Management Advisory Report:
The Small Business/Self-Employed Division Needs to Further Consider the
Impact of Potential Examination Reengineering Recommendations
December 2001
Reference
Number: 2002-30-035
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.
December 19, 2001
MEMORANDUM FOR
COMMISSIONER, SMALL BUSINESS/SELF-EMPLOYED DIVISION
FROM: Pamela J. Gardiner /s/ Pamela J. Gardiner
Deputy Inspector General for
Audit
SUBJECT: Final Management Advisory Report: The Small Business/Self-Employed Division
Needs to Further Consider the Impact of Potential Examination Reengineering
Recommendations (#200230007)
This report
represents the results of our review of the preliminary recommendations of the
Small Business/Self-Employed (SB/SE) Division’s Examination Reengineering
Project Team. The overall objective of
this review was to provide ongoing input regarding the SB/SE Division’s
examination reengineering effort.
Specifically, we assessed the impact of the reengineering team’s
recommendations on the internal control environment and on taxpayer relations/taxpayer
rights. We also brought to management’s
attention any other concerns we identified.
This management advisory report is provided for informational purposes
to assist Internal Revenue Service (IRS) management in its efforts to modernize
the IRS.
In
summary, the 23 preliminary recommendations proposed by the SB/SE Division’s
Examination Reengineering Project Team should not adversely affect the existing
control environment. In fact, many of
the proposed recommendations may improve the control environment. However, we identified some recommendations
where a more careful consideration of the impact on taxpayer relations/taxpayer
rights is needed. In addition, the
procurement of automated examination workpaper software needs management’s
oversight. Finally, management will
have difficulty measuring the effectiveness of the recommendations on
examination productivity.
Since
we are making no recommendations in this management advisory report, a response
is not required. Copies of this report
are also being sent to the IRS managers affected by the report. Please contact me at (202) 622-6510 if you
have questions or Gordon C. Milbourn III, Assistant Inspector General for Audit
(Small Business and Corporate Programs), at (202) 622-3837.
Preliminary Recommendations Should Not Negatively Affect Internal
Controls
Management Attention Is Needed to
Ensure Recommendations Do Not Adversely Affect Taxpayer Relations
Management Needs to Provide Careful
Oversight of Any Workpaper Software Procurement
Management Will Have Difficulty
Measuring the Effectiveness of Recommendations That Are Implemented
Appendix I – Detailed Objective, Scope, and Methodology
Appendix II – Major Contributors to This Report
Appendix III – Report Distribution List
The Small Business/Self-Employed (SB/SE) Division serves
approximately 40 million taxpayers that pay $915 billion in taxes
annually. These taxpayers consist of
7 million small businesses, including corporations and partnerships with
assets of $10 million or less, and 33 million self-employed and supplemental
income earners.
The SB/SE Division’s Examination function examines tax
returns to ascertain whether taxpayers have correctly determined their tax
liability. SB/SE Division management
has expressed concern about the significant decline in examination productivity
in recent years. For example, the number of tax returns examined went
from 1 out of every 79 in 1988 to 1 out of every 232 in 2000. This drop has been particularly drastic since
the beginning of 1998. In addition,
revenue agents’ time per return has increased.
For example, hours per return for individual and corporation returns
increased by 24 percent and 47 percent, respectively, from 1998 to 2000.
Because of this concern, in May 2001, the SB/SE Division
initiated an in-depth effort to reengineer its examination processes, products,
and services. Expected project
deliverables include streamlining the examination process, increasing the
effectiveness and timeliness in examining tax returns, and decreasing and
redirecting expenditures within the SB/SE Division. Assisting in the reengineering of the examination processes is a
consulting contractor and a contractor with auditing and accounting expertise.
The SB/SE Division’s Examination Reengineering Project Team
members identified 23 potential recommendations that are being further
studied for development. As part of the
reengineering effort, the Commissioner, SB/SE Division, requested the Treasury
Inspector General for Tax Administration to provide ongoing input during the
project. We are issuing this report to
advise the Commissioner, SB/SE Division, of our observations to date.
The overall objective of this review was to provide ongoing
input regarding the SB/SE Division’s examination reengineering effort. Specifically, we assessed the impact of the
reengineering team’s recommendations on the internal control environment and on
taxpayer relations/taxpayer rights. We
also brought to management’s attention any other concerns we identified.
This review was conducted at the SB/SE Division Headquarters
in Washington, DC, from May through November 2001, in accordance with the
President’s Council on Integrity and Efficiency’s Quality Standards for Inspections. Detailed information on our audit objective, scope, and
methodology is presented in Appendix I.
Major contributors to this report are listed in Appendix II.
Overall, the 23 preliminary recommendations proposed by the
SB/SE Division’s Examination Reengineering Project Team should not negatively
affect the existing control environment.
In fact, a number of the proposed recommendations could improve the
control environment. Recommendations
which should have a positive impact on the control environment include
increased management review requirements and a standardization of examination
workpapers.
The Examination Reengineering Project Team is
preliminarily recommending some initiatives which could have an adverse impact
on taxpayer relations and taxpayer rights.
For example, the reengineering team is considering changes to the
initial examination contact letter process, including adding information on
proposed tax adjustments if the taxpayer does not respond to the letter. While these proposed changes may increase
response rates, the changes could also have a negative effect on taxpayer
relations and are contrary to the numerous Internal Revenue Service (IRS)
efforts to improve customer service.
Management needs to fully weigh the costs, in terms of taxpayer
relations, of any changes it is considering in the way it communicates with
taxpayers.
In addition, recommendations have been made regarding the
examination case processing actions the IRS takes in order to meet the
requirements of the IRS Restructuring and Reform Act of 1998 (RRA 98). Because any responsi-bilities placed upon
the IRS by the RRA 98 cannot be eliminated without legislative change,
significant care needs to be exercised when considering any procedural changes
in this area. For example, the
reengineering team is recommending eliminating managerial
review of examination penalty cases.
However, the review of penalties is required by Section 3306 of the RRA
98, so the proposed change would require legislative approval.
The reengineering team has
not yet requested the involvement of the SB/SE Division Chief Counsel in
evaluating any recommendations involving the RRA 98. This could negatively affect planned project rollout. Consequently, the reengineering team should
consider engaging Chief Counsel in this process as soon as possible.
As part of the reengineering effort, the SB/SE Division is
considering the procurement of software to allow for standardized examination
workpapers. Because of the potential
for duplication of efforts already ongoing or planned elsewhere in the IRS,
careful planning of this effort is needed.
For example, the Large and Mid-Size Business (LMSB) Division has
already acquired Corporate Tax Analyzer Software, which allows examiners to
conduct complex tax calculations on notebook computers. In addition, the Reporting Compliance
Project, scheduled to begin in December 2001, is designed to address the
technical and software needs of all four IRS operating divisions. The Reporting Compliance Project is expected
to provide a total tax package, including a report-generating feature.
Further, a contract involving a workpaper product for all
15,000 compliance personnel in the SB/SE Division Examination function would be
of potentially significant value.
Therefore, management needs to ensure that the procurement policies and
procedures are followed, that there is appropriate coordination with the LMSB
Division and the Reporting Compliance Project, and that the procurement
represents the best value to the government.
The 23 preliminary recommendations proposed by the
reengineering team primarily represent either a strengthening of existing
procedures or an implementation of best practices. For example, 6 (26 percent) of the 23 recommendations
involve either strengthening management oversight or standardizing work
products.
The remaining recommendations generally focus on improving
existing procedures regarding the selection and ordering of returns, scheduling
meetings with taxpayers, case building, and workload planning. These recom-mendations are preliminary and
need further development. Consequently,
we could not determine whether they will have measurable impact on improving
examination effectiveness and timeliness.
Furthermore, SB/SE Division management
may have difficulty in measuring the impact of any changes made as the result
of the reengineering project. For
example, the decline in examination productivity in recent years can be
attributed partially to the re-deployment of Examination function resources to
provide direct assistance to taxpayers during the filing season. This re-deployment not only lessened
resources available to work cases but also interrupted the continuity of case
processing, resulting in increased cycle time per case.
In FY 2002, the SB/SE Division plans to significantly
reduce its commitment to direct assistance to taxpayers. As the reengineering team’s recommendations
are implemented, management will have difficulty determining whether any
productivity gains are attributable uniquely and directly to these
recommendations, to the increase in resources spent on examinations, or to other
factors. Consequently, as part of the
implementation of the reengineering team’s recommendations, SB/SE Division
management should specifically consider how the success of the recommendations
will be measured.
Appendix I
Detailed Objective, Scope, and Methodology
The overall objective
of this review was to provide ongoing input to Internal Revenue Service (IRS)
management regarding the Small Business/Self-Employed Division’s examination
reengineering efforts. In order to
accomplish our objective, we:
I.
Assessed the impact of the
reengineering team’s recommendations on the internal control environment and on
taxpayer relations/taxpayer rights.
A. Attended project team meetings and
interviewed selected IRS and contractor project team leaders.
B. Analyzed potential recommendations and
supporting workpapers.
C. Researched IRS procurement policies and
reviewed selected procedures related to the implementation of the IRS
Restructuring and Reform Act of 1998.
II.
Brought to IRS’ attention other
concerns, which were identified during the course of our review.
Appendix II
Major Contributors to This Report
Gordon C. Milbourn III, Assistant Inspector General for
Audit (Small Business and Corporate Programs)
Parker F. Pearson, Director
Anthony Choma, Audit Manager
Joseph F. Cooney, Senior Auditor
Joseph P. Snyder, Senior Auditor
Russell L. Phillips, Auditor
Appendix
III
Commissioner N:C
Deputy Commissioner
N:DC
Deputy
Commissioner, Small Business/Self-Employed Division S
Director,
Examination Reengineering Project Team, Small Business/Self-Employed
Division S:C
Chief
Counsel CC
National Taxpayer
Advocate TA
Director, Legislative Affairs CL:LA
Director, Office of
Program Evaluation and Risk Analysis N:ADC:R:O
Office of
Management and Controls N:CFO:F:M
Audit Liaison: Commissioner, Small Business/Self-Employed
Division S