October 27,
2005
MEMORANDUM FOR SECRETARY SNOW
FROM: J. Russell George
Inspector
General
SUBJECT: Management and Performance Challenges
Facing the Internal Revenue Service for Fiscal Year 2006
The Reports Consolidation Act of 2000[1] requires that the Treasury Inspector
General for Tax Administration (TIGTA) summarize, for inclusion in the Department of the Treasury Accountability
Report for Fiscal Year 2005, our perspective on the most serious management
and performance challenges currently confronting the Internal Revenue Service (IRS).
The TIGTA’s assessment of the major IRS
management challenge areas for Fiscal Year (FY) 2006 has not changed
substantially from the prior year. While
the IRS has continued to address each challenge area, we were unable to remove
any challenge area at this time. We
have, however, used two subcategories, Computerized Systems and Business
Structure, to further describe the challenge of modernization of the IRS. We believe these both play a crucial part in
the modernization efforts. We have also
rephrased one challenge, “Using Performance and Financial Information for
Program and Budget Decisions,” to more accurately portray our concerns. The ten current challenges, in order of
priority, are:
Modernization of the IRS includes both
computer systems modernization and business structure (reorganization)
modernization. Although both issues have
their own sets of challenges, they must both succeed to fully modernize the IRS.
Computerized Systems
Business
Systems Modernization (BSM) involves integrating thousands of hardware and
software components over 15 years.
The program is in its seventh year and has allocated approximately $1.9 billion
for contractor and integrator activities.
The IRS and its contractors have deployed projects that provide value to
taxpayers and have built the infrastructure needed to support these projects. However, since the start of the modernization
effort, the BSM program has experienced cost overruns and schedule delays in
its project development and deployment.
Over the past three fiscal years, our annual BSM program
assessments have cited four primary challenges that the IRS and its
contractors must meet to achieve program success: 1) implement planned improvements in key management processes and commit the necessary
resources to enable success; 2) manage the increasing complexity and risks of
the BSM program: 3) maintain the continuity of strategic direction with
experienced leadership; and 4) ensure contractor performance and accountability
are effectively managed. In the past
year, we reported that weaknesses continue to exist in critical program
management and system development processes.
Business Structure
The IRS
Restructuring and Reform Act of 1998 (RRA 98)[2] mandated that the IRS reorganize to
better meet the needs of taxpayers. On
October 1, 2004, the Small Business/Self-Employed (SB/SE) Division Customer
Account Services (CAS) operating unit realigned to the Wage and Investment Income
(W&I) Division CAS function. As a
result of this merger, the IRS’ W&I Division will be the only division
responsible for processing tax returns, both individual and business. While there are similarities between
individual and business tax returns, there are also many differences. For example, the mix of electronic and paper
returns for businesses is much different than that for individuals. Additionally, large corporations and tax
exempt organizations will soon be required to file tax returns electronically,
while individuals have the option to file either electronically or via
paper. The IRS is also continuing with its
plan to consolidate individual tax returns processing into fewer sites. Changes such as these present challenges to
the IRS to ensure tax returns are processed effectively and efficiently.
The completion of the initial phases of the National Research
Project (NRP) allowed the IRS recently to release an updated estimate of the
tax gap.[3] As
a result of the NRP, the IRS now estimates that taxpayers with self-employment
income underreport between $51 billion and $56 billion in employment tax. The IRS recently received authority and will
begin testing the use of contract staff to work some collection cases. It is too early to tell if the contract
resources will be able to resolve a significant number of cases or whether they
will continue to go unresolved. During
the last few years, the IRS has been implementing reengineering suggestions
aimed at increasing effectiveness of enforcement efforts. We have conducted several reviews of these
initiatives; however, it is too early to evaluate the full impact.
The
IRS relies upon critical computer systems to account for more than $2 trillion
in revenue annually. Significant disaster recovery program weaknesses continue
to be unresolved. These recurring
weaknesses include: modernization systems being placed in production without a
disaster recovery capability; insufficient disaster recovery capacity; roles
and responsibilities not being assigned and employees not being trained; and
annual tests not being conducted or not being effective. In addition, control weaknesses, such
as failure to close user accounts when employees leave the IRS, inadequate
documentation of user access authorizations, and insufficient documentation
that employees have acknowledged their security responsibilities, continued to exist,
even with the implementation of a new automated system to authorize system
access. These weaknesses continue to
occur because managers and system administrators have not adhered to the system
procedures.
Through
the years, the Federal tax system has become more complex, less transparent,
and is frequently revised. The scope and
complexity of the Internal Revenue Code make it virtually certain that
taxpayers will face procedural, technical and bureaucratic obstacles in meeting
their tax obligations. For example, in
2001, the Joint Committee on Taxation conducted a study on the complexity of
the tax law and found that, at that time, the tax code consisted of nearly 1.4
million words. There were 693 sections
of the code applicable to individuals, 1,501 sections applicable to businesses,
and 445 sections applicable to tax exempt organizations, employee plans, and
governments. At that time, a taxpayer
filing an individual income tax return (Form 1040) could be faced with a 79
line return, 144 pages of instructions, 11 schedules totaling 443 lines
(including instructions), 19 separate worksheets embedded in the instructions,
and the possibility of having to file numerous other forms.
For the 2005 tax filing season,
the IRS estimates it should take, on average, over 19 hours to complete and
file a Form 1040 and the associated Schedule A.
Although
the IRS has consistently and commendably sought to ease the process for all
taxpayers, each tax season brings new problems.
The complexities of the tax law affect the ability of the IRS to
administer the nation’s tax system. The
IRS’ efforts to provide assistance to taxpayers are hampered because of these
complexities.
Measuring
the IRS’ productivity, the efficiency with which inputs are used to produce
outputs, is difficult.[4]
The IRS has made some progress,
but using performance and financial information for program and budget
decisions is still a major challenge. The absence of accurate
and complete management information hinders the IRS’ ability to make
appropriate decisions when determining the locations and services it provides taxpayers seeking face-to-face assistance. The IRS’ financial
statements and related activities continue to be of concern to IRS
stakeholders. In its audit of the IRS’
FY 2004 financial statements, the Government Accountability Office (GAO)
concluded that the records were fairly presented in all material respects.[5]
The GAO, however, identified some continuing serious deficiencies in the
IRS’ financial systems. Without a
financial management system that can produce timely, accurate and useful
information needed for day-to-day decisions, the IRS’ financial stewardship
responsibilities continue to be one of the most serious challenges facing IRS
management.
Each
year, millions of taxpayers contact the IRS seeking assistance in understanding
the tax law and in meeting their tax obligations by either calling the various
toll-free telephone assistance lines, accessing the IRS Internet site or
visiting an IRS Taxpayer Assistance Center (TAC). Walk-in assistance has proven to be
particularly helpful for lower-income taxpayers and those with limited or no
English language proficiency.[6] The IRS discontinued
its TeleFile service, used by nearly 4 million taxpayers, in August 2005. Earlier this year, the IRS stated
that it planned to close 68 TACs, to reduce costs and create efficiencies while
maintaining a commitment to customer service.
Currently, the IRS has suspended the closure of the 68 TACs pending
further study. The TIGTA is reviewing
the methodology used to select the TACs for closure. The Small Business/Self-Employed (SB/SE)
Division Taxpayer Education and Communication (TEC) organization has made
significant progress in reaching out to the small business taxpayer community
to educate small business taxpayers on their tax and compliance
responsibilities. However, the TEC
organization needs to better market its products, especially for business
taxpayers who are not served by the tax practitioner community.
An
improper payment is any payment that should not have been made or that was made
in an incorrect amount under a statutory, contractual, administrative or other
legally applicable requirement. For the
IRS, improper and erroneous payments are generally associated with erroneous
refunds and filing fraud issues as well as vendor or contractor
overpayments. Some
tax credits, such as the Earned Income Tax Credit (EITC), and the Education
Credit, provide opportunities for abuse in income tax claims. In Tax Year (TY) 2003, the IRS reported that
approximately 21.7 million taxpayers received EITC totaling $38.1 billion. The IRS estimated that between 27 percent and
32 percent of the $31 billion in EITC claimed on TY 1999 returns should not have been paid.[7] Single
taxpayers with no dependents are receiving a “dual benefit” by claiming both
the tuition and fees deduction, and education credits. We reported this condition during the 2004 filing
season, and in the 2005 filing season, we identified 18,776 single taxpayers
claiming no dependents who were allowed both an education credit, and a tuition
and fees deduction because the IRS had yet to initiate action to identify and
disallow “dual benefits.” Our analysis
showed that these taxpayers claimed education credits of more than $13 million,
and tuition and fees deductions of nearly $39 million. TIGTA
reviews have also identified payment issues in the contract area. For example, a recent report on a contract to
support the IRS’ modernization efforts identified questionable award fees of more
than $2 million and questionable charges, which consisted of unsupported,
unreasonable, and inaccurately recorded charges.
The
IRS continues to dedicate significant resources and attention to implementing
the taxpayer rights provisions of RRA 98.
Audit
reports TIGTA issued in FY 2005 found the IRS was in full compliance with the
following taxpayer rights provisions:
The
IRS, however, did not remove all Illegal
Tax Protester Designations from its records, did not always address all Collection Due Process issues, and
sometimes improperly Denied Taxpayer
Requests for Information. In
addition, the IRS did not always properly notify taxpayers in situations
involving:
IRS management
information systems do not track specific cases so neither the TIGTA nor the
IRS could evaluate the IRS’ compliance with certain RRA 98 provisions. The TIGTA issued reports on two of the
subject RRA 98 provisions:
The IRS had a successful 2005 filing
season, timely processing over 117.5 million individual income tax returns
(including 66.6 million processed electronically) that were received through
May 27, 2005. This was the first year
that more than half of all taxpayers filed an electronic return. Key tax law changes for the 2005 filing
season were generally correctly implemented.
However, the TIGTA identified some tax law changes that were not
effectively implemented during the 2005 filing season, which may cause
taxpayers to lose entitlements or receive erroneous tax credits. For example, military taxpayers may not be
receiving the full amount of EITC they are entitled to and not all taxpayers
are benefiting from the new sales tax deduction. Also, some taxpayers are being allowed erroneous
education credits, and taxpayers are receiving “dual benefit” by claiming both
the tuition and fees deduction and education credits.
The
IRS continues to be challenged with traditional workforce issues, such as
training, recruitment and employee retention, along with issues specific to the
IRS. These issues include
reorganizations and potential restructuring from competitive sourcing results. For example, according to its FY 2006
strategic assessment, the Large and Mid-Size Business Division (LMSB) is
continuing to lose highly skilled technical employees, primarily through
retirement, and it is replacing fewer technical employees than those who have
separated. The loss of human capital,
combined with the increasing complexity of LMSB examinations, will have a
negative effect on audit coverage and business results. Additionally, the IRS Tax Exempt and
Government Entities Division has indicated that current staffing is still not
sufficient to adequately cover the volume of calls received.
[8] Although the
IRS has training assessment and development procedures, these procedures are
generally not followed by its operating divisions. While each operating division followed its own
processes, they were generally not able to provide documentation to
substantiate whether assessments were performed.
These are the ten major IRS management
challenge issues for FY 2006. The
TIGTA’s Office of Audit’s FY 2006 Annual Audit Plan
categorizes the planned audits by these issues.
If you have questions or wish to discuss our views on these management
and performance challenges in greater detail, please contact
me at (202) 622-6500.
cc: Assistant Secretary for Management and Chief
Financial Officer
Commissioner of Internal Revenue
[1] 31 U.S.C. § 3516(d).
[2] Pub. L. No.
105-206, 112 Stat. 685 (codified as amended in scattered sections of 2 U.S.C.,
5 U.S.C., 5 U.S.C. app., 16 U.S.C., 19 U.S.C., 22 U.S.C., 23 U.S.C., 26
U.S.C., 31 U.S.C., 38 U.S.C., and 49 U.S.C.).
[3] The IRS
has initiated the National Research Program to measure taxpayers’ voluntary
compliance, to better approximate the tax gap, and to develop updated formulas
to select noncompliant returns for examination. The first phase of this program
addresses reporting compliance for individual taxpayers, and data from this
phase were used to produce the recently updated estimates of this portion of
the tax gap.
[4] Government
Accountability Office, Pub. No. 05-671, Tax Administration: IRS Can Improve Its Productivity Measures by
Using Alternative Methods (July 2005).
[5] Government Accountability Office, Publ. No. 05-103,
Financial Audit: Irs’s Fiscal Years 2004
and 2003 Financial Statement (Nov. 10, 2004).
[6] IRS Oversight Board, FY2006 IRS Budget Special Report (March 2005).
[7]
Treasury Inspector General for Tax Administration, Ref. No. 2005-40-093,
The Earned Income Tax Credit Income Verification Test Was Properly Conducted
(2005).
[8]Treasury Inspector General for Tax Administration, Ref. No.
2005-10-149, The Internal Revenue Service Does Not Adequately Assess the
Effectiveness of Its Training (2005).