Enhancing Internal Controls for the Internal Revenue
Service’s Excess Collections File Could Improve Case Resolution
January 2005
Reference
Number: 2005-30-022
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.
January
21, 2005
MEMORANDUM FOR
DEPUTY COMMISSIONER FOR SERVICES AND ENFORCEMENT
FROM: Gordon C. Milbourn III /s/ Gordon C.
Milbourn III
Assistant Inspector General
for Audit
(Small Business and Corporate
Programs)
SUBJECT: Final Audit Report - Enhancing
Internal Controls for the Internal Revenue Service’s Excess Collections File Could
Improve Case Resolution (Audit #
200430004)
This
report presents the results of our review of the Internal Revenue Service’s
(IRS) Excess Collections File (XSF). The
overall objective of this review was to determine the financial effect and taxpayer burden
on credit balance accounts that are not resolved before the IRS transfers large-dollar
payments into its XSF.
In
summary, the IRS’ internal
controls for resolving cases before transferring large-dollar payments to its XSF
are not adequate. We concluded that
large-dollar payments are being transferred without sufficient research or contact
with taxpayers. When payments are transferred to the XSF without
effective case resolution, the IRS may be subjecting taxpayers to unwarranted
notices. Also, by transferring payments
without obtaining the associated tax returns, the IRS is not assisting
taxpayers in meeting their obligations to file their tax returns and pay their
taxes due. We concluded that if controls were adequate,
25 percent of the dollars in the XSF could have been credited to taxpayers’
accounts.
Our analysis of the XSF showed
the overall file had grown 65 percent during a 4-year period. In March 1999, the XSF contained
approximately $2.3 billion, but it had risen to approximately $3.8 billion through
October 2003.
A
review of 88 taxpayer accounts with at least 1 tax module totaling $1 million or more in at least 1 tax period identified 57 taxpayers with tax modules involving
approximately $931 million that could have been resolved and prevented from
being transferred to the XSF. We
identified two major types of cases. In 1
type of case, 29 of the 57 taxpayer accounts had payments transferred because
the taxpayers did not file tax returns for which they were liable. In the other type of case, 28 of the 57
taxpayer accounts had payments transferred due to insufficient IRS employee research
or IRS employee contact with the taxpayers, or improper adjustments to the
taxpayers’ accounts.
We
recommended the Director, Customer Account Services, Wage and Investment
Division, change case resolution procedures to allow for additional research
and contact with taxpayers and to ensure better coordination with each business division before tax modules with a
credit balance are closed. We also recommended
the IRS implement procedures for large-dollar cases to require field contact to
obtain delinquent returns or follow procedures required by the Internal Revenue
Code for nonfilers. Finally, we recommended
additional managerial oversight to assist in case resolution to prevent erroneous
payment transfers.
Management’s Response: The IRS generally
agreed with the intent of the recommendations.
The Director, Customer Account Services, Wage and Investment Division,
will form a task group with representatives from each operating division to
review their current procedures, the cases we reviewed, and our
recommendations. They expect to convene
the task group by January 31, 2005, and anticipate the group’s findings and recommendations
by October 2005.
The IRS did not fully agree
with the Outcome Measures contained in Appendix IV. They did not agree with the benefit of $855
million associated with the 29 taxpayers who failed to file a return. They believe taxpayers who failed to file a
proper tax return did not comply with their legal obligation and, therefore, put
themselves at risk. The IRS response
stated that the IRS is not obligated to file returns on the taxpayer’s behalf under
the provisions of Internal Revenue Code (I.R.C.) 6020(b).
IRS management did agree with the
benefit associated with the 28 taxpayers with payments of $76 million that were
attributed to insufficient research or contact or an improper adjustment. Management’s complete response to the
draft report is included as Appendix V.
Office
of Audit Comment: We recognize the
numerous systemic and procedural improvements the IRS has made to the
management of the XSF during the past 3 years.
While these improvements have made it possible for the IRS to perfect
many payments and apply them to the proper taxpayer accounts, we believe the
IRS could do more to assist those taxpayers, especially government entities, in
complying with filing requirements. Our
results show that the majority of the outcome measures are associated with government
agencies that did not file a tax return.
There are a variety of
reasons why we believe it is appropriate for the IRS to file returns for
taxpayers in these cases.
Copies of this
report are also being sent to IRS managers 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 –
Management’s Response to the Draft Report
The Internal Revenue Service (IRS) has established a system of internal
controls to ensure taxpayer payments and the associated documents are properly
applied to a taxpayer’s Master File account. When payments and the associated documents are
not received and/or processed as expected, the Accounts Maintenance (AM) function
at each IRS campus is responsible for ensuring general account resolution. After AM function research has been performed
and Internal Revenue Manual (IRM) procedures have been followed, if a payment cannot
be applied to an account, the payment is over 1 year old, and the case is still
not resolved, the payment is transferred to the Excess Collections file (XSF).
Our analysis of the overall XSF showed it had grown 65 percent during the 4-year period from March 1999 (approximately $2.3 billion) through October 2003 (approximately $3.8 billion involving more than 1.9 million tax modules).
The XSF generally contains payments that cannot be applied to the proper tax account. In our opinion, taxpayers do not send payments to the IRS unless they anticipate incurring a tax liability. The payments that eventually go to the XSF are generally caused by one of a limited number of conditions, such as when a taxpayer submits a tax payment but does not file a tax return, when a taxpayer files a tax return past the time period to receive a refund, or when the IRS is unable to determine to which taxpayer’s account to apply a payment.
The IRM instructs employees to perform research on each payment before adding it to the XSF, regardless of the dollar amount of the item. Both large- and small-dollar cases are to receive equal attention, but large-dollar cases will be worked first. Figure 1 shows the total dollars for the XSF maintained at each campus.
Figure 1: Total
Dollars in the XSF for Each Campus
Figure 1 was removed due to its size. To see Figure 1, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.
This audit was performed at the IRS Philadelphia Campus and
included analyses of the 10 campuses’ XSFs during the period October 2003
through August 2004. We interviewed IRS
management from the Wage and Investment (W&I) Division in
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.
The IRS’ internal control procedures for transferring large-dollar
payments to its XSF are not adequate. We
concluded that large-dollar payments are being transferred to the XSF without sufficient
research or contact with taxpayers. If
controls were adequate, 25 percent of the dollars in the XSF could have been credited
to taxpayers’ accounts.
When payments are transferred to the XSF without effective case resolution, the IRS may be subjecting taxpayers to unwarranted notices. Also, by transferring payments without obtaining the associated tax returns, the IRS is not assisting taxpayers in meeting their obligations to file their tax returns and pay their taxes due.
Our analysis of 88 taxpayer accounts with at least 1 tax module totaling $1 million or more in at
least 1 tax period identified 57
taxpayers with tax modules involving approximately $931 million that could have
been resolved and prevented from being transferred to the XSF. The inadequate internal controls allowed filing noncompliance or improper
adjustments to taxpayer accounts.
·
Twenty-nine (51 percent) of 57 taxpayer accounts,
totaling almost $855 million, had at least 1 tax module that required a tax
return to be filed. Because these
taxpayers submitted payments and have a filing requirement, the IRS should have
followed procedures for preparing a tax return as prescribed by the Internal
Revenue Code (I.R.C.) when attempts to obtain a voluntary tax return
failed. In some cases, taxpayers had filed the same type of return(s) for the tax periods
before and after the subject periods.
·
Twenty-eight (49 percent) of 57 taxpayer accounts
had payments totaling almost $76 million transferred due to insufficient IRS
employee research or contact with the taxpayers, or an improper adjustment to
the account.
Because necessary documentation was not available, we could not determine why payments totaling approximately $45 million were transferred for 16 of the 88 taxpayer accounts.
The remaining 16 taxpayer accounts had payments totaling almost $49 million correctly transferred to the XSF. Most of these payments were transferred because of an action taken by the taxpayers, such as filing a tax return past the time period to receive a refund.
The Government
Accountability Office (GAO) Standards for
Internal Control in the Federal Government state internal controls should
provide reasonable assurance that the objectives of the agency are being
achieved in the following categories:
We concluded the
IRS’ internal control procedures for transferring payments to the XSF are not
meeting these standards because approximately $931 million in payments was
transferred without sufficient research or contact with taxpayers.
Assisting nonfilers in meeting
their tax filing obligations will reduce the number of payments transferred to the
XSF
Part of the IRS National Non-Filer Strategy is to identify
cases for which it can obtain a tax return and assess a tax liability. The IRS’ objective
is to ensure taxpayers who are legally required to file do so and to address
those individuals who are not required to file but may be due refunds or
credits.
From our analysis, 29 taxpayers submitted payments, totaling almost $855 million, that were transferred to the XSF because the taxpayers did not file tax returns. We concluded that these cases would have been productive because the taxpayers had already attempted to comply by submitting payments.
When a taxpayer has a filing requirement and a tax return has not been received, the IRS can initiate a Taxpayer Delinquency Investigation (TDI). Of the 29 taxpayers who did not file a tax return, 14 accounts showed no evidence that a TDI was initiated. These taxpayers submitted payments totaling over $56 million.
The remaining 15 taxpayers had TDIs initiated for their accounts. However, seven TDIs were closed because the IRS determined the taxpayers were not required to file the subject returns. These returns included the Employer’s Quarterly Federal Tax Return (Form 941), the Annual Return of Withheld Federal Income Tax (Form 945), and U.S. Corporation Income Tax Return (Form 1120). Our analysis showed these TDIs were incorrectly closed and the taxpayers were, in fact, required to file the tax returns. Two of the 7 taxpayers were government entities that had submitted payments totaling approximately $744 million.
The IRM states, “Federal Agencies are not exempt from the employment tax filing, paying, and reporting requirements. [The] Congress did not provide any exceptions for Federal Agencies.” The IRM further states it is important for all government agencies to set a good example because private employers are expected to meet all requirements for filing and paying their taxes timely. One of the goals of the IRS Strategic Business Plan is to discourage and deter abuse within tax-exempt and government entities. From our analysis, we found another government entity had not filed tax returns for 7 years and had credits remaining in its tax modules of approximately $38 million.
Further, our opinion that taxpayers do not send payments to the IRS unless they anticipate incurring a tax liability is supported by an independent study performed by the LMSB Division. The IRS initiated this analysis because of concern that there may be a large amount of unpaid taxes due for nonfiled tax returns. From its sample of large-dollar tax modules, the IRS was able to secure tax returns from most of the taxpayers. Another study performed by the LMSB Division on income tax nonfilers concluded, “The presence of a credit balance is indicative that the taxpayer expects to file a return which shows tax due.”
The I.R.C. states, “If any person fails to make any return
required by any Internal Revenue Law or regulation . . . the Secretary [of the
Treasury] shall make such return from his own knowledge and from such
information as he can obtain through testimony or otherwise.” From this legal authority, the IRS developed the
Delinquent Return and Substitute for Return procedures to address taxpayers who
do not file required tax returns. The
purpose of the procedures is to assess the correct tax liability by either
securing a valid voluntary tax return from the taxpayer (Delinquent Return) or,
if securing a return is not possible, computing tax, interest, and penalties
based on information submitted by payers or based on other internally available
information (Substitute for Return). There
is no indication the IRS followed these
procedures for taxpayers with these large-dollar credit balances before
transferring the payments to the XSF.
Although these taxpayers have made an attempt to comply with their tax obligations by submitting these payments, without the proper documentation (i.e., tax returns) the IRS is unable to determine if the taxpayers have fully paid their tax liabilities.
Increasing managerial oversight
could assist in case resolution and prevent payments from being transferred to
the XSF
Our analysis of the XSF showed
the account grew 65 percent during a 4-year period. We recognize there are situations in which
payments are required to be transferred to the XSF, including tax refunds from
taxpayers who have filed their tax returns past the time to receive a refund,
photocopy fees, and conscience money. However,
increasing managerial oversight of tax modules with large-dollar payments could
prevent costly errors and protect taxpayer rights. Our analysis showed 29 taxpayer accounts required a tax return to be secured and 28 taxpayer
accounts had incorrect or insufficient actions taken.
We also identified
instances in which IRS employees transferred payments to the XSF without performing
sufficient research. For example, there
were cases in which taxpayers fabricated the amount of withholding to claim
refunds. The IRS processed these claims;
however, since the returns were filed past the statute of limitations, the fabricated refund amounts were transferred to
the XSF. In these cases, the taxpayers
actually owed a balance due, but will not receive a notice for the proper
amount of tax due, and the XSF is artificially overstated.
Contributing to this situation are several related sections of the IRM that may be preventing employees from expending additional time to research or contact taxpayers before deciding to transfer payments to the XSF. For example, the procedures for cases sent to the Statute of Limitations function state that, due to the adverse impact on the Accounts Receivable Dollar Inventory, all large dollar debit and credit tax modules involving a balance of $25,000 and over must be expeditiously resolved. When these balances are not resolved expeditiously, the time period in which the IRS may refund a credit to a taxpayer or assess a tax liability may be limited.
However, by transferring these payments expeditiously, employees may not be taking sufficient action to ensure the proper resolution. Figure 2 shows a listing of dollars in the XSF for tax modules with $25,000 or more as of October 2003.
Figure 2: Dollars by Tax Module in the XSF as of October
2003
|
|
Modules |
Dollars |
|
$25,000 - $49,999 |
5,109 |
$
173,517,277 |
|
$50,000 - $99,999 |
2,080 |
$
140,909,261 |
|
$100,000 - $249,999 |
1,006 |
$
148,385,202 |
|
$250,000 - $499,999 |
302 |
$
104,902,076 |
|
$500,000 - $999,999 |
118 |
$
79,353,674 |
|
$1,000,000 and over |
96 |
$
1,019,593,411 |
|
Total |
8,711 |
$ 1,666,660,901 |
Source: Data extract obtained by the TIGTA as of October 2003.
Also, XSF procedures advise employees to research payments and give equal attention to both large and small cases but state that large-dollar cases will be worked first. However, the procedures also state that research does not have to be conducted for statute-expired cases. These procedures are advising employees not to conduct research that could aid in case resolution.
We recognize that the IRS improved internal controls after a previous
TIGTA audit involving the XSF. However,
the type of cases identified in this review can still occur. By expending additional time on research or
contact with taxpayers and increasing the managerial review of large-dollar
cases, the IRS can leverage its resources and minimize the number of large-dollar
payments transferred to the XSF.
To assist in case resolution and prevent payments from being prematurely transferred to the XSF, the Director, Customer Account Services, W&I Division, should:
1.
Change IRM procedures to allow for additional employee
research or taxpayer contact to obtain needed information for large-dollar
cases.
Management’s Response: A task force will be formed and will review
current guidance in each operating division’s IRM and develop appropriate
procedures to ensure that large dollar cases receive proper attention.
2.
Increase managerial
review for all tax modules, at an amount established by each business operating
division, before payments are transferred to the XSF or remain unresolved.
Management’s Response: The task force
will review current guidance for each operating division and determine if
changes are needed to established practices.
3. Require IRS employee field contact, when needed, for tax modules over an amount established by each business operating division when a tax return is needed.
Management’s Response: The task force will review current guidance for each operating division and determine if changes are needed to established practices.
4. Ensure the I.R.C. procedures are used during case resolution when the taxpayer is unable or unwilling to submit a tax return for large-dollar cases.
Management’s Response: IRS management stated
the IRS is not obligated to file returns under the provisions of I.R.C. 6020(b)
on the taxpayer’s behalf. Therefore, the IRS does not fully agree with the benefit of $855 million associated
with the 29 taxpayers who failed to file a return. IRS management
stated that taxpayers who failed to file a proper tax return did not comply with
their legal obligation and, therefore, put themselves at risk. However,
the task force will review current practices
and guidance for use of I.R.C. 6020(b) procedures in resolving situations where
large-dollar credits are present, but the returns are not filed.
Office of Audit Comment: We recognize the numerous systemic and
procedural improvements the IRS has made to the management of the XSF during
the past 3 years. While these
improvements have made it possible for the IRS to perfect many payments and
apply them to the proper taxpayer accounts, we believe the IRS could do more to
assist those taxpayers, especially government entities, in complying with
filing requirements. Our results show the majority of the outcome
measures are associated with government agencies that did not file a tax
return.
There are a variety of reasons why we believe it is appropriate for the IRS to file returns for taxpayers in these cases.
5. Ensure better coordination with each business operating division before tax modules with a credit balance are closed. This coordination would include advising the respective business operating division of the large-dollar payments being transferred to the XSF.
Management’s Response: The task group
will review the need for and feasibility of this recommendation in light of
their overall findings and any proposed changes to procedures.
Appendix I
Detailed Objective,
Scope, and Methodology
The overall objective of the review was to determine the financial effect and taxpayer burden on credit balance accounts that are not resolved before the Internal Revenue Service (IRS) transfers large-dollar payments into its Excess Collections file (XSF).
To accomplish our objective, we:
I. Obtained a computer extract of the IRS’ XSF as of October 2003 from all 10 campuses.
II.
Identified all 88 taxpayers that had 96 tax
modules in the XSF with payments totaling $1 million or more in at least 1 tax
period.
III.
Researched the actions taken for these
payments using the Integrated Data Retrieval System and requested original
documentation (i.e., tax returns). We determined
if sufficient actions were taken before the payments were transferred into the
XSF.
IV.
Coordinated
with IRS analysts from the Small
Business/Self-Employed Division Accounts Management unit staff at the
Philadelphia Campus to validate our analyses.
Appendix II
Major Contributors to This
Report
Parker F. Pearson, Director
Philip Shropshire,
Director
Timothy Greiner,
Acting Audit Manager
Carole Connolly, Lead
Auditor
Donna
Saranchak, Senior Auditor
Denise
Gladson, Auditor
Dave Clous, Information Technology
Specialist
Appendix III
Commissioner C
Office of the Commissioner – Attn.: Chief of Staff C
Commissioner, Large and Mid-Size Business Division SE:LM
Commissioner, Small Business/Self-Employed Division SE:S
Commissioner, Tax Exempt and Government Entities Division SE:T
Commissioner, Wage and Investment Division SE:W
Director, Campus Reporting Compliance, Small
Business/Self-Employed Division
SE:S:CSCO:CRC
Director, Communications and Liaison, Small
Business/Self-Employed Division
SE:S:C&L
Director, Compliance, Wage and Investment
Division SE:W:CP
Director, Compliance Services Campus
Operations, Small Business/Self-Employed Division SE:S:CSCO
Director, Customer Account Services, Wage and
Investment Division SE:W:CAS
Director, Strategy and Finance,
Wage and Investment Division SE:W:S
Director, Filing and Payment Compliance, Wage
and Investment Division SE:W:CP:FP:C
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 Liaisons:
Commissioner, Large and Mid-Size Business Division SE:LM
Commissioner, Small Business/Self-Employed Division SE:S
Commissioner, Tax Exempt and Government Entities Division SE:T
Senior Operations Advisor, Wage and Investment Division SE:W:S
Appendix IV
This appendix presents detailed information on the measurable impact that our recommended corrective actions will have on tax administration. This benefit will be incorporated into our Semiannual Report to the Congress.
Type and Value of Outcome Measure:
· Taxpayer Rights and Entitlements – Actual; 57 taxpayers affected; approximately $931 million in payments transferred to the Excess Collections file (XSF) (see page 3).
Methodology Used to Measure the Reported Benefit:
As of October 2003, the XSF contained approximately $3.8
billion. Our analysis of the XSF showed 88 taxpayers had tax modules (totaling over $1 billion) with payments totaling $1
million or more in at least 1 tax period. Of the 88 taxpayers, 57 had tax
modules with payments totaling approximately $931 million that could have been
prevented from being transferred to the XSF.
Ineffective internal controls allowed for improper adjustments to
taxpayers’ accounts.
· Twenty-nine (51 percent) of 57 taxpayer accounts, totaling almost $855 million, had at least 1 tax module that required a tax return to be filed. Because these taxpayers submitted payments and have a filing requirement, the IRS should have followed procedures for preparing a tax return as prescribed by the Internal Revenue Code when attempts to obtain a voluntary tax return failed.
·
Twenty-eight
(49 percent) of 57 taxpayer accounts had payments totaling almost $76 million
transferred due to insufficient research or contact with the taxpayers, or an
improper adjustment to the accounts.
Appendix V
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.