TREASURY INSPECTOR GENERAL
FOR TAX ADMINISTRATION
THE INTERNAL REVENUE SERVICE CAN IMPROVE THE TREATMENT OF TAXPAYERS DURING SERVICE CENTER AUDITS
Reference No. 2000-10-066
Our previous audit report titled, The Internal Revenue Service Needs to Improve Treatment of Taxpayers During Office Audits (Reference Number 093602, dated April 1999), identified several weaknesses in controls over office audits, which led to improper taxpayer treatment. To determine if similar problems existed in other types of examinations, we focused this review on evaluating how taxpayers were treated during correspondence audits conducted by the Internal Revenue Service (IRS) service centers. These audits usually involve one or two tax issues and are generally handled through the mail. In Fiscal Year (FY) 1998, IRS service centers audited about 495,000 taxpayers through correspondence and recommended additional taxes and penalties of approximately $1.7 billion.
Although not technically considered an audit by the IRS, $1.8 billion was also assessed against more than a million taxpayers in FY 1998 through the service centersí Information Returns Program (IRP). Much like a correspondence audit, the IRP involves sending letters to taxpayers asking them to provide an explanation for a specific tax issue on their tax return. If the issue cannot be resolved, the IRS takes action to assess the additional tax and collect the deficiency.
The IRS has undertaken numerous initiatives recently to better protect taxpayer rights and become more responsive to their needs. However, we believe this report identifies two areas where the IRS could further enhance its efforts to ensure taxpayers are treated properly. The areas involve correcting weaknesses in the audit process conducted through the mail and reducing the risk of improper access to taxpayer data stored on the Midwest Automated Compliance System (MACS).
The Internal Revenue Service Needs to Strengthen Controls in the Correspondence Audit Process to Ensure Taxpayers Are Treated Fairly
We found two areas in the correspondence audit process where the IRS could take action to ensure taxpayers are treated fairly. We estimate that the weak controls could impact as many as 227,000 of the 495,000 taxpayers examined annually by correspondence in the service centers.
First, the IRS could do more to increase the number of taxpayers who respond to audit letters. Most of the $1.7 billion assessed in FY 1998 from correspondence audits can be traced to taxpayers who never responded to IRS letters regarding their examinations. When this occurs, the IRS assesses the tax and initiates actions to collect the deficiency. With millions of households moving each year, this can create problems for taxpayers who never receive IRS letters, or who are not aware of audit assessments until liens are filed or other collection actions are taken.
The lack of response may not be entirely the taxpayersí fault. In 32 of 66 cases (48 percent) reviewed from 2 service centers, we found different addresses for the taxpayers than the ones on IRSí letters. This indicates that the IRS may not have sent its correspondence to the proper address. We also found no evidence in the cases reviewed that service centers initiated telephone contact with taxpayers when they did not respond to IRS letters.
In addition to doing more to locate taxpayers, the IRS needs to ensure service centers follow its letter procedures for contacting taxpayers. In 20 percent of the cases we sampled, audits were started with letters proposing tax changes rather than the standard audit initiation letters. This reduces the time taxpayers have to respond to IRS inquiries since audit initiation letters indicate the IRS will wait 30 days for taxpayers to submit substantiation before proposing any changes to a tax return. Unless steps are taken to ensure letter procedures are consistently followed, the IRS risks contributing to taxpayersí perceptions that they are not treated fairly.
Actions Are Needed to Reduce the Risk of Employees Misusing Taxpayer Data
In the April 1999 audit report, we reported how the IRS employees in district offices poorly implemented MACS controls and procedures. These insufficient procedures and controls unnecessarily exposed taxpayer data to browsing and increased the risk that employees could selectively target individuals for audit. In the four service centers reviewed, we found the following weaknesses in the MACS control environment that could impact the privacy and security of up to 123 million taxpayers whose data are available on the MACS:
Summary of Recommendations
The IRS can further enhance its efforts to ensure taxpayers are treated fairly by: (1) using locator services to find taxpayers, (2) issuing initial contact letters consistently when starting an audit, (3) expanding the Correspondence Audit Programís quality review system, and (4) ensuring that MACS audit trail reviews are performed and the results are reported to responsible officials.
We issued a draft of this report to IRS management on February 29, 2000, with a March 30, 2000, response period. However, managementís response was not available at the time this report was released.