September 27, 1999

Executive Summary

Objective and Scope

Background

Results

Conclusion

Appendix I – Detailed Objective, Scope, and Methodology

Appendix II – Major Contributors to This Report

Appendix III – Report Distribution List

Appendix IV – Memorandum: Management Should Review and Take Appropriate Action on BMF Tax Modules with Frozen Million Dollar Refunds

Appendix V – Management’s Response to Memorandum

Executive Summary

We performed a limited review to determine whether the Internal Revenue Service (IRS) was properly releasing the automatic hold placed on business taxpayer accounts when a credit balance reaches an amount that would cause a refund of $1 million or more. This automatic hold is called a "Million Dollar Refund Freeze" and the affected refunds are known as "frozen refunds." This hold also results in a "Million Dollar Refund Freeze" indicator being placed on the taxpayer’s account in the IRS computer systems to alert IRS employees that this situation exists. The employee should review the account to ensure all obligations have been satisfied and prepare a refund for the remaining credit.

We conducted the review at the Memphis Service Center, one of the ten IRS sites which processes tax information. We evaluated accounts in all ten IRS processing sites to determine the additional interest the IRS paid on these accounts because the refunds were not issued timely. As of April 4, 1998, 411 business taxpayer accounts had a "Million Dollar Refund Freeze" indicator. Credits on these accounts totaled approximately $2.4 billion.

Our limited analysis showed that the IRS could provide better customer service and reduce interest expense by ensuring that frozen million dollar refunds are properly and timely released (the freeze removed and the taxpayer refunded his/her credit). We determined that the IRS incurred additional interest expense of approximately $17.5 million on 44 business taxpayer accounts that had a "Million Dollar Refund Freeze" present and manual refunds of $50,000 or more.

We reported these conditions in a memorandum to the Executive Officer for Service Center Operations (EOSCO). This executive is responsible for the effective operations of all ten IRS service centers. We also provided the EOSCO with a listing of 411 business taxpayer accounts with a "Million Dollar Refund Freeze" present on their account as of April 4, 1998.

His office began immediate corrective action to resolve these freezes, and developed new processes to identify and expedite the resolution of frozen refunds. As a result, service center management has resolved, or is in the process of resolving, the remaining accounts that were identified. These accounts may also result in additional interest expense, above the $17.5 million which we identified, to the IRS.

The following issues contributed to this problem and warrant service center management’s attention.

• Criteria used to release a "Million Dollar Refund Freeze" can prevent refunds of less than $1 million. For example, if the credit balance of an account with the freeze falls below $1 million, the freeze will remain in place until a manual refund is input.
• Follow-up transcripts are not generated when a "Million Dollar Refund Freeze" remains unresolved. For example, a transcript generates when the freeze is initially placed on the account. If the account is being audited, the credit is held pending the results of the audit. If the employee conducting the audit fails to input a manual refund to release the freeze once the audit is completed, the refund would remain frozen. No follow-up transcript will generate to alert the IRS employee of this condition.
• Although the "Million Dollar Refund Freeze" indicator is placed in the taxpayer’s account, it is not identified on a critical IRS computer display screen. As a result, IRS employees researching a tax account may not be aware that this freeze is preventing the credit balance from refunding. Therefore, instead of preparing a manual refund, they may leave the account as they found it, assuming that a refund will be sent automatically.
• Procedures for the Taxpayer Relations Branch Technical Unit, who is responsible for resolving "Million Dollar Refund Freezes," do not address how they should resolve these cases.

To ensure that the IRS does not incur additional interest expense, we recommend that service center management take the following actions:

• Modify the "Million Dollar Refund Freeze" indicator program in the IRS’ computer system to provide the option to release business taxpayer account credit balances plus computed interest that total less than $1 million (i.e., when the refund due drops below $1 million at any point in time).
• Periodically generate follow-up transcripts for business taxpayer accounts with a "Million Dollar Refund Freeze" present to ensure that unresolved accounts are reviewed and the freeze released.
• Ensure that the "Million Dollar Refund Freeze" is shown on critical IRS computer display screens so that IRS employees will be aware that this freeze is preventing the credit balance from refunding and take appropriate action.
• Enhance current IRS procedures to identify and expedite the resolution of a "Million Dollar Refund Freeze."

The above recommendations are listed on page 7 of the report.

Management’s Response: IRS management provided an adequate, detailed response to our memorandum, and agreed that current controls over "Million Dollar Refund Freezes" on business taxpayer accounts do not ensure that refunds are properly and timely released. IRS management also agreed with our recommendations, as well as additional recommendations provided by the service centers. Follow-up transcripts will be generated monthly. The "Million Dollar Refund Freeze" will be shown on a critical IRS computer display screen and IRS procedures will be enhanced. Management’s complete response to the memorandum is included in Appendix V of this report.

IRS did not provide a response to our draft report dated December 19, 1998.

Objective and Scope

This report presents the results of our limited review of business taxpayer accounts which had a hold placed on the account due to a credit balance that would result in a refund of $1 million or more. We conducted initial work for this review in the Memphis Service Center, one of the ten Internal Revenue Service (IRS) sites which processes tax information related to taxpayers’ accounts (such as returns, payments, amount due notices, etc.). For our analysis of additional interest incurred by the IRS on the accounts with these holds, we included business taxpayer accounts in all ten service centers.

This was a limited scope review, and we did not perform a typical "program audit" as prescribed in the General Accounting Office’s Government Auditing Standards. A typical "program audit" is conducted to determine the effectiveness of the IRS’ programs or activities, and the extent to which desired results are being achieved.

Our objective on this audit was limited to determining whether the IRS was timely and properly releasing the refund holds placed on business taxpayer accounts due to a credit balance which would result in a refund of $1 million or more. To accomplish our objective, we reviewed IRS’ procedures for resolving "Million Dollar Refund Freezes." To determine the impact of additional interest paid due to problems with resolving these accounts, we analyzed the IRS’ actions on business taxpayer accounts which had a "Million Dollar Refund Freeze."

Details of our audit objective, scope, and methodology are presented in Appendix I. Major contributors to this report are listed in Appendix II.

Background

When a business taxpayer account reaches a credit balance which, combined with interest, would result in a refund of $1 million or more, the IRS’ computer system places an automatic hold on the account. This automatic hold is called a "Million Dollar Refund Freeze" and the affected refunds are known as "frozen refunds" or "frozen credits." This hold also results in a "Million Dollar Refund Freeze" indicator being placed on the taxpayer’s account in the IRS computer system to alert IRS employees that this situation exists.

The computer system causes the automatic printing of details of the taxpayer’s account (called a transcript), which is sent to an IRS employee in the service center (a tax examiner in the Taxpayer Relations Branch Technical Unit). The tax examiner is responsible for reviewing the account and taking the actions needed to resolve the freeze. They should offset any debit balances the taxpayer owes for other tax periods (years or quarters for which tax returns are due), abate (delete) any interest not due to the taxpayer, and prepare a refund for the remaining credit. The refund they prepare is called a manual refund, as opposed to one which is automatically sent by the IRS computer system.

The manual refund releases the "Million Dollar Refund Freeze" as long as it causes the remaining credit balance on the account to be below $1 million. In addition, if no manual refund is prepared, the account balance dropping to zero or a debit balance will also remove the freeze. The freeze will remain in place until one of these two things occurs.

Results

The IRS could provide better customer service and reduce interest expense by ensuring that frozen million dollar refunds are properly and timely released (the freeze removed and the taxpayer refunded his/her credit). The IRS incurred additional interest expense of approximately $17.5 million on 44 business taxpayer accounts that had a "Million Dollar Refund Freeze" present and manual refunds of $50,000 or more.

The following issues contributed to this problem, and warrant service center management’s attention:

• Criteria Used to Release a "Million Dollar Refund Freeze" Can Prevent Refunds of Less Than $1 Million
• Follow-up Transcripts Are Not Generated When a "Million Dollar Refund Freeze" Remains Unresolved
• The "Million Dollar Refund Freeze" Is Not Identified on a Critical IRS Computer Display Screen
• Procedures for the Taxpayer Relations Branch Technical Unit Do Not Address Resolving "Million Dollar Refund Freeze" Transcripts

We reported these conditions in a memorandum to the Executive Officer for Service Center Operations (EOSCO). This executive is responsible for the effective operations of all ten IRS service centers. We also provided the EOSCO with a listing of 411 business taxpayer accounts with a "Million Dollar Refund Freeze" indicator, as of April 4, 1998.

His office began immediate corrective action to resolve these freezes, and developed new processes to identify and expedite the resolution of frozen refunds. As a result, service center management has resolved, or is in the process of resolving, the remaining accounts that were identified. These accounts may also result in additional interest expense to the IRS.

Criteria Used to Release a "Million Dollar Refund Freeze" Can Prevent Refunds of Less Than $1 Million

A "Million Dollar Refund Freeze" indicator is placed on a business taxpayer account when the credit balance plus computed interest is $1 million or more. To release the freeze, an IRS employee must input a manual refund, and the remaining credit balance on the account after the refund must be less than $1 million. The freeze is also released when the account becomes a zero or debit balance, even if no manual refund was prepared.

However, there is a flaw in the criteria used to remove a "Million Dollar Refund Freeze." If the account’s balance with interest falls below $1 million but remains a credit, and no manual refund is input, the freeze will remain in place and prevent the refund from going to the taxpayer. For example, if the account dropped to a credit balance of $50,000, that amount would still not refund due to the "Million Dollar Refund Freeze."

Follow-up Transcripts Are Not Generated When a "Million Dollar Refund Freeze" Remains Unresolved

Transcripts are automatically generated for accounts when a "Million Dollar Refund Freeze" is initially placed on an account. The transcripts are sent to employees in the Taxpayer Relations Branch Technical Unit of the service center to ensure that the accounts are reviewed and the freeze is released. The employee should offset any debit balance the taxpayer owes for another tax period, abate any interest not due to the taxpayer, and prepare a manual refund for the remaining credit.

There are occasions when the Technical Unit employee should not refund a credit balance. For example, when the IRS is auditing the account, a manual refund should not be prepared so that the credit is held pending the results of the audit. This prevents the IRS from refunding a large amount of money, and then having to issue a bill if the taxpayer is assessed additional tax as a result of the audit in process.

Since transcripts for the "Million Dollar Refund Freezes" are only generated when the freezes are initially placed on the accounts, unresolved accounts can remain in credit balance for an extended period of time. If the employee conducting the audit, in the example above, failed to prepare a manual refund and release the freeze when the audit was completed, the account would remain with a frozen refund. No follow-up transcript would generate to alert IRS employees to this situation.

During our limited review of business taxpayer accounts with frozen million dollar refunds, we identified an account that had been placed in a refund freeze and had a transcript generated in June 1997. This account was being audited at the time and the Technical Unit did not release the refund. The employee performing the audit did not properly release the freeze when the audit was closed and approximately $37,000 in additional interest accumulated on the account during the next six months. This problem is attributed to the situation detailed in the next section regarding information available during research of tax accounts.

The "Million Dollar Refund Freeze" Is Not Identified on a Critical IRS Computer Display Screen

One critical IRS computer display screen, which is used to research a taxpayer’s account, is designed to have more detailed tax account information than any other single display option. By accessing this display screen, IRS employees can identify which, of many, freeze conditions (holds placed on a taxpayer’s account for various reasons; defined by specific freeze codes) are affecting a particular taxpayer’s account.

However, the "Million Dollar Refund Freeze" for business taxpayers is not identified with a freeze code and the indicator is not shown on this computer display screen used for research. As a result, IRS employees researching a tax account, using this display screen, would not be aware that a "Million Dollar Refund Freeze" is preventing the credit balance from refunding. Therefore, instead of preparing a manual refund, they may leave the account as they found it, assuming that the credit balance would cause a refund to be sent automatically.

Procedures for the Taxpayer Relations Branch Technical Unit Do Not Address Resolving "Million Dollar Refund Freeze" Transcripts

Normally, the Taxpayer Relations Branch is responsible for working "Million Dollar Refund Freeze" cases. A transcript is generated when this freeze is placed on a business taxpayer account, and the transcript is routed to the Taxpayer Relations Branch. Tax examiners in the Technical Unit of the Taxpayer Relations Branch are responsible for performing the necessary research to resolve refund freezes. However, there are no Technical Unit procedures to ensure that "Million Dollar Refund Freeze" transcripts are actually worked.

Generally, the Internal Revenue Manual (IRM) is the document which provides guidance on how a particular office or department in the IRS is to perform its duties. While there is an IRM that details procedures for the Technical Unit of the Taxpayer Relations Branch, this IRM does not specifically address the working of transcripts for "Million Dollar Refund Freeze" accounts.

To ensure that the IRS does not incur additional interest expense in the future, we recommend that service center management take the following actions:

1. Modify the "Million Dollar Refund Freeze" indicator program in the IRS’ computer system to provide the option to release business taxpayer account credit balances plus computed interest that total less than $1 million (i.e., when the refund due drops below $1 million at any point in time).
2. Periodically generate follow-up transcripts for business taxpayer accounts with a "Million Dollar Refund Freeze" present.
3. Ensure that the "Million Dollar Refund Freeze" is shown on critical IRS computer display screens.
4. Enhance current IRM procedures to identify and expedite the resolution of a "Million Dollar Refund Freeze."

Management’s Response: IRS management provided an adequate, detailed response to our memorandum, and agreed that current controls over "Million Dollar Refund Freezes" on business taxpayer accounts do not ensure that refunds are properly and timely released. IRS management also agreed with our recommendations, as well as additional recommendations made by the service centers. Follow-up transcripts will be generated monthly. The "Million Dollar Refund Freeze" will be shown on a critical IRS computer display screen and IRS procedures will be enhanced. Management’s complete response to the memorandum is included in Appendix V of this report.

However, IRS did not provide a response to our draft report dated December 19, 1998.

Conclusion

It is important that the IRS properly handle business taxpayer accounts where refunds are due of $1 million or more. This is important both from a customer service aspect, as well as to protect the funds of the government by avoiding payments of excess or unnecessary interest.

We found that the IRS could provide better customer service and reduce interest expense by ensuring that frozen million dollar refunds are properly and timely released. The IRS incurred additional interest expense of approximately $17.5 million on 44 business taxpayer accounts that had a "Million Dollar Refund Freeze" present and a manual refund of $50,000 or more.

Detailed Objective, Scope, and Methodology

Our overall objective was to determine whether the Internal Revenue Service (IRS) was timely and properly releasing the refund holds placed on business taxpayer accounts (Business Master File (BMF) tax modules) due to a credit balance which would result in a refund of $1 million or more. These holds are called a "Million Dollar Refund Freeze," and the refunds are called "frozen refunds" or "frozen credits." This was a limited scope review, and we did not perform a typical "program audit" as prescribed in the General Accounting Office’s Government Auditing Standards. The typical "program audit" is designed to determine the effectiveness of the IRS’ programs and activities, and the extent to which desired results or benefits are being achieved.

To accomplish our objective, we conducted the following tests:

1. Analyzed the BMF Report of Frozen Credits for September 27, 1997, and April 4, 1998, to identify cases with the "Million Dollar Refund Freeze" present.
2. Reviewed system processing procedures for the "Million Dollar Refund Freeze" and for generating related transcripts (records of the taxpayers’ accounts). This included the review of how the IRS’ employees and computer systems identify and handle accounts which should, or do, contain "Million Dollar Refund Freezes."
3. Reviewed Internal Revenue Manual procedures for IRS employees responsible for resolving "Million Dollar Refund Freezes."
4. Computed the additional interest the IRS incurred due to the untimely release of frozen million dollar refunds. We selected all accounts from the BMF Report of Frozen Credits identified in Objective A above which had manual refunds of $50,000 or more. We then computed the interest on those accounts.

Major Contributors to This Report

Walter E. Arrison, Associate Inspector General for Audit (Wage and Investment Income Programs)

M. Susan Boehmer, Director

Harry B. Odom, Director

Terry W. Black, Audit Manager

Philip D. Adams, Senior Auditor

Van Warmke, Senior Auditor

Nelva Blassingame, Auditor

Steve Gibson, Auditor

Mary West, Auditor

Tina Wong, Auditor

Report Distribution List

Deputy Commissioner Operations C:DO

Chief Operations Officer C:OP

Assistant Commissioners (Forms and Submission Processing) OP:FS

National Director, Submission Processing OP:FS:S

Executive Officer for Service Center Operations OP:SC

Director, Memphis Service Center D

National Director for Legislative Affairs CL:LA

Office of Management Controls M:CFO:A:M

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

Audit Liaison:

Assistant Commissioner (Customer Service) OP:C

Memorandum: Management Should Review and Take Appropriate Action on BMF Tax Modules with Frozen Million Dollar Refunds

INTERNAL REVENUE SERVICE

REGIONAL INSPECTOR

Million dollar refund transcripts are generated for review in the service center to ensure that tax modules with the freeze indicator are examined. Tax examiners are to offset any debit balance modules, abate any interest not due to the taxpayer, and prepare a manual refund for the excess credit. There are certain situations, however, where the credit balance should not be refunded (i.e., the account has an audit indicator).

The Command Code (CC) TXMOD, which accesses accounts on the Taxpayer Information File (TIF), is designed to have the most detailed tax module information than any other single command code. By inputting the CC TXMOD, the IDRS operator can identify Master File freeze conditions (defined via alpha codes) which can affect certain module account activity depending on the particular freeze condition.

Management’s Response to Memorandum