Copies of this report are also being sent to the IRS managers who are affected by the report recommendations. Please contact me at (202) 622-6510 if you have questions, or your staff may call Walter Arrison, Associate Inspector General for Audit (Wage and Investment Income Programs), at (770) 455-2475.

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 – Management's Response to the Draft Report

Executive Summary

This follow-up review relates to the important area of revenue protection and addresses the Internal Revenue Service’s (IRS) efforts to detect and deter electronic return preparer fraud. The Criminal Investigation (CI) function implemented the Return Preparer Program (RPP) in 1996 to protect revenue by identifying, investigating, and prosecuting abusive return preparers (including both electronic and paper returns).

Our overall objective was to assess whether the IRS effectively implemented corrective actions contained in a 1994 IRS Inspection Service (now Treasury Inspector General for Tax Administration) Audit Report on Electronic Return Preparer Fraud (Reference Number 045601). As a result of the prior review, the CI function established a multi-functional national RPP to address preparer fraud. The Office of Electronic Tax Administration (ETA) established procedures to remove dishonest electronic return preparers and to perform visitations on suspicious preparers to ensure compliance with electronic filing (e-file) procedures. ETA also strengthened admittance standards to reduce the number of abusive preparers in the e-file program. Additionally, the IRS established procedures to ensure that unscrupulous preparers are referred to the Examination function for penalty assessment or prohibition from participation in the e-file program.

However, CI can improve the effectiveness of the RPP by increasing emphasis and oversight. Additionally, ETA can improve controls over the removal of dishonest e-file preparers by separating duties performed by district ETA coordinators.

IRS management generally implemented corrective actions addressing the recommendations made in the prior review noted above. However, the effectiveness of electronic return preparer activities can be improved. Specifically:

Additional resources are needed to better address return preparer schemes. Service Center Criminal Investigation Branches (CIB) did not always have full-time resources devoted to identifying return preparer schemes, and CI field personnel did not always consider the RPP as a priority or mandated program. Additionally, there was no document that established overall authority and functional responsibility for this program. Although CI was responsible for leading the multi-functional RPP, no national analyst was dedicated to coordinate RPP activities for most of calendar year 1998.

The ETA function established procedures for removing dishonest return preparers from the e-file program. However, this process can be improved by separating the duties that the district ETA coordinators perform. These officials are responsible for promoting e-file and removing noncompliant electronic preparers. These are key duties that involve conflicting goals.

To address the issues identified in this report, we recommended that the IRS provide adequate resources for RPP activities, develop procedures establishing CI as the lead office for the RPP, and that CI assign a full-time analyst to coordinate the RPP. In addition, we recommended that the IRS assign responsibility for the removal of noncompliant return preparers to someone other than the district ETA coordinator.

Management’s Response: IRS management agreed with our recommendations and, beginning in Fiscal Year (FY) 2000, will provide increased resources to RPP activities. Additionally, a Servicewide Return Preparer Strategy is planned for implementation in FY 2000 focusing on return preparers who prepare Earned Income Tax Credit returns. As part of this strategy, a memorandum of understanding is being developed to clearly define CI as being responsible for the fraud aspect of the strategy. Future efforts will address additional areas of abuse as identified.

ETA will coordinate with Examination to assume responsibility for monitoring and removal of noncompliant electronic return originators. As a result, the duties of the ETA coordinators will no longer include compliance-type activities.

Management’s complete response to the draft report is included as Appendix IV.

Objective and Scope

We performed this follow-up review to provide Internal Revenue Service (IRS) management with an assessment of the effectiveness of corrective actions implemented in response to a September 21, 1994, IRS Inspection Service (now Treasury Inspector General for Tax Administration) Audit Report on Electronic Return Preparer Fraud (Reference Number 045601).

Our overall objective was to assess whether the IRS implemented corrective actions specified in the 1994 report noted above. To accomplish this objective, we:

• Determined whether Criminal Investigation (CI) established an effective Return Preparer Program (RPP) with specialized objectives, procedures, and resources to deal with electronic return preparer fraud.
• Determined if the IRS established and implemented procedures for removing dishonest return preparers from the electronic filing (e-file) program.
• Determined if procedures were established to ensure that unscrupulous return preparers, identified by IRS reviews, are referred to Examination for penalty assessment or prohibition from participation in the e-file program.
• Assessed whether admittance standards for e-file were strengthened to reduce the number of unscrupulous preparers in the program.

Our work on this follow-up review was performed at the IRS National Office functions including CI, Examination and Electronic Tax Administration (ETA), four service centers (Andover, Atlanta, Austin, and Brookhaven), and three districts (Georgia, New England, and South Texas). We also performed work at the Office of the Director of Practice and contacted the Criminal Investigation Branch (CIB) staff at the Fresno Service Center. Audit work was conducted from October 1998 through February 1999. This review was performed in accordance with Government Auditing Standards.

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

Background

As a result of the 1994 report on Electronic Return Preparer Fraud (Reference Number 045601), the IRS agreed to establish a multi-functional national RPP. CI was designated to lead and coordinate this program. Specifically, CI agreed to coordinate RPP activities with other IRS functions and to provide resources to staff and fund program activities. Additionally, detailed procedures and guidelines were to be developed for determining which cases will be sent to CI or Examination.

CI and other IRS compliance functions, at the service centers and district offices, identify preparers engaged in fraudulent activity. The initial identification of questionable returns occurs on a return by return basis by IRS personnel. When indications of fraudulent activity by return preparers are discovered, CI may initiate an investigation and later recommend prosecution. In suspected schemes where the identification of additional returns does not appear to be leading to a criminal referral, the case should be referred for examination.

Return preparer fraud involves the preparation and filing of false income tax returns (in either paper or electronic form). The RPP was implemented in 1996 to protect revenue by identifying, investigating, and prosecuting abusive return preparers, including e-file preparers.

Results

The IRS generally implemented corrective actions addressing recommendations contained in the 1994 report on Electronic Return Preparer Fraud. Specifically, CI established a multi-functional national RPP to address preparer fraud. ETA established and implemented procedures to remove dishonest e-file preparers and to perform visitations on suspicious preparers to ensure compliance with e-file procedures. ETA also strengthened admittance standards to reduce the number of abusive preparers in the e-file program. Additionally, procedures are in place to ensure that unscrupulous preparers are referred to Examination for penalty assessment or prohibition from participation in the e-file program.

The following chart shows that CI has attained positive results from return preparer activities:

CI can improve the effectiveness of the RPP by providing increased emphasis and oversight. Additionally, ETA controls can be improved over the removal of dishonest electronic return preparers from the program by providing for separation of duties for ETA district personnel. These duties relate to promoting participation in the e-file program and removing noncompliant preparers.

The Internal Revenue Service Can Provide Increased Emphasis and Oversight to Return Preparer Activities

Actions can be taken to better ensure that RPP activities are effectively performed. In addition, CI can provide increased emphasis and oversight.

We determined that: (1) CIBs did not always have full-time resources devoted to the RPP; (2) CI did not establish program roles and responsibilities through any formal document; and (3) CI did not have an analyst or other official dedicated to oversee or coordinate return preparer activities for much of 1998.

CI committed to take the lead and coordinate a multi-functional RPP in its response to the 1994 report on Electronic Return Preparer Fraud. Additional resources would be provided to staff and fund the RPP in the CIBs. CI management also noted that increased compliance checks (visitations) to identify suspicious return preparers would be stressed.

We found that CI field personnel did not always consider the RPP as a priority or mandated program. CIBs generally did not have full-time resources devoted to developing return preparer schemes.

Interviews with CIB branch chiefs and examiners at five service centers indicated that field personnel did not consider the RPP as a priority or mandated by the National Office. At three of five CIBs contacted, return preparer scheme work was carried out on a part-time basis using staff from another CI activity, the Questionable Refund Program (QRP). Due to the priority placed on the QRP, CIBs did not receive staffing and funding for the RPP until February 1998. This staffing was received as a result of the Earned Income Tax Credit (EITC) initiative. Criminal Investigation then committed to assign up to two full-time employees at each center to develop EITC criminal referrals.

Limited district CI and Examination resources could adversely affect the RPP. CIB personnel at two of four locations visited noted that district offices do not accept many schemes due to the lack of resources. For instance, 1 CIB identified 20 return preparer schemes that were not accepted due to a lack of resources. Another CIB identified an average of 28 schemes annually over 3 years, but noted that many cases were not accepted by district CI or Examination due to a lack of resources.

CIB personnel at another location referred 130 return preparer schemes in the last 3 years but stated that other less flagrant schemes were not always fully developed. This situation was attributed to the perception that CI or Examination would reject these cases due to lack of resources or interest.

Further, information provided by 1 CIB showed that $13.9 million in questionable refunds were released over a two-year period due to limited Examination resources to audit the returns.

We did not identify any documentation that established overall authority and functional responsibilities for the RPP. Additionally, although CI was responsible for leading the RPP, there was no national analyst assigned this responsibility for much of 1998.

Interviews with CI, ETA, Examination and Director of Practice officials showed that there is no formal document establishing program roles and responsibilities. This document should include functional responsibilities and requirements for coordination, as well as resource commitments.

Although CI designated the RPP as a national priority, the CI analyst responsible for monitoring the program left this position in April 1998 and was not replaced until January 1999. During this period, no analyst was assigned responsibility for monitoring the RPP.

An August 1998 CI memorandum to the Chief Operations Officer noted that little progress was made over the last few years to identify, develop, and refer preparer cases. Limited resources, lack of interest, and deviations from guidelines were cited as reasons. Problems in monitoring and capturing data on results were also noted. We also found that there were limited resources and emphasis for the RPP.

Increased oversight and emphasis will better ensure that return preparer schemes are effectively identified, developed, and referred for appropriate action.

1. Ensure that adequate resources are provided for the identification and development of return preparer schemes.

Management’s Response: For Fiscal Year (FY) 2000, Service Center CIBs will be allocating increased resources (up to 61 full-time equivalent positions) to research and develop preparer schemes. A Servicewide Return Preparer Strategy is planned for implementation in FY 2000. This strategy will focus on return preparers who prepare Earned Income Tax Credit returns. Additionally, IRS guidelines for preparer schemes will be changed to ensure the monitoring and tracking of these investigations.

2. Develop procedures that clearly establish CI as the lead office for the RPP to better ensure that activities can be effectively coordinated cross-functionally. A memorandum of understanding or similar document should be prepared to specify cross-functional responsibilities (CI, Examination, and the ETA) and to obtain functional commitment to the RPP.

Management’s Response: As part of the FY 2000 Return Preparer Compliance Strategy, a Memorandum of Understanding (MOU) is being developed to clearly define CI as the responsible organization for the fraud aspect of the strategy. CI will assist other compliance functions in the identification of abusive preparers. The Assistant Commissioner (Research and Statistics of Income) will be the lead office for coordinating other areas of the strategy. The strategy co-owners will continue to be the National Director, Tax Refund Fraud and the Assistant Commissioner (Research and Statistics of Income). In addition, the IRS has established a multi-functional team and developed an integrated compliance and education strategy.

3. Ensure that CI assigns the responsibility for monitoring and coordinating the RPP to a national program analyst on a full-time and on-going basis.

Management’s Response: Since January 1999, an analyst has been assigned full-time to the RPP.

The Internal Revenue Service Can Improve the Control Over the Removal of Dishonest Electronic Return Preparers

ETA implemented procedures for removing dishonest return preparers from the IRS e-file program. This process can be improved by separating the duties that the ETA district coordinators perform. These duties pertain to promoting participation in the IRS e-file program and removing noncompliant preparers.

IRS Revenue Procedures provide that the IRS can immediately suspend an e-file preparer from the program. The ETA coordinator facilitates the removal of dishonest e-filers (including return preparers) by serving as the contact point for all compliance functions and by obtaining the approval of the district director. The ETA coordinator then notifies the Andover Service Center that has responsibility for removing e-filers violating IRS Revenue Procedure provisions.

District ETA coordinators perform duties related to both promoting and increasing participation in the IRS e-file program, as well as removing electronic preparers who do not comply with established Revenue Procedures. These are key duties that involve conflicting goals.

Two of three district ETA coordinators interviewed expressed concerns that there is a conflict in promoting the IRS e-file program and removing noncompliant preparers. This concern pertains to a potential reluctance to remove noncompliant preparers, considering their duties in promoting participation in the program.

ETA coordinators have been assigned these potentially conflicting duties since the e-file program began. ETA officials were unsure as to why these potentially conflicting duties were assigned to ETA coordinators.

Sound management practices provide that key duties be separated among individuals. Assignment of duties and responsibilities to a number of individuals help to ensure that effective checks and balances exist.

The perception of conflicting responsibilities exists when the same individual performs duties related to both promoting IRS e-file participation and removing noncompliant preparers.

4. Assign responsibility for the removal of noncompliant return preparers to someone other than the district ETA coordinator.

Management’s Response: Plans are being made for district ETA coordinators to perform account management and/or to promote and market the e-file program. Their duties will no longer include compliance activities that could be perceived as a conflict of interest.

ETA will coordinate with Examination to assume responsibility for monitoring and removal of noncompliant electronic return originators.

Conclusion

The IRS generally implemented corrective actions addressing recommendations contained in the 1994 report on Electronic Return Preparer Fraud. Specifically, CI established a multi-functional national RPP to address preparer fraud. ETA established and implemented procedures to remove dishonest electronic return preparers and to perform visitations on suspicious preparers to ensure compliance with e-file procedures. ETA also strengthened admittance standards to reduce the number of abusive preparers in the e-file program. Additionally, procedures are in place to ensure that unscrupulous preparers are referred to Examination for penalty assessment or prohibition from participation in the e-file program.

However, CI can improve the effectiveness of the RPP by providing increased emphasis and oversight. Additionally, controls over the removal of dishonest preparers can be improved by providing for separation of duties for ETA district personnel. These duties relate to promoting participation in the e-file program and removing noncompliant preparers.

Detailed Objective, Scope, and Methodology

The objective of the review was to assess whether the Internal Revenue Service (IRS) effectively implemented corrective actions contained in a 1994 IRS Inspection Service (now Treasury Inspector General for Tax Administration) Audit Report on Electronic Return Preparer Fraud (Reference Number 045601). We determined whether the IRS established a Return Preparer Program (RPP) to include identifying and removing dishonest preparers from the electronic filing (e-file) program.

To accomplish the overall objective, we performed the following audit tests:

1. Evaluated whether Criminal Investigation (CI) established an effective RPP with specialized objectives, procedures, and resources to deal with e-file preparers by:

1. Determining if a multi-functional national RPP was established, led and coordinated by CI.
2. Identifying and assessing existing RPP objectives and procedures as they relate to e-file return preparers.
3. Ascertaining whether CI provided additional resources to staff and fund the RPP in the service centers.

1. Determined if the IRS established and implemented procedures for removing dishonest return preparers from the e-file program, including the performance of compliance checks on suspicious preparers to detect violations of revenue procedures by:

1. Determining if branch chiefs with e-file responsibilities in the service centers and district return preparer coordinators have the authority to suspend preparers who do not comply with requirements during the filing season.
2. Determining if districts are carrying out e-file visitations with cross-functional teams to coordinate fraud awareness, prevention, and detection.

1. Assessed whether unscrupulous e-file preparers identified during compliance checks, Questionable Refund Detection Team reviews, or CI reviews are referred to Examination for appropriate actions by ascertaining that procedures in place and used by the functional groups noted above ensure that dishonest return preparers are referred to Examination for appropriate penalties.
2. Determined if e-filing preparer admittance standards were tightened to reduce the number of unscrupulous preparers in the program by ensuring that e-file requirements reflect preparer admittance standards that were changed to protect system integrity.

Major Contributors to This Report

Walter Arrison, Associate Inspector General for Audit (Wage & Investment Income Programs)

Kerry Kilpatrick, Director

Mark Nathan, Audit Manager

John O'Rourke, Senior Auditor

John Piecuch, Senior Auditor

Donald Martineau, Auditor

Report Distribution List

Chief Operations Officer OP

Assistant Commissioner (Criminal Investigation) OP:CI

Assistant Commissioner (Electronic Tax Administration) OP:ETA

Assistant Commissioner (Examination) OP:EX

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

Assistant Commissioner (Research & Statistics of Income) OP:RS

Executive Officer for Service Center Operations OP:SC

National Director for Legislative Affairs CL:LA

Office of Management Controls M:CFO:A:M

Management's Response to the Draft Report

Response has been removed due to its size. To see the complete Response, please go to the Adobe PDF version of this report.