The Engineer
Specialist Program Controls Could Be Improved to Ensure More Timely and
Accurate Examinations of Large Corporations
September 2002
Reference
Number: 2002-30-149
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
16, 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 Engineer
Specialist Program Controls Could Be Improved to Ensure More Timely and
Accurate Examinations of Large Corporations (Audit # 200230013)
This
report presents the results of our review
to assess how timely the expertise of Engineer Specialists is requested by and
delivered to Large and Mid-Size Business (LMSB) Division examiners.
In summary, we found that
the LMSB Division’s return on investment for the Engineer 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
an Engineer Specialist when they should.
As a result, significant engineering and valuation tax issues have been
overlooked.
While the time span of the
examinations is not always under the direct control of examiners and their
managers, steps can be taken to better focus attention on improving the
timeliness of examinations.
Specifically, we found that improved controls are needed to ensure
management’s information system is complete.
Further, 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.
Finally, in addition to improving the timeliness of requesting and
delivering Engineer Specialists’ services, a control process is needed that
ensures Engineer Specialists have an opportunity to assist in determining
the scope and depth of all IC corporate examinations.
Management’s
Response: Internal Revenue Service (IRS) management agreed
with the findings and recommendations presented in the report. Management
indicated that they are working to replace the Specialists Inventory System
with an Oracle-based system and will implement an Electronic Referral System
that will allow examiners to request Engineer Specialists’ services using an
Internet based on-line process while serving as a control process for monitoring case referrals. In addition, management will 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.
Coordinated Industry Case Corporate Examinations Benefited
the Most from Engineer Specialists
Engineer 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 Commissioner, Large and Mid-Size Business (LMSB)
Division, has overall responsibility for the Internal Revenue Service’s (IRS)
Engineer Specialist Program, which is directed nationally under the Field
Specialists Program. In Fiscal Year
(FY) 2001, there were 39 Engineer Specialist managers throughout the country
that coordinated the work of the 350 Engineer Specialists in the field.
The IRS has established procedures intended to result in
assigning Engineer Specialists only to those examinations that present more
difficult and complex engineering and valuation issues. Specifically, examiners are required to
request an Engineer Specialist’s involvement when examining the nation’s
largest corporations. An Engineer
Specialist manager then evaluates the examiner’s request and decides whether to
assign an Engineer Specialist to the examination. Once the engineers conduct the examination, they are responsible
for preparing a report on the engineering issues examined.
The LMSB Division is structured around five industry
segments and has the formidable task of examining the nation’s largest
corporations. The LMSB Division divides
58,000 large corporations into two segments.
About 1,300 are classified as Coordinated Industry Cases (CIC), while
the remaining ones are referred to as Industry Cases (IC). Unlike IC examinations, CIC examinations are
conducted using a team of IRS examiners.
Although CIC and IC corporate examinations account for about
two-thirds of all recommended additional taxes from all IRS examinations, 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 then 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 aimed at reducing the time on IC and
CIC corporate examinations.
This audit is part of our FY 2002 emphasis focusing on the
LMSB Division’s post-filing examination process. We performed our audit in accordance with Government Auditing
Standards at the LMSB Division Headquarters in Washington, DC, and offices
in the New York, Chicago, and Los Angeles metropolitan areas from October 2001
to April 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 Engineer Specialists’ time.
As shown in Figure 1, Engineer Specialists spent about 57 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 the Specialist Inventory (SPIN) System shows
that LMSB Division’s investment in Engineer Specialists is producing good
results. Overall, Engineer Specialists
spent 295,983 hours on the CIC corporate examinations that were closed in FY 2000
and 2001 and recommended approximately $17.6 billion in adjustments to taxable
incomes. From these data, we calculated
that for each hour spent on a CIC corporate examination, an Engineer Specialist
recommended about $59,374 in adjustments to taxable incomes and credits.
Table 1 shows that the LMSB Division’s Financial Services
Industry Segment outpaced the other four industry segments in FY 2000 and 2001
in terms of the time Engineer Specialists applied to CIC corporate
examinations.
Table 1: Engineer
Specialists’ CIC Corporate Examination Time and Additional Recommended
Adjustments to Taxable Incomes by LMSB Division Industry Segments (FYs 2000 -
2001)
|
LMSB Division Industry
Segment |
Examination
Hours Worked |
Recommended
Adjustments to Taxable Incomes |
Average
Adjustment per Hour |
|
Financial
Services |
121,803 |
$5.7
billion |
$46,965
|
|
Natural
Resources and Construction |
32,979 |
$2.1
billion |
$62,910 |
|
Communications,
Technology, and Media |
28,947 |
$5.8
billion |
$199,009 |
|
Retailers,
Food, Pharmaceuticals, and Healthcare |
6,486 |
$190
million |
$29,308 |
|
Heavy
Manufacturing and Transportation |
10,617 |
$220
million |
$20,741 |
|
Unable
to determine due to limitations in IRS databases |
95,151 |
$3.6
billion |
$37,914 |
Source: TIGTA analysis of the
Specialist Inventory System (SPIN).
The Financial Services Industry Segment is made up of
corporations and partnerships that are involved in the commercial banking,
savings and loans, securities, and other financial services businesses. Documentary evidence obtained from the LMSB
Division may explain why this industry segment outpaced the other four industry
segments. Taxpayers under the
jurisdiction of the Financial Services Industry segment are experiencing
widespread consolidation across industries and large growth from international
expansion. Corporate combinations that
involve one company purchasing the business of another company can give rise to
numerous fair market valuation tax issues, thereby creating an increased demand
for the Engineer Specialists.
The time taken to request and deliver Engineer Specialists’
services may hamper the LMSB Division’s efforts to meet its goals for timely
completing examinations and reducing the burden lengthy examinations can have
on taxpayers. 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 are 29 and 54 months, respectively.
Our analysis of the FY 2000 and 2001 SPIN System of closed
IC corporate examinations shows that the time taken to request and deliver
Engineer Specialists’ services is substantial.
For example, it is taking, on average:
Figure 2 shows the average elapsed time between when returns
were filed and key stages in 371 referrals from the IC examinations and 324 referrals
from the CIC corporate examinations that were closed in FY 2000 and 2001 and
involved an Engineer 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 Figure 2 shows in the second
set of columns from the right, the Engineer Specialists’ portion of time from
the return file date to their completion is, on average, 1,069 days (about 36 months)
for an IC corporate examination and 1,690 days (about 56 months) for a CIC
corporate examination. The far right
columns show the overall time frame in FY 2001 for IC corporate examinations
was 1,098 days (about 37 months) and for CIC corporate examinations was 1,791 days
(about 60 months).
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 Engineer Specialists, examiners, and their managers. For example, taxpayers may procrastinate in
responding to an engineer’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 Engineer Specialist services.
First, the centralized management information system is
incomplete because the SPIN System does not capture information on when an
examination is started or why delays are occurring. Key dates for establishing milestones, such as planned start and
completion dates, were also missing in about 40 percent of the closed
examination referrals listed in the SPIN System for FYs 2000 and 2001. Consequently, the LMSB Division is inhibited
in its ability to spot and address problems that affect the timeliness of
requesting and delivering Engineer Specialists’ services.
Second, managers and Engineer Specialists do not have
guidance for establishing specific time frames for completing examinations that
are aligned with the LMSB Division goals.
In some instances, even when planned completion dates were established,
they were not always aligned with the LMSB Division goals. For example, we measured the elapsed time
from return filed dates to the planned examination completion dates for 754 IC
and CIC corporate examinations and found 223 planned completion dates (30 percent)
outside the 31- and 57-month time frames of the LMSB Division goals. While the Director, Field Specialists
Program, has also recognized the need for and 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 Engineer Specialists’
services:
1.
Enhance management information systems and communication
processes to improve the timeliness of requesting and delivering Engineer Specialists’
services.
Management’s Response: Management submitted a Request for Information Services to
replace the SPIN System with an Oracle-based system. In addition, management is implementing an Electronic Referral
System (ERS) that will allow examiners to request Engineer Specialists’
services using an Internet based on-line process.
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 an Engineer Specialist in determining the
scope and depth of examinations involving corporations that report assets of
$10 million or more. While the required
referrals to Engineer Specialists were made in CIC corporate examinations we
reviewed, we found the opposite condition in the IC corporate examinations
reviewed.
We selected a judgmental sample of
33 IC corporations reporting $50 million or more in assets from across the
nation whose examinations were completed in FYs 2001 and 2002 and determined
that mandatory engineering referrals were not made in 20 (61 percent) of the 33
cases. Several LMSB Division Engineer
Specialists reviewed our exception cases and found that approximately $606
million of potential engineering and valuation tax issues were not referred to
an engineer. An example of the types of
issues that Engineer Specialists need to review is intangible assets. In some instances, corporations improperly
inflate or deduct the costs of acquiring intangible assets, which can result in
significant tax benefits.
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 Engineer Specialists in IC corporate
examinations. Our results indicate that
the LMSB Division controls to meet its guidelines on involving Engineer
Specialists in examinations were not always effective or adequate.
We believe the controls were not
effective because the LMSB Division managers and IC examiners we spoke with
were aware of the guideline to request the assistance of Engineer
Specialists. However, they did not
always follow the guideline because they saw no potential engineering 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
Engineer Specialists spent, on average, about 14 months to complete
mandatory IC referrals in FYs 2000 and 2001, there may be justification for
their concerns.
The controls were also not
adequate because they do not ensure an Engineer 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 with the IRS’ Ogden Submission Processing Center rather than
with the other Submission Processing Centers scattered across the country. To determine which returns to select for
examination, the LMSB Division scores the returns on specific criteria that
result in about 90 percent fewer returns entering the examination stream.
Given the Engineer Specialist role
in identifying significant tax issues, they should not have to depend on
examiners less qualified and experienced in engineering and valuation issues to
determine if and when their involvement is needed. Rather, a control is needed to ensure that they have the
opportunity to evaluate all returns selected for examination, particularly now
that significantly fewer returns are entering the examination stream and are
coming 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 by managers and examiners, so that
Engineer Specialists have an opportunity to assist in determining which IC
corporate examinations could benefit most from their involvement.
Management’s
Response:
Management will use the ERS as a
control process for monitoring case referrals and recommend Continuing
Professional Education topics for IC examiners to improve their knowledge and
ability to make timely referrals.
Appendix I
Detailed Objective, Scope, and Methodology
Our objective was to assess how timely the expertise of
Engineer 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 internal management
reports and databases. 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 Engineer 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 2000 and 2001 Examination Program
Monitoring Table 37, Audit Information Management System, Specialist Inventory
(SPIN) System to determine the Engineer Specialist staffing levels, results
from their examinations, and where they applied their examination time.
III.
Analyzed the SPIN System data and reviewed a judgmental sample
of 19 out of 128 open Coordinated Industry Case corporate examinations in the
Los Angeles and New York metropolitan areas to determine whether examiners were
requesting the assistance of Engineer Specialists as required, how much time
was involved in requesting and delivering the assistance, and if the Engineer
Specialists were unnecessarily extending the length of examinations.
IV.
Analyzed the SPIN System data and reviewed a judgmental sample
of 33 out of 46 closed Industry Case examinations of corporations reporting
assets of $50 million or more in assets in the LMSB Quality Management System
inventory to determine whether examiners were requesting the assistance of
Engineer Specialists as required, how much time was involved in requesting and
delivering the assistance, and if the Engineer Specialist was unnecessarily
extending the length of examinations.
V.
Verified whether specific time frames and other performance
measures have been established for requesting and delivering the technical
advice from Engineer 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 Engineer
Specialists.
VII.
Applied the GAO’s Standards for Internal Control in the
Federal Government to existing controls over requests for and delivery of
Engineer 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)
Philip Shropshire, Director
Frank Dunleavy, Audit Manager
Earl Charles Burney, Senior Auditor
Robert Jenness, Senior Auditor
Stanley Pinkston, Senior Auditor
Lisa Stoy, Senior 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.