Assistant Chief on St. Croix, and 11 Revenue
Officers each on St. Thomas and St. Croix. The Revenue Officers received Internal Revenue
Service training and used collection procedures and forms implemented by the Internal
Revenue Service. An accounts receivable listing produced by the Bureau's Computer
Operations Branch indicated that, as of July 1996, the Delinquent Accounts Branch was
primarily responsible for collecting $82.4 million from 12,4 10 taxpayers whose income taxes
were delinquent for tax years 1978 to 1995.

As part of the fiscal year 1995 budget, the Legislature approved an additional $300,000 to
hire personnel to collect delinquent taxes. However, the Bureau's Director said that because
the funds allocated to the Bureau for fiscal year 1995 costs were less than the funds
appropriated, the $300,000 supplemental appropriation to hire additional personnel was used
to make up for the budget shortfall. During our audit fieldwork, a turnover in personnel in
the Delinquent Accounts Branch occurred, and although additional Revenue Officers were
hired to replace those who had left or retired, an increase in Revenue Officer staffing did not

occur. The Bureau Director said that staffing in the Branch was adequate but that measures
were needed to improve productivity.

According to the Internal Revenue Code and Bureau policy, a tax account, to be classified
as delinquent, must have been assessed within the legally established statute of limitations, and
two notices of demand for payment must have been sent to the taxpayer by the Processing

9

 
Accounts and Returns Branch. If the outstanding balance was not satisfied after the second
notice of demand for payment, the account was transferred to the Delinquent Accounts
Branch for collection. There, the Revenue Officers were responsible for issuing the third
notice of demand for payment ("Notice of Intent to Levy").

Collection Practices

The Internal Revenue Code, the U.S. Master Tax Guide, and the Virgin Islands Code contain
regulations governing collection practices. In addition to these regulations, in March 1996,
the Chief of the Delinquent Accounts Branch sent a memorandum entitled "Expectations for
Revenue Officer Performance" to the Delinquent Accounts Branch staff The memorandum
outlined the collection procedures for the Revenue Officers and included specific guidelines
to ensure that: (1) taxpayers were contacted promptly and effectively; (2) priority was given
to large dollar cases; (3) history sheets were complete, current, and neat; (4) the statute of
limitations on collections was not allowed to expire; (5) accounts that were currently not
collectible were reported promptly; and (6) proper use was made of internal and external
sources of information to locate taxpayers.

To determine whether the Revenue Officers effectively used adequate collection practices to
enforce the collection of amounts owed, we selected a judgmental sample of 5 of the 11
St. Thomas Revenue Officers and reviewed all of their case files. In total, we reviewed 1,760
case files containing about 4,200 taxpayer delinquent accounts, totaling $15.2 million.

Followup Collection Practices. We found that the Revenue Officers in the Delinquent
Accounts Branch did not effectively use follow-up practices to enforce the collection of
amounts owed. Specifically:

- No follow-up collection activity was performed by the Revenue Offkers on 839
(49 percent) taxpayer case files after the "Notice of Intent to Levy" was sent to the taxpayers.
The Notice stated that a tax lien may be filed at any time to protect the Government's
interests and that if payment was not received by the Bureau within 30 days of the date of the
Notice, the Bureau, without further notice to the taxpayer, "may levy upon and seize taxpayer
property." The March 1996 memorandum stated that taxpayers were not to be issued
duplicate Notices and that enforcement measures should be taken promptly after expiration
of the 30.day period. The memorandum further stated: "Further contacts demonstrate that
you [the Revenue Officer] won't enforce collection and that the taxpayer is in control of the
situation. Levies and other enforcement action demonstrate you [the Revenue Officer] are
in control." (Emphasis in original.) Further, the Collection Quality Measurement System
Handbook in the Internal Revenue Manual requires that "revenue officers initiate followup
action within ten (10) calendar days after the taxpayer misses a specific deadline." Because
follow-up collection actions were not taken, 1,244 (73 percent) taxpayer case files had no
payment activity for the last year, and 516 (30 percent) taxpayer case files had no payment
activity.

- Case history sheets were not included or did not adequately document the collection
actions taken for 754 (44 percent) taxpayer case files. The March 1996 memorandum

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required that the case history sheets document all collection actions, including verification of
the taxpayer's physical address and telephone number, and that a plan of action to close the
case be included. The Internal Revenue Manual's General Procedural Guidelines require that
the case history for reassigned cases be reviewed to "ensure continuity of case action and
avoid duplicating steps taken." We found that the transfer of cases among the Revenue
Officers occurred frequently. However, the Revenue Officers told us that they often had to
duplicate preliminary collection efforts, such as determining a taxpayer's residence and
telephone number, because this information was not included in the case file.

- The statute of limitations on collections had expired in 104 (6 percent) taxpayer case
files that contained 218 taxpayer delinquent accounts, totaling $324,000. The U.S. Master
Tax Guide and the Virgin Islands Code allow 10 years for the collection of Federal taxes and
6 years for the collection of local taxes, respectively, following assessment of the tax. The
Internal Revenue Manual also requires the close monitoring of tax receivable cases to ensure
that action is taken before the statute of limitations expires. We found that case history sheets
indicated that followup collection actions were taken in only 36 of the 218 delinquent
accounts in which the statute of limitations had expired. Further, our review showed that
another 214 taxpayer case files, which contained 528 taxpayer delinquent accounts, totaling
$940,000, would become uncollectible within the next 2 years (calendar year 1998) because
of the expiration of the statute of limitations.

We found that of the five St. Thomas Revenue Officers included in our sample, two Revenue
Officers did not maintain a master inventory listing of the taxpayer cases assigned to them and
three Revenue Officers maintained only a master inventory listing of their "work in process"
accounts. Accordingly, the Revenue Officers were not cognizant of all the cases assigned to
them, which hampered effective followup collection activity, including ensuring that the
statute of limitations did not expire. During our review, the Revenue Officers requested a
copy of the master inventory listings that we compiled as part of our audit.

Collection Tools

The Delinquent Accounts Branch did not effectively use collection tools such as liens and
levies, installment agreements, and special programs to enforce the collection of amounts
owed.

Tax Liens. The Internal Revenue Service Publication "IRS Practice and Procedure,"
which interprets guidelines contained in the Internal Revenue Code and Internal Revenue
Manual, states: "A lien is a claim or charge on property for the payment of a debt. By itself,
the creditor's lien does not transfer the debtor's property to the creditor; such a transfer can
be made only by a levy or seizure." The general rule (Title 33, Chapter 27, Section 103 1, of
the Virgin Islands Code) is as follows:

If any person liable to pay any internal revenue tax neglects or refuses to pay the same
after demand, the amount (including any interest, additional amount, addition to tax,
or assessable penalty, together with any costs that may accrue in addition thereto)

11

 
shall be a lien in favor of the government of the United States Virgin Islands upon ail
property and rights to property, whether real or personal, belonging to such person.

The "IRS Practice and Procedure" publication further states that a tax lien arises by operation
of law when: "(1) a tax assessment has been made; (2) the taxpayer has been given notice of
the assessment stating the amount and demanding its payment; and (3) the taxpayer has failed
to pay the amount assessed within ten days after the notice of demand."

The Delinquent Accounts Branch did file liens in approximately 1,300 of the 1,760 taxpayer
cases that we reviewed. However, we found 67 instances in which a tax lien was not filed for
taxpayers who had delinquent accounts in excess of $1,000 and 338 instances in which tax
liens were not filed for taxpayers who had delinquent accounts totaling less than $1,000.
Since the filing of a tax lien was "literally the basis for collection of a tax administratively and

. judicially" and to protect the Government's interests, we believe that such an action should
have been taken by the Bureau in these cases to ensure the payment of delinquent taxes.

Tax Levies. The "IRS Practice and Procedure" publication states, "Levy procedures are
designed to give taxpayers a reasonable chance to settle their tax liabilities voluntarily before
administrative action is taken to collect delinquent taxes." The general rule (Title 33,
Chapter 27, Section 105 1, of the Virgin Islands Code) is as follows:

If any person liable to pay any internal revenue tax neglects or refuses to pay the same
within 10 days after notice and demand, it shall be lawful for the Director or any
authorized representative to collect such tax together with interest . . . by levy upon
all property and rights to property. . . belonging to such person or on which there is
a lien provided in this chapter for the payment of such tax.

Despite these guidelines, we found that a levy was attempted in only 45 of the 1,760 cases
which we reviewed. Further, ofthe 45 cases, the Delinquent Accounts Branch was successful
in securing the tax liability only eight times. Without the serving of a notice of levy and the

seizure of property, the Bureau cannot collect taxes owed when all other collection efforts
have been made.

Stop Tax Evasion Program. The Stop Tax Evasion Program, a joint initiative between
the Bureau and the Department of Licensing and Consumer Affairs, required applicants for
business licenses to obtain a tax clearance letter from the Bureau before the applicants
obtained or renewed a license. The tax clearance letter, in accordance with Title 27,
Chapter 9, Section 304, of the Virgin Islands Code, affirmed that the applicant had filed and
paid all taxes or had made satisfactory agreement to pay the taxes.

We found that, although the Delinquent Accounts Branch allowed applicants to enter into
installment agreements with the Bureau (in accordance with regulations) to obtain a business
license, the Bureau did not follow up on applicants who defaulted on the installment
agreements. Specifically, we found seven instances in which an installment agreement was
made with the applicant, an initial payment was made by the applicant, and the tax clearance
letter was issued by the Bureau. In all of these instances, the applicant did not make any

12

 
subsequent payments in accordance with the installment agreement. As a result, we believe
that one of the most important collection tools to require payment of delinquent taxes was
not fully effective.

Operation Fresh Start. Operation Fresh Start was a special program initiative
implemented by the St. Thomas unit of the Delinquent Accounts Branch to encourage
Government employees on that island who had delinquent tax accounts to set up regular
payroll deductions to avoid further collection actions.

The Delinquent Accounts Branch identified 301 Government employees who had outstanding
tax liabilities, totaling $796,000, as of January 31, 1995. In February 1995, the Revenue
Officers hand delivered or mailed notices of balances due to these employees, and 214
employees subsequently either paid off the balance due, filed amended agreements, or entered
into payroll deductions or installment agreements.

However, the Bureau did not receive responses from the 87 remaining Government
employees, who had outstanding tax liabilities totaling $439,000. Moreover, the Delinquent
Accounts Branch did not take any followup actions to collect the taxes, including filing tax
levies, as stated in the notices of balances due that were sent to the employees. In addition,
9 of 21 Government employees who entered into installment agreements defaulted on the
agreements, but no follow-up collection efforts were made in these nine cases.

The Revenue Officers said that they spent a considerable portion of their work day responding
to taxpayer inquiries and believed that they could use collection practices and tools more

effectively if they did not have to respond to these inquiries. They also stated that they
believed that Taxpayer Representatives, which the Delinquent Accounts Branch did not have,
could respond to these inquiries. Accordingly, in our opinion, the Bureau should evaluate the
feasibility of allocating, from other branches, Taxpayer Representatives, who could respond
to taxpayer inquiries, or of redirecting calls telephonically to other branches where Taxpayer

Representatives are located.

Tax Penalty Waivers

Title 33, Chapter 3, Section 45(d), of the Virgin Islands Code states that the Bureau "may
waive any and all penalties" if a taxpayer provides "satisfactory proof. . . that failure to file
a return or pay any tax or penalty required under the provisions of this chapter was due to
reasonable cause and not to wilful neglect." Because the Virgin Islands Code did not define
"reasonable cause," the Bureau used the Internal Revenue Code, which gave nine examples
of "reasonable cause." The Internal Revenue Code also stated that "the taxpayer must give
sufficient detail to prove ordinary prudent business practice" for a penalty waiver to be
granted. The Revenue Code further stated, "The taxpayer must show that the event that
caused noncompliance or increased liability could not have been anticipated."

Of the 544 penalty waivers processed during calendar years 1995 and 1996, we found that
534 waivers were processed by the Delinquent Accounts Branch and the remaining 10
waivers by the Bureau's Legal Counsel.

13

 
We found that all 10 penalty waivers processed by the Legal Counsel were processed in
accordance with established regulations. In that regard, each case that we reviewed contained
a written request from the taxpayer and a written decision by the Legal Counsel based on
"reasonable cause," as defined by the Internal Revenue Code, to provide support for the
approval or denial of the taxpayer's request for the penalty waiver. However, 500
(94 percent) of the 534 taxpayer files that we reviewed at the Delinquent Accounts Branch
did not contain the necessary documentation from the taxpayer requesting the penalty waiver
or written documentation from the Branch supporting its approval of the penalty waiver
request. As a result, there was no assurance that penalty waivers of about $795,000 issued
by the Branch for these 500 taxpayer cases were processed in accordance with applicable
regulations.

Further, our review showed that when supporting documentation was submitted by taxpayers
requesting a penalty waiver which was processed through the Delinquent Accounts Branch,
a "reasonable cause" was not cited in the documents but the penalty waivers were still
granted. For example, according to the case files, taxpayers requested penalty waivers based
on the following:

- "[Elxtensive road repair directly in front of store curtailed business; poor business
location of another store and a failed partnership agreement."

- "[C]ollections of accounts receivables became stagnant so we fell behind on payments."

In our opinion, these requests for penalty waivers did not meet the guidelines contained in the
Internal Revenue Code that allow penalty waivers in situations such as the following: when
the return is mailed on time but is not delivered on time; when the delay is caused by death
or serious illness of the taxpayer; or when the taxpayer is unable, for reasons beyond his
control, to obtain the records necessary to determine the taxes due. Based on our concerns
regarding the lack of support for penalty waivers processed by the Delinquent Accounts
Branch, the Branch Chief, during our review, created a document entitled "Request for
Penalty Waiver," which allowed taxpayers to complete a written request for the waiver. The
Bureau implemented the document in January 1997.

Recommendations

We recommend that the Director of the Virgin Islands Bureau of Internal Revenue:

1. Ensure that Revenue Offkers in the Delinquent Accounts and Returns Branch follow
up with all taxpayers within 10 days after a taxpayer misses the specific payment deadline in
accordance with the Internal Revenue Code.

2. Ensure that Revenue Officers maintain a master inventory listing and case histories for
each taxpayer account assigned to them. The master inventory listing should identify when
the statute of limitations will expire for each case, and the case histories should include the
taxpayer's residential address and telephone number, each collection action taken by the
Revenue Officer, and a plan of action to close the case.

14

 
  3. Enforce the provisions of the Virgin Islands Code regarding the use of liens and levies
as collection tools.

4. Determine the feasibility of assigning, permanently or temporarily, Tax Revenue Clerks
and/or Taxpayer Representatives from other branches to the Delinquent Accounts Branch,
who can address taxpayer inquiries, or of redirecting calls telephonically to other branches
where Taxpayer Representatives are located.

5. Ensure that penalty waivers are granted only in accordance with established
regulations. In that regard, each request for a penalty waiver should include a written request
from the taxpayer and a written decision by the Bureau to approve or deny the request based
on "reasonable cause" as defined by the Internal Revenue Code.

Governor of the Virgin Islands Response and Office of Inspector General
=ply

The Governor of the Virgin Islands did not provide a response to the draft report. Therefore,
the recommendations are considered unresolved (see Appendix 2).

15

 
C. AUDIT ENFORCEMENT

The Audit Enforcement Branch did not implement adequate internal controls to effectively
administer its audit function. Specifically, the Audit Branch did not: (1) use computer
printouts produced by the Computer Branch to detect and prevent nonfilers; (2) commence
audits of the casualty loss claims filed as a result of Hurricane Marilyn; (3) conduct a
sufficient number of audits of corporations and high-income taxpayers; (4) document changes
made to Revenue Agent findings; (5) mail statutory notices (go-day letters) of audit results
to taxpayers in a timely manner; and (6) transmit closed cases to the Processing Branch for
assessment in a timely manner. We found that, although the Internal Revenue Code, the
Internal Revenue Manual, the Law of Federal Income Taxation, and the Virgin Islands Code
contain criteria applicable to the audit process, the deficiencies existed because the Audit
Branch, during fiscal years 1995 and 1996, concentrated its audit efforts on earned income
credit issues and because staffing, particularly of Senior Revenue Agents, was not adequate.
As a result, the Audit Branch did not conduct audits of 4,500 taxpayers who received Forms
1.099~MISC (miscellaneous income) and 21,625 taxpayers who received Forms W-2 for tax
year 1992 but who either did not report the income on a filed tax return or did not file a tax
return with the Bureau.

Audit Enforcement Branch

The Audit Enforcement Branch was responsible for classifying and examining income tax and
local tax returns. The Audit Branch had 16 employees as of May 1996 as follows:
1 Reviewer/Classifier/Conferee and 2 Group Supervisors (1 on St. Thomas and 1 on
St. Croix), 11 Revenue Agents (5 on St. Thomas and 6 on St. Croix), and 2 Tax Technicians
on St. Thomas. In July 1996, the only Senior Revenue Agent of the six Revenue Agents on
St. Croix resigned.

The Bureau's Reviewer/Classifier/Conferee told us that in October of each tax year, he
reviewed income tax returns received by the Bureau to select returns for audit examination
based on his observation of "unusual items."* The returns selected for audit were transmitted
to the St. Thomas and St. Croix Group Supervisors of the Audit Branch for assignment to
a Revenue Agent for audit examination. In addition to this review to select tax returns for
audit examination, the Audit Branch concentrated its audit efforts on taxpayers who claimed
the earned income credit. Audit Branch personnel said that they selected this item because
of the significant refunds associated with the credit and the number of instances in which the
credit was claimed by individuals who did not meet all applicable criteria to`receive this credit.
For example, 20,843 taxpayers claimed a total of $29.2 million for the earned income credit
for tax years 1994 and 1995. By auditing a large percentage of these cases, the Bureau was
able to significantly reduce the amount of refunds that would have been remitted to the
taxpayers.

2The Reviewer/Classifier/Conferee defined "unusual items"
business expenditures that justified an audit examination.

as

such as a company' s high cost of sales or high

16

 
Based on our analysis of the Revenue Agents' work load for fiscal years 1995 and 1996
(through April), we found that the Audit Branch completed 6,775 cases, with 6,245
(92 percent) of those cases representing earned income credit issues. Therefore, during this
time period, the Audit Branch completed only 530 cases of all other taxpayers. The Audit
Branch's records indicated that the 11 Revenue Agents maintained a total inventory of about
800 cases in process and that the 2 Group Supervisors had an additional 1,300 cases waiting
to be assigned to the Revenue Agents.

In March 1995, the Bureau's Director sought $150,000 in disaster assistance funds from the
Federal Emergency Management Agency (FEMA) to hire six Internal Revenue Agents for
1 year to assist in the examination of casualty loss claims resulting from Hurricane Marilyn.
In February 1996, FEMA's Federal Coordinating Officer denied the Bureau's request, basing
the denial on the fact that the request was not for an eligible public assistance activity, such
as debris removal or emergency services. Additionally, although the Audit Branch's budget
request for fiscal year 1996 totaled $1 million and included $170,000 to hire three Senior
Revenue Agents, the Governor's recommended budget for the Audit Branch totaled only
$760,000. Therefore, sufficient funding was not available to hire the additional Senior
Revenue Agents. Accordingly, the Bureau's Director sought to hire, on contract, retired
Internal Revenue Service Senior Revenue Agents. However, as of November 1996, although
the Bureau identified candidates to hire on contract, a funding source to pay for the contract
employees was not identified. In the Bureau Director's budget request for fiscal year 1996,
which was submitted to the Office of Management and Budget in March 1995, the Bureau
Director noted that since most of the Revenue Agents worked on earned income credit issues
and since there was a lack of Senior Revenue Agents to audit complex tax issues, all other
taxpayers were left "with a virtual tax audit holiday."

Audit Activity

Chapter 8 of "IRS Practice and Procedure" publication states that the Internal Revenue
Service "uses examination of returns as an enforcement measure to promote the highest
degree of voluntary compliance on the part of the taxpayer." The publication further states,
"[I@ more concrete terms, it is believed that greater taxpayer compliance with the internal
revenue laws will result from examinations." The publication also states that returns selected
for audit examination should be those that have the potential to produce additional revenue.
As noted previously, during fiscal years 1995 and 1996, the Audit Branch concentrated its
audit efforts on taxpayers who filed the earned income credit. Therefore, other audit
categories, such as nonfilers, filers of the casualty loss claims as a result of Hurricane Marilyn,
and corporate and high-income filers, were not audited on a priority basis by the Audit
Branch.

Nonfilers. In June and July 1995, the Bureau's Computer Branch produced, as discussed
in Finding A, listings of Forms 1099MISC and Forms W-2 for tax year 1992 for which the
taxpayer either did not report the income on a filed tax return or did not file a tax return. The
Computer Branch's listings contained 4,500 instances in which the amounts on the Forms
1099MISC were underreported by the taxpayer or were not reported on the tax return filed
by the taxpayer or in which there was no tax return filed by the taxpayer. For the Forms W-2,

 
the computer compared wages on magnetic tape received from the Social Security
Administration with tax returns filed by the taxpayers. The computer matching produced an
exception when a tax master (tax return) was not found for the amounts on the Forms W-2
reported to the Social Security Administration. The Computer Branch's exception listing
identified 21,625 instances of taxpayer nonfilers for the Forms W-2

Our analysis of information from the Forms 1099.MISC showed that of the 4,500 instances
of taxpayer exceptions, there were 114 instances in which the miscellaneous income paid to
an individual exceeded $100,000. The unreported income for these 114 instances totaled
$3 8.9 million. There was no indication that the Audit Branch selected any of these cases in
excess of $100,000 for audit. Because the miscellaneous income shown on the Form
1099.MISC was paid to the taxpayer on a gross basis, no taxes were withheld. Therefore,
the Bureau did not receive any tax revenues from this source.

Our analysis of information from the Forms W-2 showed that of the 21,625 taxpayer
exceptions, there were 17 taxpayer cases which were in excess of $100,000 (totaling
$2.4 million) and for which a tax return was not filed. Although the Computer Branch's
listing indicated that taxes of $233,370 were withheld, there was no indication that the Audit
Branch selected any of the Form W-2 exception cases for audit. In addition, there were 5,520
(about 25 percent) of the exceptions that represented employees of the Government of the
Virgin Islands.

The St. Thomas Group Supervisor told us that the Computer Branch also produced a listing
of taxpayers who filed duplicate dependent claims for a tax year prior to 1992. Neither the
St. Thomas Group Supervisor nor the Reviewer/Classifier/Conferee was able to locate this
computer printout during our audit fieldwork. However, both employees indicated that the
earned income credit issue took precedence and that, because of limited audit staff, only a
minimal amount of audit effort was expended on this issue.

We believe that in order to promote the highest degree of voluntary compliance with the tax
laws, the Audit Branch should use the printouts produced by the Computer Branch which
identify nonfilers and filers of duplicate dependent claims to select returns for audit
examination on the basis of their potential for tax change.

Casualty Loss Claims. Virgin Islands taxpayers were eligible to file casualty loss claims
for income tax purposes as a result of Hurricane Marilyn, which occurred in September 1995.
Federal guidelines issued by the Internal Revenue Service state that property which is
damaged or lost in a hurricane is termed a "casualty" loss. The guidelines further state that
the loss from a casualty may be deductible on an income tax return in the year the casualty
occurred. In order to file a casualty loss, according to the guidelines, the taxpayer is required

to make a list of damaged, lost, or destroyed property and to compute the decrease in
property value attributable to the casualty net of any insurance proceeds.

As of September 1996,537 individual income taxpayers had filed hurricane-related casualty
loss claims totaling $15.2 million. The tax year 1996 refunds associated with these claims
totaled $1.7 million. (At our March 4, 1997, meeting, the Director stated that the total

18

 
amount of hurricane-related casualty loss claims filed by individual income taxpayers had
subsequently increased to more than $75 million.) The Director and the Audit Branch's
Reviewer/Classifier/Conferee told us that they originally planned to audit all of the casualty
loss claims but later decided to establish audit criteria and audit only those claims that met the
established criteria. However, as of December 1996, such criteria had not been established.

In accordance with Title 33, Chapter 31, of the Virgin Islands Code and Chapter 49C of
Mertens Law of Federal Income Taxation (which summarizes and interprets the Internal
Revenue Code), income taxes are to be assessed within 3 years from the date the return is
filed. Tax year 1995 returns, which were filed in calendar year 1996, contained the taxpayers'
casualty loss claims. Therefore, the Audit Branch has until calendar year 1999 to audit the
casualty loss claims filed as a result of Hurricane Marilyn. However, audits of casualty loss
claims did not begin during 1996 because specific audit selection criteria had not been
established and because of a lack of Senior Revenue Agents. Therefore, the Audit Branch
has only 2 years in which to begin and complete the audits of these returns.

Complex Tax Issues. Because the Audit Branch allocated most of its audit resources
(except for the Senior Revenue Agent on St. Croix and one Revenue Agent on St. Thomas)
to audit earned income credit issues during fiscal years 1995 and 1996 (through April), audits
of complex tax issues were not accomplished. Complex tax issues involve corporate returns
and returns of high-income taxpayers and generally require the audit to be performed by an
experienced Revenue Agent. Our review of the Group Supervisors' audit inventory on
St. Thomas and St. Croix showed that the St. Thomas Group Supervisor had 82 complex
taxpayer cases waiting to be assigned to a Revenue Agent for audit and that the St. Croix
Group Supervisor had 14 complex taxpayer cases which had to be suspended because of the
retirement of the Senior Revenue Agent in July 1996. Of these 96 taxpayer cases, 94 were
for tax years prior to 1994. Therefore, the 3-year statute of limitations to make an assessment
of a filed income tax return was in jeopardy of expiring in all 94 of these cases.

In addition, we compared the "case load listings" for the five St. Thomas Revenue Agents
who worked on complex tax issues, as well as on earned income credit issues, to determine
the extent to which complex cases that were in process as of February 1995 had been
completed as of February 1996, approximately 1 year later. We found that the Revenue
Agents had 86 complex cases that remained in a "work in process" status throughout the
1 -year period. While the Revenue Agents' records showed that some work had been
performed on 71 of the 86 complex cases during the period of February 1995 to February
1996, the Revenue Agents had not charged any time for work on the other 15 cases during
the same period. We believe that the Revenue Agents were not able to complete work on the
86 complex cases because they were also assigned to conduct audits of earned income credit
issues during the period of February 1995 to February 1996.

Chapter 49B of Mertens Law of Federal Income Taxation states that a certain number of
returns should be "deliberately selected" for audit by random choice. Audit Branch officials
said that because the Branch focused its audit efforts during fiscal years 1995 and 1996 on
the earned income credit and because future years may focus the audit efforts on casualty loss
claims and selected complex tax returns, a program to randomly select an audit sample from

19

 
a universe of other taxpayers was not implemented. We believe that a random selection of
tax returns (for example, from business professionals, construction contractors, or business
license applicants) will help promote tax compliance.

Audit Process

The Audit Branch did not maintain adequate internal controls over the audit process.
Specifically, the Audit Branch did not: (1) document supervisory approval for changes made
to audit findings; (2) mail statutory notices of audit results to taxpayers in a timely manner;
and (3) transmit audit cases to the Processing Branch for assessment in a timely manner.

To evaluate the internal controls over the audit process, we randomly selected 140 cases that
were closed by the St. Thomas Revenue Agents as "agreed"3 and 15 1 cases that were closed
by the St. Thomas Revenue Agents as "unagreed"4 for the months of February 1995 and
February 1996. The 291 cases consisted of 220 cases closed in February 1995 or in February
1996 and 71 cases in excess of $5,000 that were closed by the St. Thomas Revenue Agents
from October 1994 to April 1996. Of the 29 1 cases, 257 cases represented income tax issues,
30 cases represented gross receipts tax issues, 3 cases represented withholding tax issues, and
1 case represented a hotel occupancy tax issue.

Documentation of Changes. Our analysis of the working papers produced and included
by Revenue Agents in the taxpayers' case files showed that changes made to the tax amounts
by the Revenue Agents did not contain documented supervisory approval by the Group
Supervisor or the Reviewer/Classifier/Conferee. For example, in June 1995, a Revenue Agent
closed a taxpayer's income and withholding case as "unagreed" in the  amount of
$3.7 million.  The audit file contained a December 1995 letter from the taxpayer's
representative to the Revenue Agent stating, "[BIased on my fax to you of November 29,
1995 containing our proposal and computations . . . and your acceptance of November 30,
1995 subject to revised computations . . . , enclosed is a check for $159,000 in full settlement
of the case." The working papers, however, did not contain the proposal and computations
prepared by the taxpayer's representative or any documentation of supervisory approval of
the settlement as prepared by the taxpayer's representative and agreed to by the Revenue
Agent, as indicated in the December 1995 letter.

The Reviewer/Classifier/Conferee, who reviews all audit cases, said that because of the high
volume of his work load, he often placed, in the working paper files, additional supporting
documents which refuted a Revenue Agent's finding of tax noncompliance that he had
received from a taxpayer or a taxpayer's representative. He said, however, that he did not
include a narrative explanation in the files to support changes to Revenue Agent findings. We
believe that changes made to Revenue Agent findings should be fully documented in the

3An "agreed" case represents consent by the taxpayer with the Revenue Agent's findings.

4An "unagreed" case represents the taxpayer's lack of consent with or a lack of response to the
Revenue Agent's
findings.

20

 
working papers and that supervisory approval of all changes to Revenue Agent findings
should be similarly documented.

Statutory Notices. A statutory notice of deficiency (90.day letter) is issued to a taxpayer
in audit cases where agreement on tax matters is not reached. Mertens Law of Federal
Income Taxation states, "A taxpayer who receives a statutory notice of deficiency (90.day
letter) may elect to file a petition with the Tax Court [District Court in the Virgin Islands],
execute a waiver consenting to an immediate assessment, or wait until the expiration of the
90.day period in which case the deficiency will be assessed upon the expiration of the 90.day
period." We concluded that the Audit Branch did not mail the statutory notice of deficiency
(90-day letter) to the taxpayer in a timely manner or transmit the 90.day letter to the
Processing Branch for assessment in a timely manner. Therefore, the Bureau was prevented
from initiating collection activity on tax amounts due as a result of completed audits.

Our analysis of the 15 1 "unagreed" cases showed that 54 were still in a 30.day letter (letter
which notifies taxpayer of audit results) or 90.day letter process at the time of our audit
review. Of the 54 cases, we found operational deficiencies in 28 cases as follows: (1) for 18
cases in which the 30.day letter had expired, a 90.day letter was not mailed to the taxpayer
as required; (2) for 7 cases in which a 90.day letter was sent and had expired, the case was
not transmitted to the Processing Branch for assessment as required; and (3) for 3 cases, the
90.day letter was mailed after the 3-year statute of limitations (to conduct the audit review
and make an assessment of the tax) had expired.

We determined that the volume of closed cases increased significantly during fiscal years 1995
and 1996 because most of the earned income credit cases were closed after an average of
2 working hours by a Revenue Agent. Further, many of the closed earned income credit cases

for February 1996 were closed as "unagreed," which increased the administrative processing
for the 30. and 90.day letters. Our analysis of the February 1996 closed cases showed that
it took about 2 l/2 months to mail the 90.day letter after expiration of the 30.day letter,
whereas in February 1995, the interval between the 30&y letter and the 90.day letter was
only about 2 l/2 weeks. We also found that the employee responsible for mailing the 30. and
900day letters had many other administrative responsibilities, which affected the employee's
ability to handle the increased work load. We believe that the Bureau should consider
allocating additional personnel to aid in the processing of the 30. and 90.day letters.

Recommendations

We recommend that the Governor of the Virgin Islands:

  1. Request that the Legislature appropriate funds for the Bureau to hire qualified Senior
Revenue Agents to conduct audits of the casualty loss claims filed as a result of Hurricane
Marilyn and to conduct audits of complex tax issues. In addition, the Senior Revenue Agents
should provide on-the-job training to the Audit Branch's other Revenue Agents.

We recommend that the Director of the Virgin Islands Bureau of Internal Revenue:

21

 
2. Require the Audit Branch to use the printouts that identify nonfilers and filers of
duplicate dependent claims produced by the Computer Branch and to establish audit criteria
to select returns from these lists for audit examination based on the potential to produce
additional revenue for the Bureau.

  3. Require the Audit Branch to select for audit a random sample of taxpayers from
sources such as business professionals, construction contractors, professional service
contractors with the Government of the Virgin Islands, and business license applicants in
order to have a more comprehensive universe of tax retums and to use available enforcement
measures to promote taxpayer compliance.

4. Require the Audit Branch's Reviewer/Classifier/Conferee and the Group Supervisors
to document changes to working paper files that affect tax amounts due and to include
supervisory approval of these changes in the Revenue Agents' working paper files.

5. Provide or allocate additional personnel to the Reviewer/Classifier/Conferee's
secretary to aid in the processing of the statutory notices of deficiency (90.day letters) in a
timely manner and to remove the 90-day letters from the audit files for transmission to the
Processing Branch for assessment in a timely manner.

Governor of the Virgin Islands Response and Office of Inspector General
Reply

The Governor of the Virgin Islands did not provide a response to the draft report. Therefore,
the recommendations are considered unresolved (see Appendix 2).

22

 
APPENDIX 1

CLASSIFICATION OF MONETARY AMOUNTS

       Finding Area

A. Computer Operations

Unrealized
Revenues*

Checks Not Honored                    $700,000

B. Delinquent Accounts and Returns

Accounts Receivable                    10,100,000
Statute of Limitations                     324,000
Penalty Waivers                            795.000

Total                               $11.919,000

*These amounts represent Iocal funds

23

 
APPENDIX 2

STATUS OF AUDIT REPORT RECOMMENDATIONS

Finding/Recommendation
  Reference

status        Action Required

Unresolved

Provide a response to each recommendation
indicating concurrence or nonconcurrence.
If concurrence is indicated, provide an
action plan that identifies the target date and
the title of the offkial responsible for
implementation. If nonconcurrence is
indicated, provide specific reasons for the
nonconcurrence.

24

 
ILLEGAL OR WASTEFUL ACTIVITIES
   SHOULD BE REPORTED TO
THE OFFICE OF INSPECTOR GENERAL:

Sending written documents to:            Calling:

Wthin the Continental United States

U.S. Department of the Interior
Office of Inspector General
1849 C Street, NW.
Mail Stop 5341
Washington, D.C. 20240

Our 24-hour
Telephone HOTLINE
l-800-424-5081 or
(202) 208-5300

TDD for hearing impaired
(202) 208-2420 or
l-800-354-0996

Outside the Continental United States

Caribbean Retion

U.S. Department of the Interior
Office of Inspector General
Eastern Division - Investigations
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Suite 410
Arlington, Virginia 22209

North Pacific Rezion

(703) 235-9221

U.S. Department of the Interior
Office of Inspector General
North Pacific Region
238 Archbishop F.C. Flores Street
Suite 807, PDN Building
Agana, Guam 96910

(700) 550-7428 or
COMM 9-O11-671-472-7279

 
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