Reducing the filing of federal tax returns claiming abusive refunds has been identified as a national problem. In March 1994, United States House of Representatives Ways and Means Committee members expressed to the Secretary of the Treasury their concern about the Internal Revenue Service’s (IRS) tax refund fraud prevention and detection systems. In October 1994, the Chairman of the Treasury Department Task Force on Tax Refund Fraud (the Treasury Under Secretary for Enforcement) reported back to the Ways and Means Committee that up to "$5 billion in ‘problematic’ refunds ¹ [was being] paid out annually."

One of the controls the IRS has in place to reduce the risk of bulk filing of electronic tax returns claiming abusive refunds is a process for analyzing (screening) the histories of businesses and individuals desiring to participate in electronic filing as electronic return originators (EROs)². This control checks, among other things, whether individuals or firms desiring to participate in federal electronic filing as EROs have filed their federal tax returns, have paid their taxes, or have a criminal history. If a prospective or previously accepted ERO fails the suitability review, the IRS formally informs the ERO which criteria they failed. They then have appeal rights.

The objective of this audit was to determine if the IRS' process for annually rechecking (screening) the histories of previously admitted preparers and transmitters of electronic returns effectively ensured that only EROs meeting publicized qualifications continued to be approved to participate in the IRS' electronic return (e-file) program. This IRS screening process is commonly referred to in IRS publications and Internet sites as determining EROs’ "suitability" to participate in electronic filing.

With the exception of one computer programming problem, the IRS’ annual suitability screening of bulk preparers and transmitters of electronic returns effectively ensured that only EROs meeting publicized qualifications were approved to participate in the 1999 e-file program.

The IRS' annual recheck of the suitability of preparers and transmitters of electronic returns was reasonably effective in ensuring that only EROs meeting publicized standards were approved to participate in the 1999 e-file program. A Federal Managers’ Financial Integrity Act report in 1992 had cited, as a material control weakness, the problem of electronic return preparers and transmitters with problem histories successfully re-applying "from IRS district office to IRS district office" around the country, until finding an office willing to admit them as electronic return preparers or transmitters.

• The IRS’ preliminary computerized review program checked the histories of over 150,000 EROs seeking to participate in 1999, and identified 11,804 EROs (8 percent of all reviewed) whose histories were designated for more detailed suitability research by tax examiners.
• The subsequent more detailed IRS tax examiner research into the suitability of the 11,804 EROs with possible problem histories resulted in reasonably accurate determinations of their suitability to continue as EROs. Our test of 111 randomly selected cases showed that 105 (95 percent) of the tax examiner analyses for 1999 were accurately completed. The six errors were due to tax examiner misjudgments or incomplete research.
• The tax examiner research on the 11,804 EROs confirmed that 3,834 EROs (3 percent of the over 150,000) did not meet suitability criteria. These EROs were suspended from the 1999 program.³
• The percentage of computer-identified cases confirmed by tax examiners as having problems was higher for 1999 than in previous years (12 percent for 1997, 9 percent for 1998, and 32 percent for 1999). We believe the increased confirmation rate for 1999 reflects, for the first time, the inability of EROs with questionable histories to "shop around" for IRS approval.

We noted that inappropriate EROs were scheduled to participate in the IRS’ 1999 e-file program. Due to a programming flaw, the preliminary computer screening program did not check for suitability problems in the histories of 7,274 of the approximately 195,000 ERO cases subject to review. Our follow up of the 7,274 revealed that the histories of 699 prospective EROs contained such characteristics as unpaid federal tax and unfiled federal tax returns, which should have subjected them to detailed suitability review by tax examiners prior to acceptance in the 1999 program.

We notified the Assistant Commissioner (Electronic Tax Administration) of this condition in a memorandum dated November 6, 1998, in time to suspend any unsuitable EROs before the 1999 tax filing season.

To further improve the suitability process for e-file EROs, we recommend that the IRS correct the gap in the computer screening program to prevent its recurrence in future years, and review the 699 cases for 1999 that should have been highlighted by the screening program.

Management’s Response: The Assistant Commissioner (Electronic Tax Administration) agreed with the recommendations listed in the report when they were submitted as part of an interim memorandum we issued during the review. However, as of the date of this report, IRS management had not provided a response to the report itself. The Assistant Commissioner’s response to our interim memorandum has been incorporated into the report, where appropriate, and the full text of the response to that memorandum is included as an appendix (see Appendix V). We provided the IRS with a draft report on September 15, 1999, with a 30-calendar day comment period.