The
New Process for Managing Requests for Tax Records During Examinations of Large
Businesses Can Reduce Taxpayer Burden if Implemented Consistently
August 2003
Reference Number: 2003-30-152
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.
August
6, 2003
MEMORANDUM FOR
COMMISSIONER, LARGE AND MID-SIZE BUSINESS DIVISION
FROM: Gordon C. Milbourn III /s/ Gordon C.
Milbourn III
Assistant Inspector General
for Audit (Small Business and
Corporate Programs)
SUBJECT: Final Audit Report – The New Process for Managing Requests for Tax
Records During Examinations of Large Businesses Can Reduce Taxpayer Burden if
Implemented Consistently (Audit # 200230052)
This report presents the results of our review of the Information Document Request (IDR) Management Process used in Industry Case (IC) examinations by the Large and Mid-Size Business (LMSB) Division. The overall objectives of this review were to determine what impact the IDR Management Process has on the length and burdens of IC examinations, and the status of ongoing changes to improve the IDR Management Process.
In summary, the Internal
Revenue Service (IRS) uses IDRs during examinations to request and obtain tax
records from taxpayers. However,
corporate taxpayers have long criticized the IDR Management Process for
unnecessarily adding to the adversarial nature inherent in examinations by
creating barriers to open communication that can lead to delays in resolving
issues and wasting resources. We found
that the new IDR Management Process has key elements to address these burden
and cost issues by engaging both taxpayers and examiners in accepting
responsibility for ensuring IDRs are focused, not overly broad in scope, and
responded to in a timely manner.
By emphasizing timely IDR
responses, the new IDR Management Process also offers opportunities to shorten
lengthy examinations and thereby save examination staff hours so they can be
redirected to address other high-risk compliance areas. Our analysis of 631 IDRs from 50 closed IC
examinations showed that shorter IDR response times generally resulted in
shorter examinations.
While the new IDR Management
Process has the potential to reduce taxpayer burden, its success could be
hampered by inconsistent implementation.
Our on-site visits to 16 IC examination teams found that none of
the teams were using all required procedures.
However, since the IDR Management Process guidelines provide managers
broad discretion to bypass required procedures on a “case by case” basis without
an approval process, it may be very difficult to determine if the decisions to
bypass the new procedures were appropriate.
At the quality
control level, there are areas that could be strengthened to enhance
management’s ability to identify problems and take corrective actions for
improving the IDR Management Process.
Unlike team managers over Coordinated Industry Cases (CIC) who are
required to report quarterly on IDR delinquencies to the LMSB Division’s Office
of Performance, Quality Assurance, and Audit Assistance (PQA), team managers over IC
examinations are exempted from this reporting.
In addition, the LMSB Quality Measurement System (LQMS), which sets
forth standards for examinations, does not evaluate whether examiners are
considering and using the IRS’ automated data systems to determine if required
returns, such as employment tax returns, had been filed in lieu of having taxpayers
provide the documents. Consequently,
opportunities to identify problems, take actions to resolve tax issues faster,
and further reduce taxpayer burden may be missed.
To take full advantage of
the opportunities the new IDR Management Process offers for reducing taxpayer
burden and shortening examination cycle times, we recommended that LMSB
Division management revise the IDR Management Process guidelines to (1) show examples of situations where it
may be acceptable for examination teams to bypass required procedures, (2)
require examination teams to obtain written approval from a mid-level manager
or an executive to bypass procedures, and (3) require team managers over IC
examinations to report to PQA on delinquent IDRs. In addition, the LQMS should be used to determine if examiners
are considering and using the IRS’ automated information systems to obtain
taxpayer returns and other account information.
Management’s
Response:
The Commissioner, LMSB Division, agreed
with our findings and was generally responsive to our recommendations. The
Commissioner, LMSB Division, will revise guidelines to include an outline of
the general procedures for requesting information from taxpayers, the
delinquent IDR process, and clear guidelines stating that the general and
delinquent IDR processes are applicable to both IC and CIC examinations. The Commissioner will also require that
frontline managers document examination case files if they permit their
examiners to depart from those steps in the IDR Management Process that involve
securing delinquent IDRs. In lieu of
manually preparing delinquent IDR reports for PQA, the Commissioner, LMSB
Division, responded that a new automated system is under development and will
generate the required delinquency reports for use by PQA. The Commissioner agreed that internal electronic sources can be relied
upon to perform certain examination activities. However, the Commissioner believes that the LQMS and current
guidelines are sufficient for monitoring and encouraging examiners’ use of
internal information sources in performing examinations. Management’s complete response to the
draft report is included as Appendix IV.
Office
of Audit Comment:
We
continue to believe that the LQMS should be modified
to include evaluations of whether examiners are considering and using the IRS’
automated systems to ensure required returns were filed. However, we do not intend to elevate the
disagreement to the Department of the Treasury for resolution. As explained in the report text (see pages 4
and 7), examiners routinely completed these filing checks by requesting copies
of previously filed tax returns from taxpayers, thereby missing opportunities
to reduce taxpayer burden.
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 Parker F. Pearson, Director
(Small Business Compliance), at (410) 962-9637.
Appendix I – Detailed Objectives, 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 Internal Revenue Service (IRS)
has placed a major emphasis on reducing taxpayer burden and shortening
examination cycle time, a critically important improvement area for its Large
and Mid-Size Business (LMSB) Division.
In turn, the LMSB Division addresses this tax
administration priority in its Comprehensive Issue Management Strategic
Initiative. This major initiative
includes the Information Document Request (IDR) Management Process and other business process improvement initiatives
linked together by the common goal of making taxpayer interactions less
difficult, time consuming, costly, and contentious.
The IRS uses IDRs during examinations to request and obtain information from taxpayers. Tax records supporting the income tax return information are needed to make examination determinations. However, taxpayers have long criticized IDRs for unnecessarily adding to the adversarial nature inherent in examinations by creating barriers to open communication, causing delays in resolving issues, and wasting resources.
A formal, structured process to request and secure information from the taxpayer has been established. The process emphasizes timely responses to improve cycle time and currency of cases, while at the same time, focuses on early issue resolution. As part of the IRS’ continuing effort to provide top quality service to the nation’s largest business taxpayers, the LMSB Division implemented the IDR Management Process, which is required to be used in new examination starts after June 3, 2002, for Coordinated Industry Cases (CIC) and Industry Cases (IC). However, this process does not preclude the examination team from using judgment on a “case by case” basis. The IDR Management Process was implemented under the direction of the LMSB Division’s Industry Director for Communications, Technology and Media. The process follows “best practices” developed, but not fully implemented, in the IRS’ Coordinated Examination Program during the early 1990s.
Our review was conducted in accordance with Government Auditing Standards between October 2002 and February 2003. To meet our objectives, we relied on the IRS’ databases and internal management reports. We did not establish the reliability of this data because extensive data validation tests were outside the scope of this audit and would have required extensive resources and time.
We performed on-site work in the LMSB Division Headquarters in Washington, D.C., and IRS offices in the Los Angeles, California; Phoenix, Arizona; Baltimore, Maryland; Philadelphia, Pennsylvania; and Fort Lauderdale, Florida metropolitan areas. Detailed information on our audit objectives, scope, and methodology is presented in Appendix I. Major contributors to the report are listed in Appendix II.
From both the taxpayer’s and the IRS’ perspective, IDRs are a long-standing problem. In the mid 1990s, both taxpayers and the IRS identified IDRs as a factor in increasing the costs and burdens associated with examinations. More recently, the IRS’ Fiscal Year (FY) 2002 Customer Satisfaction Survey National Report quoted taxpayers as saying:
To validate the shortcomings in IDRs and the need for a new set of required procedures to manage the process, we reviewed a sample of 50 IC closed examinations out of approximately 1,735 cases that were closed in FY 2002 prior to implementing the new IDR Management Process. These 50 cases represent closures from 46 different IRS offices across the nation and contained 631 IDRs that were issued after the examiners’ initial meeting with taxpayers.
Although our sample results cannot be projected, the results clearly indicate that there are opportunities to reduce the burdens and response times of IDRs. Of the 631 IDRs analyzed, approximately 57 percent were responded to within 30 days. However, in 23 percent of the IDRs analyzed, 46 or more days elapsed before responses were received. We also found that:
· The IDR monitoring and control process had weaknesses (45 of 50 cases). Important dates and other techniques for monitoring and controlling IDRs were not documented in case files. The missing information included IDR issuance, response and received dates, along with IDR control numbers and control logs. When monitoring and control information is missing, delays in receiving information from the taxpayer can occur.
· IDRs were routinely used to ask for previously filed tax returns, such as employment tax returns, that could have been obtained through the IRS’ automated data systems (42 of 50 cases), adding additional burden to the taxpayer.
Figure 1 shows key elements in the IDR Management Process that are designed to address criticisms cited in IRS’ FY 2002 Customer Satisfaction Survey National Report and control weaknesses identified in our case reviews.
|
Key Elements |
Expected Benefits |
|---|---|
|
Examiners and taxpayers collaborate and mutually agree on IDR response times. The agreement is then documented in a Memorandum of Understanding. |
· Establishes clear expectations. · Provides for timely responses. · Promotes cooperation and earlier issue resolution. |
|
Examiners and taxpayers
discuss the tax issues and content of IDRs prior to or at the time
information is requested. The mutual
understanding of records that will be provided is then documented in
examination case files. |
·
Improves the quality
of documentation received for more sound issue development. ·
Helps avoid IDRs that
are unfocused and overly broad. ·
Provides for more open
and meaningful communications. |
|
Alternative sources for
obtaining needed information, such as the IRS’ automated data systems, are
used. |
· Reduces the number of IDRs requiring responses. · Minimizes the amount of information requested. |
|
Managerial involvement
required in securing delinquent information. |
· Takes advantage of managers’ experience so conflicts and issues can be resolved faster. |
|
Quarterly reporting on
delinquent IDRs for analysis by the Office of Performance, Quality and
Innovation. |
·
Provides data to
identify problems, plan corrective action, and improve future performance. |
Source: Treasury Inspector General for Tax
Administration’s (TIGTA) analysis of the IDR Management Process User Guide.
Key elements in Figure 1 indicate that the IDR Management Process clearly places the responsibility for improving the timeliness of IDR responses on the collaboration between the examiner and taxpayer. This is important because improving IDR response time could enable the LMSB Division to better use its resources by shortening the length of examinations.
As illustrated in Figure 2, our regression analysis of the 631 IDRs from 50 IC closed examinations shows that shorter IDR response times generally result in shorter examinations.
Figure 2 was
removed due to its size. To see Figure
2, please go to the Adobe PDF version of the report on the TIGTA Public Web
Page.
Figure 2 shows that when the average IDR response time in a case was 15 days or less, the examination was completed within the LMSB Division’s FY 2003 cycle time goal of 31 months. As examinations become shorter, the Division will have opportunities to save staff hours and redirect these resources to address other high-risk compliance areas.
While the IDR Management Process has the potential to resolve the longstanding IDR problems, its success could be hampered by inconsistent implementation of key elements. To ensure the process becomes fully integrated into IC examinations, we believe additional steps need to be taken at both the examiner level and quality control level.
We visited 16 examination teams and reviewed 23 open
examinations that were started after the process was required to be used in all
IC examinations. We found that while team managers and examiners were aware of the new procedures
and had access to the IDR Management user guidelines, they were not
consistently using key elements of the process. Specifically:
A properly designed and operating internal control system helps ensure that management objectives are achieved. At the same time, the internal control system is designed to obtain the data for identifying problems and taking corrective actions to improve performance.
The LMSB Division’s quality control system for the IDR
Management Process consists of two components.
The Division’s Office of Performance, Quality Assurance and Audit
Assistance (PQA) requires the submission of quarterly reports on delinquent
IDRs in CICs. In addition, PQA uses the
LMSB Quality Measurement System (LQMS) to evaluate samples of open and closed
examinations to ensure that examiners met auditing standards. However, there are
areas in each of the control components that could strengthen management’s
ability to identify problems and take actions to improve the process.
While team managers of CIC
examinations are required to report quarterly on IDR delinquencies to PQA, team
managers over IC examinations are exempted from this reporting even though
significantly more IC examinations are conducted than CIC examinations. In addition, the LQMS, which sets forth
standards for examinations, does not evaluate whether examiners are considering
and using the IRS’ automated data systems to determine if required returns,
such as employment tax returns, had been filed in lieu of having taxpayers
provide the documents. Consequently,
there may be missed opportunities to identify and resolve tax issues quickly to
further reduce taxpayer burden.
Our discussions with team managers and examiners indicated the inconsistencies at the examination team level were caused by giving examination teams broad discretion in the guidelines to bypass key elements in the IDR Management Process on a “case by case” basis. However, the current guidance on the IDR Management Process does not contain (1) examples of instances where it is acceptable for examination teams to bypass required procedures, (2) a requirement for examination teams to obtain written approval from a mid-level manager or an executive to bypass procedures, and (3) a requirement for IC team managers to report delinquent IDRs to PQA. When key elements can be by-passed without higher-level management approval, it is very difficult to determine if these decisions were appropriate.
We recommend that the LMSB Division’s Industry Director, Communication Technology, and Media, coordinate with the Director, PQA, to incorporate the following revisions in the IDR Management Process guidelines and the LQMS:
1. Provide examples in IDR Management Process guidelines of situations where it may be acceptable for examination teams to bypass some or all of the IDR Management processes. The examples should include instances where it may be acceptable for examination teams to request documents from taxpayers that were previously submitted to the IRS in lieu of using the IRS’ automated data systems to obtain the documents.
Management’s Response: The Commissioner, LMSB Division, will revise
guidelines to include an outline of the general procedures for requesting
information from taxpayers, the delinquent IDR process, and clear guidelines
stating that the general and delinquent IDR processes are applicable to both IC
and CIC examinations.
2. Revise IDR Management Process guidelines to require written approval from mid-level managers or an executive to be included in case files before examination teams decide to bypass some or all of the IDR Management processes.
Management’s Response: The LMSB Division will require frontline managers to document the Examining Officer’s Activity Record, which is part of the examination case file, if they permit their examiners to depart from those steps in the IDR Management Process that involve securing delinquent IDRs.
3.
Revise IDR Management Process guidelines to include IC examinations in mandatory reporting to PQA on
delinquent IDRs.
Management’s Response: In lieu of manually preparing delinquent IDR
reports for PQA, a new automated system is under development and will generate
the required delinquency reports for use by PQA.
4.
Modify the LQMS to include
evaluations of whether examiners are considering and using the IRS’ automated
systems to obtain copies of employment tax and other types of returns needed
for examinations.
Management’s Response: The Commissioner, LMSB Division, agreed that
internal electronic sources can be relied upon to perform certain examination
activities. However, the LMSB Division
believes that the LQMS and current guidelines are sufficient for monitoring and
encouraging examiners’ use of internal information sources in performing
examinations.
Office of Audit Comment: We continue to believe that the LQMS should be modified to include evaluations of whether examiners are considering and using the IRS’ automated systems to ensure required returns were filed. However, we do not intend to elevate the disagreement to the Department of the Treasury for resolution. As explained on pages 4 and 7, examiners routinely completed these filing checks by requesting copies of previously filed tax returns from taxpayers, thereby missing opportunities to reduce taxpayer burden.
Appendix I
Detailed Objectives, Scope,
and Methodology
The objectives of this review were to determine what impact the new Information Document Request (IDR) Management Process has on the length and burdens of Industry Case (IC) examinations, and the status of ongoing changes to improve the IDR Management Process. To meet our objectives, we relied on the Internal Revenue Service’s (IRS) databases and internal management reports. We did not establish the reliability of this data because extensive data validation tests were outside the scope of this audit and would have required extensive resources and time. Our specific audit tests included the following.
I. Reviewed the IDR Management Process user guide to identify the goals, key elements, requirements, potential benefits, and potential barriers of the Process.
II. Interviewed IRS officials who are either involved with or affected by the IDR Management Process to obtain their opinions about how the process may reduce taxpayer burden and shorten examinations.
III. Evaluated a judgmental sample of 50 ICs out of 1,735 corporate examinations that were closed in Fiscal Year (FY) 2002 prior to the implementation of the IDR Management Process to affirm the shortcomings in IDRs and the need for procedures to manage the Process. Judgmental sampling was used because a statistical sample to project results would have required extensive resources and time.
IV. Analyzed 631 IDRs in our sample cases that were issued after examiners met with taxpayers to identify potential opportunities to reduce taxpayer burden, response times of IDRs, and lengths of examinations.
V. Evaluated a judgmental sample of 23 open IC corporate examinations out of 228 IC examinations that were started after the IDR Management Process was implemented to assess how effectively the process was being integrated into IC examinations. Judgmental sampling was used because a statistical sample to project results would have required extensive resources and time.
VI. Analyzed FYs 2001 and 2002 Examination Program Monitoring Table 37 and the Audit Information Management System to assess trends in the length of Large and Mid-Size Business Division examinations.
VII. Verified whether a quality control system had been established over the IDR Management Process so that management could identify problems, plan corrective actions, and improve future performance.
Appendix II
Major Contributors to This Report
Parker F. Pearson Director
Philip
Shropshire, Director
Frank
Dunleavy, Audit Manager
Robert Jenness, Senior Auditor
Stanley Pinkston, Senior Auditor
Debra Mason, Auditor
Ali Vaezazizi, Auditor
Appendix III
Commissioner N:C
Deputy
Commissioner for Services and Enforcement
N:SE
Acting
Deputy Commissioner, Large and Mid-Size Business Division LM
Director,
Communications, Technology, and Media Industry, Large and Mid-Size Business
Division LM:CTM
Director,
Performance, Quality Assurance and Audit Assistance LM:PQA
Chief
Counsel CC
National
Taxpayer Advocate TA
Director,
Office of Legislative Affairs CL:LA
Director,
Office of Program Evaluation and Risk Analysis
N:ADC:R:O
Office
of Management Controls N:CFO:AR:M
Audit
Liaison: Commissioner, Large and
Mid-Size Business Division LM:CL
Appendix IV
Management’s Response to
the Draft Report
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.