More Effective Actions Can Be
Taken When Collecting Accounts of Defunct Businesses
September 2003
Reference Number:
2003-30-196
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
24, 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 - More Effective
Actions Can Be Taken When Collecting Accounts of Defunct Businesses (Audit # 200230031)
This
report presents the results of our review of the Internal Revenue Service’s
(IRS) collecting of accounts of defunct businesses. The overall objective of this review was to determine whether the Collection Field function (CFf)
uses the proper procedures when closing delinquent accounts of defunct
businesses as Currently Not Collectible (CNC).
In summary, most tax liabilities of businesses arise from their fiduciary responsibility to collect and pay trust fund taxes. Trust fund taxes are the Federal taxes withheld from employee earnings and the employee and employer portions of taxes required by the Federal Insurance Contributions Act (FICA). Unpaid trust fund taxes are the second largest component of the accounts receivable inventory of the IRS. As of September 2002, these taxes represented $14.5 billion (31 percent) of the $46.7 billion in accounts receivable owed to the IRS.
When the IRS determines that
a business is no longer in operation and has no assets to pay its tax
liabilities, the accounts are closed as CNC – Defunct. The amount of trust fund taxes closed as CNC
– Defunct increased from $919 million in Fiscal Year (FY) 2000 to $1.3 billion
in FY 2002. Another $926 million in
trust fund cases has already been closed CNC – Defunct in the first 6 months of
FY 2003.
Our review of 319
judgmentally sampled cases closed as CNC – Defunct showed that the CFf properly
determined that the businesses were defunct and did not have assets sufficient
to pay off all or part of the tax liabilities.
However, some cases took a significant amount of time before they were
closed in the CFf. The 319 closed cases in our sample averaged
25.7 months in open CFf inventory (from date of assignment to date of
closure). Of the 319 cases, 82 (26
percent) had taken over 36 months to be closed. The IRS considers CFf collection cases over-aged when they have
been in the field for 16 months. Many
of the taxpayers in our sample were in business when the delinquency case was
received in the CFf. In 207 (65 percent)
of the 319 cases, the entity was in business when the case was received in the
CFf and later went out-of-business.
In addition, controls for
calculating and determining the Trust Fund Recovery Penalty (TFRP) were not
always effective. In 38 of the 319
cases, the return delinquency investigations were not completed before the TFRP
was considered, causing the TFRPs to be asserted for amounts less than
appropriate or not to be asserted at all.
Also, responsible officers received
personal income tax refunds totaling $204,000 in 30 of the 166 cases in which
the TFRP was not asserted.
We recommended the Director,
Compliance Policy, Small Business/Self-Employed (SB/SE) Division, make computer
programming changes to ensure that delinquent tax return investigations are
addressed in TFRP calculations, and remind CFf managers to address unfiled
returns and the TFRP in workload reviews and in their approvals of cases closed
as CNC – Defunct. We also recommended
the Director consider studying the impact of revenue lost when the TFRP is not
assessed and responsible officers subsequently receive refunds.
Management’s Response: The SB/SE
Division's Compliance and Compliance Policy functions generally agreed with our
recommendations. The Field Payment
Compliance office submitted a Request for Information Services for a computer
programming enhancement, and group managers were trained to address the areas
we recommended. However, the SB/SE Division’s Compliance
Policy management disagreed with the impact of revenue lost when the TFRP is not assessed and
responsible officers subsequently receive refunds. Management cited the difficulty for revenue officers to
accurately predict which taxpayers will receive refunds, and the potential for
refunds being returned because of injured spouse claims. Management’s complete response to the
draft report is included as Appendix IV.
Office
of Audit Comment: We recognize that
assessing the TFRP in all cases may not be practical. While the potential for
future taxpayer refunds may be difficult to predict, we believe there are
compelling reasons for studying the impact of revenue lost when the TFRP is not
assessed and responsible officers receive refunds. Specifically, Trust Fund liabilities are increasing and are a top
priority for the CFf, responsible officers frequently received personal income
tax refunds in cases in which the TFRP was not asserted, and refund offsets are
a cost-effective collection tool for the IRS.
While we still believe our recommendation is worthwhile, we do not
intend to elevate our disagreement concerning this matter to the Department of
Treasury for resolution.
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 Pearson, Director
(Compliance), at (410) 962-9637.
Revenue Officers Generally Followed Procedures When Closing Cases as Defunct
Closing Defunct Business Accounts Took a Significant Amount of Time
Controls for Calculating and Determining the Trust Fund Recovery Penalty Were Not Always Effective
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 collection mission of the Internal Revenue Service (IRS) is to promptly collect the correct amount of Federal tax from all persons and entities which have been determined to have a legitimate tax liability. If a taxpayer does not pay the proper amount of tax due, the IRS collection process starts with a form letter to the taxpayer requesting payment of the balance due (a tax delinquency). If the taxpayer does not pay, the IRS attempts to contact the taxpayer by telephone to resolve the delinquency, or the case is assigned to an office of the Collection Field function (CFf). The tax delinquency case is assigned to a revenue officer (RO) who attempts to make field contact with the taxpayer and resolve the delinquency.
Most tax liabilities of business entities arise from their fiduciary responsibility to collect and pay trust fund taxes. These are the Federal taxes withheld from employee earnings and the employee and employer portions of taxes required by the Federal Insurance Contributions Act (FICA). In some instances, an entity goes out-of-business and unpaid tax liabilities still exist. The term “defunct entity” specifically applies to any business that is no longer operating or has gone out-of-business. For these cases, IRS procedures require the RO to:
When the RO locates
the business or its owners/managers and determines that the business is no
longer in operation and has no assets to pay its tax liabilities, the account
is closed as Currently Not Collectible (CNC) – Defunct. Since the
business has ceased operations, frequently the only remaining option for the RO
is to identify the responsible officers or business owners, apply the Trust
Fund Recovery Penalty (TFRP) against these individuals personally, and attempt
to collect unpaid trust fund taxes from them.
The TFRP is not applicable for collection of corporate income tax.
Unpaid trust fund taxes are the second largest component of the accounts receivable inventory of the IRS. As of September 2002, these taxes represented $14.5 billion (31 percent) of the $46.7 billion total potentially collectible accounts receivable owed to the IRS. TFRP assessments represented another $3.5 billion (7.5 percent).
The amount of trust fund taxes closed as CNC – Defunct increased from $919 million in Fiscal Year (FY) 2000 to $1.3 billion in FY 2002. Another $926 million in trust fund cases has already been closed as CNC – Defunct in the first 6 months of FY 2003.
Our audit was conducted between July 2002 and June 2003 in
offices of the Small Business/Self-Employed (SB/SE) Division, the IRS
Philadelphia Campus, and CFf offices in Philadelphia, Pennsylvania, and Cherry
Hill, New Jersey. The audit was
conducted 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.
Our review of 319 judgmentally sampled defunct entity cases closed as CNC – Defunct showed that CFf ROs made the correct determinations that the entities were, in fact, defunct and did not have assets sufficient to pay off all or part of the tax liabilities. ROs researched appropriate sources (state, city, county records), made field visits to business locations, and contacted third parties for information. While these determinations were appropriate, ROs did not always work the cases timely or properly assess the TFRP.
The 319 closed cases in our sample
averaged 25.7 months in open CFf inventory (from date of assignment
to date of closure). Of the 319 cases, 82 (26 percent) had
taken over 36 months to be closed. The
IRS considers CFf collection cases over-aged when they have been in the field
for 16 months.
In
addition, many of the taxpayers in our sample were in business when the
delinquency case was received in the CFf.
In 207 (65 percent) of the 319 cases, the entity was in business when
the case was received in the CFf and later went out-of-business. When in-business trust fund cases are not
worked timely, unpaid trust fund liabilities can continue to accumulate, thereby increasing the potential of revenue
lost to the IRS. In addition, taxpayers
may go out-of-business, leaving the IRS little chance of collecting the taxes
due.
In a prior report,
we brought timeliness issues to the attention of Collection function
management. In that report, we
recommended that Collection function management adopt quicker time
periods for assigning in-business trust fund cases and contacting
taxpayers.
IRS management has recently attempted to improve the
timeliness of working trust fund cases through a stronger emphasis on trust
fund in-business cases, quicker assignment to the field, and more case
involvement by managers. These actions
should improve timeliness.
ROs recommended assertion of the TFRP
in 153 of the 319 businesses we sampled.
Only the tax withheld and the employee portion of the FICA taxes can be
included in the TFRP amount (interest, other penalties, and the employer
portion of the FICA taxes cannot be included in the TFRP asserted amount). Our review of the 166 cases where the TFRP
was not asserted identified 2 areas in which the IRS can make improvements to
procedures for assessing the TFRP.
Unfiled tax returns were not always secured and considered when assessing the TFRP
IRS procedures require
the closing of trust fund tax return delinquency investigations prior to the
calculation of the TFRP. These
investigations are for trust fund returns that were due but had not been filed
when the business became defunct. ROs
can close these investigations by securing the tax return from the business
officers, preparing a return using prior quarter information to estimate the
amount of taxes due, or closing the account as not liable if the business had
no employees for those periods.
Of the 319 businesses sampled, 38 had open trust fund tax return investigations when the RO closed the case. Because these investigations were not closed, responsible officers for 14 of these 38 businesses were potentially assessed a TFRP for an amount less than appropriate. For the remaining 24 businesses, the TFRPs were not asserted because the balance was below the threshold for assessing the amount. However, the securing of delinquent unfiled returns could have raised the trust fund liability over the dollar threshold for assessing the TFRP in these instances. Not asserting the TRFP for all tax periods results in potential loss of revenue.
ROs use the Automated Trust Fund Recovery (ATFR) system to calculate the TFRP. However, the ATFR system does not include potential dollars associated with these tax return delinquency investigations. When approving CNC accounts, managers did not ensure that the tax return delinquency investigations were properly closed.
In a prior audit, we recommended that the ATFR system be modified to require that open investigations be addressed. IRS management agreed with the recommendation in their official response to the draft audit report; however, corrective action, scheduled to have been completed December 1, 2001, has not been implemented.
The TFRP is frequently not asserted against responsible officers that later receive refunds
Procedures allow for the
IRS to apply to TFRP assessments the refunds from personal taxes of those
responsible officers assessed the TFRP.
When determining collectibility, ROs should consider the fact that
responsible officers may receive future refunds. Sometimes, this consideration is not given.
We determined that
responsible officers received personal income tax refunds totaling $204,000 in
30 (18 percent) of the 166 cases in which the TFRP was not asserted. In 24 cases, the TFRP was not asserted
because the trust fund amount was below the dollar threshold. In six cases, the penalty was not asserted because the ROs determined
there was no collection potential. If TFRPs had been asserted (and subsequently
assessed) on these individuals, IRS computer systems would have offset some of
their refunds against existing liabilities.
The offsets would have been limited to the amounts of actual trust fund
taxes owed and injured spouse considerations, since the TFRP is usually
assessed against only one of the two spouses who filed a joint return.
We recognize that some
costs exist to obtain the information to determine the responsible officers,
calculate the TFRP amounts, and make the assessments. However, the ROs have been working these cases for a significant
period of time and may already have much of the information available. The IRS does not maintain cost estimates for
the TFRP determination and assessment process.
In our opinion, having refunds applied to a penalty assessment in these
cases may justify any minimal cost associated with assessing the TFRP. Offsetting the refunds would increase
revenue collected and improve tax compliance by making those responsible
officers more accountable for their actions.
The Director, Compliance Policy, SB/SE Division, should:
1.
Make programming changes to the ATFR
system to ensure delinquent return investigations are addressed in TFRP
calculations. These changes could
include inserting logic provisions in the form used to calculate the TFRP.
Management’s Response: The Field Payment Compliance office submitted a Request for Information Services for a programming enhancement to the ATFR system. The programming change will require ROs to address all unfiled returns prior to closing a case using the Law Enforcement Manual criteria.
2.
Remind CFf managers to address
unfiled returns and the TFRP in workload reviews and in their approvals of
cases closed as CNC – Defunct.
Management’s Response: Group managers were trained in an interactive
video tele-training session on September 4, 2003.
3. Study the impact of revenue lost when the TFRP is not assessed and responsible officers subsequently receive refunds. Implement changes for asserting the TFRP, if appropriate.
Management’s Response:
SB/SE Division Compliance Policy management did not agree with this
recommendation. They stated that to
comply with this recommendation, ROs would need to accurately predict which
taxpayers will receive refunds, and some of these refunds may be returned due
to injured spouse claims.
Office of Audit Comment: While the potential for future taxpayer refunds may be difficult to predict, we believe there are compelling reasons for studying the impact of revenue lost when the TFRP is not assessed and responsible officers receive refunds. Specifically:
· Trust Fund liabilities are increasing and are a top priority for the CFf.
· We determined that responsible officers received personal income tax refunds totaling $204,000 in 166 cases in which the TFRP was not asserted.
Appendix I
The overall objective of this review was to determine whether the Collection Field function
uses the proper procedures when closing delinquent accounts of defunct
businesses as Currently Not Collectible (CNC).
To accomplish our overall objective, we:
I.
Evaluated the processes used to identify defunct
entities and selected a sample of defunct cases closed as CNC – Defunct by:
A. Determining and evaluating the methods the Internal Revenue Service (IRS) uses to identify business entities as defunct.
B. Analyzing national IRS data for tax accounts closed with Transaction Code (TC) 530 (denotes CNC) and Closing Code (CC) 10 (denotes Defunct Corporation) by extracting 326,206 tax modules from the Integrated Collection System (ICS) on June 12, 2002. These modules represented taxpayer accounts closed on the ICS, with corresponding closures on the Master File/Integrated Data Retrieval System (IDRS), with TC 530 and CC 10 between September 14, 1998, and May 23, 2002. The combination of these codes reflected all out-of-business entities closed as CNC – Defunct during that period.
C. Establishing a universe from which a sample could be selected for in-depth case review. Sixty percent (195,759 of 326,206) of the modules were coded differently on the Master File/IDRS and the ICS. Most of these discrepancies were modules coded on the ICS as either “in-business” or as individuals. From this sub-group of 195,759 modules, we judgmentally selected 321 for further analysis. These 321 modules represented 319 unique taxpayers (businesses).
II. Determined whether proper Collection closing and Trust Fund Recovery Penalty (TFRP) procedures were applied in the sample of 319 cases by:
A. Determining whether revenue officers (RO) made the correct determinations that accounts were not collectible.
B. Identifying the length of time the sampled cases remained in open inventory.
C. Determining whether the ROs made the proper determinations for asserting and calculating the TFRP against the appropriate responsible officers.
D. Determining whether potential assessment amounts from unfiled trust fund returns were considered when calculating the TFRP.
E. Determining the extent of refunds issued to potential responsible officers that were not assessed TFRPs and the potential trust fund amounts that could have been offset against those refunds.
Appendix
II
Major Contributors to This Report
Parker Pearson, Director
Richard Dagliolo, Director
Preston B. Benoit, Acting Director
Gary Swilley, Audit Manager
Joseph F. Cooney, Acting Audit Manager
James
S. Mills, Jr., Senior Auditor
Cristina Johnson, Auditor
Mildred Rita Woody, Auditor
Appendix III
Commissioner C
Deputy Commissioner for Services and Enforcement SE
Acting Deputy Commissioner, Small Business/Self-Employed Division SE:S
Director, Compliance, Small Business/Self-Employed Division SE:S:C
Project Director, Compliance Policy, Small Business/Self-Employed Division SE:S:C:CP
Director, Filing Compliance, Small Business/Self-Employed Division SE:S:C:CP:FC
Director, Payment Compliance, Small Business/Self-Employed Division SE:S:C:CP:PC
Chief Counsel CC
National Taxpayer Advocate TA
Director, Office of Legislative Affairs CL:LA
Director, Office of Program Evaluation and Risk Analysis RAS:O
Office of Management Controls OS:CFO:AR:M
Audit Liaison:
Commissioner, Small Business/Self-Employed Division SE:S
Appendix
IV
Management’s Response to the Draft Report
The response
was removed due to its size. To see the
response, please go to the Adobe PDF version of the report on the TIGTA Public
Web Page.