Processing Changes Would Enhance Service to Taxpayers Filing
Amended U.S. Corporation Income Tax Returns
August
2003
Reference
Number: 2003-30-169
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
19, 2003
MEMORANDUM FOR
COMMISSIONER, SMALL BUSINESS/SELF-EMPLOYED 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 – Processing Changes
Would Enhance Service to Taxpayers Filing Amended U.S. Corporation Income Tax
Returns (Audit # 200230055)
This
report presents the results of our review to determine if the Internal Revenue
Service’s (IRS) Submission Processing Sites are properly identifying Amended
U.S. Corporation Income Tax Returns (Form 1120X) that meet certain criteria and
forwarding them to other functional areas for processing, and correctly
processing the remaining amended returns.
Corporations
submit Forms 1120X primarily to correct income tax returns previously
filed. Tax Examiners (TE) in the
Submission Processing Sites’ Code and Edit functions screen Forms 1120X to
identify those meeting the criteria for referral to other functions where more
complex issues are handled, those that need to be returned to the taxpayers for
additional information, and those that can be processed at the Submission
Processing Site.
In summary, although most
adjustments to taxpayers’ accounts were processed as reported by the taxpayers
on Forms 1120X, cases worked in the Submission Processing Sites were not always
worked in the most efficient manner or did not fully resolve taxpayers’
accounts. TEs sometimes: 1) made
incorrect tax adjustments or interest computations; 2) overlooked documents
attached by taxpayers for processing; 3) sent inaccurate notices to taxpayers;
and 4) did not address misapplied payments, discrepancies in credits claimed,
filing requirements, elections and address changes.
These
errors occurred for several reasons.
Guidelines did not instruct these TEs to compare payments, income, and
tax shown on Forms 1120X with data in taxpayers’ accounts, and guidelines for
referring cases to other functions were incomplete. In addition, TEs at the Cincinnati Submission Processing Site did
not have access to terminals for the Integrated Data Retrieval System (IDRS),
which contains taxpayers’ account information.
Consequently, they did not search for conditions in taxpayers’ accounts
that would require the Forms 1120X be referred to other functions, and could
not verify data on the Forms 1120X.
As
a result, the Submission Processing Sites did not resolve some accounts either
accurately or completely, generating some refunds in error or unnecessarily delaying others, requiring the Federal
Government to pay interest unnecessarily, and making some taxpayers correspond
unnecessarily with the IRS to get their accounts corrected. Specifically, a refund was erroneously
processed, but stopped before issuance, for over $1 million because information
on the Form 1120X was not compared to information in the taxpayer’s account;
over $1 million was refunded in cases that should have been referred to the
Examination function; and refunds were delayed in 12 accounts. Further, over $1 million in interest was
unnecessarily refunded or caused to be refunded because cases were not referred
to the Accounts Management (AM) Adjustment function; and actions unnecessarily
caused some type of additional interaction with taxpayers in 40 cases.
Additionally,
the Cincinnati Submission Processing Site did not code Forms 1120X accounts
when the Forms were referred to the Examination function for processing. IRS procedures require this coding to
establish a record that the claims were filed and referred to the Examination
function; however, local Submission Processing Site management did not ensure
that the procedures were followed.
We
recommended that the Director, Customer Account Services (CAS), Small
Business/Self-Employed Division, ensure that Forms 1120X are processed in CAS
where the TEs have access to IDRS and the skill set necessary to recognize and
resolve all related issues affecting the taxpayers’ accounts. However, if the Submission Processing Sites’
Code and Edit functions continue to process Forms 1120X, they should follow the
same processing guidelines as the AM Adjustment function and refer all Forms
1120X that exceed their capabilities to that function for processing. The TEs in the Code and Edit functions in
the Cincinnati Submission Processing Site would require access to and training
on the use of the IDRS. In addition,
the Director, CAS, should ensure the proper coding of accounts of Forms 1120X
referred to the Examination function.
Management’s Response: IRS
management agreed that processing changes need to be made to enhance the IRS’
service to taxpayers filing Forms 1120X and is taking steps to implement our
recommendations. Discussions will be
held to determine whether to place the processing of Forms 1120X in Submission
Processing or the AM Adjustment function.
After this determination is made, the Internal Revenue Manual will
provide procedural guidance for the processing of these amended returns. The IRS will ensure that proper IDRS
research training is provided to the CAS employees working this program. In addition, procedures
will reflect the input of the appropriate action code prior to referring the
Forms 1120X to the Examination function.
Management’s
complete response to the draft report is included as Appendix VI.
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 Objective, Scope, and Methodology
Appendix II – Major Contributors to This Report
Appendix III – Report Distribution List
Appendix IV – Outcome Measures
Appendix V – Results of Case Review
Appendix VI – Management’s Response to Draft Report
Amended U.S Corporation Income Tax Returns (Form 1120X) are filed by corporate taxpayers primarily to correct income tax returns previously filed. Forms 1120X are generally received throughout the year by the Internal Revenue Service’s (IRS) Submission Processing Sites.
Forms 1120X can contain a wide variety of issues, from the complex to the elementary. For example, one claim filed on Form 1120X can be for a refund in excess of $10 million while another can be a protective claim, filed by a corporation only to hold the statute of limitations open to receive some future benefit. Some require special interest computations. It is important that the IRS function processing the Forms 1120X has sufficient expertise in the issues contained on the forms.
Employees in the Submission Processing Sites’ Code and Edit functions screen Forms 1120X to identify those meeting criteria for referral to other functions where more complex issues are handled, those that need to be returned to taxpayers for additional information, and those that can be worked within the Submission Processing Site. When Forms 1120X are referred to a function outside of Submission Processing or returned to taxpayers, accounts are coded to establish a record that the form was referred to that function or returned to the taxpayers.
Forms 1120X that do not meet the criteria to be transferred or returned to taxpayers continue to be processed in the Submission Processing function. Within the Submission Processing function, any adjustments to taxpayers’ accounts as a result of the Forms 1120X may be processed in one of two ways, as determined by local management. The first method, used in the Ogden Submission Processing Site, requires employees in the Code and Edit functions to enter adjustments directly to taxpayers’ accounts using the Integrated Data Retrieval System (IDRS). The other method, used in the Cincinnati Submission Processing Site, requires Forms 1120X to be forwarded to another function within Submission Processing, called Data Conversion, where the adjustment information is entered onto computer tapes, which are later transmitted to the IRS’ Business Master File to update taxpayers’ accounts.
The Submission Processing Sites received over 41,000 Forms 1120X from January 2001 through June 2002. They adjusted 16,438 corporate accounts during Calendar Year (CY) 2001 and the first half of CY 2002. During that same period, they referred 24,854 Forms 1120X to the Accounts Management (AM) Adjustment function.
We performed this audit at the Brookhaven Campus from October 2002 through February 2003. Our audit work included cases received in the Ogden and Cincinnati Submission Processing Sites. The audit was performed 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.
Two major strategies in the IRS’ Strategic Plan for Fiscal Years 2000-2005 are meeting the needs of the taxpayer and reducing taxpayer burden. The first calls for first-quality service whenever the IRS deals with the taxpayer. The second calls for addressing taxpayer problems as early in the process as possible.
Even though most adjustments to taxpayers’ accounts were processed as reported by the taxpayer on Form 1120X, we found that many of the cases worked in the Submission Processing Sites were not worked in the most efficient manner or did not fully resolve taxpayers’ accounts. We reviewed 202 Forms 1120X cases processed by the Submission Processing Sites’ functions and found that 88 were not properly resolved. The errors we found included the following:
· Incorrect tax adjustments or incorrect interest calculations (26 cases).
· Documents attached by taxpayers for processing overlooked by the IRS (five cases).
· Inaccurate notices sent to taxpayers (seven cases).
· Misapplication of payments, discrepancies in credits claimed, and requests for credit elects not addressed (25 cases).
· Filing requirements, elections to forego net operating loss carrybacks, address changes, U.S. Corporation Income Tax Returns (Form 1120) that should be reprocessed to the correct tax period, or employer identification number not addressed (11 cases).
· Forms 1120X not properly processed, but no immediate impact to the taxpayers or the IRS (14 cases).
For a complete description of the error cases, see Appendix V.
These errors occurred for several reasons:
· Instructions provided to the Code and Edit functions’ Tax Examiners (TE) in the Submission Processing Sites do not require them to compare payments, income, and tax shown on the Forms 1120X with account information on IRS computers. In contrast, this research is required of employees in the AM Adjustment function that process Forms 1120X, and a recent update of procedures for processing Amended U.S. Individual Income Tax Returns (Form 1040X) requires employees in the Code and Edit functions to perform this research when processing Forms 1040X. Verifying data on Forms 1120X to account information would help to prevent incorrect tax adjustments and enable TEs to identify problems that might need resolution at the same time the Forms 1120X are processed.
· Information required in Form 1120X notices issued to taxpayers by the Code and Edit functions differs from the information required in notices issued by other functions processing these forms.
· Criteria provided to the Code and Edit functions’ TEs for referring cases to other functions with more technical expertise do not include all circumstances that it should. For example, when payments received with Forms 1120X are misapplied, TEs should ensure that the payments are corrected before tax adjustments are made to the accounts.
· TEs in the Code and Edit functions at the Cincinnati Submission Processing Site did not have access to IDRS terminals. Without access to the IDRS, these employees cannot directly access taxpayer account information to search for conditions on the taxpayer’s account that would require the Form 1120X to be referred to another function (such as an ongoing examination), or to verify data on the Form 1120X.
As a result, some refunds were generated in error or were unnecessarily delayed, the Federal Government was required to pay interest unnecessarily, and some taxpayers were unnecessarily required to correspond with the IRS to get their accounts corrected. In the 88 accounts that were not properly resolved or referred:
· A refund for over $1 million was erroneously processed, but was stopped before issuance, because information on Form 1120X was not compared to information in the taxpayer’s account.
· Over $1 million was refunded in cases that should have been referred to the Examination function.
· Refunds were delayed in 12 accounts.
· Over $1 million in interest was unnecessarily refunded or caused to be refunded because cases were not referred to the AM Adjustment function.
· Actions unnecessarily caused some type of additional interaction with taxpayers in 40 cases.
The Director, Customer Account Services (CAS), Small Business/Self-Employed (SB/SE) Division, should ensure that:
1. Forms 1120X are processed in a function of the CAS where the TEs have access to the IDRS and the skill set necessary to recognize and resolve all related issues affecting the taxpayers’ accounts.
Management’s Response: The Directors of AM and Submission Processing will meet to decide whether to place the processing of Forms 1120X in Submission Processing or the AM Adjustment function. After this determination is made, the Internal Revenue Manual will provide procedural guidance for the processing of these amended returns including IDRS activity.
2. If the Submission Processing Sites’ Code and Edit functions continue to process Forms 1120X, they should follow the same processing guidelines as the AM Adjustment function and refer Forms 1120X to the AM Adjustment function for processing when they do not have the capabilities to process all necessary corrections to the Form 1120X accounts. This would necessitate access to and training on the use of the IDRS for the TEs in the Cincinnati Submission Processing Site’s Code and Edit functions.
Management’s Response: The Director, CAS, will ensure procedures are followed that refer Forms 1120X to the AM Adjustment function when appropriate. Additionally, the IRS will ensure that proper IDRS research training is provided to CAS employees working this program.
The Cincinnati Submission Processing Site is not coding the accounts of Forms 1120X when the forms are referred to the Examination function. IRS procedures require entering to each account a specific code (action code) that establishes a record that the amended return was referred to the Examination function. However, local Submission Processing Site management did not ensure that the procedures were followed. Without the coding, taxpayer inquiries regarding the Forms 1120X cannot be properly resolved.
Further, IRS employees would not be able to determine that the Forms 1120X were referred to the Examination function until the Forms are entered on the Examination inventory system. If the accounts were already open in the Examination function when the Forms 1120X were filed, it is impossible for the IRS to identify the filing of the Form 1120X, unless the taxpayers’ accounts are properly coded.
3.
The
Director, CAS, should ensure that when Submission Processing Sites refer Forms
1120X to the Examination function, the appropriate action code is processed to
each account to establish a record of the referral.
Management’s Response: The Director,
CAS, will ensure that procedures reflect the input of the appropriate action
code prior to referring the Forms 1120X to the Examination function.
Appendix I
Detailed Objective, Scope,
and Methodology
The overall objective of this review was to determine if the Submission Processing Sites are properly identifying Amended U.S. Corporation Income Tax Returns (Form 1120X) that meet certain criteria and forwarding them to other functional areas for processing; and correctly coding, editing and processing the remaining amended returns timely, or contacting taxpayers for necessary information.
In order to accomplish our objective, we:
I.
Determined whether Submission
Processing Sites properly identified Forms 1120X that met criteria for routing
to the Examination function.
A.
Reviewed Internal Revenue
Manuals (IRM) relating to the processing of Forms 1120X and the criteria for
identifying returns for examination.
B.
Reviewed a judgmental sample
202 cases, including the related Forms 1120X (in 194 cases), processed in
Submission Processing Sites during Calendar Year (CY) 2001 and the first half
of CY 2002 to determine whether the Forms 1120X met the criteria for referral
to the Examination function and were properly handled. Reviewed a judgmental sample rather than a
statistical sample to allow a greater range of review. See III. C. for additional details of the
case selection.
II.
Determined whether Submission
Processing Sites properly identified Forms 1120X that met the criteria for
routing to the Accounts Management (AM) Adjustment function.
A.
Reviewed IRMs relating to the
processing of Forms 1120X and the criteria for identifying returns to be
forwarded to the AM Adjustment function.
B.
Reviewed a judgmental sample
of 202 cases of Forms 1120X processed in Submission Processing Sites during CY
2001 and the first half of CY 2002 to determine whether the Forms 1120X met the
criteria for referral and were correctly referred to the AM Adjustment
function.
III.
Determined whether Submission
Processing Sites correctly processed Forms 1120X in a timely manner.
A.
Researched for any prior
General Accounting Office and Treasury Inspector General for Tax Administration
reports regarding the processing of Forms 1120X.
B.
Reviewed IRMs relating to the
processing of Forms 1120X.
C.
Scanned accounts of
adjustments processed by all the Submission Processing Sites during CY 2001 and
the first half of CY 2002 to determine the types of errors and issues to be
addressed. Using this method, we were
able to determine other criteria for referral that should be included in the
Submission Processing procedures based on the effect on these accounts. We performed an in-depth review of 202
accounts and the related Forms 1120X (in 194 cases) to determine whether all
required information was received from the taxpayers, the adjustments were
correct, the statuses of the taxpayers’ accounts were correct, and all
appropriate issues were addressed. We
judgmentally selected the 202 cases for review as follows: We reviewed 19 of the first 56
accounts in a database of 285 accounts where the tax was increased based on
Forms 1120X at 1 site. We reviewed the
19 cases because there was some indication of a processing problem. We reviewed another 183 Forms 1120X from
other databases of Forms 1120X processed by the Submission Processing Sites in
a similar manner.
D.
Determined whether each Form
1120X reviewed pertained to a Large and Mid-Size Business Division account or a
Small Business/Self-Employed Division account, and whether the original return
filed was a U.S. Income Tax Return for an S Corporation (Form 1120S).
E.
Reviewed the accounts of all
Forms 1120X processed with tax decreases by the Cincinnati and Ogden Submission
Processing Sites. Determined the additional
interest paid to taxpayers for cases where the processing time exceeded 45
days.
F.
Interviewed staff in the Code
and Edit functions to determine whether any problems had been identified or
recent processing changes had been made.
G.
Interviewed staff in the
Unpostable function (a function responsible for resolving transactions that
could not be posted to taxpayers’ accounts) to determine whether there was a
high rate of unpostables from Form 1120X adjustments processed in Submission
Processing Sites.
Appendix II
Major Contributors to This Report
Richard J. Dagliolo, Director
Parker F. Pearson, Director
Kyle R. Andersen, Acting Director
Robert
K. Irish, Audit Manager
John
Chiappino, Acting Audit Manager
Dolores
Castoro, Senior Auditor
Stephen Wybaillie, Auditor
Appendix III
Commissioner N:C
Deputy Commissioner for Services and Enforcement N:SE
Acting Deputy
Commissioner, Small Business/Self-Employed Division S
Director, Customer
Account Services, Small Business/Self-Employed Division S:CAS
Director, Communications and Liaison, Small
Business/Self-Employed Division S:M:CL
Staff Assistant, Small Business/Self-Employed Division S
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, Small Business/Self-Employed Division S
Appendix IV
This appendix presents detailed information on the measurable impact that our recommended corrective actions will have on tax administration. These benefits will be incorporated into our Semiannual Report to the Congress.
Type and Value of Outcome Measure:
· Revenue protected – Actual; $1,271,731.21; 7 taxpayer accounts affected (see page 2).
· Increased revenue – Actual; $2,238.10; 4 taxpayer accounts affected (see page 2).
· Funds put to better use – Actual; $1,127,361.22 (see page 2).
· Taxpayer rights and entitlements – Actual; 12 taxpayer accounts affected (see page 2).
· Taxpayer burden – Actual; 40 taxpayer accounts affected (see page 2).
Methodology Used to Measure the Reported Benefit:
In our judgment sample of 202
cases, we identified 7 cases with erroneous refunds totaling $1,271,731.21 and
4 cases in which tax totaling $2,238.10 was incorrectly abated or not
assessed. Also, we found that in 10
cases interest totaling $1,127,361.22 could have been avoided. In addition, 12 refunds were delayed, and 40
taxpayers had additional interaction with the Internal Revenue Service that
could have been avoided.
Appendix V
We reviewed 202 Amended U.S. Corporation Income Tax Return (Form 1120X) cases processed by the Submission Processing Sites. We found that the following 88 cases were not properly resolved:
· In nine cases, the request for a credit elect or reduction of a penalty was not addressed. Eight taxpayers requested that the overpayments be applied to the following tax year (credit elect), but the overpayments were instead erroneously refunded. Four of these taxpayers returned the refund checks, but the Internal Revenue Service (IRS) paid interest in excess of $10,000 on the other four refunds. One taxpayer requested a reduction of the estimated tax penalty, but the penalty was not addressed. The taxpayer had to make a second request for abatement of the penalty.
· In nine cases, filing requirements, address changes, and U.S. Corporation Income Tax Returns (Form 1120) in the wrong accounts were not addressed. In five cases in which filing requirements were not addressed, Tax Delinquency Investigations were initiated erroneously for two taxpayers, and two other taxpayers were treated as Subchapter S Corporations, paying no corporate tax, even though they were not allowed to file Subchapter S returns until the following tax year. Addresses were not changed in two cases. In two other cases, because returns were not reprocessed, taxpayers were charged penalties erroneously.
· In 19 cases, incorrect adjustments were made to the taxpayers’ accounts. In three of the cases, tax adjustments were made to the wrong tax year, one of which was later corrected to allow for another adjustment. Multiple adjustments were made erroneously in 2 cases, and taxes were adjusted incorrectly in 12 cases. Two cases should have been referred to the Examination function; 1 of these 2 cases was a protective claim erroneously processed for a refund in excess of $1 million, and had an unprocessed Form 1120X attached that was for a year in which the statute of limitations is currently expired. Some errors were never detected, and others created additional unnecessary interaction with the taxpayers.
· In eight cases, Forms 1120X were incorrectly processed without restricting the interest and/or disallowing the loss or election. Two of 5 cases processed with the incorrect interest were subsequently corrected, but in 1 case the IRS must attempt to collect back interest in excess of $600,000. One of the five should have been disallowed entirely. In the remaining three cases, a loss carried forward reducing tax and two untimely elections should have been disallowed.
· In five cases, we found six unprocessed documents attached to Forms 1120X. These documents included two additional Forms 1120X, three Forms 1120, and a Corporation Application For Tentative Refund (Form 1139). When the Treasury Inspector General for Tax Administration forwarded the Form 1139 for processing, the taxpayer, who had been issued erroneous notices for the Form 1120X balance due amount, was issued a refund that included interest in excess of $400,000, all of which could have been avoided.
· In 17 cases, misapplied payments and errors in credits claimed were not addressed. In 8 of the 17 cases, refunds were delayed because the payment made for the original return had either been misapplied or not claimed by the taxpayer on the original Form 1120. In the other nine cases, the payments received with Form 1120X were misapplied, causing incorrect notices to be issued. A refund was returned because it included one of the misapplied payments.
· In seven cases, notices were not customized to prevent additional, unnecessary interaction with the taxpayer.
· In 14 cases, the Forms 1120X were not properly processed, but there was no immediate impact to the taxpayers or the IRS.
Appendix VI
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.