United States General Accounting Office

GAO Testimony

Before the Subcommittee on Oversight, House Committee

on Ways and Means

For Release

on Delivery

Expected at

10:00 a.m. EDT

Friday,

September 26, 1997

TAX ADMINISTRATION

Taxpayer Rights and

Burdens During Audits of

Their Tax Returns

Statement of James White, Associate Director, Tax Policy

and Administration Issues, General Government Division

GAO/T-GGD-97-186

Summary 

Tax Administration: Taxpayer Rights and

Burdens During Audits of Their Tax Returns

Taxpayers and Congress have expressed concerns with how the Internal

Revenue Service (IRS) treats taxpayers in audits and whether audits are too

burdensome. Based on its ongoing and previous work, GAO makes the

following points on these issues:

• IRS has limited data on both the treatment of taxpayers and the burdens

imposed on them during audits. IRS recently created a system to track

taxpayers’ complaints about improper treatment but IRS does not solicit

input on all improper treatment. Similarly, IRS has no comprehensive

definition of, and little data on, the burden its audits impose on taxpayers.

IRS has recently developed a survey that will ask individual taxpayers

about their satisfaction with various parts of the audit process but results

will not be available until 1998.

• IRS has various indicators and standards on audit performance. One

measure of audit performance is how much additional tax is

recommended. IRS does not have a corresponding measure on how much

of the recommended tax is ultimately collected after taxpayer appeals.

Without an indicator to balance taxes recommended against those

collected, IRS auditors could have an incentive to recommend taxes that

would be unlikely to withstand a taxpayer challenge. IRS has nine audit

standards. The standards focus on the efficient use of auditors’ time and

not on when they should use particular audit techniques. To ensure

adherence to the standards, IRS relies on oversight by the auditors’

managers. However, their workload limits their time for doing oversight.

• GAO’s work on one set of IRS audit techniques—those used in analyzing

taxpayers’ financial status to identify unreported income—showed that IRS

used these techniques in less than a quarter of the audits completed in the

time periods covered by GAO’s review. In about one-quarter of the audits in

which financial status techniques were used, IRS did not have to contact

the taxpayer to obtain information on the taxpayer’s financial status

beyond what was reported on the tax return. GAO also found that IRS’ use of

financial status techniques has not increased in recent years. Regarding

revenue impact, GAO found that in about 16 percent of the cases where

they were used, these techniques did help to identify significant amounts

of unreported income—$10,000 or more. However, in over three-quarters

of the total audits in which these techniques were used, no changes

resulting from the use of these techniques were made to the income

reported. Most of the audits did result in some tax change for other

reasons. Data are not available to permit GAO or IRS to determine the

additional burden imposed on taxpayers from the use of the techniques in

audits.

Page 1 GAO/T-GGD-97-186
Summary 

Tax Administration: Taxpayer Rights and

Burdens During Audits of Their Tax Returns

• IRS is concerned that its ability to target the potentially most noncompliant

taxpayers for audits is deteriorating. IRS’ concern arises because it has not

been able to rely on its past approach for developing statistically valid

research data that allowed IRS to create and periodically update formulas

to target the returns with the most potential for noncompliance. IRS last

collected these data through audits of a random sample of taxpayers for

tax year 1988. IRS subsequently abandoned that approach due to concerns

about its costs and to concerns from the public and Congress about the

taxpayer burden involved with those audits.

Page 2 GAO/T-GGD-97-186
Statement 

Tax Administration: Taxpayer Rights and

Burdens During Audits of Their Tax Returns

Madam Chairman and Members of the Subcommittee:

We are pleased to be here today to assist the Subcommittee in its inquiry

into the rights of taxpayers and their treatment during audits of their tax

returns by the Internal Revenue Service (IRS). Recently, taxpayers, tax

professionals, and Congress have expressed concerns about how IRS treats

taxpayers during audits and whether audits are overly burdensome. You

asked us to discuss IRS’ data on taxpayer complaints and the burden

imposed on taxpayers as well as IRS’ indicators for measuring audit

performance. You also asked us to discuss our ongoing work for the

Chairman of the House Committee on Ways and Means on IRS’ use of a

particular audit technique—reviews of taxpayers’ financial status (i.e.,

their flow of income and expenses)—and IRS’ methodology for selecting

tax returns for audit.

Today, I would like to make four points taken from this ongoing work as

well as from previous reports and testimonies.

• First, IRS has limited data on both the treatment of taxpayers and the

burdens imposed on them during audits. IRS recently created a system to

track taxpayers’ complaints about improper treatment but IRS does not

solicit input on all improper treatment. Similarly, IRS has no

comprehensive definition of, and little data on, the burden its audits

impose on taxpayers. IRS has recently developed a survey that will ask

individual taxpayers about their satisfaction with various parts of the audit

process but results will not be available until 1998. While recognizing the

difficulties in collecting data from taxpayers about treatment and burden,

we believe that this survey may have the potential to provide better

information than presently exists.

• Second, IRS’ Examination Division has various indicators and standards on

audit performance. One measure IRS uses for audit performance is how

much additional tax is recommended. IRS does not have a corresponding

measure on how much of the recommended tax is ultimately collected

after taxpayer appeals. Without an indicator to balance taxes

recommended against those collected, IRS auditors could have an incentive

to recommend taxes that would be unlikely to withstand a taxpayer

challenge. IRS has nine audit standards. The standards focus on the

efficient use of auditors’ time and not on when they should use particular

audit techniques. To ensure adherence to the standards, IRS relies on

oversight by the auditors’ managers. However, their workload limits their

time for doing oversight.

Page 3 GAO/T-GGD-97-186
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Tax Administration: Taxpayer Rights and

Burdens During Audits of Their Tax Returns

• Third, our work on one set of audit techniques—those used in analyzing

taxpayers’ financial status to identify any unreported income—provided

several interesting statistics. We estimated that IRS auditors used these

techniques in less than a quarter of the audits completed in the time

periods covered by our review. When used, financial status techniques

were always part of an audit that included other techniques or

methodologies. In about one-quarter of the audits in which financial status

techniques were used, IRS did not have to contact the taxpayer to obtain

information on the taxpayer’s financial status beyond what was reported

on the tax return. We also found that the use of financial status techniques

has not increased in recent years. Regarding revenue impact, we found

that in about 16 percent of the cases where they were used, these

techniques did help to identify significant amounts of unreported

income—$10,000 or more. However, of the total audits in which these

techniques were used, in over three-quarters no changes resulting from the

use of these techniques were made to the income reported, although most

of the audits resulted in some tax change for other reasons. Data are not

available to permit either us or IRS to determine the additional burden

imposed on taxpayers from the use of financial status techniques in audits.

• Fourth, IRS is concerned that its ability to target the potentially most

noncompliant taxpayers for audits is deteriorating. IRS’ concern arises

because it has not been able to rely on its past approach for developing

statistically valid research data that allowed IRS to create and periodically

update formulas to target the returns with the most potential for

noncompliance. IRS last collected these data through audits of a random

sample of taxpayers for tax year 1988. IRS subsequently abandoned that

approach due to concerns about its costs and to concerns from the public

and Congress about the taxpayer burden involved with those audits. For

context, we note that from the 1960s, when IRS first created its

research-based audit formulas until it stopped gathering that research data

after 1988, it had reduced the rate to which its audits made no

recommended tax change from more than 40 percent to around 10 to

15 percent, depending on the type of return and the year of the audit.

I would like to discuss each of these points in more detail after providing

an overview on why IRS audits tax returns and how IRS is supposed to do

the audits.

Overview of IRS

Audits of Tax Returns

IRS’ Examination Division audits tax returns to ensure that taxpayers

report and pay the amount of tax they owe. Because our tax system is

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Tax Administration: Taxpayer Rights and

Burdens During Audits of Their Tax Returns

based on self-assessment, IRS also does audits to induce taxpayer

compliance and promote public confidence in the tax system.1

The income tax gap—the difference between taxes owed and taxes paid

voluntarily and on time—is one reason why IRS seeks to provide an audit

presence. Under IRS’ most recent estimate, the 1992 income tax gap for

individuals exceeds $90 billion, of which about two-thirds can be

attributed to individuals not reporting income on their tax returns.

In recent years, IRS has been auditing about one to two percent of the

100-million plus income tax returns filed annually by individual taxpayers.2

IRS’ policies and procedures are generally directed at selecting returns that

appear to be most noncompliant. After selecting the returns, IRS audits

them either (1) through 1 of its 33 district offices by meeting with

taxpayers or their representatives or (2) through 1 of its 10 service centers

by corresponding with the taxpayers. Since fiscal year 1992, these audits

have been recommending between $5 billion to $8 billion in additional

taxes each year. Appendix I of my statement summarizes selected audit

statistics since fiscal year 1992.

IRS auditors are instructed to not only verify the eligibility and amounts for

various types of tax deductions, credits, and exemptions, but to also look

for any indications of unreported income. If auditors find such indications,

they are to exercise their judgment in deciding whether to do further

probes in an effort to determine whether the taxpayer underreported

income.

To guide auditors, IRS manuals and publications have identified the rights

of taxpayers during audits and the manner in which auditors should treat

taxpayers. For example, IRS documents say that taxpayers have the right,

among others, to know why IRS is asking for information about the tax

return and to authorize another person to represent them during the audit.

Through its documents and training programs, IRS instructs its audit staff

to explain these rights to the audited taxpayer and to protect those rights.

In addition, audit staff are instructed to protect taxpayers’ privacy as well

as treat them with professionalism and courtesy.

1

IRS also induces compliance through taxpayer assistance, third-party reporting to IRS of payments

(such as wages and interest) made to taxpayers, computer matching of tax returns to third-party data,

income tax withholding, and penalties for noncompliance.

2

IRS also annually audits tens of thousands of income tax returns filed by corporations and

partnerships as well as thousands of other types of returns such as those filed to report estate tax, gift

tax, employment tax, and excise tax.

Page 5 GAO/T-GGD-97-186
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Tax Administration: Taxpayer Rights and

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IRS Data on Audit

Burden and Taxpayer

Complaints About

Treatment

Recently, taxpayers, tax professionals, and Congress have criticized IRS for

treating taxpayers improperly and imposing unnecessary burdens during

audits. At a general level, these criticisms have asserted that auditors

lacked sufficient experience, training, motivation, or competence. Specific

criticisms have focused on a range of asserted IRS behaviors, including:

• subjecting compliant taxpayers to unnecessary audits, resulting in no

change to the tax liability reported on the tax returns;

• wasting taxpayers’ time during the audit by asking for irrelevant

documentation or by delving into issues that are minor or personal; and

• treating taxpayers unprofessionally or abusively, regardless of whether

they underpaid their taxes, by lying, making threats, applying pressure,

and the like.

IRS has limited data for use in responding to such assertions. With respect

to unprofessional or improper treatment, in 1994 and 1996, we reported

that IRS lacked comprehensive data on the nature and magnitude of the

complaints as well as their resolutions.3

 Nor did IRS have clear definitions

that allowed it to determine whether these complaints indicated auditor

behaviors that were “abusive” or “unnecessary.”

Since our 1996 report, IRS has developed a definition and tracking system

for complaints about improper treatment. IRS defines a complaint as an

allegation by taxpayers or their representatives that an IRS employee

violated the law, regulation, or IRS rules of conduct or used inappropriate

behavior (e.g., rude, overzealous, discriminatory, intimidating) or that an

IRS system failed to function properly or within the prescribed time frame.

IRS’ complaint tracking system does not systematically solicit input from

taxpayers on their treatment during audits; rather, it records only those

complaints initiated by taxpayers. As a result, neither we nor IRS have

representative data on the extent to which auditors treat taxpayers

improperly across the roughly 2 million audits.

Nevertheless, IRS does report the data the system collects on taxpayer

complaints. For the first quarter of fiscal year 1997, IRS reported that

taxpayers initiated 1,203 complaints, of which 290 (25 percent) involved

audit staff. Of the 290 audit-related complaints, almost half involved

assertions of inappropriate behavior by an auditor and about one-quarter

of these complaints were addressed through counseling or administrative

3

Tax Administration: IRS Can Strengthen Its Efforts to See That Taxpayers Are Treated Properly

(GAO/GGD-95-14, Oct. 26, 1994), and Tax Administration: IRS Is Improving Its Controls for Ensuring

That Taxpayers Are Treated Properly (GAO/GGD-96-176, Aug. 30, 1996).

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action or through the employee leaving IRS; for the remaining

three-quarters of the complaints, IRS concluded that the employee’s

behavior was appropriate or that information provided by the taxpayer

was not complete enough to take disciplinary action against the employee.

With respect to taxpayer burden, IRS has limited data on the

burden—whether necessary or not—imposed by audits. For example, in

fiscal year 1996, IRS tax auditors made no changes to 14 percent of the

individual tax returns. However, IRS does not know the amount of burden

imposed by these or other audits.

Data on burden can be difficult to collect for various reasons. Neither IRS

nor its stakeholders have clear definitions or agreement on what

constitutes audit burden as well as unnecessary burden. Further, our work

has shown that taxpayers do not keep records on the amount of audit

burden in terms of time or money.4

IRS has recently developed a survey that will ask individual taxpayers

about their satisfaction with the audit process. Results will not be

available until 1998. Recognizing the difficulties in collecting data about

treatment and burden, we believe that this survey may begin to provide

better information about taxpayer treatment and burden but its usefulness

will need to be evaluated.

IRS’ Indicators to

Measure the Impacts

of Audits

IRS has established some indicators for measuring its audit performance.

However, existing indicators primarily focus on interim results without

also considering final results from the audits. Similarly, IRS has established

nine audit standards to guide its auditors. However, the standards do not

provide objective criteria on when to use particular audit techniques.

IRS’ Examination Division has used additional tax recommended as an

important indicator of audit performance (see app. II for the fiscal year

1997 indicators).5

 We expressed concerns in previous work that

overreliance on additional taxes recommended as an indicator of

performance could create undesirable incentives for auditors (and other

Examination staff) to recommend taxes that would be unlikely to

4

Tax System: Issues in Tax Compliance Burden, (GAO/T-GGD-96-100, Apr. 3, 1996) and Tax System

Burden: Tax Compliance Burden Faced by Business Taxpayers, (GAO/T-GGD-95-42, Dec. 9, 1994).

5

Taxpayers do not necessarily have to pay the recommended taxes. Taxpayers may challenge them

through administrative channels within IRS or the courts. If they win the challenge, the recommended

taxes will not be assessed as owed. If they lose or raise no challenge, the recommended taxes are

assessed.

Page 7 GAO/T-GGD-97-186
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Burdens During Audits of Their Tax Returns

withstand a taxpayer challenge.6 While we recognize the complexity of the

Internal Revenue Code and the difficulties faced by both IRS and the

taxpayer in determining the “correct tax,” the fact remains that audit

recommendations that do not withstand such a challenge may have

imposed an unnecessary burden on the taxpayer. For this reason, in our

previous work, we supported the need to measure taxes recommended but

advocated balancing that indicator with others such as taxes ultimately

collected.

Our work also pointed out that developing an indicator of taxes ultimately

collected from audits would be challenging. For example, the time lag

between an audit and the ultimate tax collected makes linking the two

problematic. IRS is working on developing a way of determining the

ultimate taxes collected.

In addition to indicators of audit performance, IRS also has nine audit

standards to provide guidance to auditors on minimizing the time spent on

an audit, checking large and unusual claims on tax returns, probing for

unreported income, and preparing adequate audit workpapers (see app. III

for all nine standards). These nine standards do not address the proper

treatment of taxpayers. Further, although the standards provide guidance

on the proper depth and breadth of audits given the time available, they

provide little objective guidance to auditors on when to use particular

audit techniques such as those related to an analysis of a taxpayer’s

financial status.

To ensure adherence to the standards, IRS relies on managers’ oversight of

auditors. However, according to IRS officials, these managers cannot

review all audits because their workloads limit the time available for

review. As audits close throughout the year, separate groups of IRS staff

supplement the managerial review process by reviewing a small sample of

audits to measure adherence to the nine standards (see appendix III for

measurement results in fiscal years 1992 through 1996).

IRS’ Use of Financial

Status Techniques

Given recent complaints about the asserted burdens and intrusions

associated with IRS’ financial status audit techniques, the Chairman of the

House Committee on Ways and Means asked us to report on the frequency

and results of IRS’ use of these techniques. IRS uses these techniques to

identify unreported income. During our analyses of audits done in 1992-93

6

Tax Administration: Compliance Measures and Audits of Large Corporations Need Improvement

(GAO/GGD-94-70, Sept. 1, 1994) and Tax Administration: Factors Affecting Results From Audits of

Large Corporations (GAO/GGD 97-62, Apr. 17, 1997).

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Burdens During Audits of Their Tax Returns

and 1995-96, we found that IRS relied primarily on two financial status

techniques:7

1)Cash transaction analysis (or cash-T), in which the auditor uses the tax

return and other sources to ensure that adequate income has been

reported on the return to cover expenses. In deciding to use this

technique, auditors may first do a preliminary cash-T. It differs from the

regular cash-T in that the auditor does it before meeting with taxpayers,

relying on information reported on tax returns.

2)Bank deposit analysis, in which the auditor verifies that the taxpayer’s

bank deposits are consistent with the income reported on the tax return.

To do our work, we randomly sampled from the universe of audits closed

in IRS districts in which IRS scheduled meetings with taxpayers to review

their records. These samples covered 1992-93 and 1995-96 and were both

projectable to universes of about a half million audits.

On the basis of our analysis of these two samples, we estimate that the use

of financial status techniques had not increased over the time frames we

reviewed—the techniques were used in about one-quarter of the audits in

each of our two universes. Financial status techniques were never used

alone; they were always part of audits that included other audit techniques

to explore issues other than unreported income, such as overstated

deductions.

These techniques imposed no or little additional burden on taxpayers in

some of the audits where they were used. For example, IRS auditors used

just the preliminary cash-T in 23 percent of the 1995-96 audits that used

financial status techniques. The preliminary cash-T technique imposes no

additional burden on the taxpayer because the auditor relies on the

information on the tax return and does not have to contact the taxpayer to

obtain additional information or explanations to complete this technique.

We found that use of the financial status techniques in some cases helped

to identify significant amounts of unreported income—$10,000 or

more—that IRS would not have otherwise found. However, over

three-quarters of the audits in which these techniques were used resulted

in no changes that were directly attributable to the use of these

7

Other techniques include an analysis of (1) a taxpayer’s net worth and (2) a business taxpayer’s

reported cost of goods sold and data on average markups within the specific business to estimate

gross receipts generated by that taxpayer.

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Burdens During Audits of Their Tax Returns

techniques, even though IRS did find noncompliance in most of these

audits through other techniques.

While neither we nor IRS know the actual burden imposed on taxpayers,

our review of IRS’ workpapers illustrated some conditions under which use

of certain techniques may impose additional burdens. For example, a bank

deposit analysis can be very burdensome if the auditor asks for records on

many bank accounts and asks many questions about the deposits in those

accounts. A regular cash-T may or may not be very burdensome,

depending on the number of contacts with taxpayers to request

information and the amount of information requested.

Barriers to Selecting

the Most

Noncompliant Tax

Returns for Audit

As discussed in previous reports, IRS is concerned about its ability to

objectively select tax returns so that it focuses on the most noncompliant

taxpayers.8 IRS’ concerns arise because it has not been able to rely on its

past approach for developing statistically valid research data that allowed

IRS to create and periodically update formulas to target the returns with

the most potential for noncompliance. IRS refers to these as discriminant

function (DIF) formulas, which have served as the major method for

selecting returns for audit.9 IRS fears that its DIF formulas have become

imprecise because the formulas use outdated statistical data.

In past years, IRS collected the statistically valid research data under its

Taxpayer Compliance Measurement Program (TCMP). TCMP involved

full-scale audits of a random sample of tax returns—usually for about

50,000 individual taxpayers every 3 years. In 1995, IRS abandoned this

approach due to concerns about its costs and to concerns from the public

and Congress about the taxpayer burden involved with those audits. As a

result, IRS’ last TCMP covered tax year 1988.

In a 1996 report, we discussed IRS’ need for compliance data that are

statistically valid and more current.10 IRS needs the data not only to update

8

Tax Research: IRS Has Made Progress But Major Challenges Remain, (GAO/GGD-96-109, June 5,

1996); Tax Administration: Alternative Strategies to Obtain Compliance Data (GAO/GGD-96-89, Apr.

26, 1996); Tax Gap: Many Actions Taken, But a Cohesive Compliance Strategy Needed

(GAO/GGD-94-123, May 11, 1994); and Tax Administration: IRS’ Plans to Measure Tax Compliance Can

Be Improved (GAO/GGD-93-52, Apr. 5, 1993).

9

Tax Administration: Audit Trends and Results for Individual Taxpayers (GAO/GGD-96-91, Apr. 26,

1996). IRS has up to 40 methods for identifying returns to audit. Appendix IV summarizes the number

of audits selected by the major methods for fiscal years 1992 through 1996.

10Tax Administration: Alternative Strategies to Obtain Compliance Data (GAO/GGD-96-89, Apr. 26,

1996).

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its DIF formulas but also to support most of its compliance programs.

Accordingly, we recommended that IRS develop a cost-effective, long-term

strategy to ensure the continued availability of such compliance data.

Since IRS started to use DIF in the 1960s to better target its audits through

fiscal year 1996, IRS has reduced the rate at which its auditors made no tax

changes from more than 40 percent of the audited returns to around 10 to

15 percent, depending on the type of return and the year of the audit. IRS is

concerned that as time passes, DIF’s precision in identifying noncompliant

returns may decrease unless IRS updates the formulas with valid data, and

that as a result, more and more compliant taxpayers will be unnecessarily

burdened with an audit. We are now designing a study of this issue at the

request of the Chairman of the House Committee on Ways and Means.

Madam Chairman, this concludes my testimony. I would be pleased to

answer any questions you or other members of the Subcommittee may

have.

Page 11 GAO/T-GGD-97-186
Appendix I 

Selected Information About the Returns

Filed and Examined and Recommended

Additional Taxes (Fiscal Years 1992-96)

Description 1992 1993 1994 1995 1996

Number of returns

Filed 152,031,900 153,453,600 152,732,800 154,293,700 155,279,600

Examined 1,452,009 1,300,230 1,426,573 2,100,144 2,136,819

Percent coverage .96 .85 .93 1.36 1.38

Recommended additional tax

and penalties (in billions)

$26.9 $23.1 $23.9 $27.8 $28.1

Individual returns 6.3 5.7 6.2 7.8 $7.6

Corporate returns 18.1 14.7 15.1 17.7 $18.0

All othera 2.5 2.7 2.6 2.3 $2.5

Average tax and penalty per return examined by

Revenue agent for non-CEPb $25,161 $24,704 $18,177 $21,237 $24,407

Revenue agent for CEP 3,940,148 2,700,352 3,279,298 4,032,528 3,998,409

Tax auditor 2,280 2,625 3,113 3,497 3,051

Service center 2,541 2,934 1,945 1,427 1,733

aOther includes fiduciary, estate, gift, employment, excise, windfall profit, and miscellaneous

taxes.

bCEP = Coordinated Examination Program, under which IRS audits the largest corporations.

Page 12 GAO/T-GGD-97-186
Appendix II 

IRS Examination Division Measures for 1997

Basic measures across Examination activities include

1.Amount of additional tax and penalties recommended.

2.Percentage of additional recommended amounts plus interest amounts

that were collected before IRS issued the second notice on the amounts

that were assessed.

3.Average number of days that an audit case remains open.

4.Amount of additional tax and penalty recommended as well as the

amount of tax protected in audits divided by the total full-time-equivalent

staffing invested.

For the Coordinated Examination Program (CEP), additional measures

include

1.Average number of tax years for tax returns filed by a CEP taxpayer that

have not yet been audited.

2.Amount of additional tax and penalty recommendations that CEP

taxpayers agreed to pay minus amount overassessed divided by the total

full-time-equivalent staffing invested.

3.Amount of total adjusted revenues divided by the total

full-time-equivalent staffing invested.

Page 13 GAO/T-GGD-97-186
Appendix III 

IRS’ Examination Quality Measurement

System

The Office of Compliance Specialization, within IRS’ Examination Division,

has responsibility for Quality Measurement Staff operations and the

Examination Quality Measurement System (EQMS). Among other uses, EQMS

measures the quality of closed audits against nine IRS audit standards. The

standards address the scope, audit techniques, technical conclusions,

workpaper preparation, reports, and time management of an audit. Each

standard includes additional key elements describing specific components

of a quality audit. Table III.1 summarizes the standards and the associated

key elements.

Table III.1: Summary of IRS’ Examination Quality Measurement System (EQMS) Auditing Standards (as of October 1996) 

No. Standard Key elements Purpose Overview

1 Considered large,

unusual, or

questionable items

A.Balance sheet and Schedule

M considered

B.Income, deduction, and

credit items considered

C.Scope of examination was

appropriate

Measures whether

consideration was given to the

large, unusual, or questionable

items in both the precontact

stage and during the course of

the examination.

This standard encompasses,

but is not limited to, the

following fundamental

considerations: absolute dollar

value, relative dollar value,

multiyear comparisons, intent

to mislead, industry/business

practices, compliance impact,

and so forth.

2 Probes for

unreported income

A.Consideration of internal

controls for all business returns

B.Consideration of books and

records

C.Consideration of financial

status

D.Appropriate use of indirect

methods

Measures whether the steps

taken verified that the proper

amount of income was reported.

Gross receipts were probed

during the course of

examination, regardless of

whether the taxpayer

maintained a double entry set

of books. Consideration was

given to responses to interview

questions, the financial status

analysis, tax return information,

and the books and records in

probing for unreported income.

3 Required filing

checks

A.Consideration of prior and

subsequent year tax returns

B.Consideration of related

returns

C.Compliance items considered

Measures whether

consideration was given to

filing and examination potential

of all returns required by the

taxpayer, including those

entities in taxpayer’s sphere of

influence/responsibility.

Required filing checks consist

of the analysis of return

information and, when

warranted, the pick-up of

related, prior, and subsequent

year returns. In accordance

with Internal Revenue Manual

4034, examinations should

include checks for filing

information returns.

(continued)

Page 14 GAO/T-GGD-97-186
Appendix III 

IRS’ Examination Quality Measurement

System

No. Standard Key elements Purpose Overview

4 Examination depth

and records

examined

A.Adequate interviews

conducted

B.Adequate exam techniques

used

C.Fraud adequately

considered and developed

D.Issues sufficiently developed

Measures whether the issues

examined were completed to

the extent necessary to provide

sufficient information to

determine substantially correct

tax.

The depth of the examination

was determined through

inspection, inquiry, interviews,

observation, and analysis of

appropriate documents,

ledgers, journals, oral

testimony, third-party records,

etc., to ensure full development

of relevant facts concerning the

issues of merit. Interviews

provided information not

available from documents to

obtain an understanding of the

taxpayer’s financial history,

business operations, and

accounting records in order to

evaluate the accuracy of books

or records. Specialists

provided expertise to ensure

proper development of unique

or complex issues.

5 Findings

supported by law

A.Correct technical or factual

conclusions reached

Measures whether the

conclusions reached were

based on a correct application

of tax law.

This standard includes

consideration of applicable

law, regulations, court cases,

revenue rulings, etc., to

support technical or factual

conclusions.

6 Penalties properly

considered

A.Recognized, considered,

and applied correctly

B.Penalties computed correctly

Measures whether applicable

penalties were considered and

applied correctly.

Consideration of the

application of appropriate

penalties during all examination

is required.

7 Workpapers

support

conclusions

A.Fully disclose audit trail and

techniques

B.Legible and organized

C.Adjustments in workpapers

agree with 4318, 4700, and

reports

D.Activity record adequately

documents exam activities

E.Disclosure

Measures the documentation of

the examination’s audit trail and

techniques used.

Workpapers provided the

principal support for the

examiner’s report and

documented the procedures

applied, tests performed,

information obtained, and the

conclusions reached in the

examination.

8 Report writing

procedures

followed

A.Applicable report writing

procedures followed

B.Correct tax computation

Measures the presentation of

the audit findings in terms of

content, format, and accuracy.

Addresses the written

presentation of audit findings in

terms of content, format, and

accuracy. All necessary

information is contained in the

report, so that there is a clear

understanding of the

adjustments made and the

reasons for those adjustments.

(continued)

Page 15 GAO/T-GGD-97-186
Appendix III 

IRS’ Examination Quality Measurement

System

No. Standard Key elements Purpose Overview

9 Time span or time

charged

A.Examination time

commensurate

B.Exam initiation

C.Examination activities

D.Case closing

Measures the utilization of time

as it relates to the complete

audit process.

Time is an essential element of

the auditing standards and is a

proper consideration in

analyses of the examination

process. The process is

considered as a whole and at

examination initiation,

examination activities, and

case-closing stages.

Source: IRS data.

Standard Success

Rate

EQMS quality reviewers use the key element definitions to determine

whether an audit adhered to the standard. Thus, adherence to audit quality

is measured by the presence or absence of associated key elements. For a

standard to be rated as having been met, each of the associated key

elements must also be rated as met or not applicable. If the audit does not

demonstrate the characteristics described by one of the key elements,

then the standard is rated as not met.

One measure that IRS uses to evaluate the audit quality is the standard

success rate. It measures the percentage of cases for which all the

underlying key elements of each standard are rated as having been met.

According to IRS, this measure is useful for determining whether a case is

flawed and in what area. Figures III.1 and III.2 show the standard success

rates for each of the standards for fiscal years 1992-96 for office and field

audits, respectively.

Page 16 GAO/T-GGD-97-186
Appendix III 

IRS’ Examination Quality Measurement

System

Figure III.1: Standard Success Rates for Office Audits (Fiscal Years 1992-96)

0%

20%

40%

60%

80%

100%

Percentage of standard success rates

 Probes for

unreported income

 Required

filing checks

 Examination depth

and records examined

 Findings

supported by law

 Penalties

properly considered

 Workpapers

support conclusions

 Report writing

procedures followed

Time span/

 Considered

 time charged

large, unusual, or

 questionable items

Standards

1992

1993

1994

1995

1996

Source: IRS data.

Page 17 GAO/T-GGD-97-186
Appendix III 

IRS’ Examination Quality Measurement

System

Figure III.2: Standard Success Rates for Field Audits (Fiscal Years 1992-96)

0%

20%

40%

60%

80%

100%

Percentage of standard success rates

Standards

1992

1993

1994

1995

1996

 Probes for

unreported income

 Required

filing checks

 Examination depth

and records examined

 Findings

supported by law

 Penalties

properly considered

 Workpapers

support conclusions

 Report writing

procedures followed

Time span/

 time charged

 Considered

large, unusual, or

 questionable items

Source: IRS data.

Key Element Pass

Rate

IRS also uses the key element pass rate as a measure of audit quality. This

measure computes the percentage of audits demonstrating the

characteristics defined by the key element. According to IRS, the key

element pass rate is the most sensitive measurement and is useful when

describing how an audit is flawed, establishing a baseline for

improvement, and identifying systemic changes. Figures III.3 and III.4

show the pass rates for the key elements of standard 2 for fiscal years 1992

through 1996 for office and field audits, respectively.

Page 18 GAO/T-GGD-97-186
Appendix III 

IRS’ Examination Quality Measurement

System

Figure III.3: Key Element Pass Rates for Key Elements of Standard 2 for Office Audits (Fiscal Years 1992-96)

0%

20%

40%

60%

80%

100%

Percentages of key element pass rates

Consideration of

internal controls for 

 all business

Consideration of

 books and records

Consideration of 

 financial status

Appropriate use of

 indirect methods

Key Elements of Standard 2, Probes for unreported income

1992

1993

1994

1995

1996

Source: IRS data.

Page 19 GAO/T-GGD-97-186
Appendix III 

IRS’ Examination Quality Measurement

System

Figure III.4: Key Element Pass Rates for Key Elements of Standard 2 for Field Audits (Fiscal Years 1992-96)

0%

20%

40%

60%

80%

100%

Consideration of

internal controls for 

 all business

Consideration of

 books and records

Consideration of 

 financial status

Appropriate use of

 indirect methods

Key Elements of Standard 2, Probes for unreported income

Percentages of key element pass rates

1992

1993

1994

1995

1996

IRS data.

Page 20 GAO/T-GGD-97-186
Page 21 GAO/T-GGD-97-186
Appendix IV 

Number and Percent of Individual Returns

Audited by Audit Source (Fiscal Years

1992-96)

Fiscal year 1992

Audit sources Number Percent

DIF/DIF related 452,445 38%

Nonfilers 119,865 10

Tax shelter related 101,453 8

Self-employment tax 71,126 6

Regular classification 52,528 4

State information 48,418 4

Service center studies and tests 43,333 4

Compliance projects 40,403 3

Claims for refund 33,163 3

Return preparers 27,706 2

Non-DIF multiyear 26,866 2

Unallowable items 13,117 1

Other sources 175,596 15

Total 1,206,019 100%

Page 22 GAO/T-GGD-97-186
Appendix IV 

Number and Percent of Individual Returns

Audited by Audit Source (Fiscal Years

1992-96)

Fiscal year 1993 Fiscal year 1994 Fiscal year 1995 Fiscal year 1996

Number Percent Number Percent Number Percent Number Percent

372,116 35% 239,557 20% 263,200 14% 351,867 18%

190,809 18 402,435 33 410,612 21 212,226 11

48,070 5 29,687 2 27,473 1 20,300 1

46,310 4 43,032 4 48,578 3 40,601 2

50,709 5 47,170 4 46,637 2 48,534 3

3,564 0 4,573 0 3,210 0 71,582 4

20,059 2 22,825 2 25,026 1 18,684 1

44,267 4 41,959 3 38,624 2 45,680 2

37,203 4 26,412 2 23,175 1 31,495 2

28,231 3 27,708 2 26,542 1 33,637 2

29,373 3 26,742 2 24,926 1 29,927 2

12,099 1 134,007 11 761,886 40 824,721 42

176,156 16 179,600 15 219,548 11 212,306 11

1,058,966 100% 1,225,707 100% 1,919,437 100% 1,941,560 100%

Note 1: For this table, we used the format from our 1996 report on audit trends (GAO/GGD-96-91,

Apr. 1996). That format listed the top 10 sources for each of the fiscal years 1992 through 1994.

Using that format, we updated the numbers and percentages for those categories for fiscal years

1995 and 1996.

Note 2: See next page for definitions of terms used in this table.

Note 3: Percentages are the percent of total audits for the year and have been rounded to the

nearest whole percent.

Source: GAO analysis of IRS data.

Page 23 GAO/T-GGD-97-186
Appendix V 

Definitions of Audit Sources

Claims for Refund Ammended returns audited because of taxpayers’ claims for refunds.

Compliance Projects Returns identified through IRS’ information gathering projects.

DIF/DIF Related Returns selected on the basis of a computer-generated score (the scoring

is based on an analysis technique known as discriminant function). Also

included are related returns identified during an audit of a DIF-source

return and related returns from prior or subsequent years for the same

taxpayer.

Non-DIF Multiyear Related returns from prior or subsequent years for the same taxpayer,

when the initial source was other than a DIF-source return.

Nonfilers Audits initiated against known taxpayers who did not file a return with IRS.

Other Sources Over 25 other audit sources, such as referrals from other IRS Divisions,

which were not one of the 10 largest sources during the period of our

review.

Regular Classification Manually selected returns for audit that do not result from other specified

audit sources.

Return Preparers Returns identified for audit due to questionable tax preparers.

Self-Employment Tax Returns involving self-employment tax issues identified by IRS service

center examination staff.

Service Center Studies and

Tests

Returns identified through service center projects initiated by the IRS

National Office.

State Information Returns identified from various state sources, generally under exchange

agreements between IRS and the states.

Page 24 GAO/T-GGD-97-186
Appendix V 

Definitions of Audit Sources

Tax Shelter Related Related returns of partners, grantors, beneficiaries, and shareholders

identified during audits of either partnerships, fiduciaries, or Subchapter S

corporations involving potential tax shelter issues.

Unallowable Items Returns involving refundable credits and dependency exemptions, such as

the Earned Income Tax Credit, identified by service center examination

staff.

(268819) Page 25 GAO/T-GGD-97-186
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