Additional Efforts Are Needed for Improving Revenue Protection
January 2001
Reference Number: 2001-40-021
This report has cleared the Treasury Inspector General for Tax Administration disclosure review process and information determined to be restricted from public release has been redacted from this document.
January 9, 2001
MEMORANDUM FOR CHIEF, CRIMINAL INVESTIGATION
FROM: Pamela J. Gardiner /s/ Pamela J. Gardiner
Deputy Inspector General for Audit
SUBJECT: Final Audit Report - Additional Efforts Are Needed for Improving Revenue Protection
This report presents the results of our review of the Internal Revenue Service's (IRS) process to assess the impact of the Revenue Protection Strategy (RPS) on taxpayer compliance. We focused on determining the impact of the RPS program on ensuring and promoting taxpayer compliance. In addition, we evaluated IRS’ methodology in evaluating and reporting the results of the RPS. In summary, we found the IRS has implemented additional checks in its tax return processing procedures to improve taxpayer compliance. However, we believe the IRS needs to develop a long-term RPS with measurable goals and objectives for effectively addressing taxpayer noncompliance and establish a process to measure the effectiveness of the initiatives on reducing taxpayer noncompliance.
As a result of this review, we recommend that the Chief, Criminal Investigation, should develop a comprehensive RPS with established measurable goals and objectives to evaluate the effectiveness of the Strategy. Until the RPS is developed and implemented, the IRS should develop a process to measure the effectiveness of individual initiatives on reducing noncompliance. The RPS should also contain provisions for measuring the effect of its components on reducing noncompliance.
Management agreed with these recommendations. The IRS’ newly implemented Strategic Planning and Budgeting process will produce a comprehensive compliance strategy. In addition, a multi-functional Compliance Council will oversee the execution of the Strategic Planning and Budgeting process. The new process places responsibility for the compliance strategy with the corresponding operating division commissioner. Further, the IRS will look into measuring the effectiveness of the Earned Income Credit outreach efforts. IRS Management's complete response has been incorporated into the report where appropriate, and the full text of their comments is included as an appendix.
Copies of this report are being sent to the IRS managers who are affected by the report recommendations. Please contact me at (202) 622-6510 if you have questions, or your staff may call Walter E. Arrison, Associate Inspector General for Audit (Wage and Investment Income Programs), at (770) 936-4590.
Appendix I – Detailed Objective, Scope, and Methodology
Appendix II – Major Contributors to This Report
Appendix III – Report Distribution List
Appendix IV – Management’s Response to the Draft Report
Following the release of an independent vulnerability assessment in September 1993, the Congress and the Internal Revenue Service (IRS) became interested in identifying the nature of tax filing fraud and abuse problems. In 1993, the IRS acknowledged the problem of filing fraud and estimated tax fraud and abuse to be in the millions of dollars. Since February 1995, the General Accounting Office (GAO) has identified filing fraud as a high-risk area for the IRS.
To combat the return filing fraud and abuse, the IRS implemented the Revenue Protection Strategy (RPS). The RPS was comprised of individual initiatives to improve taxpayer compliance. These initiatives were developed and implemented by various IRS functional areas such as the Examination and the Criminal Investigation (CI) Divisions. Examples of these initiatives include prevention efforts focused on validating Social Security Numbers (SSN) and Taxpayer Identification Numbers (TIN), identifying fraudulent refund schemes for referral to CI field offices, and conducting suitability requirements for practitioners’ entry into the electronic filing system.
The overall objective of this review was to determine whether the IRS has an effective process to assess the impact of the RPS on improving taxpayer compliance.
Results
In April 1994, the IRS established the Office of Refund Fraud (ORF), headed by the Director of Investigations within the CI Division, to set broad service-wide policy and respond to the challenges the IRS faced in the detection and prevention of tax filing refund fraud and abuse. The ORF established an RPS that focused efforts primarily on the Earned Income Credit (EIC) and electronic filing fraud and abuse. The ORF worked with various IRS functions as well as other governmental agencies, such as the Social Security Administration, to develop new ways for addressing filing fraud and abuse. There was a big emphasis on the RPS, and the ORF received executive support.
In 1997, the Congress appropriated over $700 million over a 5-year year period, beginning with Fiscal Year (FY) 1998, to fund initiatives to improve EIC compliance. In 1998, the IRS established the EIC Program Office to oversee and coordinate the IRS’ EIC program. The establishment of this appropriation and office caused a major shift in focus from the ORF to the new EIC Program Office. Despite the shift in focus, the ORF continued to address filing fraud and abuse issues, including the EIC.
As a result of the RPS, the IRS implemented additional checks in its return processing procedures to improve taxpayer compliance. For example, it: (1) expanded the number of up-front filters in the electronic filing system that are designed to screen electronically filed returns for problems, (2) employed math error procedures for missing or incorrect TINs, and (3) employed due diligence requirements for EIC preparers. These processing checks resulted in increased revenue protection by detecting tax filing schemes and abuse and by preventing the IRS from issuing many erroneous refunds.
However, the management of these initiatives has been fragmented. Each functional area has its own results measure, and there is no overall goal and performance measure to gauge the impact of these initiatives on reducing noncompliance. The individual initiatives alone are not enough to ensure the IRS is effectively addressing filing fraud and abuse. Additional efforts are needed to ensure goals and objectives are established and that actual performance can be compared against these goals and objectives to enable management to make decisions about the effectiveness of these initiatives, future outcomes, and how they can be best accomplished.
The Internal Revenue Service Needs a Long-Term Revenue Protection Strategy for Effectively Addressing Taxpayer Noncompliance
While the IRS has implemented individual revenue protection initiatives, it does not have a documented multi-year strategy with clearly defined goals and objectives. As increased emphasis has been placed on customer service and taxpayer education, compliance resources have been reallocated to support these activities. Since inception of the RPS, a significant number of RPS initiatives have focused on the EIC, and the IRS has concentrated its efforts on maintaining and refining the prior years’ initiatives. These factors have contributed to a complacence in the development of long-term goals and the design of a long-term strategy to achieve those goals.
Sound management practices require that program activities be planned over the long term and documented to improve program performance. Without a long-term strategy, the IRS risks not being able to direct well-organized and effective responses in areas of actual fraud and abuse.
The Internal Revenue Service Needs a Process to Measure the Effectiveness of the Revenue Protection Initiatives on Reducing Taxpayer Noncompliance
From FYs 1996 to 1999, an RPS communication package was published to educate internal and external parties about each current year’s revenue protection initiatives and report the results of the past year in terms of the numbers of returns selected or adjustments to refunds. Although the IRS reported the results of each initiative in the communication packages, no evaluation of the impact of these initiatives on reducing noncompliance was performed. In the past, the IRS measured noncompliance through its Taxpayer Compliance Measurement Program (TCMP). The last TCMP involved Tax Year (TY) 1988 returns.
In an attempt to measure compliance within one segment of the taxpaying population, the IRS conducted compliance studies on taxpayers claiming the EIC. A TY 1994 study showed a 25.8 percent overclaim rate. A subsequent study was commissioned by the IRS on TY 1997 returns. This study, released August 2000, indicated that of the estimated $30.3 billion in EIC claims, approximately $7.8 billion should not have been paid.
In addition, the Congress included a provision in the IRS Restructuring and Reform Act of 1998 (RRA 98) requiring a joint study on noncompliance. The provision required the Secretary of the Treasury and the IRS Commissioner to complete the study within 1 year after enactment of the law (July 22, 1998). This study is in draft and will soon be released.
With the elimination of the TCMP, the IRS has not been able to measure noncompliance and, therefore, is unable to measure the impact of the individual initiatives on improving taxpayer compliance. IRS management informed us that changes every year with respect to laws, budget, resources, and abuse patterns make it difficult to measure the success of these initiatives. Furthermore, in its report Major Challenges and Program Risks: Department of the Treasury (GAO/OCG-99-14), the GAO identified system weaknesses, and the lack of adequate data as affecting the IRS’ ability to identify delinquencies for targeting compliance and enforcement initiatives.
To support results-oriented management, the Government Performance and Results Act of 1993 (GPRA) requires agencies to develop strategic plans, set performance goals, and report annually on actual performance as compared to those goals. The GAO stated during testimony before the Congress, "Regularly measuring progress in voluntary compliance is important to gauge whether the IRS is accomplishing a key aspect of its mission. Also, information about taxpayers to be generated as part of measuring voluntary compliance should help the IRS identify the characteristics of taxpayers who have difficulty understanding and meeting their tax responsibilities. The IRS must better understand the problems of noncompliant taxpayers and the sources of their problems so that it can develop better products and services to meet the needs of those taxpayers." Without an effective process for assessing the impact of the initiatives on compliance, the IRS will be unable to evaluate program accomplishments and analyze resource and budgetary allocation to reduce taxpayer noncompliance.
Summary of Recommendations
The Chief, CI, should develop a comprehensive RPS with established measurable goals and objectives to evaluate the effectiveness of the Strategy. Until the RPS is developed and implemented, the Chief, CI, should develop a process to measure the effectiveness of individual initiatives on reducing noncompliance. The RPS should also contain provisions for measuring the effect of its components on reducing noncompliance.
Management’s Response: The IRS recently implemented a Strategic Planning and Budgeting process that will produce a comprehensive compliance strategy. Strategic Program plans will provide direction, goals and objectives, and balanced performance measures. In addition, the IRS has established a multi-functional Compliance Council to oversee the Strategic Planning and Budgeting process. The new process places responsibility for the compliance strategy for each taxpayer segment with the corresponding operating division commissioner. Further, the IRS will look into measuring the effectiveness of their EIC outreach efforts. Management's comments have been incorporated into the report where appropriate, and the full text of their comments is included as Appendix IV.
The overall objective of this review was to determine whether the Internal Revenue Service (IRS) has an effective process to assess the impact of the Revenue Protection Strategy (RPS) on taxpayer compliance. We focused on the development and planning of the RPS, along with the evaluation process for assessing its impact on taxpayer compliance.
Audit work was performed at the IRS National Headquarters during October 1999 through March 2000. This audit was performed in accordance with Government Auditing Standards.
Details of our audit objective, scope, and methodology are presented in Appendix I. Major contributors to this report are listed in Appendix II.
Following the release of an independent vulnerability assessment in September 1993, the Congress and the IRS became interested in identifying the nature of tax filing refund fraud and abuse problems. The IRS recognized the need to increase its efforts to address this problem. In April 1994, the Office of Refund Fraud (ORF) was established to set broad service-wide policy and respond to the challenges the IRS faced in the detection and prevention of tax filing refund fraud and abuse. The Director of Investigations within the Criminal Investigation (CI) Division was designated as the lead executive of the IRS’ efforts. Chief Officers, Regional Commissioners, and Regional Chief Compliance Officers were directed to seek guidance from the Director of Investigations and ensure his continued involvement in their initiatives to address tax filing refund fraud.
The ORF worked with various IRS functions as well as other governmental agencies, such as the Social Security Administration, to develop new ways for addressing filing fraud and abuse. There was a big emphasis on the RPS, and the ORF received executive support.
In 1994, the ORF had a narrow focus on refund fraud in Electronic Filing (ELF). After a limited study of early Tax Year (TY) 1993 returns, preliminary results showed the problem was more than ELF returns; it extended to paper returns. The study also showed that Earned Income Credit (EIC) problems were bigger than originally thought—both in fraudulent and unintentionally erroneous claims. A Revenue Protection Strategy (RPS) was developed to deal with the broader issues identified. Since the creation of the strategy, the main focus has been EIC noncompliance, but other areas included the Questionable Refund Program, established in 1997, and the Return Preparer Program, implemented in 1996.
The RPS was comprised of individual initiatives to improve taxpayer compliance. These initiatives were developed and implemented by various IRS functional areas such as the Examination and the CI Divisions. Examples of these initiatives include prevention efforts focused on validating Social Security Numbers (SSN) and Taxpayer Identification Numbers (TIN), identifying fraudulent refund schemes for referral to CI field offices, and conducting suitability requirements for practitioners’ entry into the electronic filing system.
In 1993, the IRS acknowledged the problem of filing fraud and estimated tax fraud and abuse to be in the millions of dollars. However, a subsequent study of TY 1994 returns conducted by the IRS revealed the problem to involve billions of dollars. Since February 1995, the General Accounting Office (GAO) has identified filing fraud as a high-risk area for the IRS. In 1997, the Congress appropriated over $700 million over a 5-year year period, beginning with FY 1998, to fund initiatives to improve EIC compliance. In 1998, the IRS established the EIC Program Office to oversee and coordinate the IRS’ EIC program. The establishment of this appropriation and office caused a major shift in EIC focus from the ORF to the new EIC Program Office. The ORF continued to address filing fraud and abuse issues, including the EIC.
From FYs 1996 to 1999, an RPS communication package was published to educate internal and external parties about each current year’s revenue protection initiatives and report the results of the past year in terms of the numbers of returns selected or adjustments to refunds. The RPS was built on the following four-pronged approach to address the problems associated with fraudulent and questionable returns:
Understanding - Research and analyze data in an ongoing effort to understand fraud and the various methods of abuse, with a special emphasis on emerging trends.
Prevention - Validate return information up front to prevent fraudulent or questionable claims from entering the filing system.
Detection - Develop improved detection systems to identify multiple-return fraud schemes and patterns of abuse among groups of taxpayers.
Enforcement - Pursue criminal investigation and prosecution of fraudulent refund claims. In addition, conduct pre-refund audits to determine eligibility for certain tax benefits.
As a result of the RPS, the IRS implemented additional checks in its return processing procedures to improve taxpayer compliance. For example, the IRS implemented the following checks:
These processing checks resulted in revenue protection by detecting tax filing schemes and abuse and by preventing the IRS from issuing many erroneous refunds.
However, the management of these initiatives has been fragmented. Each functional area has its own results measure, and there is no overall goal and performance measure to gauge the impact of these initiatives on reducing noncompliance. For example, there exists some confusion about these and other revenue protection initiatives being part of an IRS revenue protection strategy. The ORF informed us that it does not have a document that frames a comprehensive RPS.
The individual initiatives alone are not enough to ensure the IRS is effectively addressing filing fraud and abuse. Additional efforts are needed to ensure goals and objectives are established and that actual performance can be compared against these goals and objectives to enable management to make decisions about the effectiveness of these initiatives, future outcomes, and how they can be best accomplished.
The Internal Revenue Service Needs a Long-Term Revenue Protection Strategy for Effectively Addressing Taxpayer Noncompliance
While the IRS has implemented individual revenue protection initiatives, it does not have a documented multi-year compliance strategy with clearly defined goals and objectives.
The voluntary compliance of taxpayers is essential to the efficient operation of the tax system. Therefore, specific attention should be given by IRS officials to the isolation and definition of problems in tax administration that might adversely affect voluntary compliance. Sound management practices require that program activities be planned over the long term and documented to improve program performance. Strategic planning includes:
A continuous evaluation and adjustment process is important because it allows an organization to adapt to changes in the environment, such as reduction in budget and changes in law and personnel.
With the enactment of the IRS Restructuring and Reform Act of 1998 (RRA 98), customer service and satisfaction have become the fundamental principles of the IRS mission. In response to this shift in program emphasis, some IRS resources have been reallocated from compliance to customer service. More efficient processing of returns and a quicker issuance of refunds is central to the service centers’ goal of customer satisfaction. The function of the RPS is to identify and stop fraudulent refunds, which may delay the issuance of valid refunds. Due to these differing goals, conflict arises among functions.
Since inception of the RPS, a significant number of RPS initiatives have focused on the EIC, and the IRS has concentrated its efforts on maintaining and refining the prior years’ initiatives. These factors have contributed to a complacence in the development of long-term goals and the design of a long-term strategy to achieve those goals. Top management support is critical to the development and maintenance of a successful long-term RPS.
Currently, the IRS is going through a total redesign and the ORF has been renamed the Office of Refund Crimes. In support of the overall IRS mission, the Office of Refund Crimes will detect fraudulent returns, prevent issuance of related false refunds, and support the mission of CI field operations relative to tax administration.
Without a long-term strategy, the IRS risks not only being unable to direct well-organized and effective responses in areas of actual fraud and abuse, but may miss opportunities to prevent and deter potential fraud. Lack of a coordinated multi-functional strategy makes the IRS vulnerable in its ability to recognize, adapt, and respond quickly and effectively to emerging trends, schemes, and methods. It also contributes to a system geared toward maintenance of previously successful initiatives and reactive responses versus continued development of new initiatives and proactive approaches. In a system geared toward maintenance and reaction, the IRS is forced to respond after new fraudulent activities have been discovered and revenue already lost. If the area of fraud involves a sophisticated scheme not quickly identified, the IRS stands to lose significant revenue before the fraud has been stopped. Once the money has been refunded, it becomes very difficult to recover.
Recommendations
Management’s Response: The IRS’ recently implemented Strategic Planning and Budgeting process will produce a comprehensive compliance strategy. Strategic Program plans will provide direction, goals and objectives, and balanced performance measures. In addition, the IRS has established a multi-functional Compliance Council to oversee the execution of the Strategic Planning and Budgeting process.
The Internal Revenue Service Needs a Process to Measure the Effectiveness of the Revenue Protection Initiatives on Reducing Taxpayer Noncompliance
Although the IRS has developed and reported the results of each initiative in the communication packages released to the public, no evaluation of the impact of these initiatives on reducing noncompliance was performed. In the past, the IRS measured noncompliance through its Taxpayer Compliance Measurement Program (TCMP). The last TCMP involved TY 1988 returns.
In an attempt to measure compliance among one segment of the taxpaying population, the IRS conducted compliance studies on taxpayers claiming the EIC. A TY 1994 study showed a 25.8 percent overclaim rate. A subsequent study was commissioned by the IRS on TY 1997 returns to provide a baseline measure for EIC overclaims. This study, released August 2000, indicated that of the estimated $30.3 billion in EIC claims, $7.8 billion should not have been paid.
Additionally, the Congress included a provision in the RRA 98 requiring a joint study on noncompliance. The provision required the Secretary of the Treasury and the IRS Commissioner to complete the study within 1 year after July 22, 1998, the date of the law’s enactment. This study is in draft and will soon be released. The study will address some of the same interests as the TCMP.
Without the TCMP, the IRS has not been able to measure noncompliance and, therefore, is unable to measure the impact of the individual initiatives on improving taxpayer compliance. IRS management informed us that changes every year with respect to laws, budget, resources, and abuse patterns make it difficult to measure the success of these initiatives. Furthermore, in its report Major Challenges and Program Risks: Department of the Treasury (GAO/OCG-99-14), the GAO identified system weaknesses and the lack of adequate data as affecting the IRS’ ability to identify delinquencies for targeting compliance and enforcement initiatives.
To support results-oriented management, the Government Performance and Results Act of 1993 (GPRA) requires agencies to develop strategic plans, set performance goals, and report annually on actual performance as compared to those goals. As the federal government implements this legislation, these plans and goals should be integrated into (1) the budget process, (2) the operational management of agencies and programs, and (3) accountability reporting to the public on performance results and on the integrity, efficiency, and effectiveness with which they are achieved. The GAO stated during testimony before the Congress, "Regularly measuring progress in voluntary compliance is important to gauge whether the IRS is accomplishing a key aspect of its mission. Also, information about taxpayers to be generated as part of measuring voluntary compliance should help the IRS identify the characteristics of taxpayers who have difficulty understanding and meeting their tax responsibilities. The IRS must better understand the problems of noncompliant taxpayers and the sources of their problems so that it can develop better products and services to meet the needs of those taxpayers."
Without an effective process for assessing the impact of the initiatives on compliance, the IRS will be unable to evaluate program accomplishments and analyze resource and budgetary allocation to reduce taxpayer noncompliance.
Recommendation
Management’s Response: Until specific measures of noncompliance are developed, the impact of individual initiatives cannot be determined. Where possible, the results of Office of Program Evaluation and Risk Analysis’s findings in measuring the effectiveness of the EIC Program Office’s outreach efforts will be tracked and the results acted upon to achieve increased compliance. The Strategic Planning and Budgeting process in conjunction with the Business Performance Review system requires each operating division to continuously evaluate its performance and adjust its program goals and objectives to maximize the impact on compliance within their taxpayer segment.
We found the IRS has implemented initiatives to reduce taxpayer filing fraud and abuse. However, we believe the IRS should develop a coordinated RPS with an effective process for assessing its impact. This would allow for the evaluation of program accomplishments and resource and budgetary allocation to reduce taxpayer noncompliance.
Appendix I
Detailed Objective, Scope, and Methodology
The overall objective of this review was to determine whether the Internal Revenue Service (IRS) has an effective process to assess the impact of the Revenue Protection Strategy (RPS) on improving taxpayer compliance.
To accomplish our objective, we determined if the RPS program provides adequate oversight and guidance for revenue protection initiatives. Specifically, we:
Appendix II
Major Contributors to This Report
Walter E. Arrison, Associate Inspector General for Audit (Wage and Investment Income Programs)
Michael Phillips, Director
Debra Gregory, Audit Manager
Patricia Lee, Audit Manager
James Traynor, Senior Auditor
Thomas Dori, Auditor
Bobbie Draudt, Auditor
Kathy Henderson, Auditor
Appendix III
Commissioner, Wage and Investment Division W
Chief, Criminal Investigation CI
Director, Refund Crimes CI:RC
Director, Strategy and Finance W:S
Director, Legislative Affairs CL:LA
Management Controls Coordinator A
Chief Counsel CC
Director, Office of Program Evaluation and Risk Analysis (OPERA) N:ADC:R:O
National Taxpayer Advocate TA
Audit Liaison:
Refund Crimes CI:RC
Appendix IV
Management’s Response to the Draft Report
The response was removed due to its size. To see the complete response, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.