Taxpayers Identified As Serving in Combat Zones Were
Properly Afforded Tax Benefits, but Account Identification and Maintenance
Processes Need Improvement
April 2005
Reference Number: 2005-40-077
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.
April
28, 2005
MEMORANDUM FOR
COMMISSIONER, WAGE AND INVESTMENT DIVISION
FROM: Pamela J. Gardiner
/s/ Pamela J. Gardiner
Deputy
Inspector General for Audit
SUBJECT: Final
Audit Report - Taxpayers Identified As Serving in Combat Zones Were Properly
Afforded Tax Benefits, but Account Identification and Maintenance Processes
Need Improvement (Audit # 200440012)
This
report presents the results of our review of the Internal Revenue Service (IRS)
handling of Combat Zone tax accounts.
The overall objective of this review was to determine whether the IRS is
correctly handling the accounts and tax returns of taxpayers who have been
deployed in a Combat Zone. Since the
inception of the first modern income taxation in the United States in 1913, the
Congress has granted special Federal income tax benefits for members of the
Armed Forces in World War I, World War II, Korea, Vietnam, the Persian Gulf,
Bosnia, Kosovo, and now Afghanistan and Iraq.
These benefits include extensions of time to file tax returns or pay
taxes and the suspension of any audit or collection activities. The IRS also provides these benefits to civilian
taxpayers supporting military operations.
To get these special benefits, both military and
civilian taxpayers had to notify the IRS they were serving in a Combat
Zone. This could be done by writing
“Combat Zone” on the tax return when it was filed or contacting the IRS via
telephone, correspondence, or email using a special email address set up solely
for use by Combat Zone taxpayers. In
2003, the IRS coordinated with the Department of Defense (DOD) to receive
payroll information on military service members who had entered or exited a
Combat Zone. This information allows the IRS to update tax account
information on a more current basis and with less burden on the military
taxpayers. Civilians serving in a Combat
Zone still need to notify the IRS directly to get the special benefits.
In
summary, the IRS is providing tax benefits to taxpayers identified on the IRS
Master File as being in a Combat Zone.
When the IRS is notified a taxpayer is serving in a designated Combat
Zone, it places an indicator on the taxpayer’s account that extends the due
dates for filing returns and paying taxes, suppresses any notices, and suspends
audit and collection activities. This
Combat Zone active indicator remains on the
taxpayer’s account until the IRS receives information the taxpayer is no longer
in a Combat Zone, at which time the indicator changes from active to historical
and normal processing of the account resumes.
While
taxpayers who were identified on the IRS Master File as serving in a Combat
Zone received the benefits and special treatment they are entitled to, we
identified a processing issue that affects the accuracy of the Combat Zone
indicators and the overall effectiveness and efficiency of the Combat Zone
program.
Our
sample results indicate over 58 percent of the 520,000 taxpayers with an active
Combat Zone indicator are incorrect (i.e., the taxpayers are no longer serving
in a Combat Zone). An incorrect, active Combat
Zone status allows taxpayers to receive special tax treatment they are no
longer entitled to receive, such as filing late, not being audited, or having
collection action suspended.
The
inaccurate indicators were caused by weaknesses in the account identification
and maintenance processes. The IRS was
not identifying and correcting error records created when attempting to update
the Master File with DOD information. These
errors could occur for various reasons, such as missing information or mismatches
between names or Social Security Numbers. In addition,
the Combat
Zone indicators were not being reviewed annually to identify and correct
inaccurate indicators.
Another impact of these conditions is that taxpayers who
are serving in a Combat Zone may not have the indicators input on their Master
File accounts and would be at risk of not getting the Combat Zone benefits they
deserve. Unfortunately, the error
records were not kept by the IRS, so we could not determine the extent, if any,
of this condition.
We
discussed these issues with the IRS during the course of our audit, and it has
taken steps to correct the conditions we identified. The IRS is working to improve the process of
updating of the Master File with the DOD information and has indicated that the
problem with the missing Combat Zone exit dates has been corrected. In addition, the IRS is developing a computer
program to automatically analyze and correct inaccurate Combat Zone indicators
on an annual basis, which it plans to implement in May 2005. To further help ensure Combat Zone indicators
are correct, we recommended the Commissioner, Wage and Investment Division, continue
to work on perfecting the information on Combat Zone participation that is used
to update the Master File, such as identifying and correcting other types of
error records than those missing exit dates; develop a quality review program
to ensure the accounts being analyzed for inaccurate indicators by the new
computer program are processed correctly; and conduct the account review on an
annual basis.
Management’s
Response: IRS management is pleased with our finding
that the IRS is properly providing the appropriate tax benefits to taxpayers
serving in Combat Zones. The IRS agrees
with our recommendations and has initiated corrective action. Specifically, the IRS stated it corrected its programming for
downloading entry and exit dates from the DOD.
In addition, to correct other types of error records beyond missing exit
dates, management stated a verification program will be run, prior to the
download, during which various account information is verified prior to the posting
of the exit date.
Management stated a one-time cleanup computer program
will be implemented May 31, 2005, to identify any accounts with an entry date
that is greater than 3 years old and no exit date. This cleanup will help ensure Combat Zone
indicators are accurate. A sample review
will be conducted on the cases identified by the cleanup to ensure they
accurately reflect the exit date of 3 years from the entry date. Management’s complete response to the
draft report is included as Appendix V.
Copies of this
report are also being sent to the IRS managers affected by the report
recommendations. Please contact me at
(202) 622-6510 if you have questions or Michael R. Phillips, Assistant Inspector General for Audit (Wage and Investment
Income Programs), at (202) 927-0597.
Taxpayers Identified As Serving in
Combat Zones Receive Special Treatment
Inaccurate Combat Zone Indicators Are Not Being Corrected
Appendix
I – Detailed Objective, Scope, and Methodology
Appendix
II – Major Contributors to This Report
Appendix
III – Report Distribution List
Appendix
IV – Geographic Areas Considered Combat Zones
Appendix V –
Management’s Response to the Draft Report
Since the inception of the first modern income taxation in the United
States (U.S.) in 1913, the Congress has granted special Federal income tax
benefits for members of the Armed Forces in World War I, World War II, Korea,
Vietnam, the Persian Gulf, Bosnia, Kosovo, and now Afghanistan and Iraq. These benefits include additional time to file
tax returns or pay taxes and the suspension of any audit or collection
activities. The Internal Revenue Service
(IRS) also provides these benefits to civilian taxpayers supporting military
operations.
Figure 1:
Soldier in Combat Zone
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.
Personnel serving in a Qualified Hazardous Duty Area receive the same tax
treatment under the Internal Revenue Code as personnel serving in a Combat
Zone. The Congress has designated
certain countries as Qualified Hazardous Duty Areas and has specified that each
designated country will lose its status as a Qualified Hazardous Duty Area when
the Department of Defense (DOD) stops paying members either imminent danger or hostile
fire pay. Thus the DOD, by controlling
the payment of imminent danger or hostile fire pay to military members, can
also control when military members will no longer be entitled to the special
tax benefits.
Any income earned by members of the U.S. Armed Forces in a Combat Zone is
not taxable and is reflected as such on their Wage and Tax Statements (Form
W-2).
Figure 2: Example of Form W-2
Showing Nontaxable Combat Wages
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.
An individual
serving in an official capacity in a Combat Zone will have the payment and
collection of any Federal tax liability suspended during the period the
individual is in the Combat Zone, plus any continuous period of hospitalization
due to injury or illness received while in the Combat Zone, plus the next 180 days
thereafter. The deadlines for filing tax
returns, paying taxes, filing claims for refund, and taking other actions with
the IRS are automatically extended for the same period.
These tax benefits are also provided by the IRS to members of the
Merchant Marine, Red Cross personnel, and other civilian taxpayers who are
supporting military operations. Nonmilitary
individuals who worked in a Combat Zone must notify the IRS before they receive
the special Combat Zone benefits. This
notification or “self-identification” can be done by writing “Combat Zone” at
the top of the tax return when it is filed, contacting the IRS via telephone or
correspondence, or using a special email address the IRS has set up for Combat
Zone participants.
Figure
3: Example of Combat Zone Identification
on
Figure 3 was removed due to its size.
To see Figure 3, please go to the Adobe PDF version of the report on the
TIGTA Public Web Page.
In special
situations, members of the Armed Forces will work in areas outside a Combat
Zone but in support of Combat Zone actions.
These Armed Forces members are also eligible to receive extensions of
tax-related deadlines. The DOD codes the
qualifying income of these individuals as combat pay, so they are receiving all
the special tax-related benefits of Combat Zone activity instead of just
deadline extensions. This relieves the
IRS of having to determine what income qualifies for any special treatment.
Recently, the DOD
began sending information to the IRS for military service members who have
entered or exited a Combat Zone. The IRS
began processing this information in late Calendar Year (CY) 2003 and early CY 2004;
it should receive monthly updates of military Combat Zone activity, which will
then be incorporated into the IRS Master File data. This monthly information from the DOD will
allow the IRS to update its Master File records on a more current basis, which
should result in less taxpayer burden for members of the Armed Forces. This will also allow the IRS to have a more
automated process for granting deadline extensions and other special treatment
to Combat Zone participants.
This review was performed using national data and was coordinated with the Wage and Investment (W&I) Division Compliance and Submission Processing functions in Atlanta, Georgia, and the Fresno, California, Compliance Site during the period April through September 2004. 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.
The IRS is providing the tax benefits legislated by the Congress to taxpayers who have been identified on the IRS Master File as being in a Combat Zone. When the IRS receives the Combat Zone entry date from the DOD or the taxpayer, the IRS updates the Master File with an indicator on the taxpayer’s account so the special benefits legislated by the Congress can be granted automatically. The current IRS processes extend the deadlines for filing tax returns and paying taxes, suppress any notices, prevent audit activities, and suspend collection actions (accumulation of interest and penalties). These tax benefits are extended for 180 days after the IRS is notified a taxpayer has exited a Combat Zone.
The IRS receives monthly updates of DOD information. The information consists of the entry date into and exit date from a Combat Zone, the Combat Zone location code, and the taxpayer’s Social Security Number and name. Using this information, the IRS can compute tax return due dates and any applicable interest or penalty based on the additional time legislated because of Combat Zone activity.
The IRS also has other ways to assist taxpayers who serve in Combat Zones or Qualified Hazardous Duty Areas. Taxpayers who indicate their Combat Zone activity directly to the IRS will have their accounts coded in the same manner as the military taxpayers, allowing them to receive the appropriate tax benefits. The IRS has also created an email address so taxpayers in a Combat Zone can send notification of their Combat Zone deployment directly to the IRS.
While the IRS is providing the tax benefits legislated by the Congress to taxpayers identified on the Master File as being in a Combat Zone, we determined the Combat Zone indicators are not always accurate to identify taxpayers who have entered or exited a Combat Zone. We identified two areas in the account identification and maintenance processes that could be improved.
The
IRS was not identifying and correcting its Master File records to accurately
reflect that individuals are no longer in a Combat Zone. The
Combat Zone active indicator remains on a taxpayer’s
account until the IRS receives information the taxpayer is no longer in a
Combat Zone, at which time the indicator changes from active to historical and
normal processing of the account resumes.
As of February 2004, the IRS
Master File had over 520,000 taxpayer accounts with active Combat Zone
indicators.
We sampled 200 of these active accounts and determined over 58 percent appear to be inaccurate based on available information (i.e., the taxpayers are no longer serving in a Combat Zone). These taxpayers will continue to receive special tax benefits they are no longer entitled to until the Master File records are corrected.
Another possible condition is taxpayer accounts that should, but do not, reflect current service in a Combat Zone because the information did not get recorded on the IRS Master File. Taxpayers whose accounts do not reflect current service in a Combat Zone are at risk of having penalties and interest charged when they are eligible for extensions of time to pay and file their tax returns. These taxpayers may also be subject to compliance actions, such as audits or collection activities, that should be suspended. Unfortunately, the error records were not kept by the IRS, so we could not determine the extent, if any, of this condition.
We identified two specific causes for the inaccurate Combat Zone indicators on the Master File.
Errors created when updating DOD information to the Master File are not resolved
Recently, the DOD
began sending information to the IRS for military service members who have
entered or exited a Combat Zone. When
the IRS processed this information, some of the data did not update to the
Master File. These errors could occur
for various reasons, such as mismatches between names or Social Security
Numbers. Error records were created by
the computer programs for those individuals whose information was not updated,
but the IRS did not develop programs or procedures to correct these error
records when it requested the DOD information.
To obtain the
maximum benefit from the DOD information, the IRS needs to resolve the error
records so taxpayer accounts accurately reflect Combat Zone service.
Master File accounts with Combat Zone indicators have not been periodically reviewed and corrected
Through
2001, the IRS would
annually run a computer program that identified active Combat Zone accounts on
the Master File. This program would
generate a listing of taxpayers to whom the IRS would send letters to verify whether
the taxpayers were still actively serving in a Combat Zone. Based on responses to the letters and other
research, the IRS would either keep the active Combat Zone indicators on the
taxpayer accounts or change the status to inactive.
However, in December 2001, the IRS made a policy decision to
stop running the annual Combat Zone verification program. This decision was made to minimize the number
of sensitive situations in which verification letters might be received by
military personnel serving in
In 2003, the IRS began working with the DOD to obtain
Combat Zone entry and exit date information to further minimize the number of
taxpayer contacts required to validate Combat Zone status. However, because of these decisions, the Combat
Zone validation program was not run for CYs 2002 and 2003, and consequently,
active Combat Zone accounts were not reviewed or corrected.
During this time, the number of accounts in Combat Zone
status grew tremendously. In CY 2001,
there were a little over 46,000 accounts with active Combat Zone indicators on
the Master File. As of February 2004, there
were over 520,000 accounts with active Combat Zone indicators on the Master
File. While the largest percentage of
increase in active Combat Zone indicators was the increase in military
personnel sent to
Figure
4: Taxpayer Accounts With Active Combat
Zone Indicators
Figure 4 was removed due to its size.
To see Figure 4, please go to the Adobe PDF version of the report on the
TIGTA Public Web Page.
Our analysis of sample cases indicated the following
conditions exist for inaccurate active Combat Zone indicators.
·
Taxpayers have Combat
Zone entry dates as far back as 1990 but have no exit dates.
·
Married taxpayers do
not have all the correct exit information posting to their accounts when one or
both have served in a Combat Zone.
·
Military taxpayers
file tax returns indicating Combat Zone activity after the DOD exit date
information has already posted.
·
Civilian taxpayers who
self-identify have not been contacted by the IRS for the past 3 years for the
exit dates.
The cumulative effect of not correcting these accounts on an annual basis is two-fold. First, some taxpayers, military and civilian, are being given special tax benefits when they are no longer eligible because their IRS accounts still indicate they are in a Combat Zone. Second, the number of taxpayers listed as active Combat Zone participants who self-identify about their Combat Zone activity will continue to grow each year because the IRS is not contacting them for the dates they left the Combat Zones.
Recent Management Actions: During and after the completion of our audit work, the IRS took or is planning actions that should help alleviate the conditions presented above.
·
The
Director, Compliance, W&I Division, was recently made responsible for the
Combat Zone program. We believe having
an IRS executive responsible for the program should help the IRS improve its
processes and coordination efforts internally and with the DOD.
·
The IRS
indicated that, as of January 2005, it had corrected the missing exit date problem
with the DOD information we identified during the audit. While the IRS has taken corrective action for
missing exit dates, it is still not identifying and correcting other types of error
records.
·
The IRS stated it is in the process of
developing a computer program that will analyze and correct the inaccurate Combat
Zone account indicators. According to
the IRS, the computer program is scheduled to be implemented in May 2005.
To help ensure Combat Zone indicators are accurate, the Commissioner, W&I Division, should:
1. Continue working to further perfect the information on Combat Zone participation that is used to update the Master File, such as identifying and correcting other types of error records than those missing exit dates.
Management’s Response: The IRS stated it corrected its programming for downloading entry and exit dates from the DOD. In addition, to correct other types of error records beyond missing exit dates, management stated a verification program is run, prior to the download, during which various account information is verified prior to the posting of the exit date.
2. Develop a quality review program to review a sample of the accounts that are closed automatically using the new program to ensure the reversal of the active Combat Zone indicator is correct. In addition, the plan should include a sample review of the remaining active accounts to verify the program is not missing any accounts that should be reversed. The program and the quality reviews should be conducted annually.
Management’s Response: Management stated a one-time cleanup computer program will be implemented May 31, 2005, to identify
any accounts with an entry date that is greater than 3 years old and no exit
date. The system will automatically turn
off the Combat Zone indicators that were set by an entry date or
self-identified tax return. This cleanup,
in combination with use of DOD entry and exit dates, will help ensure Combat
Zone indicators are accurate. A sample
review will be conducted on the cases identified by the cleanup to ensure they accurately
reflect the exit date of 3 years from the entry date. Letters will be sent to civilians to ensure
they are not still serving in a Combat Zone.
Appendix I
Detailed
Objective, Scope, and Methodology
The overall objective of this audit was to determine whether the Internal
Revenue Service (IRS) is properly handling the accounts and tax returns of
taxpayers who have been deployed in a Combat Zone. To accomplish our objective, we:
I.
Determined
whether Combat Zone indicators and freeze codes were properly posted to the
taxpayers’ accounts.
A.
Determined
whether the Department of Defense (DOD) information sent to the IRS posted to
taxpayers’ accounts and set the Combat Zone indicator correctly.
B.
Determined
whether self-identified taxpayer information posted to the taxpayers’ accounts
set the indicator correctly.
C.
Confirmed
whether the appropriate Combat Zone freeze code (-C) was applied to the
taxpayers’ accounts.
II.
Reviewed
a sample of active (currently in a Combat Zone) accounts for appropriate IRS
activity.
A.
Reviewed
a statistically valid sample of 400 accounts (sample details below) with a
Combat Zone indicator of “1” (Open) to analyze the tax account information and
determine whether the IRS Submission Processing function is correctly
processing designated Combat Zone returns (granting additional time to file tax
return documents, not assessing interest or penalties during the additional
filing and payment grace period, etc.).
B.
Analyzed
tax account information to determine whether the IRS Collection and Examination
functions were correctly handling designated Combat Zone accounts (suspending
collection actions, extending Collection Statute Expiration Date [the latest
date the IRS is allowed to take collection action], closing or suspending
examination activity, etc.).
III.
Reviewed
a sample of historical (no longer in a Combat Zone) accounts for appropriate
IRS activity.
A. Reviewed a statistically valid sample of 400
accounts (sample details below) with a Combat Zone indicator of “2” (Closed) to
determine whether the IRS Submission Processing function correctly processed the
tax returns (enforced normal due dates to file tax returns, assessed interest
or penalties when appropriate, etc.).
B.
Analyzed tax account information to determine
whether the IRS Collection and Examination functions correctly handled the
accounts (resumed normal collection actions and examination activities).
The overall population of Combat Zone tax accounts was obtained from the IRS Master File information as of February 2004 where the ‘Combat Indicator’ field was not blank or a “0.” This produced a population of 522,720 accounts showing an active Combat Zone indicator (taxpayer is currently in a Combat Zone) and 1,071,272 accounts showing a historical Combat Zone indicator (taxpayer is no longer in a Combat Zone).
These population numbers were used to create 2 statistically valid samples of 400 cases each (400 for active and 400 for historical) to be used for our review. After we had reviewed about one-half of each sample, the IRS agreed with our findings and we stopped at 200 cases in each sample. This changed our confidence level from 95 percent ±5 percent at a 50 percent estimated error rate to 95 percent ±6.93 percent at a 50 percent estimated error rate.
In addition, a sample of the DOD
data was obtained from the IRS to assist with the review of the active Combat Zone
indicator cases. The sample we received
from the IRS was for any DOD data that occurred in Calendar Year (CY) 2003 so
we could compare CY 2003 IRS data to CY 2003 DOD data.
Appendix II
Major Contributors to This
Report
Michael R.
Phillips, Assistant Inspector General for Audit (Wage and Investment Income
Programs)
Scott A. Macfarlane,
Director
Richard J. Calderon,
Audit Manager
Glory Jampetero, Lead
Auditor
Kathleen Hughes, Senior Auditor
Andrea McDuffie, Auditor
Kevin
O’Gallagher, Information Technology
Specialist
Dorothy Richter, Information Technology
Specialist
Appendix III
Commissioner C
Office of the
Commissioner – Attn: Chief of Staff C
Deputy
Commissioner for Services and Enforcement
SE
Commissioner,
Small Business/Self-Employed Division
SE:S
Deputy
Commissioner, Small Business/Self-Employed Division SE:S
Deputy
Commissioner, Wage and Investment Division
SE:W
Director, Communications, Government
Liaison, and Disclosure, Small Business/Self-Employed Division SE:S:CGL&D
Director,
Compliance, Wage and Investment Division
SE:W:CP
Director, Strategy and Finance, Wage and Investment
Division SE:W:S
Acting Chief, Performance Improvement, Wage and Investment
Division SE:W:S:PI
Director, Reporting Compliance, Wage and Investment
Division SE:W:CP:RC
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:
Chief, Customer Liaison, Small
Business/Self-Employed Division SE:S:COM
Senior Operations Advisor, Wage and Investment Division SE:W:S:W
Appendix IV
Geographic Areas Considered
Combat Zones
Combat Zones
are designated by an Executive Order from the President as areas in which the United
States Armed Forces are engaging or have engaged in combat. There are currently three such Combat Zones:
Three
parts of the former
In
addition, the Department of Defense designated the following locations as Combat
Zones due to their direct support of Operations Enduring Freedom and Iraqi
Freedom:
Appendix V
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.