Executive Summary

Objective and Scope

Background

Results

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

Appendix V – Head of Household (HOH) Projections

Executive Summary

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.

Objective and Scope

The overall objective of our audit was to determine if Internal Revenue Service (IRS) employees identified, resolved, and correctly processed tax returns filed in 1998 with either incorrect or missing taxpayer identification numbers. We performed this audit from March through May 1998 in accordance with Government Auditing Standards. The complete management response was received in January 1999.

We conducted audit tests at the Kansas city Service center and selected tests at the Andover, Atlanta, and Fresno Service centers to determine if employees identified tax returns with missing taxpayer identification numbers. We also conducted tests to determine if employees correctly resolved and then processed returns originally filed with either incorrect or missing taxpayer identification numbers.

Appendix I contains the detailed objective, scope, and methodology for this review. Appendix II contains a listing of major contributors to this report.

Background

The IRS initiated the Revenue Protection Strategy (RPS) in 1995 to identify questionable returns and prevent taxpayers from filing fraudulent returns. The General Accounting Office identified filing fraud as a highly vulnerable risk area for the IRS and a Treasury task force report estimated the IRS paid about $5 billion in refunds based on fraudulent tax returns. These tax returns usually involve erroneous exemptions and tax credits based on either missing or incorrect taxpayer identification numbers.

The Small Business Job Protection Act of 1996
(Public Law 104-188) and the Personal Responsibility and Work Opportunity Reconciliation Act of 1996
(Public Law 104-193) give the IRS authority to process tax returns with either missing or incorrect taxpayer identification numbers as math errors. For example, a return will be processed as a math error if the taxpayer claimed a tax credit, but did not provide a taxpayer identification number for the individual that qualified the taxpayer for the credit.

We conducted a prior audit of the IRS’ math error processing during 1997. In that report, Math Error Processing for Revenue Protection Issues (Reference Number 083322) dated May 22, 1998, we recommended the IRS improve the use of revenue protection program resources and improve computer programming to identify and resolve these cases.

Results

We identified improvements that were needed in some computer programs to more effectively identify and resolve incorrect and missing taxpayer identification numbers. We also identified some areas where employee performance can be improved.

A New computer Program to Identify Specific Returns Did Not Work as Intended

In response to our prior audit, IRS implemented a new computer program in 1998. The program was intended to identify taxpayers who filed a tax return in 1998, and in the prior year, with the same incorrect taxpayer identification number. Once identified, these tax returns are forwarded to the Error Resolution Unit so employees could attempt to resolve the incorrect taxpayer identification number. If they could not resolve the issue, the employees would disallow the taxpayer’s personal exemption. If the taxpayer claimed an Earned Income Tax credit (EITc), (available to certain low income working taxpayers) the credit would also be disallowed. This program did not work as intended.

Shortly after the new program took effect, we identified three tax returns where the personal exemptions should have been, but were not, disallowed. Because the computer program did not identify the returns, they bypassed the Error Resolution Unit. The initial program did not work correctly due to inadequate communication and involvement by employees requesting and using the new computer program.

On April 1, 1998, we informed IRS Headquarters officials about the problem and they corrected the program by

April 23, 1998.

1. We recommend the IRS require more user involvement in the testing process for new computer programs to ensure the test criteria produce the desired results.

Management’s Response: Operations and Information Systems management will ensure joint participation in the development and documentation of computer programming changes. In addition, they will also ensure that computer programming requirements are reviewed and that walk-throughs of new requirements are made to reduce the probability of programming errors.

The System to Validate Taxpayer Identification Numbers Should Be Studied and certain Processing Instructions Revised

The IRS checks the accuracy of taxpayer name and address information on tax returns against two different computer files to ensure the validity of taxpayer identification numbers on returns. Indicator codes are then computer generated based on the information matched.

One indicator shows the taxpayer identification number, name, and address are on both the Master File and the Entity Index File. The other indicator shows there is no record of the taxpayer on the Entity Index File. Both of the indicators should not be present on the same return.

We identified 59 tax returns where both indicators were present. In eight cases, the taxpayers did not have tax accounts on the Master File, and they filed the tax returns with incorrect taxpayer identification numbers. These returns bypassed an error resolution system where the primary exemption and EITc would have been disallowed, if applicable. The eight tax returns were sent to the Unpostable Unit so employees could resolve problems created when transactions do not meet computer validity checks. The employees took the appropriate actions on seven of the eight tax returns.

computer error check routines to identify this combination of indicators as a potential problem have not been established. We estimate that approximately 2,950 tax returns (processed at 1 service center during 1 week) had both indicators, and 400 of these tax returns had incorrect taxpayer identification numbers.

Modifying Unpostable Procedures Would Strengthen the Revenue Protection Strategy

Tax return processing guidelines were revised as a result of our prior audit. The revised guidelines are adequate for tax returns claiming the EITc. However, if this tax credit is not involved, the tax return will be allowed to post to the invalid side of the Master File and the account will be coded to prevent refund issuance. The tax law requires the IRS to disallow a taxpayer’s personal tax exemption if an incorrect taxpayer identification number is used.

We identified 38 tax returns where taxpayers used an incorrect taxpayer identification number and did not claim the EITc. The personal exemption amounts on these returns should have been, but were not, disallowed.

Unpostable Unit employees changed 8 of the 38 returns to temporary numbers used by the IRS for processing purposes. While the employees’ actions allowed them to continue with processing, the employees did not resolve the personal exemption issue. The employees did not disallow the exemptions because they did not have the capability to adjust the account. As a result, the taxpayers did not receive the proper notice and they may be unaware of the need to correct their taxpayer identification numbers. A better course of action would be to route the returns to employees in another unit, who do have the capability to disallow the personal exemption.

Recommendations

2. We recommend a study of the taxpayer identification number validation system to ensure indicators are reliable. Specifically, ensure indicator codes properly identify all incorrect taxpayer identification numbers.

Management’s Response: Information Systems management will work with Submission Processing and customer Service management in the Office of the chief Operations Officer organization to analyze the need to conduct a study, analyze alternatives, and institute changes if necessary.

3. We also recommend the Unpostable Unit develop additional procedures to send all tax returns with either incorrect or IRS temporary identification numbers, but not claiming the EITc, to the Reject Unit.

Management’s Response: Unpostable procedures are being revised to send all tax returns with incorrect taxpayer identification numbers to the Reject Unit for processing. The new Internal Revenue Manual procedures are scheduled to be in the field by January 1999.

Internal Revenue Service Employees Need a Better Way To Recognize When a Taxpayer’s Filing Status Should Be changed

In 1997 and 1998, the IRS incorrectly allowed taxpayers to use the Head of Household filing status even though the dependents they claimed were correctly disallowed during routine tax return processing. Employees are to disallow the dependents shown on tax returns when the dependents’ taxpayer identification numbers are either incorrect or missing. The employees are also supposed to change the taxpayers’ filing status to Single.

We identified 1,106 tax returns in 2 IRS service centers where all dependents were disallowed because of either incorrect or missing taxpayer identification numbers. However, the taxpayers’ filing status was not changed from Head of Household to Single. We reviewed a sample of 40 of these tax returns and determined the dependents were correctly disallowed on 34 tax returns, but the filing status was not changed. We also determined that in five instances dependents claimed were inappropriately disallowed. In the remaining instance, a qualifying dependent was listed elsewhere on the return.

Based on our sample results, we estimate the IRS lost approximately $310,000 in revenue by not properly changing the filing status on 946 tax returns filed during 3 weeks of processing. Using the same sample, we estimate that the IRS inappropriately disallowed dependents on 142 tax returns at the 2 service centers (see Appendix V).

Additionally, we reviewed the notices sent to the
40 taxpayers explaining why their tax return information was changed. We found that 28 taxpayers received incorrect notices.

We identified this same issue in our prior audit. In response to that audit report, the IRS agreed to develop a new computer program that would identify these returns. However, IRS programmers will not be able to complete the necessary programming until January 2000.

Recommendation

4. To protect revenue and ensure the correct tax is assessed, a new computer control should be implemented as soon as possible to identify for the Error Resolution Unit those tax returns claiming Head of Household filing status and no dependents.

Management’s Response: A new computer control has been re-requested to ensure Error Resolution employees take a second look at tax returns claiming Head of Household filing status where all dependents claimed were disallowed, but the filing status was not changed. This change was previously requested for implementation in January 1999, but was not acted upon due to Information Systems resource issues. A new implementation date is planned for January 2000. Until that time, additional emphasis will be given to this issue during employee training.

Improved Training on Resolving Returns With Taxpayer Identification Number Problems May Be Helpful

We reviewed 293 tax returns with 1 or more incorrect or missing taxpayer identification numbers. The Error Resolution employees correctly resolved more than one half of these returns; however, they did not make all the necessary corrections on 107 returns.

The incorrect resolution of taxpayer identification numbers caused several problems for the IRS. First, 52 of 107 taxpayers (49 percent) received incorrect tax assessments. Thirty-two of these taxpayers were under assessed $42,622 and 20 were over assessed $15,617.

Secondly, 77 taxpayers received incorrect notices regarding changes made to their tax returns. In these cases, taxpayers either did not receive notices alerting them to problems on their returns or they received information explaining actions that the IRS should not have taken. The issuance of incorrect notice information was generally caused by Error Resolution employees incorrectly resolving the account.

We could not link these problems to any single cause. We did find, however, that employees did not always follow procedures to revalidate corrected taxpayer identification numbers. The failure to revalidate the numbers might be directly related to a systemic deficiency in the core training program. Error Resolution employees are required to "clear" certain error conditions when confronted with them in training modules. It is possible the errors are occurring simply because employees have learned the habit of clearing the error conditions.

We also determined that employees have another source of taxpayer identification number information available to help them resolve these problems. Form 2441, child and Dependent care Expenses, contains taxpayer identification numbers for children claimed. By changing work procedures to allow Error Resolution employees to validate and use this information, IRS might more easily resolve some of the existing taxpayer identification number problems and might not need to conduct additional research to find a correct taxpayer identification number.

Recommendations

5. To assist in reducing procedural errors, the IRS should develop specialized training and create a training module that allows Error Resolution employees to correctly resolve incorrect taxpayer identification number problems.

Management’s Response: Increased emphasis on taxpayer identification number issues will be incorporated into Error Resolution employee training in 1999. A training module will not be considered until January 2000 because Information Systems resources are reserved for legislative changes.

6. We also recommend Error Resolution employees be instructed to use and validate taxpayer identification number information on Form 2441, child and Dependent care Expenses. This could be done by changing work procedures.

Management’s Response: The Error Resolution Unit work procedures have been revised to instruct Error Resolution employees to check Form 2441 and Form 8814, Parent’s Election to Report child’s Interest and Dividends, to perfect name and taxpayer identification number information. The new procedures are scheduled to be in the field by January 1999. computer programming changes for the validation of taxpayer identification number data entered by Error Resolution employees are being submitted for January 2000 implementation.

conclusion

Our audit indicates that a computer program and system to identify certain returns for correction, as well as some procedures, did not work as planned. Specifically, a computer program to identify instances where taxpayers filed returns using an incorrect taxpayer identification number in multiple years did not work. Also, a system to validate taxpayer identification numbers did not work and some returns bypassed some review processes. We also determined that procedures should be changed to ensure that employees with the proper authority and capability receive and resolve certain returns with errors.

Further, we determined that in some cases the filing status of some taxpayers was not properly changed, resulting in an estimated revenue loss of approximately $310,000. In other cases, taxpayers were under assessed $42,622 and others over assessed $15,617. Many did not receive notices alerting them to the problem.

We believe the IRS can better fulfill its Revenue Protection Strategy by implementing our recommendations.

Detailed Objective, Scope, and Methodology

The overall objective of our audit was to determine if Internal Revenue Service (IRS) employees identified, resolved, and correctly processed tax returns filed in 1998 with either incorrect or missing taxpayer identification numbers.

Objective 1: To determine if code and Edit Unit employees properly identified tax returns that did not have taxpayer identification numbers for taxpayers, their spouses, and/or their dependents, we:

1. Identified 50 tax returns (from a 2 percent sample of tax returns processed at the Kansas city Service center) on which the taxpayer claimed the Earned Income Tax credit (EITc) or child and Dependent care credit. Two tax returns met our criteria (missing taxpayer identification numbers) and we reviewed them to determine if employees identified all missing taxpayer identification numbers.
2. Identified 81 tax returns which were coded as missing primary, secondary, dependent, or EITc qualifying child taxpayer identification numbers. We reviewed 44 tax returns to determine if employees identified all missing taxpayer identification numbers.
3. Reviewed 46 tax returns with selected notices to determine if taxpayers received notices that properly described all taxpayer identification number problems on their tax returns.
4. Reviewed 29 tax returns at the Kansas city Service center on which a child and Dependent care credit was claimed and no dependents were shown living at home. We also reviewed revised Internal Revenue Manual guidelines and training manual changes to determine if they were adequate.
5. Reviewed 25 tax returns with a Form 2441, child and Dependent care Expenses, that were identified at the Kansas city Service center. We also followed up on the status of programming changes that require transcribing and validating provider names and taxpayer identification numbers, and that create a code identifying incorrect taxpayer identification numbers.

Objective 2: To determine if Error Resolution employees properly resolved those conditions where taxpayers either failed to provide taxpayer identification numbers or where taxpayers provided incorrect numbers for themselves, their spouses, and/or dependents, we:

1. Reviewed 50 tax returns (from a 2 percent sample of tax returns processed at the Kansas city Service center) to determine if Error Resolution employees properly disallowed exemptions and credits for child and Dependent care and/or Earned Income.
2. Reviewed 64 tax returns identified as missing primary, secondary, dependent, or EITc qualifying children taxpayer identification numbers to determine if employees properly disallowed the respective exemption(s) and/or EITc.
3. Reviewed 41 tax returns identified as having incorrect primary, secondary, dependent or EITc qualifying children taxpayer identification numbers to determine if Error Resolution employees properly disallowed primary and dependent exemptions and credits for child and Dependent care and/or Earned Income.

1. Queried 173,026 return records from a 2 percent sample of tax returns processed during 2 weeks at the Andover, 1 week at the Fresno, and 12 weeks at the
   Kansas city Service centers.
2. Queried 11,864 return records from a 2 percent sample of tax returns processed during 1 week at the Kansas city Service center. Reviewed 59 accounts to determine if the codes reflected tax account information.
3. Identified and reviewed three tax returns filed with incorrect taxpayer identification numbers that appeared to have incorrect indicator codes.

1. Reviewed 106 tax returns to determine if the taxpayer received a notice that described all taxpayer identification number problems on the return.
2. Reviewed 25 tax returns to determine if the correct computer field was properly used to disallow dependent exemptions and if taxpayers received correct notices. We also evaluated the adequacy of processing instructions and the status of programming changes, which were submitted to update this process.
3. Reviewed 40 tax returns identified at the Atlanta and Kansas city Service centers as having either incorrect or missing dependent taxpayer identification numbers. We reviewed the tax returns to determine if the correct computer field was used to disallow dependents and the filing status was changed from Head of Household to Single, and to determine if taxpayers received correct notices. We reviewed 5 of the 40 tax returns for other taxpayer identification number issues to determine if they were resolved correctly. We also followed up on the status of the request for programming changes to create a new computer code for this condition.
4. Reviewed four tax returns where the primary taxpayer identification number was a temporary number, an unissued social security number, or a number associated with either resident or non-resident alien taxpayers to determine if the EITc was properly disallowed and if taxpayers received correct notices. We also reviewed processing instructions to determine if they were adequate.
5. Reviewed 92 tax returns identified at the Atlanta, Andover, and Kansas city Service centers to determine if employees were selecting the correct notice for taxpayer identification number problems. We also determined if training material was adequate.

Objective 3: To determine if the service center programs ensured that valid taxpayer identification numbers for dependents and EITc qualifying children were present, we:

1. Reviewed 10 tax returns identified at the Kansas city Service center as missing taxpayer identification numbers for the EITc qualifying children.
2. Reviewed 41 tax returns identified as having no information in certain required fields to determine if taxpayer identification numbers were validated before amounts for exemptions and credits for child and Dependent care and/or Earned Income were allowed. We also determined if taxpayers received correct notices.
3. Reviewed three tax returns identified at the Andover and Kansas city Service centers as having blanks in two fields to determine if EITc children’s taxpayer identification numbers were validated when employees subsequently received a missing EITc schedule and if taxpayers received correct notices. We also followed up on the status of the request for programming changes to the revalidation process.

Major contributors to This Report

Gary E. Lewis, Acting Regional Inspector General for Audit

Stanley c. Rinehart, Deputy Regional Inspector General for Audit

Kevin P. Riley, Audit Manager

George Morrow, Jr., Senior Auditor

Nelva U. Blassingame, Senior Auditor

Ellen M. Devlin, Senior Auditor

charles R. Winn, Senior Auditor

Todd M. Anderson, Auditor

Lynn A. Rudolph, Auditor

Donald J. Martineau, Auditor

cindy J. Harris, Auditor

Grace M. Terranova, Auditor

David P. Robben, Auditor

Report Distribution List

Deputy commissioner for Operations c:DO

chief Operations Officer OP

chief Information Officer IS

Assistant commissioner (Forms and Submission Processing) OP:FS

Assistant commissioner (Program Evaluation and Risk Analysis) M:OP

National Director, Submission Processing OP:FS:S

Director corporate Processing Division IS:S:cP

Executive Officer for Service center Operations OP:Sc

Office of Management controls M:cFO:A:M

National Director for Legislative Affairs cL:LA

Regional commissioners

Service center Directors

Management's Response to the Draft Report

Head of Household (HOH) Projections