The Financial
Products Specialist Program Controls Could Be Improved to Ensure More Timely
and Accurate Examinations of Large Corporations
September 2002
Reference
Number: 2002-30-147
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.
September
12, 2002
MEMORANDUM FOR
COMMISSIONER, LARGE AND MID-SIZE BUSINESS DIVISION
FROM: Pamela J. Gardiner /s/ Pamela J. Gardiner
Acting Inspector General
SUBJECT: Final Audit Report - The Financial
Products Specialist Program Controls Could Be Improved to Ensure More Timely
and Accurate Examinations of Large Corporations (Audit # 200230006)
This
report presents the results of our review
to assess how timely the expertise of Financial Products Specialists is
requested by and delivered to Large and Mid-Size Business (LMSB) Division
examiners. The LMSB Division’s return
on investment for the financial products specialist program is high. However, their services are not always
timely requested by and delivered to LMSB Division examiners. In addition, examiners conducting Industry
Case (IC) corporate examinations do not consistently request the assistance of
a Financial Products Specialist when examination procedures require such
involvement. As a result, significant
financial products tax issues have been overlooked.
In summary, we found that
while the time span of the examinations is not always under the direct control
of examiners and their managers, steps can nevertheless be taken to better
focus attention on improving the timeliness of examinations. Specifically, management’s information
system needs enhancing because it does not capture information on when an examination
is started or why delays are occurring.
In addition, key milestones such as planned start and completion dates
are missing. Consequently, the LMSB
Division is inhibited in its ability to spot and address problems that affect
the timeliness of requesting and delivering Financial Products Specialists’
services. Until performance measures
are implemented, another step that can be taken to focus attention on
timeliness is providing managers with guidance on establishing specific time
frames for completing examinations that are aligned with the LMSB Division
goals.
In addition to improving the
timeliness of requesting and delivering Financial Products Specialists’
services, a control process is needed to ensure
these specialists have an
opportunity to assist in determining which IC corporate examinations
could benefit the most from their involvement.
Management’s
Response: Internal Revenue Service (IRS) management
agreed with the findings and recommendations presented in the report. IRS management indicated that they are
developing an Electronic Referral System
that will accelerate the referral time and serve as a
control process for monitoring case referrals. IRS management will also notify all employees of the timeliness
goal, share the Field Specialist Business Plan with all managers, and emphasize
cycle time. Management’s
complete response to the draft report is included as Appendix IV.
Copies of this
report are also being sent to IRS officials 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.
Financial Products Specialists’
Services Need to Be More Timely Requested and Delivered
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 term “financial products” generically describes a
variety of instruments sold by investment companies and others in the financial
services industry. Conventional financial
products include equity securities such as stock and debt instruments such as
bonds. Other less conventional
financial products include stock options and stock index futures that can help
corporations and other investors to offset risks or hedge against possible
losses from other investments.
The Internal Revenue Service’s (IRS) Financial Products
Specialist Program (FPSP) began in response to the use of aggressive new
products in financial markets that generated significant tax benefits. Today, the IRS has selected approximately
147 experienced examiners to become Financial Products Specialists by training
them to understand the various products, tax law, terminology, and systems of
accounting used in the financial services industry. The Commissioner, Large and Mid-Size Business (LMSB) Division,
has overall responsibility for the FPSP, but it is directed within the LMSB
Division under the Field Specialist Program.
Among its responsibilities, the LMSB Division is tasked with
examining the nation’s largest corporations.
For examination purposes, the LMSB Division splits these corporations
into two groups. Of the approximately
58,000 large corporations, about 1,300 of the largest and most complex are
classified as Coordinated Industry Cases (CIC), while the remaining are
referred to as Industry Cases (IC).
CIC and IC corporate examinations account for $13.9 (70 percent)
of the $19.8 billion in recommended additional taxes from all IRS
examinations. However, the length of
time it takes to complete the examinations has been an ongoing concern of both
the IRS and stakeholders.
Large corporate examinations may not start for several years
after the corporate return is filed and take several more years to
complete. As part of an ongoing effort to improve the post-filing
examination process, the LMSB Division has a strategic initiative to reduce the
cycle time on CIC and IC corporate examinations.
This review is part of our Fiscal Year (FY) 2002 emphasis on
the LMSB Division’s post-filing examination process. We performed our work in accordance with Government Auditing
Standards at the LMSB Division’s Headquarters and offices in the New York,
Chicago, and Los Angeles metropolitan areas from October 2001 to March
2002. Detailed information on our audit
objective, scope, and methodology is presented in Appendix I. Major contributors to the report are listed
in Appendix II.
CIC corporate examinations are the largest and most complex
examinations that the IRS conducts.
Because of their size and complexity, these examinations consume a large
portion of the Financial Products Specialists’ time. As shown in Figure 1, documentary evidence obtained from the LMSB
Division shows that the specialists spent about 69 percent of their direct
examination time on CIC corporate examinations in FY 2001.
Figure 1 was
removed due to its size. To see the
figure, please go to the Adobe PDF version of the report on the TIGTA Public Web
Page.
Our analysis of Financial Products Transaction (FPT) System
data showed that the LMSB Division’s investment in Financial Products
Specialists is producing good results. Overall,
the specialists spent approximately 7,419 staff days (59,355 staff hours) on
371 CIC corporate examinations that were closed in FY 2001 and recommended
approximately $3.8 billion in adjustments to taxable incomes and disallowed
claims. From these data, we calculated
that for each hour spent on a CIC examination, a Financial Products Specialist
recommended about $63,778 in adjustments to taxable incomes.
The time taken to request and deliver Financial Products
Specialists’ services may hamper the LMSB Division’s ability to meet its FY
2002 and 2003 goals for timely completing IC corporate examinations. According to the FY 2002 LMSB Division
goals, an IC corporate examination is considered timely if it is completed
within 31 months after the return is filed, while a CIC corporate examination
is timely if it is closed within 57 months of the return file date. In FY 2003, the goals for closing IC and CIC
corporate examinations will be 29 and 54 months, respectively.
Our analysis of the FY 1995 through 2001 FPT System data,
matched to the FY 2001 closed Audit Information Management System (AIMS) data,
showed that the time taken to request and deliver Financial Products
Specialists’ services in IC corporate examinations was substantial. For example, it took, on average:
·
About 14.5 months (434 days) for the Financial Products
Specialist to issue a report once he or she started working on an IC corporate
examination.
Figure 2 shows the average elapsed time between when returns
were filed and key stages in CIC and IC corporate examinations closed in FY 2001
that involved a Financial Products Specialist.
Figure
2 was removed due to its size. To see
the figure, please go to the Adobe PDF version of the report on the TIGTA
Public Web Page.
As the third from the left column of Figure2 shows, the
Financial Products Specialists’ portion of time from the return file date to
their completion was an average of 1,277 days (about 42.6 months) for a CIC
examination, and 1,106 days (nearly 37 months) for an IC examination. The far right column shows that the overall
time frame for CIC and IC corporate examinations closed in FY 2001 was 1,791 days
(about 59.7 months) and 1,098 days (about 36.6 months), respectively.
The General Accounting Office’s (GAO) Executive Guide: Effectively Implementing the Government
Performance and
Results Act and reports that we have issued discuss
the need for controls that aid in setting priorities, adjusting resources, and
providing the basis for improving performance.
We recognize that the time span of examinations is not always under the
direct control of Financial Products Specialists, examiners, and their
managers. For example, taxpayers may
procrastinate in responding to a Financial Products Specialist’s report or
requests for information and thereby extend the length of an examination. However, there are two other reasons why
these delays are occurring that the LMSB Division could address to better focus
attention on improving the timeliness of requesting and delivering Financial
Products Specialists’ services.
First, the centralized management information system is
incomplete because the FPT System does not capture information on when an examination
is started or why delays are occurring.
In addition, key milestone dates such as planned start and completion
dates are missing. As a result, the
LMSB Division is limited in its ability to identify and address problems that
affect the timeliness of requesting and delivering Financial Products
Specialists’ services.
Second, managers and Financial Products Specialists do not
have guidance for establishing specific time frames for completing examinations
that are aligned with the LMSB Division goals.
While the Director, Field Specialists Program, has also recognized the
need for and the importance of establishing time frames for completing
examinations, as well as other performance measures, they have yet to be fully
developed and implemented.
The Director, Field Specialists Program, should take
the following steps for improving the timeliness of providing financial
products specialists’ services:
1.
Enhance the FPT System so that it can be better used to
improve the timeliness of requesting and delivering Financial Products
Specialists’ services.
Management’s Response: Management is designing a new Electronic Referral System
(ERS). Management envisions the new
system will accelerate the referral time because it will transmit the referral
electronically. The new system will
also capture critical information such as the referring team’s examination
starting dates and the specialist’s starting and expected closing dates.
2.
Until performance measures are implemented, provide guidance
to managers for establishing specific time frames for completing examinations
that relate to the LMSB Division’s goals for timely examinations.
Management’s Response: Management will notify all employees of the timeliness goal,
share the Field Specialist Business Plan with all managers, and emphasize cycle
time.
LMSB Division examiners are
required to request the assistance of a Financial Products Specialist in determining the scope and depth of examinations
involving corporations that report assets of $50 million or more. While Financial Products Specialists were involved in CIC corporate examinations as required,
examiners conducting IC corporate examinations do not consistently request the
assistance of a Financial Products Specialist when examination procedures
require such involvement.
We randomly selected a judgmental
sample of 33 IC corporations reporting $50 million or more in assets from
across the nation whose examinations were completed in FY 2001 and FY 2002 and
determined that mandatory Financial Products Specialist referrals were not made in 24 (73 percent) of the 33 cases. Several LMSB Division Financial
Products Specialists reviewed our exception cases and
found that approximately $118 million of potential financial products tax issues were not referred to a specialist.
The GAO’s Standards for
Internal Control in the Federal Government specify that control activities
are the policies, procedures, techniques, and mechanisms that enforce
management’s directives. In short,
controls ensure actions are taken to minimize risks. We applied these standards in evaluating the problem with the
limited number of referrals made to Financial Products Specialists in IC
corporate examinations. Our results
indicate that the LMSB Division controls to meet its guidelines on involving
Financial Products Specialists in examinations were not always effective or
adequate.
We believe the controls were not
effective because the LMSB managers and IC examiners we spoke with were aware
of the guideline to request the assistance of Financial Products
Specialists. However, they did not
always follow the guideline. This
happened because they saw no potential financial products issues worth
examining or did not want to involve an “outside” specialist due to concerns
that the process could be time consuming and, thereby, delay closing the
examination. Considering that Financial
Products Specialists spent, on average, about 37 months
to complete their portion of an IC corporate examination in FY 2001, there may
be justification for these concerns.
The controls were also not
adequate because they did not ensure a Financial Products Specialist has an opportunity to review all large corporations in the
examination stream. In the past,
establishing such a control was difficult because all large corporate returns
were placed in the examination stream so that they could be manually screened for
tax issues by examiners or their managers in local IRS offices. The screening process and criteria used
could vary by office, and most of the returns that were entered into the
examination stream were eventually eliminated from consideration.
Today, the LMSB Division uses a
centralized and much more structured approach to select large corporate returns
for examination. All large corporate
returns are filed only at the IRS’ Ogden Submission Processing Center rather
than at all 10 Submission Processing Centers located across the country. To determine which returns to select for
examination, the LMSB Division scores the returns on specific criteria that
results in fewer returns remaining in the examination stream.
Given the Financial
Products Specialists’ role in identifying significant
tax issues, they should not have to depend on examiners less qualified and
experienced in financial products tax issues to determine if and when their
involvement is needed. Rather, a
control is needed to ensure they have an opportunity to evaluate all returns selected
for examination, particularly now that significantly fewer returns remain in
the examination stream and come from a centralized location.
3.
The Director, Field Specialists Program, should
coordinate with the LMSB Division’s Industry Directors to establish a control
process that cannot be easily ignored, so Financial Products Specialists have an opportunity to assist in determining which IC
corporate examinations could benefit the most from their involvement.
Management’s
Response:
Management will use the new ERS to establish a control process for
monitoring case referrals.
Appendix I
Detailed Objective, Scope, and Methodology
Our objective was to assess how timely the expertise of
Financial Products Specialists is requested by and delivered to the Large and
Mid-Size Business (LMSB) Division examiners.
To meet our objective we relied on the Internal Revenue Service’s
(IRS) internal management reports, databases, and review of a sample of
Industry Case (IC) and Coordinated Industry Case (CIC) corporate
examinations. We did not establish the
reliability of these data because extensive data validation tests were outside
the scope of this audit. Except as
noted above, our work was conducted in accordance with Government Auditing
Standards. Our specific audit tests
included the following:
I.
Defined the purpose, scope, inputs, outputs, and customer
needs of the Financial Products Specialist Program by reviewing the LMSB
Division’s guidelines and interviewing LMSB Division executive level,
mid-level, and front-line managers.
II.
Analyzed Fiscal Year (FY) 2001 data from the Examination
Program Monitoring Table 37 and FY 1995 through FY 2001 data from the Audit
Information Management System and the Financial Products Transactions (FPT)
System to determine the Financial Products Specialist staffing levels, results
from their examinations, and where they applied their examination time.
III.
Analyzed the FPT System data and reviewed a judgmental sample
of 18 open CIC corporate examinations from the Los Angeles and Chicago
metropolitan areas to determine whether examiners were requesting the
assistance of Financial Products Specialist as required, how much time was
involved in requesting and delivering the assistance, and if the Financial
Products Specialists were unnecessarily extending the length of
examinations. A judgmental sample was
used because a statistical sample to project results would have required
extensive resources and time.
IV.
Analyzed the FPT System data and reviewed a judgmental sample
of 33 closed IC corporate examinations from across the nation to determine
whether examiners were requesting the assistance of Financial Products
Specialists as required, how much time was involved in requesting and
delivering the assistance, and if the Financial Products Specialists were
unnecessarily extending the length of examinations. A judgmental sample was used because a statistical sample to
project results would have required extensive resources and time.
V.
Verified whether specific time frames and other performance
measures have been established for requesting and delivering the technical
advice from Financial Products Specialists and if the measures were aligned
with those in the LMSB Division.
VI.
Reviewed the General Accounting Office’s (GAO’s) Executive
Guide: Effectively Implementing the
Government Performance and Results Act and prior reports issued by the
Treasury Inspector General for Tax Administration to assess the applicability
of performance measures for Financial Products Specialists.
VII.
Applied the GAO’s Standards for Internal Control in the
Federal Government to existing controls over requests for, and delivery of,
Financial Products Specialist services and evaluated whether risks were
sufficiently minimized.
Appendix II
Major Contributors to This Report
Gordon C. Milbourn III, Assistant Inspector
General for Audit (Small Business and Corporate Programs)
Phil Shropshire, Director
Frank Dunleavy, Audit Manager
Earl Charles Burney, Senior Auditor
Stanley Pinkston, Senior Auditor
Jean Kao, Auditor
William Tran, Auditor
Appendix III
Commissioner N:C
Deputy
Commissioner N:DC
Deputy
Commissioner, Large and Mid-Size Business Division LM
Director,
Field Specialists, Large and Mid-Size Business Division LM:FS
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 Liaison:
Commissioner,
Large and Mid-Size Business Division LM
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.