TREASURY INSPECTOR GENERAL

FOR TAX ADMINISTRATION

FINANCIAL REVIEW OF CRIMINAL INVESTIGATIONíS GROUP I UNDERCOVER OPERATIONS

September 2001

Reference No. 2001-10-174

Executive Summary

In support of the overall Internal Revenue Service (IRS) mission, the Criminal Investigation function (hereafter referred to as CI) is responsible for investigating potential criminal violations of the Internal Revenue Code and related financial crimes in a manner that fosters confidence in the tax system and compliance with the tax laws. CI Group I operations include the most sensitive undercover operations conducted, are expected to last longer than 6 months, and have anticipated costs in excess of $20,000.

Group I operations can involve setting up various business activities as a cover to assist in obtaining evidence of illegal actions. The IRS has the authority to use proceeds from the cover business to offset the expenses of the undercover operation. Using income earned during an operation to offset expenses is referred to as churning.

Because of concerns expressed by the Senate Finance Committee staff and the IRS CI management, we performed a financial review of closed IRS CI Group I undercover operations, including operations that were authorized to use the churning authority. Our overall objective was to determine whether the financial records fairly present the results of the operation.

Results

The financial records for 16 of the 17 Group I undercover operations that we reviewed fairly present the revenue and expenses of the operations. In one instance, we were unable to attest to whether or not the financial records fairly presented the revenues and expenses of the operation because of inconsistent accounting practices.

Additionally, the IRS has not maximized the benefits from its churning authority and, inadvertently, did not accurately report the expenses of the operations with churning authority to the Congress. We also noted that accounting practices could be improved to adequately safeguard IRS resources.

The Internal Revenue Service Is Not Consistently Treating Income Earned from Undercover Operations

The IRS has churning authority, which allows the income earned from undercover operations to be used to offset the expenses of the operation. However, undercover operations with churning authority were not consistently treating earned income to offset expenditures of the operation. Five of the 17 Group I undercover operations we reviewed were authorized to churn funds. Four of these five operations earned sufficient income to attempt to use the churning authority. However, in all four instances, the IRS did not consistently use its churning authority to offset expenses.

In December 1997, the Chief, CI, issued a memorandum stating that income earned could not be used to pay expenses of the undercover operation directly. According to the Director, Special Investigative Techniques Section, the offsetting of expenses was cumbersome for the agents, and it was decided that the income, up to the amount of confidential funds authorized, would be remitted to the IRS Finance Division.

We believe that the use of consistent accounting methods enhances the reliability of the information presented. The Chief, CI, needs to provide for the consistent treatment of income earned during undercover operations to ensure that it is properly used to offset the expenses of the operation.

Expenditures of Undercover Operations Were Not Accurately Reported to the Congress

CI inadvertently did not accurately report to the Congress financial information on undercover operations that were authorized to churn. We analyzed the expenditures reported to the Congress in Fiscal Year (FY) 1999 and FY 1998 for the five operations included in our review that were authorized to churn. Each operation used different time periods to capture the expenditures reported to the Congress in the FY 1998 and 1999 reports. As a result, these annual reports to the Congress do not provide a reliable means for determining the total expenditures of an operation. For instance, in FY 98, CI reported to the Congress that a total of $812,000 was expended for undercover operations that it was authorized to churn, and CI reported that a total of $1.44 million was expended in FY 99. In contrast, we calculated the expenditures from the inception for these operations at $931,000 in FY 1998 and $1.46 million in FY 1999. Accordingly, we believe CI needs to ensure that all operations use the same time periods when calculating the expenditures reported to the Congress to provide an accurate portrayal of income and expenses of the operations.

Some Improvements Are Needed in the Accounting Practices for Undercover Operations

Accounting practices at various locations need improvement to adequately safeguard IRS resources. We determined that income and expenses were not properly reported, recoverable funds were commingled with confidential funds, and documentation was insufficient to properly account for expenses. Further, we could not attest to the revenue and expenses in the operation ****2d**** due to inconsistent accounting practices.

Summary of Recommendations

The Chief, CI, should issue guidance regarding the handling of income and expenses for churning purposes and reporting expenditures of applicable operations to the Congress and ensure that guidance issued to account for funds used in undercover operations promotes accuracy, uniformity, and consistency in accounting for undercover operations.

Managementís Response: CI management agreed that some clarification and consistency is needed on the financial aspects of their undercover operations and has already addressed two issues raised in the draft report. CI management has changed the format used to request financial information from undercover operations that are authorized to churn and has mandated the use of Quickbooks to account for funds for all undercover operations. CI management will also issue guidance for the treatment of churned income. Managementís complete response to the draft report is included as Appendix V.

 

Redaction Legend:

2d = Law Enforcement Technique(s)