**HEARING BEFORE THE U.S. HOUSE OF** **REPRESENTATIVES**

**COMMITTEE ON THE BUDGET**

![](media/image1.png)

**July 9, 2003**

**10:00 a.m. 210 Cannon House Office Building**

**Washington, DC**

**Pamela J. Gardiner**

**Deputy Inspector General for Audit**

# **Treasury Inspector General for Tax Administration**

####  

Mr. Chairman and Members of the Committee, I appreciate the opportunity
to appear before you today to discuss five important questions involving
waste, fraud, and abuse in Internal Revenue Service (IRS) programs.
Government agencies must always spend taxpayers' dollars wisely.
However, during times of extremely tight budgets, it becomes even more
important that steps are taken to eliminate waste, fraud, and abuse.

1\. [Your current estimate of the magnitude (in dollars) of waste,
fraud, and abuse within your agency's mandatory programs.]{.underline}

It is impossible to accurately estimate the magnitude of waste, fraud,
and abuse in IRS programs, but there are a number of areas of concern.
For example, statistics are frequently cited that the tax gap (i.e., the
difference between the amount of tax owed and the amount of tax
voluntarily paid) is \$280 billion. The IRS estimated between \$8.5 and
\$9.9 billion of the \$31.3 billion in Earned Income Tax Credit (EIC)
claims on Tax Year (TY) 1999 returns should not have been paid. Further,
an estimated \$40 to \$70 billion in taxes are believed to be avoided by
an estimated 1 to 2 million taxpayers using offshore bank accounts.

However, all of these figures are just estimates, some are outdated, and
some can be misleading. For example, it is not always clear what
constitutes waste, fraud, and abuse. With respect to the EIC, if
divorced parents share custody of a child, and both claim the EIC
because each believes he or she is entitled to receive it, is that
waste, fraud, or abuse? The \$8.5 to \$9.9 billion range cited earlier
is for noncompliance; the amount involving outright waste, fraud, or
abuse is not known.

Nonetheless, there clearly is waste, fraud, and abuse in IRS programs.
For example, during Calendar Year 2001, IRS Fraud Detection Centers,
which are designed to detect fraudulent returns and prevent issuance of
related false refunds, identified \$338.3 million in 38,846 fraudulent
claims involving 3,447 schemes. In addition, the advent of electronic
filing of income tax returns has provided a new mechanism for
unscrupulous preparers to commit fraud. IRS Criminal Investigation
determined that fraudulent electronic filings through December 16, 2002,
had increased 720 percent since the end of 1999. As another example, the
IRS Frivolous Return Unit is using a computer program my office
developed to identify and stop reparations credit claims (i.e., false
claims for a special tax credit to African-American taxpayers who may be
descendents of slaves). In just a 2-day period in March 2002, the
Frivolous Return Unit reported that it identified 19 such claims, most
of which were for more than \$40,000. I will be discussing more specific
instances of waste, fraud and abuse in my response to question 3.

2\. [The general nature of these problems and how long they have
persisted.]{.underline}

The IRS has been experiencing many significant problems that include
declining enforcement actions, the lack of a current baseline measure of
reporting compliance, a growing balance of uncollected accounts
receivable, delays in modernizing its computer systems, weaknesses in
its financial management controls, increasingly complex tax laws, and
IRS employees' concerns over the mandatory termination provision in
section 1203(b) of the IRS Restructuring and Reform Act of 1998 (RRA
98). Despite experiencing these problems, in recent years the IRS has
processed a steadily increasing number of tax returns and revenue. From
1987 to 2001, the number of returns filed increased by 22 percent, from
140 million to 171 million. In approximately the same time frame, the
amount of revenue received by the IRS increased from \$935 billion to
\$2.1 trillion.

[Declining Enforcement Actions:]{.underline} The examination rate has
dropped significantly in recent years to a level that appears to have
already been detrimental to the system. Specifically, the percentage of
individual tax returns selected for examination has dropped from 1.67
percent in Fiscal Year (FY) 1996 to .57 percent in FY 2002.
Additionally, a survey conducted for the IRS Oversight Board identified
an 11-point drop (from 87 percent in 1999 to 76 percent in 2001) in the
percentage of Americans who believe it is *inappropriate* to cheat on
their tax returns.

Enforcement actions against individuals and businesses that purposefully
conceal tax liabilities or even refuse to submit tax returns have fallen
dramatically, despite concerns that tax cheating remains at high levels.
The following chart exhibits the fact that, since FY 1996, the level of
IRS enforcement activities has significantly declined.

+-----------------------------+----------------------------------------+
| ####### Enforcement Action  | ####### Overall Decline                |
|                             |                                        |
|                             | **FY 1996 -- FY 2002**                 |
+-----------------------------+----------------------------------------+
| Face-to-Face Audits         | 70%                                    |
+-----------------------------+----------------------------------------+
| Correspondence Audits       | 56%                                    |
+-----------------------------+----------------------------------------+
| Liens                       | 34%                                    |
+-----------------------------+----------------------------------------+
| Levies                      | 79%                                    |
+-----------------------------+----------------------------------------+
| Seizures                    | 97%                                    |
+-----------------------------+----------------------------------------+

The overall decline in enforcement actions has been primarily attributed
to a long-term reduction in compliance staffing, the redirection of
compliance resources to customer service functions during the filing
season, a decline in direct examination time, and concerns over section
1203(b) of the RRA 98. Specifically, collection revenue officer staffing
decreased from 5,537 in FY 1996 to 3,495 in FY 2002, while during the
same time examination staffing decreased from 17,406 to 13,046. Further,
the number of examination and collection staff years detailed to
customer service increased from 165 in FY 1996 to 974 in FY 2000,
although it has since declined to 217 for FY 2002. Direct examination
time decreased from 52 percent in FY 1996 to 41 percent in FY 2000, but
has since rebounded to 51 percent in FY 2002. Finally, as a result of
the mandatory termination provision in section 1203(b) of the RRA 98,
some IRS employees have been reluctant to take enforcement actions. This
has been a deterrent to fair enforcement of the tax laws.

[Lack of a Current Baseline Measure of Reporting
Compliance:]{.underline} The IRS has not conducted Taxpayer Compliance
Measurement Program (TCMP) examinations since 1988. These examinations
required an exhaustive review of the entire tax return for those
taxpayers randomly selected. The results of the TCMP were used to
improve the effectiveness of selecting for examination returns that
would result in a change. Without the TCMP, the IRS has neither had a
reliable method to measure voluntary compliance, nor been able to
determine the effect that increased customer service and diversion of
compliance resources are having on voluntary compliance.

[Uncollected Accounts Receivable:]{.underline} The IRS is challenged by
an increasing balance of accounts receivable (i.e., amounts owed to the
IRS because of balance due, but unpaid, filings by taxpayers, and IRS
enforcement actions). From FY 1996 to 2002, this balance increased from
\$216 billion to \$280 billion. The IRS has estimated that approximately
\$77 billion of the \$280 billion is potentially collectible.

[Need for Modernized Computer Systems:]{.underline} The IRS' goal of
providing efficient and responsive information services to its operating
divisions is heavily dependent on modernizing its core computer systems
while maintaining the existing systems. Since 2001, the Business Systems
Modernization (BSM) Program has been deploying projects and learning
valuable lessons that should help improve future projects. As of the end
of FY 2002, the 8 BSM projects that are currently being developed and
deployed had experienced cost increases of 26 percent and delays
averaging 13 months over initial estimates, most occurring during the
planning and design phases of these projects. The BSM Office forecasts
that future project costs and schedules will be much closer to the
estimates.

One of these projects, the Customer Account Data Engine or CADE, will
eventually replace the existing Master File of taxpayer accounts. CADE
will be the foundation for managing taxpayer accounts in the modernized
IRS. CADE and related applications will improve customer service and
compliance. Although the IRS and its contractor have made progress in
delivering the CADE project, the Release 1 deployment date is now
estimated to be August 2003, which is about 20 months behind its
original planned delivery date. Since CADE is the foundation for other
projects, its delay means that taxpayers are not receiving the benefits
of faster processing, and other projects that will provide improved
customer service and compliance activities will also be delayed.

[Weaknesses in Financial Management Controls:]{.underline} Although the
General Accounting Office (GAO) gave the IRS an unqualified (clean)
opinion on its FY 2002 financial statements, GAO reported that the IRS'
internal controls were not effective and its financial management
systems lacked substantive compliance with the Federal Financial
Management Improvement Act. Some control weaknesses affect the IRS'
ability to properly manage unpaid assessments, resulting in both
taxpayer burden and potentially billions of dollars in lost revenue.
Other weaknesses in controls over tax refunds could result in the
disbursement of billions of dollars of improper refunds. Also,
weaknesses in computer security controls may allow unauthorized
individuals to access, alter, or abuse proprietary programs and
electronic data and taxpayer information.

[Increasing Complexity of the Tax Laws]{.underline}: This further
complicates the IRS' efforts to administer the tax system and minimize
waste, fraud, and abuse. For several years, the Taxpayer Advocate has
identified tax law complexity as a major concern. For example, according
to the FY 2000 Taxpayer Advocate's Annual Report to Congress, tax law
complexity was the highest-ranking problem individual and business
taxpayers had with the IRS. In the 2002 report, the Taxpayer Advocate
stated that the scope and complexity of the tax code make it virtually
certain that taxpayers will face procedural, technical and bureaucratic
obstacles in meeting their tax obligations. Small businesses are
particularly affected by the complexity of tax law and IRS' related
processes. For example, each year an estimated 46,000 small businesses
are not successful in filing their U.S. Income Tax Return for an S
Corporation (Form 1120S) because the IRS does not have valid elections
on file to allow their returns to be processed. Consequently, these
taxpayers spend an estimated 2.3 million hours each year preparing
returns that cannot be successfully processed.

3\. [Illustrative examples of these problems.]{.underline}

On June 20, 2003, TIGTA provided a letter to the Chairman and this
committee containing examples of audits and investigations that
identified waste, fraud, and abuse involving the IRS in FYs 2002 and
2003. Our letter was in response to an effort initiated in May 2003 to
scrutinize certain mandatory programs and identify examples of waste,
fraud, and abuse sufficient to reduce outlays in those programs by 1
percent.

The following three sections provide brief synopses of (1) audit reports
resulting in cost savings,[^1] (2) significant audits/investigations
that identified internal and external fraud, and (3) audit reports that
identified revenue protection[^2] or trends in compliance and systems
modernization. The first two sections were included in our June 20
letter; the third section, while not directly related to cost savings in
appropriated funds, is nonetheless important since this audit work shows
the importance of protecting tax revenue and other important trends. For
each audit report, we have included a link to our web site to provide
access to the entire report.

**Reports That Identified Cost Savings**

**at the Internal Revenue Service**

**[Opportunities Exist to Expand the Telefile Program]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2003reports/200340092fr.pdf**](http://www.treas.gov/tigta/auditreports/2003reports/200340092fr.pdf)

Opportunities exist for the IRS to expand its TeleFile Program to
provide more taxpayers with the option of filing via telephone. The
number of taxpayers who use the TeleFile system each year decreased from
the 1998 to 2002 Filing Seasons. Since the expansion of the TeleFile
Program in 1997, the IRS has not identified any additional opportunities
to expand taxpayer TeleFile Program eligibility. The IRS' reluctance to
expand the TeleFile Program is based primarily on management's incorrect
perception that the processing costs for TeleFile tax returns
significantly exceed the processing costs for paper filed and other
electronically filed tax returns. Management also believes that the use
of a telephone to file tax returns is considered obsolete because of the
widespread use of computers and the Internet. To provide measurable
benefits to both the taxpayer and the IRS, and to enable the IRS to
continue to move towards its goal of having 80 percent of all tax
returns *e-filed* by 2007, we recommended that IRS management develop a
strategy outlining steps to be taken to offer the TeleFile Program to
those taxpayers who file a Form 1040EZ and are currently ineligible to
use the TeleFile system. We estimated that our audit would result in
\$31.86 million in funds put to better use.

**[The Internal Revenue Service Continues to Owe Millions of Dollars in
Interest to Taxpayers With Frozen Refunds]{.underline}**

**<http://www.treas.gov/tigta/auditreports/2002reports/200230062fr.pdf>**

The IRS was experiencing problems in releasing large dollar refunds
because of the automatic freeze placed on accounts containing a credit
balance of \$1 million or more. In a prior report, we indicated that
controls did not ensure that frozen refunds were timely released and
additional interest of approximately \$17.5 million was paid to
taxpayers with frozen accounts. The IRS did not implement our
recommendations as agreed, and our current review found that the IRS
continues to pay millions of dollars in interest to taxpayers with
frozen refunds. In 51 percent of the frozen accounts we reviewed, the
improperly frozen accounts resulted in issuing approximately \$185.8
million in refunds and paying taxpayers an additional \$15.4 million in
interest. As a result of our recommendation, we identified \$12.9
million in funds put to better use.

**[Improved Oversight of the Guard Services Contract Is Needed to Ensure
Compliance With Contract Terms and Conditions]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2003reports/200310076fr.pdf**](http://www.treas.gov/tigta/auditreports/2003reports/200310076fr.pdf)

Increased oversight of the guard services contract is needed to ensure
the contractor's compliance with all contract terms and conditions,
particularly those concerning licensing. Although validations completed
through October 2002 did not identify any issues related to the current
employment of security guards with criminal convictions or immigration
violations, the IRS paid \$4.7 million in costs during the time when the
contractor was in violation of the contract, all of which we classified
as questioned costs.

**[The Internal Revenue Service Could Reduce the Number of Unnecessary
Notices Sent to Taxpayers Regarding Unreported Income From Schedules
K-1]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2003reports/200330071fr.pdf**](http://www.treas.gov/tigta/2003reports/200330071fr.pdf)

In an effort to increase tax-reporting compliance and because of a
mandate from the Senate Committee on Finance, the IRS began matching
information reported to taxpayers on Schedules K-1 to the taxpayers'
individual income tax returns. The IRS must ensure notices issued to
taxpayers as a result of this matching are appropriate; otherwise, the
IRS' compliance efforts will be compromised. Recently, the IRS suspended
issuing notices resulting from underreported Schedule K-1 income and
committed to evaluate the program to make enhancements. The IRS
implemented several procedures to try and ensure notices were not issued
to taxpayers unnecessarily. Despite these steps, the rate of assessments
made on Underreporter Program cases related to Schedule K-1 income is
significantly lower than the rate of assessments made for other
Underreporter Program case income types. We recommended that the IRS
make changes to the Form 1040 Schedule E to account for the original
amount of Schedule K-1 income and to show offsets to this income. We
further recommended that the IRS reevaluate the costs and benefits of
key verifying data (entering data twice) or evaluate other ways to
improve the accuracy of Schedule K-1 information in the IRS' database.
Our audit identified \$3 million in funds put to better use that could
be used to improve the accuracy of IRS processing of paper Schedules
K-1.

**[Additional Cost Savings and Increased Productivity in the Print
Operation and Computer Support Function Can Be Achieved at the Campus
Locations]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2003reports/200320035fr.pdf**](http://www.treas.gov/tigta/2003reports/200320035fr.pdf)

IRS management has frequently evaluated and modified the organizational
structure of its Information Systems Division to accomplish program
objectives. However, management could further increase the electronic
dissemination of internal reports and improve performance measures. IRS
management should require users to discontinue printing reports that are
currently available in both printed and electronic format, convert
additional reports to electronic format, and establish a process for
migrating identified efficient report distribution processes to all
campuses. Performance measures should also be established to assess the
efficiency of the print operation and computer support function.
Finally, performance management reports for the print operation and
computer support function should be created to ensure that results are
compared against performance measure goals and actions are taken to
improve operational efficiency. As a result of our recommendations, we
identified \$2.24 million in funds put to better use.

**[The Management of Information Systems Maintenance Contracts Can Be
Improved]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2002reports/200220100fr.pdf**](http://www.treas.gov/tigta/2002reports/200220100fr.pdf)

The IRS is unnecessarily paying for maintenance on some computer assets.
Maintenance contracts costing an estimated \$451,400 per year cover
5,236 computer monitors, 108 printers, and 206 fax machines. We
estimated 10 percent of these items would fail and require repairs each
year. Canceling the maintenance contracts and allocating approximately
\$57,500 for replacements would save approximately \$393,900 per year
(\$1,141,500 over 3 years).[^3] In addition, cabinets and racks
typically do not require periodic maintenance and, therefore, should not
be included in maintenance contract coverage. Canceling these
maintenance contracts would save approximately \$13,600 per year
(\$39,400 over 3 years).[^4] In total, our recommendations resulted in
\$1.18 million in funds put to better use.

**[Pricing Discrepancies on the Long Term Maintenance Computing Center
Contract]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2002reports/200210008fr.pdf**](http://www.treas.gov/tigta/2002reports/200210008fr.pdf)

The contractually agreed-upon price for specific contract line items was
incorrectly priced by the contractor and/or its subcontractor.
Specifically, the IRS was billed monthly for the yearly costs of
maintenance coverage for nine contract line items. Additionally, the IRS
paid for a higher priced software upgrade than that provided by the
contractor. Approximately \$580,000 was associated with these billing
discrepancies, all of which we classified as questioned costs.

**Audits and Investigations That Identified**

**Internal and External Fraud**

**[Significant Efforts Have Been Made to Combat Abusive Trusts, But
Additional Improvements Are Needed to Ensure Fairness and Compliance
Objectives Are Achieved]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2002reports/200230050fr.pdf**](http://www.treas.gov/tigta/2002reports/200230050fr.pdf)

Since 1997, the IRS has made significant efforts to combat abusive
trusts. However, our review of abusive trust-related returns examined
and closed during the first quarter of FY 2001 showed that the IRS may
not be consistently asserting the accuracy-related penalty. There is a
risk that not penalizing taxpayers involved with abusive trusts could
result in further noncompliance. We recommended that IRS management
develop new penalty tables to monitor the application of the
accuracy-related penalty and develop a system to capture examination
data. We estimate that this could result in \$138.2 million in increased
tax revenue over a 2-year period.

**[Computer Programming Can Be Used to More Effectively Stop Refunds on
Illegal Claims for Reparations Credits]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2002reports/200230071fr.pdf**](http://www.treas.gov/tigta/2002reports/200230071fr.pdf)

Since the early 1990s, thousands of false claims have been filed with
the IRS for reparations credits. Promoters use a variety of techniques
to market the promise of a special tax credit to African-American
taxpayers, who may be descendents of slaves. Because the manual
screening of tax returns by IRS employees is subject to human error and
some employees may knowingly allow these illegal claims to be processed,
some claims for reparations credits are processed and refunds sent to
taxpayers. IRS computer controls that identify and stop reparations
claims processing could be significantly improved by using a
TIGTA-developed computer program. It is estimated that by using this
program, IRS employees could identify 91 percent more of these returns
than they could using the existing processes and stop an additional
\$90.7 million in refunds (revenue protection) from claims for
reparations credits over a 5-year period.

**[Management Advisory Report: Significantly More Individual Taxpayers
Inappropriately Received Disabled Access Credits for Tax Year 2000 Than
for 1999]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2002reports/200230048fr.pdf**](http://www.treas.gov/tigta/2002reports/200230048fr.pdf)

We reported that individual taxpayers were inappropriately receiving tax
credits on their TY 1999 U.S. Individual Income Tax Returns (Form 1040).
These taxpayers received the Disabled Access Credit even though their
tax returns indicated no business reasons for taking the credits. The
number of taxpayers involved was limited but the issue was significant
in that many of the taxpayers were elderly Americans who were possible
victims of promoters recommending unwise investments in pay telephones
and automated teller machines and promising bogus tax credits. From TYs
1999 to 2000, the number of tax returns for which this credit was
inappropriately allowed had increased by 28 percent. The amount of
credit allowed on these returns totaled over \$1.25 million.

**[Identity Theft Ring Nets \$7 Million In Fraudulent Tax
Refunds]{.underline}**

A criminal complaint charged 19 individuals with conspiracy to file
false claims against the United States. The investigation began when
bank officials notified the TIGTA that tax refund checks were deposited
in a tax preparer's bank account. TIGTA agents subsequently arrested the
tax preparer for the theft and negotiation of stolen IRS income tax
refund checks. The tax preparer, with co-conspirators, engaged in the
filing of numerous fraudulent income tax returns using stolen social
security numbers, resulting in millions of dollars in IRS refunds. The
tax preparer pled guilty to conspiracy to file false claims against the
United States.

In April 2003, the eighteen co-conspirators were indicted by grand jury
on twenty-nine counts including conspiracy to file false claims.

**[Two IRS Employees Destroy Records]{.underline}**

Two IRS employees were indicted for their role in the attempted
destruction of IRS records. A citizen contacted the IRS to advise that
numerous tax returns and other confidential documents were strewn on a
city street. TIGTA agents secured several trash bags filled with current
tax returns and taxpayer correspondence that had been removed from an
IRS processing center by one of the employees. The other employee placed
the bags filled with the documents on the curb to be collected as trash.
Both employees were terminated from employment and pled guilty to
unauthorized disposal of government documents. The IRS reviewed over 300
taxpayer accounts and determined the total impact to the applicable
taxpayers and the agency was approximately \$1.2 million.

**[IRS Employee Pled Guilty to Stealing Over \$191,000 in
Remittances]{.underline}**

An IRS Submission Processing Site employee altered the payee named on
tax remittance checks and attempted to convert the money for personal
use by depositing the checks into a personal bank account. The employee
pled guilty and was sentenced to 5 years probation for stealing checks
and a money order totaling \$191,871. TIGTA recovered the stolen money
and the taxpayers' accounts were properly credited.

**[IRS Employee Arrested by TIGTA Special Agents for Solicitation of
\$200,000 Bribe]{.underline}\
**

An attorney representing a corporation reported that during a routine
IRS examination, an IRS employee solicited a cash bribe of \$200,000
from the company's attorney to reduce the company's tax liability. In
January 2002, with assistance from TIGTA, an electronically recorded
meeting took place between the attorney and the employee. After
receiving the \$200,000 bribe, the IRS employee provided the attorney
with a fraudulent Revenue Agent Report. TIGTA special agents arrested
the IRS employee before the employee left the meeting. The former IRS
employee was sentenced to 24 months in prison followed by 3 years of
supervised probation.

**[Former IRS Employee Pled Guilty to Misuse of IRS Computer System and
Improper Relationships With Taxpayers]{.underline}**

A former IRS revenue officer was charged with allegedly accepting gifts
from different taxpayers, including approximately \$1,000 in cash, a
television set, free health club privileges, free auto repairs, and free
garage door repairs, for a payment plan of taxes and abatement of
penalties owed by the taxpayers totaling \$158,741. The former employee
was also charged with allegedly accessing an IRS computer without
authorization and obtaining information from the IRS and with allegedly
failing to deposit money of the United States under his control. The
former IRS employee pled guilty and in March 2002, was sentenced to 4
months imprisonment and ordered to pay restitution of \$11,648.

**[Business Owner Indicted for Bribery]{.underline}**

A business owner owed the IRS approximately \$410,829 in assessed taxes,
penalties, and interest arising from an examination. The owner gave an
IRS revenue officer checks totaling \$18,665 in return for delaying the
collection of the owner's tax liability. In June 2002, the owner was
charged with bribing an IRS employee.

**Reports That Identified Revenue Protection or Trends in Compliance and
Systems Modernization**

**[Management Advisory Report: Improvements Are Needed to Assess the Use
and Impact of the Earned Income Credit Appropriation]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2001reports/200140064fr.pdf**](http://www.treas.gov/tigta/auditreports/2001reports/200140064fr.pdf)

In 1997, the Congress provided the IRS with a special 5-year, \$716
million appropriation for the improved application of the EIC. The IRS
does not adequately validate EIC results information, causing the
inaccurate reporting of the use of the EIC appropriation funds to the
Congress. Also, although establishment of some compliance initiatives
and a process to track the spending of funds have improved the
application of the credit, the IRS has been unable to measure
improvements in the EIC compliance for the approximately \$297 million
spent on improving the application of the EIC. We recommended the IRS:
establish a process to ensure the workload results reported in the *IRS
Tracking Earned Income Tax Credit Appropriation* report to the Congress
are complete, accurate, and reliable; and effectively measure the impact
of the EIC initiatives on improving EIC compliance. Based on audit
tests, we determined 1 function overstated the number of EIC cases by
approximately 29 percent (1,015 cases) and a second function overstated
the number of notices sent to taxpayers by approximately 23 percent
(155,000 notices).

[**Better Controls Are Needed to Ensure Appropriated Funds Are Used to
Improve the Application of the Earned Income Credit**]{.underline}

[**http://www.treas.gov/tigta/auditreports/2002reports/200240020fr.pdf**](http://www.treas.gov/tigta/auditreports/2002reports/200240020fr.pdf)

The Congress has been concerned with the IRS' ability to administer the
EIC. The IRS established the EIC Program Office to administer the EIC
appropriation and oversee the EIC-related activities of IRS functions
involved in efforts to ensure the efficient application of the law; to
increase participation of eligible taxpayers; and to reduce waste,
fraud, and abuse. However, the IRS does not have an effective process in
place to ensure that the expenditure of the EIC appropriation is only
for EIC issues, programs, and projects. We recommended the IRS establish
procedures to ensure that funds appropriated by the Congress for the
improved application of the EIC are used for that purpose. These
procedures should include providing guidance to the appropriate
functions on using the EIC-related funds for expenditures, maintaining
reliable data, and conducting periodic reviews of the expenditures to
ensure they are being used for EIC-related items. Our analysis of the
total labor expenses for 2 IRS functions and a judgmental sample of the
IRS' equipment purchases for FY 2000 and the first quarter of FY 2001
identified approximately \$28 million in questionable expenses.

**[There Are Significant Weaknesses in the Internal Revenue Service's
Efforts to Measure Earned Income Credit Compliance]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2002reports/200240021fr.pdf**](http://www.treas.gov/tigta/auditreports/2002reports/200240021fr.pdf)

From TYs 1997 to 1999, the IRS made some improvements in its methodology
to measure EIC compliance. However, that methodology still has some
significant weaknesses. Specifically, some of the examinations in the
TYs 1997 and 1999 EIC compliance studies lacked the necessary
information to support the IRS' results, the IRS was inconsistent in its
study methodology, the IRS' emphasis on EIC taxpayers with business
income during the TY 1999 EIC compliance study increased the time spent
on the examinations but has not produced any apparent benefits, and poor
planning by the IRS has caused taxpayers to be needlessly examined as
part of the TY 1998 EIC compliance study. We recommended the IRS
coordinate among functions to: ensure the quality review process occurs
immediately after the examinations are completed (before they are
closed), ensure IRS auditors are effectively trained on EIC issues and
reminded of the importance of the studies, ensure the examination
results from the EIC compliance studies are accurately credited or
charged to taxpayer accounts, develop an acceptable methodology
concerning where and how examinations are to be conducted on all future
EIC compliance studies, develop a standardized sampling methodology that
will measure EIC compliance rates at the lowest cost with the least
amount of burden to the taxpayers, and capture and maintain detailed
costing figures to monitor each study's return on investment. Based on
our audit tests, we believe approximately 308 examinations used for
compliance measurement are questionable.

**[Significant Tax Revenue May Be Lost Due to Inaccurate Reporting of
Taxpayer Identification Numbers for Independent
Contractors]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2001reports/200130132fr.pdf**](http://www.treas.gov/tigta/auditreports/2001reports/200130132fr.pdf)

The IRS' ability to encourage the filing of accurate information returns
for nonemployee compensation, through its administration of the existing
back-up withholding and penalty provisions, is extremely limited and
largely ineffective. Between TYs 1995 and 1998, the number of
Miscellaneous Income documents (Forms 1099-MISC) reporting nonemployee
compensation, received by the IRS with missing or incorrect Taxpayer
Identification Numbers (TIN), increased by 36 percent. We recommended
the IRS propose to the Department of the Treasury changes to several tax
laws, explore opportunities to supplement its future Internet-based TIN
confirmation program, and modify some administrative guidelines. Because
the IRS was unable to match the documents with tax returns, we estimated
that our audit would result in \$2.2 billion in income taxes collected
per year through back-up withholding on nonemployee compensation
payments to independent contractors that fail to furnish a TIN.

**[The Internal Revenue Service Has Made Some Progress, but Significant
Improvements Are Still Needed to Reduce Errors in Manual Interest
Calculations]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2002reports/200230042fr.pdf**](http://www.treas.gov/tigta/auditreports/2002reports/200230042fr.pdf)

In 1993, the IRS Inspection Service (now the TIGTA) reported that 40
percent of the tax accounts it reviewed either contained errors in
interest amounts computed by IRS employees or were unnecessarily
restricted from automated computations. In 1994, in accordance with the
Federal Managers' Financial Integrity Act, the IRS reported this issue
as a material weakness in its internal control system. As a result, the
IRS established a goal to reduce its high number of erroneous restricted
interest assessments. While the IRS has achieved some success in
increasing the automation of interest calculations, overall, its actions
taken to address the material weakness in its controls over the
calculation of restricted interest have not been effective. We
recommended the IRS: limit the calculation of restricted interest to
centralized staffs within the various functions and locations of the
IRS, establish a national quality review process that includes all
restricted interest cases, establish training that must be completed
before an employee can work restricted interest cases, authorize a
standard interest computation tool that would be used by all employees
working restricted interest cases, and explore all available options to
provide the technology and programming necessary to allow more interest
calculations to be performed by computer. We estimate that, over a
5-year period, the IRS could undercharge some taxpayers over \$145
million.

**[Trends in Compliance Activities Through Fiscal Year
2002]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2003reports/200330078fr.pdf**](http://www.treas.gov/tigta/2003reports/200330078fr.pdf)

The IRS' overall FY 2002 compliance efforts and results were mixed but
showed some continuing positive changes that started in FY 2001.
Specifically, the level of compliance activities and the results
obtained in many Collection areas in FY 2002 showed a continuing
increase, although some measurements decreased slightly in FY 2002 after
increasing in FY 2001. Enforcement actions were higher or about the same
in FY 2002 compared to the numbers in FY 2001. While enforcement revenue
collected increased in FY 2002, the inventory of delinquent accounts and
the total amount of uncollected liabilities have continued to grow. For
example, from FY 1996 to FY 2002, enforcement revenue collected
decreased from a yearly total of \$37.96 billion to \$34.09 billion,
while gross accounts receivable increased from \$216 billion to \$280
billion. The number of examinations of tax returns increased in FY 2002,
but the overall percentage of tax returns examined stayed about the same
due to increases in the number of tax returns filed. The numbers and
percentages of examinations of corporate and other business returns
(except partnerships and very large corporations) continued to decrease
or stay at about the same level. There were also slight increases in the
numbers of examinations of fiduciary income, employment, and excise tax
returns. We made no recommendations in this report.

**[Analysis of Business Systems Modernization Cost, Schedule, and
Functionality Performance]{.underline}**

[**http://www.treas.gov/tigta/auditreports/2003reports/200320007fr.pdf**](http://www.treas.gov/tigta/2003reports/200320007fr.pdf)

Beginning in 2001, the BSM Program delivered business results by
deploying projects and learning valuable lessons that should help
improve future projects. Deployed projects have increased the capacity
of the IRS telephone system; improved the ability to receive, route, and
respond to taxpayer telephone calls; and provided refund information via
the Internet. However, as reported in previous TIGTA and GAO reports,
the BSM Program has been experiencing difficulties meeting the original
cost, schedule, and functionality estimates included in the BSM Spending
Plans submitted to the Congress. Since the purpose of this review was to
identify and analyze the cost, schedule, and functionality performance
compared to the original project estimates, we did not make any
recommendations in this report.

4\. [What actions are being taken to eliminate or reduce these
problems.]{.underline}

Given the volume of returns and revenue processed by the IRS, it would
be a difficult task to fully eliminate all the problems that lead to
waste, fraud, and abuse. However, the IRS has taken or plans actions to
at least partially address some of the more significant problems I have
described.

[Compliance and Enforcement]{.underline}: In recent years, the IRS has
reversed the trend toward devoting significant compliance resources to
customer service. This action has helped to stabilize some compliance
results, and customer service activities have received staffing
increases to provide services.

For example, while the decline in many categories of enforcement actions
and results since FY 1996 has been dramatic, there are recent
indications that in some categories this trend has stabilized or even
shown improvement. Overall, the IRS' FY 2002 compliance efforts and
results were mixed, but showed some continuing positive changes that
started in FY 2001. Specifically, the level of compliance activities and
the results obtained in many, but not all, collection areas in FY 2002
showed an increase. In addition, for FY 2002, the number of criminal
investigation cases initiated and in ending inventory was the highest
since FY 1998. However, the number of cases referred to the Department
of Justice and case convictions remained lower in FY 2002 than in FY
1998, yet higher than in FYs 2000 and 2001.

The IRS also increased the focus of its examination resources on six
high-risk areas of non-compliance with the tax laws. These six strategic
priority areas are: offshore credit card users; high-risk, high-income
taxpayers; abusive schemes and promoter investigations; high-income
non-filers; unreported income; and the National Research Program (NRP),
which is discussed in more detail below.

[National Research Program]{.underline}: To address the void created
from the discontinuation of the TCMP, the IRS NRP Office was established
in April 2000 as a component of the Research, Analysis, and Statistics
Division. NRP is a comprehensive effort, using a statistically valid
sample, to measure reporting, filing, and payment compliance for
different types of taxes and various sets of taxpayers. The NRP will be
used to update IRS' examination selection systems. After the IRS'
workload selection formulas are updated with NRP data, the number of
no-change examinations is expected to significantly decrease. As of
February 14, 2003, a total of 33,738 NRP sample cases had been shipped
to the field, which represented about 72 percent of the total 2002 NRP
sample of 46,860. Of this total, related information has been assembled
on 22,256 cases, and they are ready to be assigned to an examiner.

The NRP is scheduled to allow for the updating of the examination
workload selection formulas by 2005. To accomplish this objective,
examination of the NRP sample cases is scheduled to be completed by
April 2004.

GAO issued a report in June 2002 on the IRS' NRP planning efforts. GAO
concluded that the NRP design is likely to yield the type of information
the IRS needs. In addition, GAO concluded that the NRP meets one of the
IRS' key goals to minimize the burden that the NRP poses to taxpayers.
GAO has assessed the IRS' efforts to gather trend data regarding the
overall burden imposed by the 2002 NRP and will issue a report in this
area soon.

TIGTA believes that the NRP is a much-needed first step for providing
the information necessary to gauge compliance levels and direct IRS
compliance resources towards areas where attention is most needed. TIGTA
is currently conducting audit work to provide an early assessment of the
implementation of the 2002 NRP at the field office level. To accomplish
this objective, TIGTA is performing on-site interviews and analyzing
actions to date on a sample of NRP cases at selected IRS field offices.
TIGTA has met with the GAO NRP team several times to coordinate the
audit approach to avoid overlap.

[Planned Use of Collection Agencies]{.underline}: The IRS' proposal to
contract out the collection of delinquent accounts to private collection
companies has the potential to recover a significant amount of IRS
accounts receivable. In 1996, the IRS piloted the use of collection
agencies, and after a detailed internal evaluation, concluded that their
use was not economically viable. The IRS' current approach, however,
differs significantly from the prior methodology. Most importantly, in
1996 the collection companies were compensated with monies from the IRS'
appropriated funds. In contrast, as part of its 2004 budget submission,
the IRS has requested authority to fund the use of collection companies
directly from the revenues collected by those companies.

The IRS plans to eventually place 2.6 million cases annually with
collection companies. Treasury projects that this initiative will
produce revenue of as much as \$1 billion through 2013. While this
amount is significant, it represents a small portion of the \$280
billion in accounts receivable that were due at the end of FY 2002.

[EIC Initiatives]{.underline}: IRS efforts to improve the administration
of the EIC Program are ongoing. The IRS has implemented a number of
initiatives targeting outreach, education, and compliance efforts. Also,
it participated with Treasury in a task force to study EIC overclaims.
This resulted in the IRS initiating significant changes to the way it
will address EIC noncompliance, for example, by requiring some EIC
applicants to provide additional information to the IRS to validate
eligibility before payment (pre-certification).

The President's FY 2004 budget proposal includes an increase of \$105
million in EIC funding. This increase includes \$100 million to
implement the pre-certification initiative. The IRS is also supposed to
use compliance and other available data to determine whether specific
groups of claimants can be eliminated from the pre-certification process
because they pose less risk of claiming more EIC than that for which
they are eligible. The Treasury's EIC taskforce estimated that the
pre-certification process would potentially reduce EIC overclaims by
\$2.3 billion.

In addition, the IRS recently reorganized the EIC Program Office to
capitalize on the strategic planning and research resources in the Wage
and Investment Division's Office of Strategy and Finance, and created an
Executive Advisory Council made up of IRS executives involved in the
administration of the EIC Program to help provide better oversight and
coordination of the Program. The Program Office has also drafted new
annual performance measures for the EIC Program for FYs 2003 and 2004.

[Offshore Tax Shelters]{.underline}: In FY 2001, the IRS established the
Offshore Credit Card Project. Underpinning the project are 2 "John Doe"
summonses[^5] served on MasterCard International and Visa for the
records of foreign bank accounts in more than 30 countries. This data,
supplemented with merchant summons[^6] data, is to be used to develop
cases for referral to the Compliance field function. TIGTA recently
issued a draft report on its audit of the program, describing concerns
with the IRS inconsistently using the accuracy-related penalty,
potentially examining returns beyond the statute expiration date (which,
except for special circumstances, would bar any tax assessments), and
not having an adequate management information system to provide key
information and trends for decision making.

In addition, in January 2003, the IRS initiated the Offshore Voluntary
Compliance Initiative to help taxpayers become compliant if they are
involved in abusive arrangements. The program ended in April 2003.

[BSM Progress]{.underline}: During 2002, the IRS and its PRIME
contractor identified and aggressively focused on improving 12 key
processes to better ensure future success. Deployed projects have
increased the capacity of the IRS' telephone system; improved the
ability to receive, route, and respond to taxpayer telephone calls; and
provided refund information via the Internet. There will be many
challenges ahead, and the IRS and PRIME contractor need to effectively
implement planned improvements in key management processes; commit the
resources necessary to enable success; manage the increasing complexity
and risks of the BSM Program; and maintain the continuity of strategic
direction with experienced leadership.

[Scheduled Corrective Actions for Financial Management
Weaknesses]{.underline}: As shown in the attachment, the Department of
the Treasury lists 9 internal control and financial management
weaknesses at the IRS, including such things as the EIC, the growing
inventory of accounts receivable, and the need for detailed transactions
data to support custodial financial reporting of revenue. Some of these
weaknesses have existed for many years, for example, property management
and accounts receivable have both been listed since the 1980's.

[Automated System for Tracking Tax Law Changes]{.underline}: In
September 2002, TIGTA reported that the IRS had recognized the
importance and sensitivity of tax law complexity, elevated the concerns
to the highest levels within the IRS, and invested significant resources
throughout the organization to address the problems. In addition, TIGTA
concluded that the IRS' Legislative Implementation Tracking System will
be an effective control to monitor the implementation of new tax
legislation. The system is designed to provide timely, useful
information to management and quickly elevate any delays in implementing
new tax laws to a level of management high enough to address the
problem.

5\. [What additional actions, of either an administrative or legislative
nature, are required.]{.underline}

Addressing the issue of tax law complexity would require legislative
actions. In fact, the National Taxpayer Advocate's FY 2001 Annual Report
to Congress outlined proposals to simplify or clarify six areas of tax
law -- family status issues, joint and several liability, alternative
minimum tax for individuals, penalty and interest issues, home-based
service workers, and IRS collection procedures. Also in 2001, the staff
of the Joint Committee on Taxation issued a comprehensive study of tax
law complexity, which included numerous specific recommendations.

Legislation will have to be passed to authorize the Secretary of the
Treasury to use private collection agencies and to allow the IRS to use
a portion of taxes collected to fund the project. TIGTA has concerns
whether IRS resources will be sufficient to provide adequate project
management, contract oversight, and quality review; whether taxpayer
rights and privacy will be adequately protected; and that the detailed
design for the collection project has not been developed, including the
system that will be responsible for selecting, controlling, and updating
cases assigned to private collection companies.

Tax law changes are needed to effect significant improvement in
information reporting and to protect the substantial tax revenues that
are potentially being lost each year. The IRS agreed to consider the
feasibility of proposing some new legislation to require mandatory
withholding of income taxes on nonemployee

compensation payments, and changing the criteria for asserting the
Incorrect Information Penalty. However, TIGTA is concerned that the IRS
does not plan to enforce accurate TIN reporting once a TIN verification
program is made available to payors. If the IRS does not require
accurate TIN information from payors, compliance is not likely to
improve.

Tax professionals and others expressed concerns about the difficulty in
matching information from Schedules K-1 to individual income tax
returns. The IRS must ensure notices issued to taxpayers as a result of
this matching are appropriate; otherwise, the IRS' compliance efforts
would be compromised. The IRS should carefully consider the benefits of
the program, the cost of the program to the Federal Government and to
taxpayers, and the enhancements that can be made to the program in the
near term as a result of its own analyses, before proceeding with a
program to match all data from Schedules K-1 again in 2003.

With regard to the BSM Program, we have recommended that the IRS issue
more performance-based contracts to the PRIME contractor, tie incentives
and disincentives to performance, and require the use of firm
fixed-price task orders whenever possible and appropriate. We also
recommended that the IRS reduce the number of BSM projects being
developed in order to better control and manage the program, and to
improve its management and governance capabilities and processes.
Finally, we recommended that the IRS ensure that project development
teams follow the established systems development life cycle methodology
and processes to increase the likelihood of success. We will be issuing
audit reports this year with additional recommendations to improve the
effectiveness and results of the program.

The IRS needs to establish long-term goals and measures for the EIC
Program that reflect the Program's anticipated outcomes over time, and
establish a consistent method to measure progress toward these long-term
goals. Only through consistent measurement will the IRS be able to
demonstrate its progress over time and show how it has reduced erroneous
payments or increased participation.

Finally, the IRS and other important stakeholders, such as the IRS
Oversight Board, believe the agency needs more resources to accomplish
its mission and goals. For FY 2004, the IRS requested funding of \$10.4
billion and 100,043 Full-Time Equivalents. This is an increase of \$521
million (5.3 percent) over the President's FY 2003 request. The largest
portion of this increase will go towards strengthening compliance and
customer service. The IRS emphasized that since

71 percent of its budget consists of salaries and benefits, any negative
changes in the agency's financial situation could result in a negative
impact on staffing levels. We believe that the IRS should consider
expanding its workforce planning process from 3 to 5 years. This would
increase the IRS' ability to identify risks and provide necessary data
to key stakeholders.

Mr. Chairman and Members of the Committee, I appreciate the opportunity
to share significant problems and challenges that confront the new
Commissioner and IRS senior management. TIGTA will continue its efforts
to provide reliable and objective reviews and assessments of IRS
programs and operations. It is our intent to not only identify waste,
fraud, and abuse in IRS programs, but also to propose solutions to IRS
management that address the underlying causes of the problems.

[^1]: Cost savings include funds put to better use and questioned costs.
    Funds put to better use are defined as funds that could be used more
    efficiently if management took actions to implement and complete a
    recommendation. Questioned costs are costs that are questioned
    because of an alleged violation of a provision of a law, regulation,
    contract, or other requirement governing the expenditure of funds;
    or a finding that, at the time of the audit, such cost was not
    supported by adequate documentation.

[^2]: Revenue protection involves the proper denial of claims for
    refund, including recommendations that prevent erroneous refunds or
    efforts to defraud the tax system.

[^3]: This calculation was based on the estimated savings for one year
    and the current Federal Funds Rate of 1.75 percent.

[^4]: ^3^

[^5]: A John Doe summons is any summons that does not identify the
    person with respect to whose liability the summons is issued. A John
    Doe summons can only be issued after the approval by a Federal
    court.

[^6]: A merchant summons is a summons served on the merchants involved
    in transactions with the credit cards identified via the John Doe
    summons.