Improvements Are Needed to Enable the National Non-filer
Strategy to Achieve Its Objectives
March 2002
Reference Number:
2002-30-060
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.
March
15, 2002
MEMORANDUM FOR
COMMISSIONER, SMALL BUSINESS/SELF-EMPLOYED DIVISION
FROM: Pamela J. Gardiner /s/ Pamela J. Gardiner
Deputy Inspector General for
Audit
SUBJECT: Final Audit Report – Improvements Are
Needed to Enable the National Non-filer Strategy to Achieve Its Objectives
(Audit # 200130029)
This
report presents the results of our review of the Internal Revenue Service’s
(IRS) efforts to develop a strategy to address non-filed tax returns. The overall objective of this review was to determine whether the National Non-filer Strategy
for Fiscal Years (FY) 2001 through 2003 will be effective in helping the IRS
reach its goal of bringing non-filers into the tax system and keeping them
there.
In summary, the IRS has long
struggled to address the failure of a sizeable number of taxpayers to file
required tax returns. The IRS’ records
indicate that at the end of FY 2001, there were potentially 2.3 million
un-filed individual taxpayer returns and 2.1 million un-filed business
returns. To help address this problem,
the IRS developed the National Non‑filer Strategy.
The
National Non-filer Strategy includes necessary coordination with the IRS’
Criminal Investigation (CI) function on all significant action items where it is appropriate.
This coordination should help enhance future communication between the Small Business/
Self-Employed (SB/SE) Division and the CI function regarding potential
non-filer fraud cases.
Successful
implementation of several of the cornerstones of the National Non-filer
Strategy, however, will require improvements.
·
Additional
efforts are needed to ensure successful completion of action items relating to
the implementation of third-party information matching.
·
Sufficient
accountability, specificity, and measurable milestones are not fully
established to help track the completion of, and ensure the success of, all
action items. Although management
identified the development of milestones as essential to the strategy, they
were not timely prepared. In August
2001, we advised management that the continued absence of detailed steps and
milestones in support of the National Non-filer Strategy would make effective
monitoring and coordination of the implementation team’s efforts
difficult. In November 2001, project
management completed the development of approximately 200 steps and milestones
in support of the Strategy; however, additional improvements are still
needed.
Management’s Response: IRS management agreed with our
recommendations and is proposing a number of actions to address the problems
identified in our report. The Non-filer
Strategy Implementation Team has provided additional milestones for the
third-party matching projects that are underway and will evaluate the results
from each state independently. The
Implementation Team will also conduct a cost/benefit analysis and confirm test
results for each activity, if feasible, before proceeding to the next
step. In addition, the Implementation
Team is reevaluating critical action items and plans to refocus deliverables
and responsibilities during their upcoming meeting. Finally, a regular meeting schedule for the Executive Steering
Committee was established and, when feasible, the Implementation Team will
measure return on investment for the
Non-filer activities.
Management did not fully
agree with our assessment of the third-party matching projects. Specifically, management indicated that
their primary focus has been on the Matching of State Employment Wage data and
that at this time, they are merely studying the feasibility of developing State
Sales Tax Matching as a secondary program.
However, management did include satisfactory corrective action in their
response to address our concerns regarding the need for a cost/benefit analysis
and evaluation of results from the Matching of State Employment Wage data.
Office of Audit Comment: Our
conclusions regarding the IRS’ third-party data matching initiatives were based
on an evaluation of all efforts where resources were being expended, and our
purpose was to evaluate the general framework within which the IRS was managing
those efforts. We noted a number of
areas where this overall effort can be improved, including the periodic
evaluation of project benefits and costs for any project under development.
Management’s complete response to the draft report is included as Appendix IV.
Copies of this report are also 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 Gordon C. Milbourn III, Assistant Inspector General for Audit (Small Business and Corporate Programs), at (202) 622-3837.
Additional Efforts Are Needed to Ensure Successful Delivery of a Key Element of the Strategy
The Strategy Does Not Include a Methodology to Measure Results
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
The timely filing of required tax returns is critical to the United States’ (U.S.) system of voluntary compliance with Federal tax laws. Taxpayer noncompliance with return filing requirements can result from a wide range of causes, including lack of knowledge, confusion, poor record keeping, differing legal interpretations, unexpected personal emergencies, and temporary cash flow problems. In addition, some noncompliance is intentional and can result in referrals to the Criminal Investigation (CI) function for a criminal tax evasion investigation.
The Internal Revenue Service (IRS) identifies potential individual non-filers by using historical filing information and some limited third-party data. For example, the IRS requires employers, financial institutions, and other business entities to submit income and various other types of tax-related information to the IRS. These third-party data are matched to the data on filed returns and are also used to identify non-filers.
IRS records show that as of the end of Fiscal Year (FY) 2001, there were potentially 2.3 million un-filed individual taxpayer returns and 2.1 million un-filed business returns in active inventory. The individual un-filed return inventory includes taxpayers with small businesses filing a U.S. Individual Income Tax Return (Form 1040) with a Profit or Loss from Business (Schedule C) attached. The business un-filed return inventory includes employment, corporate income, excise, and highway use tax returns.
To address the ongoing problem of un-filed tax returns, the IRS has employed a variety of different strategies over the past several years. From FYs 1993 through 1995, a multifunctional, national non-filer strategy was conducted using the Collection function’s open inventory. Another national non-filer strategy was developed for FYs 2000 and 2001; however, it was terminated due to the reorganization of the IRS. Subsequently, the National Non-filer Strategy for FYs 2001 through 2003 was developed. It relies on a combined approach of outreach and compliance efforts, and the Small Business/Self-Employed (SB/SE) Division has overall responsibility for its implementation.
This review was conducted at the SB/SE Division Headquarters
in Washington, DC, and at Compliance Area 1, 10, and 13 Offices, headquartered
in Boston, MA; Dallas, TX; and Oakland, CA; respectively. We conducted the audit from July through
September 2001 in accordance with Government
Auditing Standards.
Detailed information on our audit objective, scope, and methodology is presented in Appendix I. Major contributors to the report are listed in Appendix II.
The National Non-filer
Strategy includes coordination with the CI function on all significant action
items where it is appropriate. The CI
function is responsible for conducting criminal investigations and recommending
prosecution of taxpayers when material fraud exists. This coordination should help enhance future communication
between the SB/SE Division and the CI function regarding potential non-filer
fraud cases. Some of the key
coordination action items include joint efforts, support of employee technical
training, and development of taxpayer awareness/education.
Additional efforts are
needed to ensure the successful delivery of the National Non-filer Strategy
initiatives involving third-party data matching. The expanded use of
third-party data, such as state sales tax and state employ-ment tax
information, to assist the IRS in resolving non-filer cases is a cornerstone of
the Strategy. Comprehensive third-party
data would allow the IRS to better identify non-compliance and focus its scarce
resources when attempting to resolve non-filer cases.
The IRS has long used information regarding interest
income, dividend income, and miscellaneous income such as rents and royalties
collected. However, there are numerous
other sources of third-party data the IRS could also use, such as state sales
tax records and state employ-ment tax data.
Since many businesses conduct cash transactions, about which information
is often not reported to the IRS, such sources could be especially helpful to
identify non-filers. While some of the
IRS’ individual field offices have collected state tax data in the past, such
efforts have generally been sporadic.
In addition, these efforts often required extensive and time-consuming manual analysis and review before the
information could be used to assist in identifying taxpayers who fail to file
required tax returns.
To develop a nationwide third-party data-matching program
involving state tax data, the National Non-Filer Strategy team identified and
gathered information on a variety of recent field office matching efforts. Currently, the Strategy team is in the
process of reviewing a sample of employment tax data from one state and a
sample of sales tax data from another state.
In both cases, the data were selected from states that had preexisting
matching programs with IRS field offices.
Since these testing efforts are still ongoing, we were unable to
evaluate the results.
However, there are several areas where this overall effort
could be improved. Specifically, the
Strategy does not include a requirement to periodically evaluate the state tax
matching project viability, including an ongoing review of project costs,
benefits, and risks. This evaluation
should consider all costs and human resource requirements associated with
obtaining, perfecting, and matching third-party information, and be
sufficiently detailed to allow management to access and evaluate the state tax
matching projects as they move through the various phases of their
development. Additionally, the Strategy
does not contain a provision for confirming the initial state sales tax test
results using data from one or more different states before proceeding to the
next step of the project. Project
planning by the Strategy team has been primarily focused on data acquisition
and sample analysis.
Sufficiently validated test results and a careful ongoing
analysis of project costs and benefits, as well as the risks of new information
technology efforts under development, are essential to informed decision-making
and effective project management.
Ineffective validation and evaluation of project viability could result
in developing a matching system that is largely unworkable or cost-prohibitive
to implement and operate.
The
Director, Compliance, SB/SE Division,
should:
1.
Incorporate into
the Strategy a requirement for a periodic review of project costs, benefits,
and risks of any third-party data-matching program under development. The analysis should consider all costs
associated with obtaining, perfecting and matching third-party information,
including an estimate of the human resources necessary at all steps of the
matching process.
Management’s
Response: The Implementation Team recently provided additional
milestones for the third-party matching projects (State Employment Wage data)
that are underway, and IRS management indicated they will evaluate the results
from each state independently. The team
will conduct a cost/benefit analysis and confirm test results for each
activity, if feasible, before they proceed to the next step. Preliminary data analysis will determine if
they should further develop the Sales Tax Match.
Management did not fully agree with our assessment of the third party matching projects. Specifically, management indicated that their primary focus has been on the Matching of State Employment Wage data and that at this time, they are merely studying the feasibility of developing State Sales Tax Matching as a secondary program.
Office of Audit Comment:
Our conclusions regarding the IRS’ third-party data matching initiatives
were based on an evaluation of all efforts where resources were being expended,
and our purpose was to evaluate the general framework within which the IRS was
managing those efforts. We noted a
number of areas where this overall effort can be improved, including the
periodic evaluation of project benefits and costs for any project under
development.
2.
Incorporate
into the Strategy a provision for confirming any initial test results regarding
matching programs before proceeding to the next step of the project.
Management’s
Response: The IRS will confirm independent test
results from each state, if feasible, before proceeding to the next step. The Non-filer Strategy already includes milestones for each phase of the
State Employment Wage Data-Matching project.
The initial National
Non-filer Strategy for FYs 2001 through 2003 did not establish sufficient
accountability to help ensure the successful completion of its objectives. Although management identified the development
of milestones as essential to the strategy, they were not timely prepared. In August 2001, we advised management that
the continued absence of any detailed steps and interim milestones in support
of the National Non-filer Strategy would make effective monitoring and
coordination of the implementation team’s efforts difficult.
In November 2001,
project management completed the development of over 200 detailed steps and
milestones in support of the Strategy.
Although these milestones, in general, significantly clarified the steps
needed to accomplish the multi-year action items, additional improvement in
some key areas is still needed. Also,
responsibilities for implementing the steps are still not always clearly
defined.
For example, the
initiation of matching of state sales tax data to improve case resolution is
jointly assigned to personnel in three different SB/SE Division functions, as
well as functions in two other IRS operating divisions. Although one of the SB/SE Division functions
is designated as the lead on this project, it is unclear what deliverables are
expected from each of the assisting functions.
In addition, initiation of sales tax matching, which is scheduled to
begin in December 2002, has no supporting interim milestones listed for any
time during FY 2002.
Similarly, the
development of outreach plans to non-filers, including sending informational
notices to targeted groups, is supported by only one general milestone, and
there is no documented progress relating to this area. The expanded use of education and outreach
to address the non-filing of tax returns has the potential to be the most
cost-effective action in the Strategy.
The development of milestones was delegated to the responsible functions
and not subject to detailed review by project management.
Finally, although an
Executive Steering Committee (ESC) was broadly tasked with developing an
integrated Strategy to address non-filers and overseeing the activities of an
Implementation Team, effective controls were not established to ensure that ESC
members are timely and periodically appraised of the action items’ progress,
results, and problems. For example, the
last meeting of the ESC was held in June 2001. A number of significant actions have taken place since then, such
as the completion of several non-filer studies, the development of the over 200
detailed milestones, and the amendment of delivery dates on a number of action
items.
Effective internal
control environments include ongoing monitoring, clear delineation of
responsibilities, and the availability of relevant information regarding
program results. Without sufficient
accountability and oversight, there is an increased risk that the Strategy will
not be implemented timely and as designed, which in turn, could result in
continuing noncompliance and an increase in un-filed returns. In addition, without detailed milestones to
help in the coordination of the over 30 different organization segments
assigned to the Strategy, there is a potential that work will be duplicated,
and opportunities for information sharing may be missed.
The Director, Compliance, SB/SE Division, should:
3.
Reevaluate
all critical action items and ensure that clearly defined lines of
responsibility, clear deliverables, and periodic milestones support them.
Management’s
Response: The Non-filer Strategy Implementation
Team is reevaluating critical action items and plans to re-focus deliverables
and responsibilities during their upcoming meeting. The first office listed for each action item has been designated
as the lead, with overall reporting responsibility for the status of the action
item. The lead also coordinates
milestone updates and communication among the co-owners. Milestones and updates are compiled and
reported at the end of the first month of each quarter, followed by discussions
approximately 2 weeks later, during quarterly Implementation Team
meetings.
4. Establish a regular meeting schedule for
the ESC and require formal, periodic reporting of the status and results of
Strategy action items to the ESC, including the identification of problem areas
and delays.
Management’s Response: The ESC met on January 31, 2002, and established a quarterly meeting schedule in order to avoid scheduling conflicts. A special follow-up meeting is planned to continue with unfinished business from the January meeting and discuss the Implementation Team’s activities from a meeting it held on February 13, 2002. During the January 31, 2002, meeting, the ESC acknowledged its strategic role in developing the Non-filer Strategy and reaffirmed its responsibilities to oversee and monitor the Implementation Team’s activities.
The National Non-filer
Strategy for FYs 2001 through 2003 does not include a comprehensive methodology
to measure either the results of the implementation of the action items or the
resources devoted to achieve the results.
Although the Strategy does include the measure of its effectiveness as a
priority action item, there are no specific steps or milestones to support
this. IRS procedures state that timely
and relevant information is necessary for effective management decisions
regarding planning, evaluating alternatives, monitoring progress, and measuring
performance. Management informed us
that they placed primary emphasis on first developing detailed steps and
milestones for action items directly related to implementing new initiatives
and systems.
Without reliable
management information regarding Strategy results and costs, it will be
difficult for management to effectively determine which specific initiatives
are successful and whether the Strategy is meeting its objectives overall. Development of this type of information is
especially critical given the limited resources the IRS has historically
devoted to addressing the non-filing of required tax returns. Complicating any effort to develop useful
information concerning progress towards achieving Strategy objectives is the
fact that during the development of the Strategy, the IRS never defined what
was meant by the term “non-filer.”
Management informed us they expected to develop a non-filer definition
in January 2002.
5. The Director,
Compliance, SB/SE Division, should develop
a comprehensive methodology to measure both the progress of the Strategy in
meeting its overall objectives and the cost of implementing the Strategy.
Management’s Response: When feasible, the Implementa-tion Team will measure return on investment for the Non-filer Strategy activities. IRS management established milestones to monitor progress and results of individual activities and to judge the short-term effectiveness of the Strategy. They also established an action item to develop a comprehensive Compliance measure, but will not be able to measure overall success for several years since the Non-filer Strategy is a sustained, multi-year effort.
Appendix I
Detailed Objective, Scope, and Methodology
The overall objective of this review was to determine whether the National Non-filer Strategy for Fiscal Years (FY) 2001 through 2003 will be effective in helping the Internal Revenue Service (IRS) reach its goal of bringing non-filers into the tax system and keeping them there.
To accomplish our overall objective, we:
I. Determined what steps the IRS has taken to ensure that this National Non-filer Strategy will avoid the pitfalls and capitalize on the successes of prior National Non-filer Strategies.
A.
Reviewed the prior National Non-filer Strategies to identify
the similarities and differences between those strategies and the present
Strategy.
B.
Evaluated management’s appraisal of overall successes/failures
associated with the last two strategies and analyzed the measurement system
used to arrive at these determinations.
II. Determined if the National Non-filer Strategy for FYs 2001 through 2003 was compatible with the goals, strategies, and initiatives of the various IRS functions charged with implementing it.
III. Determined if the Strategy’s Executive Steering Committee (ESC) was sufficiently empowered and could effectively monitor the implementation and measure the success of the Strategy.
A. Identified ESC members and their levels of authority in implementing the National Non-filer Strategy action items.
B. Evaluated the availability and allocation of resources for the start-up of action items approved by the ESC.
C. Determined how the ESC would manage the National Non-filer Strategy start-up and any initial implementation problems.
D. Evaluated how the ESC would monitor the Strategy in the long‑term to ensure it was progressing as anticipated and achieving the results it expected.
E. Analyzed the measurement system and associated goals the ESC would rely on to evaluate the long-term results of the Strategy.
IV. Determined whether the action items in the Strategy addressed and were consistent with non-filer trends identified in recent data gathered by the Small Business/Self-Employed (SB/SE) Division’s Research and Statistics function.
A. Analyzed results of recent Research and Statistics function studies relating to identification of non-filers and determined whether these results were adequately considered during the development of the current Strategy.
B. Analyzed results of recent Market Segment studies involving state licensing of non-filers and determined whether these results were used during the development of the current Strategy.
V. Determined whether key Strategy milestones (action items) were reasonable, including actions to be performed by functions not part of the SB/SE Division’s Compliance function.
A. Interviewed personnel responsible for selected action items and determined whether projected completion dates were reasonable.
B. Identified any existing Federal/State initiatives, such as matching sales tax data, and evaluated the effectiveness of the IRS’ use of data gathered through these efforts.
C. Interviewed government liaison personnel to determine the status of any pending Federal/State matching initiatives.
D. Determined the status of the proposed Federal/State licensing project and analyzed the reasonableness of any projected benefits.
E. Interviewed government liaison personnel to determine the number of states that may/could participate in this licensing venture.
F.
Determined
whether these sources were adequately used to help identify non-filers that had
a high potential of having a tax liability.
VI.
Identified internal stakeholder concerns
regarding the Strategy in selected field offices of the SB/SE Division’s
Compliance function, the SB/SE Division’s Taxpayer Education and Communication
function, and the Criminal Investigation function.
Appendix II
Major Contributors to This
Report
Gordon C. Milbourn III, Assistant Inspector General for
Audit (Small Business and Corporate Programs)
Parker Pearson, Director
Anthony Choma, Audit Manager
James Mills, Jr., Senior Auditor
Donald
Evans, Auditor
Mildred Rita Woody, Auditor
Appendix III
Commissioner N:C
Deputy Commissioner, Small Business/Self-Employed Division S:DC
Chief Counsel, Small Business/Self-Employed Division S:CC
Chief, Criminal Investigation CI
Director, Compliance, Small Business/Self-Employed Division S:C
Director, Compliance Policy, Small Business/Self-Employed Division S:C:CP
Director, Filing and Payment Compliance, Small Business/Self-Employed Division S:C:CP:FP
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 Controls N:CFO:F:M
Audit Liaisons:
Commissioner, Small Business/Self-Employed Division S
Chief, Criminal Investigation CI
Director, Compliance, Small Business/Self-Employed Division S:C
Appendix IV
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.