TREASURY INSPECTOR GENERAL

FOR TAX ADMINISTRATION

The Tax Exempt and Government Entities Division Needs to Improve the Oversight Process for Compliance Project Examination Activities

December 2000

Reference No. 2001-10-028

Executive Summary

In recent years, the examination selection process for the Tax Exempt and Government Entities (TE/GE) Division has been the subject of a number of news reports. Many of these reports raised questions on whether the processes used by the TE/GE Division fairly selected exempt organizations for examination.

The TE/GE Division primarily uses local and national compliance projects to identify and select cases for examination through a process that researches tax return information maintained on the Returns Inventory Classification System (RICS). The compliance projects should be clearly justified and approved by managers in the TE/GE Division.

This audit evaluated the effectiveness of controls for identifying and selecting exempt organization returns for examination using the RICS. We further determined whether controls provided reasonable assurance that examinations were initiated only for business-related purposes, thereby protecting the rights of both exempt organizations and IRS employees.

Results

Overall, the TE/GE Division has controls in place to effectively administer the process of identifying and selecting exempt organization returns for examination when using information maintained on the RICS. Procedures had been established for:

The TE/GE Division also complied with most of the procedures established to monitor compliance projects and evaluate program controls. Quarterly status reports from the Key District Offices (KDO) were submitted to officials in the TE/GE Division headquarters office, and peer reviews were performed. In addition, managers in the local offices were able to demonstrate that they followed most of the operating procedures.

However, the TE/GE Division needs to improve compliance with its operating procedures that require justification for initiating a project and management approval for examinations. Managers should also ensure that projects are consistent with Examination strategies in the annual work plan. In addition, procedures are needed to ensure that managers in the Review and Classification function approve non-examined closures and that the reasons for these actions are documented in the case files.

Compliance Projects Should Include a Clear Justification for Initiating the Project and the Approval of Managers in the Tax Exempt and Government Entities Division

The TE/GE Division did not always comply with its procedures that require justification for initiation of and management approval for new compliance projects. Managers should also ensure that new compliance projects are consistent with Examination strategies outlined in the annual work plan. Our analysis of 14 project files from 2 KDOs showed that only 2 of the projects contained documentation of the necessary managerial approvals and only 1 included the reason for initiating the project. These conditions occurred because it was the practice of one of the KDOs to provide only oral management approval of new projects. In addition, TE/GE Division operating procedures were unclear on the need to provide a justification on the initiation documents or for ensuring that projects are consistent with strategies in the annual work plan.

The TE/GE Division can reduce the risk of examinations being initiated for other than legitimate business purposes by ensuring that projects are consistent with strategies outlined in the annual work plan. In addition, compliance project files should include the required management approvals and a clear justification for initiating the projects.

Procedures Are Needed to Require Management Approval of Decisions to Close Cases Without an Examination in the Review and Classification Function

The TE/GE Division does not have procedures that require classifiers to document the reason for closing a case without an examination. We reviewed 49 closed Examination case files that were initiated from 14 different compliance projects and found that cases closed in the Review and Classification function without an examination did not include an explanation for closing the case and were not approved by a manager. During the process of evaluating cases for examination potential, classification specialists frequently make decisions to close case files without an examination based on the lack of available resources in a particular field Examination group. However, under existing procedures, this action does not have to be documented in the case files and does not require the approval of managers in the Review and Classification function. The TE/GE Division can reduce the risk of improperly closing cases without examination by ensuring case actions are documented in the case files and are approved by a manager in the Review and Classification function.

Summary of Recommendations

While most of the necessary control procedures have been established and are being followed, the TE/GE Division needs to revise its procedures to require that: (1) project files include a clear justification for initiating the project, (2) the projects are related to the Examination strategies outlined in the annual work plan, and (3) the projects are approved by either the Area Manager in the Examination function or the Director, Exempt Organization Examinations. Additional procedures are needed to ensure classifiers record the reason for closing a case without an examination in the case file and to ensure these decisions are approved by a manager in the Review and Classification function.

Managementís Response: IRS management agreed with the facts cited in the report and is taking the appropriate corrective action. Specifically, management will ensure that examination personnel thoroughly document the reason for the initiation or closure of compliance projects, include evidence of managerial approval and indicate that the project is consistent with the annual work plan. Managementís comments are included in the body of the report where appropriate and their complete response to the draft report is included as Appendix IV.