In the past few years, the Internal Revenue Service (IRS) has attempted to reduce the number of refunds paid to persons filing fraudulent tax returns. Historically, refund fraud has involved claims for dependents or tax credits that are based on either incorrect or missing taxpayer identification numbers. The IRS has implemented a Revenue Protection Strategy (RPS) which attempts to identify returns filed with missing and incorrect taxpayer identification numbers. The objective of our audit was to determine if IRS employees identified, resolved, and correctly processed tax returns filed in 1998 with either incorrect or missing taxpayer identification numbers.

For 1998, changes were to have been made to enhance the IRS’ ability to identify potential problems with incorrect or missing taxpayer identification numbers. Our limited audit of the IRS’ 1998 processing indicates that some computer programs, as well as employee performance, could more effectively identify and resolve incorrect and missing taxpayer identification numbers on tax returns.

In response to our prior audit, the IRS implemented a new computer program in 1998. The program was to identify taxpayers who filed a tax return in 1998, and in the prior year, with the same incorrect taxpayer identification number.

computer programs that match taxpayer identification numbers against two different IRS computer files produced different results and there are no computer error routines designed to identify this problem. In addition, the processing procedure should be revised to ensure returns with errors are routed to employees who have the capability to adjust the taxpayer’s account.

We determined that another computer program, to identify taxpayers using an incorrect filing status when the qualifying dependents were properly disallowed, was not implemented. We estimate the IRS lost approximately $310,000 in revenue because some incorrect filing statuses were not changed from Head of Household to Single.

We reviewed 293 tax returns with 1 or more incorrect or missing taxpayer identification numbers. Employees correctly resolved more that one half of these returns; however, they did not make all the necessary corrections on 107 returns. This resulted in taxpayers receiving either incorrect tax assessments or incorrect notices regarding changes to the tax return.

The IRS should consider the following:

• Require more user involvement when testing new programs. Study and change the system for validating taxpayer identification numbers and ensure it is reliable. Also, develop additional written procedures to ensure resolution of returns with errors.

• create and implement programming to identify tax returns with an incorrect filing status when qualifying dependents are properly disallowed.

• consider specialized or additional training for Error Resolution employees working RPS issues. Also, change some error resolution procedures to ensure employees use information from the taxpayers’ returns, as appropriate, when correcting taxpayer identification numbers.

Management’s Response: Operations and Information Systems management generally agreed with our recommendations. They revised procedures and submitted several requests for programming changes. However, several programming changes are not scheduled for completion before January 2000. This is attributed to the Information Systems staff working on Year 2000 issues and required tax law changes.

Office of Audit comment: We agree the number of taxpayers potentially affected by Year 2000 and tax law changes vastly exceeds those affected by the issues identified in this report. The complete response to this audit report is included in Appendix IV.