The Financial Products Specialist Program Controls Could Be Improved to Ensure More Timely and Accurate Examinations of Large Corporations
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 Divisionís 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, managementís 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 Specialistsí 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 Specialistsí 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.
Managementís 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.† Managementís 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.
The term ďfinancial productsĒ 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 Serviceís (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 nationís 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 Divisionís post-filing examination process.† We performed our work in accordance with Government Auditing Standards at the LMSB Divisionís 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 Specialistsí 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 Divisionís 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 Specialistsí services may hamper the LMSB Divisionís 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 Specialistsí 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 Specialistsí 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 Officeís (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 Specialistís 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 Specialistsí 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 Specialistsí 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 specialistsí services:
1. Enhance the FPT System so that it can be better used to improve the timeliness of requesting and delivering Financial Products Specialistsí services.
Managementís 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 teamís examination starting dates and the specialistís 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 Divisionís goals for timely examinations.
Managementís 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 GAOís Standards for Internal Control in the Federal Government specify that control activities are the policies, procedures, techniques, and mechanisms that enforce managementís 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 ďoutsideĒ 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 IRSí 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 Specialistsí 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 Divisionís 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.
Managementís Response:† Management will use the new ERS to establish a control process for monitoring case referrals.†
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 Serviceís (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 Divisionís 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 Officeís (GAOís) 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 GAOís 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.
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
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
††††††††††† Commissioner, Large and Mid-Size Business Division †LM
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.