United States General Accounting Office

GAO Report to the Honorable

Paul Coverdell, U.S. Senate

February 1998 TAX

ADMINISTRATION

IRS’ Use of Information

Gathering Projects

GAO/GGD-98-39

GAO United States

General Accounting Office

Washington, D.C. 20548

General Government Division

B-277868 

February 5, 1998

The Honorable Paul Coverdell

United States Senate

Dear Senator Coverdell:

As part of its mission, the Internal Revenue Service (IRS) strives to

maintain the highest possible level of tax compliance. IRS annually audits a

number of tax returns to determine whether taxpayers have voluntarily

complied with the tax laws and paid the proper amounts of tax. In

selecting returns for audit, IRS’ computer assigns a score1

 to each filed

return to help find those having audit potential—that is, those for which an

audit would be likely to change the reported tax because of

noncompliance.

Because such computer-aided selection techniques rely solely on

information on filed returns, IRS’ Examination Division collects

information from other sources to identify areas of potential taxpayer

noncompliance. Information Gathering Projects (IGP) are one technique

that IRS uses to collect information on noncompliance and to identify

returns with audit potential.

Due to your concerns about IGPs being misused in auditing tax returns, you

asked us to study IRS’ use of IGPs in identifying returns for audit. This

report responds to your request for information on the (1) number of IGPs

nationwide and in IRS’ Georgia District during fiscal years 1994 through

1996, (2) descriptions and results of IGPs in the state of Georgia during

fiscal years 1994 through 1996, and (3) controls and procedures IRS has in

place for IGPs. We focused on fiscal years 1994-1996 because accurate and

verifiable data for prior years were unavailable.

Background An IGP is a study or survey undertaken to identify noncompliance with the

tax laws. IGPs can be proposed at any level—district, regional, or

national—within IRS but are generally initiated at one or more of IRS’ 33

district offices. IRS staff propose IGPs on the basis of past audits or studies

that have shown noncompliance for selected taxpayer populations, such

1

This computer-generated score is called discriminant function (DIF). IRS has computed such a score

since the 1960s by using a formula created from the results of compliance audits of randomly selected

tax returns filed by individuals and other taxpayer populations. Through tax year 1988, IRS did these

compliance audits about every 3 years. Using the score, IRS sorts returns into those having and not

having audit potential. DIF is IRS’ major source for objectively identifying tax returns to audit.

Page 1 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
B-277868 

as those in a particular occupation, industry, geographic area, or economic

activity, or those claiming a particular tax exemption, deduction, or credit.

During an IGP, IRS staff usually audit a limited number of taxpayers within

the selected population. For IGP audits, IRS staff are to select tax returns

after reviewing information available within IRS and from non-IRS sources

such as banks, licensing and trade organizations, or other third parties. IRS

believes that IGPs help IRS staff to select potentially noncompliant tax

returns for audit that would not otherwise be identified as having audit

potential. In this vein, IGPs have served as 1 of over 30 sources that IRS’

Examination Division uses to identify returns with audit potential. In

recent years, IGPs have accounted for less than 5 percent of the total

number of returns selected for audit.

In addition to using IGPs to identify noncompliance and take enforcement

action, IRS also intended to use them to determine the reasons for

noncompliance and recommend ways to reduce it. However, IRS has

historically used IGPs as tools for enforcing tax laws rather than as

research tools for collecting data about compliance within taxpayer

populations. Our past work has discussed some of the problems with

attempts to research noncompliance and related solutions through IGPs.2

For example, we raised concerns about whether IGPs (1) focused on

taxpayer populations with significant compliance shortfalls and

(2) collected statistically valid data that could be generalized to a larger

population. As for IRS’ management of IGPs, we pointed to the benefits of

enhanced coordination across IGPs in order to avoid unnecessary

duplication and to make fuller use of IGP results.

In recent years, IRS has been going through a transition involving its

framework for doing compliance research, including the use of IGPs as

research tools. Under its 1997 compliance initiative proposal (CIP), IRS is

attempting to link IGPs to a larger research framework and better manage

IGPs to make them more useful for doing compliance research. In fact, IRS

intends to refer to IGPs as “compliance initiatives.”3 Recognizing these

changes, IRS Examination officials continue to view IGPs as essential

2

Tax Administration: Profiles of the Major Components of the Tax Gap (GAO/GGD-90-53BR, Apr. 4,

1990), Tax Administration: Compliance 2000—A Worthy Idea That Needs Effective Implementation

(GAO/T-GGD-92-48, June 3, 1992), Tax Administration: IRS Can Better Pursue Noncompliant Sole

Proprietors (GAO/GGD-94-175, Aug. 2, 1994), and Tax Research: IRS Has Made Progress but Major

Challenges Remain (GAO/GGD-96-109, June 5, 1996).

3

The term “compliance initiative” refers to and replaces all activities/projects, such as IGPs, to study,

measure, or improve tax compliance.

Page 2 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
B-277868 

enforcement tools and sources for data on specific types of

noncompliance.

The revised framework also includes IRS’ recent efforts to develop a more

comprehensive and statistically valid approach to compliance research.

Under this approach, IRS has created new research methods and tools as

well as research units in each district to do compliance research and to

oversee compliance efforts, such as IGPs. IRS hopes that this approach will

produce valid research data to better identify significant noncompliance

and the reasons for it, as well as to better test ways to reduce the

noncompliance.

Results in Brief IRS reported that it had about 1,000 IGPs open nationwide during both fiscal

year 1995 and fiscal year 1996. Data on the nationwide number of IGPs in

fiscal year 1994 were not readily available. According to IRS officials,

nationwide IGP tracking records were discarded or lost during IRS’

reorganization efforts, which involved consolidating 63 districts into 33

and shifting responsibility for IGP records.

Of the 76 IGPs that were open in Georgia during fiscal years 1994 through

1996, over half focused on (1) business taxpayers that potentially

underreported their income or overreported expenses; (2) business

taxpayers that potentially did not properly report or pay taxes, such as the

excise tax on fuels; (3) individual taxpayers who potentially claimed an

improper exemption, filing status, or earned income credit; and

(4) business and individual taxpayers who potentially did not file required

tax returns. Of these 76 Georgia IGPs, 41 had closed as of June 1997. The

duration of these closed audits varied from several months to several

years. The audit results, such as additional taxes recommended plus

penalties, also varied, with the additional tax amounts ranging from $0 to

$269 million. For most of these IGPs, IRS audited relatively few tax returns.

IRS closed about three-quarters of these IGPs after auditing fewer than 50

returns, including 9 that closed without any audits being done.

For years, IRS has had several controls and procedures designed to limit

the vulnerability of IGPs to misuse as an audit selection technique. IRS has

always required that proposed IGPs undergo review and approval

processes at high levels within the Examination Division in each of the

districts. To oversee IGPs, IRS has a unit at each of its 33 district offices.

These units monitor how returns were selected for audit and whether the

audit results justified continuance of the project.

Page 3 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
B-277868 

Further, IRS recently has started adding processes to enhance the

contribution of IGPs to compliance research. In 1997, IRS began

implementing CIP processes. IRS is involving its Research Division in the

processes for approving and overseeing IGPs in the hopes of making IGPs

more useful for research purposes.

IGPs Nationwide and

in Georgia

IRS Examination staff can run IGPs in IRS’ National Office, its 33 district

offices, and its 10 service centers. Table 1 shows the reported number of

IGPs for IRS nationwide and for the Georgia District.

Table 1: IGPs Open Nationwide and in

the Georgia District During Fiscal

Years 1994 Through 1996

IGP area 1994 1995 1996

Nationwide a 1,097 931

Georgia District 53 38 37

aIRS could not provide data on the number of IGPs during fiscal year 1994 because records were

discarded or lost during IRS reorganizing and restructuring.

Source: IRS data for fiscal years 1994 through 1996.

Because most IGPs start in one fiscal year and close in a later year, the total

number of individual IGPs is smaller than the sum of IGPs for the 3 fiscal

years. For the Georgia District, the total number of individual IGPs reported

was 76, but the sum of the IGPs shown as open in the 3 fiscal years in table

1 was 128.

Recent IGP Results in

IRS’ Georgia District

For fiscal years 1994 through 1996, IRS provided information on 76 IGPs that

were open at some time during these years in the Georgia District. Over

half of these IGPs (44) focused on four types of taxpayers: (1) businesses

that potentially underreported income or overreported expense

deductions; (2) businesses that potentially did not properly report or pay

taxes, such as excise taxes on fuel, chemicals, or heavy vehicle use;

(3) individual taxpayers who potentially claimed an improper exemption

for dependents, a filing status (e.g., head of household), or earned income

credit; and (4) businesses and individual taxpayers who potentially did not

file required tax returns. The remaining 32 IGPs dealt with a wide range of

suspected noncompliance involving topics such as the misclassification of

employees as independent contractors, income from wagering, income

from timber sales, and taxable events for individual partners or

shareholders.

Page 4 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
B-277868 

We tracked the duration and audit results of Georgia IGPs that had closed

at the time we did our work. Of the 76 IGPs, 41 were closed as of June 1997.

The length of time that these 41 IGPs had remained open varied from 5

months to several years; more specifically, 23 of the 41 IGPs lasted 2 or

more years. The audit results for the 41 IGPs also varied widely. These

results included the number of returns audited, the additional taxes and

penalties recommended, and the percent of audited returns that

recommended no tax changes. For example:

• The number of returns audited ranged from 0 to 516 but usually involved

fewer than 50. Of the 41 closed projects, 32 involved audits, and 9 involved

no audits.4

 Of the 32 projects involving audits, 23 were closed after

auditing fewer than 50 returns each.

• The additional recommended tax plus penalty amounts per IGP ranged

from $0 (in the 9 IGPs closed without any audits) to $269 million; of the 32

IGPs with audits, 11 recommended total additional tax amounts that

exceeded $500,000, and 7 recommended total amounts exceeding

$1 million.

• Of the 32 IGPs with audits, 3 closed with a no-change rate that exceeded

50 percent, meaning that over half of the audited tax returns in these 3

projects were deemed compliant and that the audits recommended no tax

changes. Across all 32 IGPs, this no-change rate ranged from 0 percent to

60 percent, and the median no-change rate was about 20 percent.

Appendix I to this letter provides specific details on IGPs in Georgia during

fiscal years 1994-1996. Tables I.1 and I.2 provide brief descriptions of

projects that were not yet closed as well as of those that were closed as of

June 1997. Table I.3 reports the audit results of projects that were closed

as of June 1997.

IGP Controls and

Procedures

For years, IRS has had various controls and procedures in using IGPs as

audit selection tools, including the approval and review of proposed

projects, independence in the selection of returns, and limits on the

duration of the audit phase. These controls and procedures are designed

to guard against any improprieties and misuse of IGPs, as well as to better

ensure productive use of audit resources. We did not test whether and

how well these controls and procedures have worked. The following

describes what these IGP controls and procedures have included.

4

An IGP can close without any audits when the information gathering phase indicates that audits or

further study of the selected population is not warranted.

Page 5 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
B-277868 

IRS requires that IGPs be authorized by a district director or higher level

management official for a specified length of time. According to IRS

officials, the process generally starts out informally when an IRS employee,

usually a revenue agent, discovers an area of potential noncompliance.

The revenue agent discusses the issue with a manager and IGP coordinator

(who is to oversee and track all IGPs). If these parties agree about the

potential for noncompliance, an Information Gathering Project

Authorization (Form 6545) is prepared and forwarded, along with

supporting documents, through various organizational levels for review

and approval.

IRS officials also review IGP proposals to ensure that the project conforms

with Internal Revenue Manual requirements on IGPs. Among other things,

the officials are to look at the (1) purpose and objective of the project;

(2) data (such as compliance measures) that support the need for the

project; (3) description of the data needed to do the project, including why

and how the data will be used; and (4) time frames and resources

necessary to complete the project. In addition, officials are to ensure that

the project does not duplicate other IGPs and that the potential

noncompliance, which is the focus of the project, can meet or exceed the

noncompliance that would otherwise be identified through audits initiated

under DIF criteria.

If approved at each level, the proposal continues to move up the chain of

command. At a district office, this chain of command generally includes

the

• group manager of the revenue agent proposing the IGP;

• branch chief for that audit group manager;

• the chief of the Examination Division, who is responsible for all

Examination activity in the district; and

• the district director, who is responsible for ultimate approval of the IGP as

well as various other types of IRS activities within the district.

In addition, other district Examination staff play a role in reviewing and

approving IGPs. After the branch chief’s review, the IGP coordinator and the

chief of the Planning and Special Programs office (who is to oversee and

track various types of Examination programs) have a role in coordinating

any further review and approval. Once approved by the chief of the

Examination Division, proposed projects are to be routed through the

chief of the District Office of Research and Analysis, who is either to

concur or not concur. The District Disclosure Office also reviews each IGP

Page 6 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
B-277868 

request. Following this, the district director reviews the proposal. If the

director approves, work on the project can begin.

Approved IGPs normally include an information gathering phase and an

audit phase. During the information gathering phase, the project

coordinator and/or project team—usually two or more agents developing

the IGP—collect and analyze information on a particular type of taxpayer,

such as child care providers. Techniques and sources for collecting

information may include interviews with third parties as well as reviews of

internal5

 and external data related to the IGP. By analyzing the information,

the project coordinator is to identify whether the apparent noncompliance

is significant enough to warrant audits and, if so, which types of tax

returns have audit potential and should be audited.

In a 1994 report,6

 we raised two concerns about the selection of returns to

be audited under IGPs. We found that the controls and procedures (1) were

not adequate to prevent Examination staff from selectively targeting

individual taxpayers for audit, and (2) did not require a separation of

duties between staff who identified the types of returns to audit and staff

who selected the specific returns for audit. In July 1995, IRS issued new

guidance to address these two concerns about IGP controls and

procedures.

Under this new guidance, the project coordinator is to work with the IGP

coordinator to identify returns to be audited according to set criteria, such

as the type of tax return, filing status, dollar threshold, and compliance

issue being reviewed. The IGP coordinator is responsible for ordering the

returns for audit under the project that meet these criteria. When the

returns are received, the IGP coordinator (who is located in Planning and

Special Programs) is responsible for getting them manually reviewed to

check audit potential using the criteria selected by the project coordinator.

Returns with audit potential are assigned for audit according to such

criteria as the location of the taxpayer, grade levels of the agents, and their

knowledge about the issues that are the focus of the IGP.

The duration of the audit phase for an IGP depends on whether (1) the

project team continues to find tax returns that fit into the defined category

5

A primary internal data source is the Midwest Automation Compliance System (MACS). IRS can use

MACS to identify returns that fit the criteria established for the particular type of potential

noncompliance being covered by a specific IGP.

6

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

(GAO/GGD-95-14, Oct. 26, 1994).

Page 7 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
B-277868 

of taxpayers, and (2) the auditors find sufficient levels of noncompliance

on the audited returns. More specifically, the IGP audits should find more

noncompliance than that uncovered in audits routinely selected by IRS

using the computer-generated score produced under DIF. Because of these

controls, some IGPs terminate after a small number of returns are audited,

compared to the number ordered and assigned. Upon termination of the

IGP, IRS requires that a termination report be submitted to the IGP

coordinator to document audit and other results.7

In 1997, IRS began implementing additional processes under CIP that cover

all compliance initiatives, including IGPs. IRS intends for these processes to

introduce more rigor so that the results from IGPs and other projects can

be used for research purposes. CIP guidelines require substantially more

documentation for proposed compliance projects than previously

required. The proposals must identify the methodology to be used and the

extent to which the project will improve compliance within the district. A

district planning council8

 is to submit the required documentation to the

district director together with its recommendation to approve or

disapprove the proposed project. Upon completion of an approved project,

the results are to be reported to the planning council, which will make a

recommendation to the district director to either continue, expand, or

terminate the project, or to transform it into a fuller research project at the

local or national level.

Scope and

Methodology

To accomplish each objective, we interviewed responsible officials at IRS’

National Office, the Atlanta District Office, and the Southeast Regional

Office and collected data relevant to IRS’ use of IGPs to detect

noncompliance with the tax laws.

To identify the number of IGPs open both nationwide and in Georgia in

fiscal years 1994 through 1996, we reviewed available records from IRS’

National Office and Georgia District. We did not verify the accuracy of IRS’

data on the total number of IGPs conducted nationwide. IRS’ National Office

could not locate data on the total number of IGPs nationwide during fiscal

year 1994. According to officials, IRS began a total restructuring in fiscal

year 1994 that reduced the number of district offices from 63 to 33 and

7

In addition to the audit results, the termination report provides (1) an assessment as to whether the

tax adjustments justified the time spent on the project, (2) descriptions of procedures and audit

techniques, (3) explanations of difficulties encountered during the project and how they were

resolved, and (4) suggestions for reducing the specific area of noncompliance in the future.

8

The district planning council is a group that oversees district activities, such as compliance initiatives,

to ensure that they are carefully planned and consistent with IRS’ mission.

Page 8 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
B-277868 

shifted the responsibility for maintaining IGP records. Officials also told us

that IRS has no requirement to retain records on the number of IGPs.

To describe the IGPs in the Georgia District and their results, we collected

and reviewed all available IGP authorization and termination reports for

fiscal years 1994 through 1996. In addition, we reviewed Examination

Division data for individual project results, such as the number of returns

audited, total taxes recommended per audit hour and per audited return,

additional taxes recommended plus penalty amounts, and the percentage

of tax returns for which the audit recommended no tax change. We

focused our efforts on all IGPs that were open at any time during fiscal

years 1994 through 1996.

To describe the controls and procedures for IGPs, we collected and

reviewed relevant IRS documents and manuals as well as interviewed

responsible IRS officials in the National Office and the Georgia District.

These controls and procedures included those established for the approval

of proposed IGPs, the independent selection of tax returns to be audited,

and the duration of the audit phase in an IGP. We did not test how well

these controls and procedures for IGPs worked. Further, we collected

documentation and did interviews with the responsible IRS officials on the

new processes being implemented during 1997 under the CIP guidelines.

We conducted our review from June to September 1997 in accordance

with generally accepted government auditing standards.

Agency Comments

and Our Evaluation

In a letter dated December 12, 1997, IRS’ Acting Chief Compliance Officer

commented on a draft of this report (see app. II). He said the report fairly

presented the information and he elaborated on information dealing with

IRS’ controls over IGP and the new CIP.

As we arranged with your office, unless you publicly announce its

contents earlier, we plan no further distribution of this letter until 30 days

from its date of issue. We will then send copies to the Commissioner of

Internal Revenue and Members of the Georgia congressional delegation.

We also will make copies available to others upon request.

Page 9 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
B-277868 

Major contributors to this report are listed in appendix III. Please contact

me on (202) 512-9110 if you or your staff have any questions about the

report.

Sincerely yours,

Lynda D. Willis

Director, Tax Policy and

 Administration Issues

Page 10 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Page 11 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Contents

Letter 1

Appendix I 

Summary of IGP

Activity in the Georgia

District, Fiscal Years

1994-1996

14

Appendix II 

Comments From the

Internal Revenue

Service

22

Appendix III 

Major Contributors to

This Report

23

Tables Table 1: IGPs Open Nationwide and in the Georgia District

During Fiscal Years 1994 Through 1996

4

Table I.1: Profile of Georgia District IGPs Open During Fiscal

Years 1994-1996 and Not Yet Closed as of June 1997

14

 Table I.2: Profile of Georgia District IGPs That Were Closed by

June 1997

16

 Table I.3: Results of Georgia District IGPs Closed by June 1997 20

Abbreviations

CIP compliance initiative proposal

DIF discriminant function

IGP Information Gathering Project

IRS Internal Revenue Service

MACS Midwest Automation Compliance System

Page 12 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Page 13 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Appendix I 

Summary of IGP Activity in the Georgia

District, Fiscal Years 1994-1996

Table I.1: Profile of Georgia District IGPs Open During Fiscal Years 1994-1996 and Not Yet Closed as of June 1997

Project Start date Purpose

Auto dealerships 02/14/92 To identify auto dealerships that are diverting rebates from insurance and warranty

contracts sold to customers. The project also focuses on (1) overstating inventory

(cost-of-goods-sold) and other expenses due to an error in utilizing the LIFO

(last-in-first-out) inventory method and (2) underreporting issues stemming from

related finance companies and producer owned insurance companies.

Construction contractor and

subcontractor compliance

03/13/92 To increase contractor and subcontractor compliance with (1) income tax filing and

reporting requirements and (2) 1099 filing requirements. This project also focuses on

the issue of contractors building homes and transferring them to themselves for less

than fair market value, resulting in a significant dividend.

Scrap and recycling dealers 04/16/92 To determine whether the entities who receive income from selling scrap products

(paper, metal, glass, etc.) to companies dealing in recycling are reporting the

income.

Land condemnation awards 04/26/92 To determine if taxpayers are properly reflecting land condemnation awards (in

which real estate is acquired under the condemnation) on their tax returns.

Personal service corporations 05/12/92 To identify personal service corporations that do not use the required 34-percent tax

rate and to adjust their tax computation accordingly.

Printing industry 05/15/92 To (1) gain knowledge of a very large growth industry, (2) identify the areas of

noncompliance with the tax laws, and (3) develop techniques and procedures to

deal with the noncompliance in the industry. Potential issues include excessive

management compensation and changes in accounting methods resulting in large

adjustments.

Child support recovery 06/17/92 To identify individuals who may be using improper filing statuses, claiming

exemptions they are not entitled to, and erroneously receiving Earned Income Credit

(EIC). The project focuses on those individuals making child support payments and

filing incorrect tax returns in an attempt to receive an income tax refund.

Earned income credit (EIC) 02/04/93 To determine (1) the level of compliance in reporting EIC, and (2) whether taxpayers

who filed as single or heads of household and claimed EIC are actually entitled to

the credit.

Invalid 1120-S elections

(i.e., corporate returns)

02/04/93 To identify those individual shareholders who claim losses stemming from an 1120-S

corporation on their return, when the corporation either has not filed the Form 2553

(Request for 1120-S status) or has been denied 1120-S status. The project also

focuses on taxpayers’ returns where the 1120-S election was approved for a

subsequent year, but the loss was taken in the current year, for which the 1120-S

status was not granted.

Wagering 02/10/93 To identify those individuals engaged in gambling activities and to determine their

compliance with the tax laws.

Tax return preparers 02/24/93 To determine whether individuals who own tax return preparation businesses are

filing their own individual income tax returns. This project also focuses on preparers

who have claimed losses from their tax return preparation businesses.

Illegal income 03/04/93 To identify individuals who fail to report income from drug-trafficking activities. A

potential issue is that substantial amounts of money and assets are connected with

drug-trafficking activities and that individuals involved do not report their income.

Nonfilers identified by the

Criminal Investigation Branch

03/25/93 To develop cases on taxpayers who have not filed tax returns for at least 1 year. The

project focuses on those taxpayers identified by the Criminal Investigation Branch of

the Atlanta Service Center.

(continued)

Page 14 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Appendix I 

Summary of IGP Activity in the Georgia

District, Fiscal Years 1994-1996

Project Start date Purpose

Heavy vehicle 

use tax

05/24/93 To determine the degree of compliance of Georgia taxpayers with the reporting and

paying of heavy vehicle use tax.

Duplicate address returns 06/10/93 To determine which taxpayer is actually entitled to the head of household filing status

and the related tax exemptions when the same mailing address is duplicated by

several taxpayers all claiming the same filing status and exemptions.

Contract nurses 06/17/93 To identify nurses or respiratory therapists who work as subcontractors through

placement agencies. A potential issue is that a number of these nurses and

therapists do not file tax returns or claim erroneous expenses.

Excessive deductions 07/15/93 To identify potential areas of abuse and noncompliance by taxpayers filing at the

Atlanta Service Center. The project focuses on individuals who may be taking

excessive deductions on their income tax returns.

Unreported tip income 08/14/93 To determine the extent of compliance in tip reporting by employees and employers

of large food and beverage establishments.

Tow trucks and wreckers 09/09/93 To identify individuals and corporations in the vehicle towing industry that are

substantially underreporting gross receipts. The project focuses on three different

types of towing services in which taxpayers are known to be the most noncompliant:

(1) contract wrecker services for the government, ( 2) private impounding services

for the government and private property owners, and (3) private towing services for

individuals and businesses.

Bars and restaurants 02/01/94 To gain knowledge of the restaurant industry, identify areas of noncompliance with

the tax laws, and develop techniques and procedures to properly audit the industry.

Fuel excise tax 02/20/94 To determine the extent to which taxpayers are claiming allowable fuel excise tax

credits on form 4136 and whether individuals are filing correct income tax returns

and complying with the fuel excise tax laws.

Corporate used

auto sales

06/14/94 To determine whether corporate used auto dealers are properly reporting the income

and finance charges (from financed sales) on the accrual basis and properly

accounting for their ending inventory.

Voluntary Employee

Beneficiary Association

(VEBA)

07/10/94 To identify employers who utilize a VEBA to pay employee fringe benefits in a

manner that results in significant tax deductions. These deductions are not in

compliance with tax laws.

Healthcare industry 08/18/94 To determine whether (1) technical issues present in the Coordinated Examination

Program (CEP) returns are present in the returns of health care providers not

included in the CEP, and (2) fraudulent physician compensation issues are present

in the returns filed by exempt, for-profit providers.

Alimony 02/09/95 To determine whether taxpayers who are (1) paying alimony are properly deducting

it and (2) receiving alimony are properly reporting the income as required by tax

laws.

Plumbing, heating, and air

conditioning

02/20/95 To determine whether plumbing, heating, and air conditioning contractors and

subcontractors are correctly reporting income and using the proper method of

accounting. A potential issue is that this industry widely operates on a cash basis

and uses inventory as a significant income-producing factor.

Form 8300 compliance 04/15/95 To (1) determine the level of compliance by taxpayers in filing Form 8300 and (2)

identify fraud where the nonfiling of form 8300 is deliberate. Tax law requires all cash

payments received in a trade or business in excess of $10,000 to be reported on a

form 8300.

Schedule C truckers 06/21/95 To identify truckers who have claimed excessive deductions for repairs and

maintenance on their Schedule C. The goal is to have truckers deduct only

necessary repairs paid in the tax year and to depreciate any capital expenditures.

(continued)

Page 15 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Appendix I 

Summary of IGP Activity in the Georgia

District, Fiscal Years 1994-1996

Project Start date Purpose

Automotive industry—District

Office of Research and

Analysis Study

07/18/95 To determine whether individuals in the automotive industry are filing correct income

tax returns and complying with the tax laws. The project focuses on those who

appear to be filing questionable returns because they report (1) less than $25,000 in

gross receipts on their Schedule C and (2) insufficient income over multiple years to

support the expenses.

Real estate partnerships 08/25/95 To increase compliance with tax law requirements for subchapter K partnerships

(distributions and transfers of interest) in the construction and real estate industry.

Adult entertainment 12/05/95 To identify those adult entertainment clubs that classify their dancers as independent

contractors, instead of as employees, and have set up a payment arrangement that

avoids any type of form 1099 or W-2 reporting requirements. The project also

focuses on tax compliance, nonfiler, and underreporting issues.

Chemical tax 05/16/96 To determine the level of compliance in reporting excise tax on chemicals and

whether individuals are filing correct income tax returns and complying with the tax

laws.

Reclassification of 1120-S

distributions to wages

06/19/96 To determine whether 1120-S shareholders are receiving salary in the form of

distributions, instead of wages, to avoid the payment of Social Security and

Medicare taxes and the withholding of income tax.

Lump-sum timber sales to

individuals

06/28/96 To determine whether land owners who cut or sell timber are accurately reporting

timber sales, using form T, filing form 1099, and computing basis. (Form T is the form

used for lump-sum contract sales and retained pay-as-you-cut interest contracts.)

Schedule C filers qualifying

for EIC

07/15/96 To identify Schedule C filers who underreport their net Schedule C income to qualify

for EIC and receive an income tax refund. Potential issues include questionable

situations involving Schedule Cs and EIC. In these cases, the taxpayer underreports

business income and overreports business expenses to get the maximum amount of

EIC and therefore generate a refund.

Source: IRS data for 1994-96.

Table I.2: Profile of Georgia District IGPs That Were Closed by June 1997

Project Dates Purpose

Bail bond companies 01/17/92 - 01/13/95 To promote compliance in the bail bond industry and determine whether

bondsmen were correctly reporting income from deferrals and cooperative

arrangements. Potential issues included whether some bond companies

deferred income on monies received from clients whose bonds were bound

over to state court. Also, bondsmen often cooperated with bondsmen in

other cities in writing bonds for their clients but underreported income

received under the cooperative agreement.

Automobile dealers 02/14/92 - 03/01/97 To determine whether automobile dealers overstated their inventory (cost of

goods sold) due to an error in the inventory method utilized.

Corporate employee

embezzlement

03/03/92 - 04/30/94 To determine whether corporate employees who embezzled funds reported

the income.

Construction revisited 03/13/92 - 01/31/95 To conduct a follow-up review of the construction industry. A prior project

was run in 1987 to determine the level of compliance in the construction

industry with reporting and paying income taxes.

(continued)

Page 16 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Appendix I 

Summary of IGP Activity in the Georgia

District, Fiscal Years 1994-1996

Project Dates Purpose

Timber sales 03/16/92 - 12/31/93 To determine whether individuals who sold timber were reporting the

income from such sales. Form 1099s were not required to be issued to

payees by purchasers of timber.

Construction of personal

residence

03/16/92 - 03/31/95 To determine the level of compliance in reporting correct income and

expenses of taxpayers who constructed their personal residences at a cost

of over $100,000.

Child care providers 03/26/92 - 04/05/94 To determine whether child care providers were complying with tax laws.

Potential issues include whether some providers cared for many more

children than that allowed by the state, but only reported money earned

from the “state allowed” number. Another issue was that the providers who

qualified for food reimbursement from the state failed to report it on their tax

return.

Poultry industry 04/16/92 - 10/27/93 To determine whether the industry was in compliance with the income

reporting requirements of the tax law.

Hazardous waste sites 04/16/92 - 01/23/95 To determine the degree of compliance in the industry, including whether

companies assessed fines or penalties for environmental law violations

deducted such penalties on their tax returns.

Customizing shops (vans and

cars)

04/23/92 - 03/24/94 To determine whether automobile customizing shop owners were

complying with tax laws and filing income tax returns. The project also

focused on individuals and customers who frequent these businesses and

spend large amounts of cash on customizing their cars, vans, etc.

Advertising industry 06/15/92 - 05/22/95 To determine the degree to which the advertising industry was in

compliance with the income reporting requirements under tax law. Issues

included cash versus accrual method accounting and inventory costs

associated with the production activities of an advertising agency.

Casino report 06/15/92 - 05/31/96 To identify those individuals who gambled at various casinos, purchased

large amounts of chips in cash, and were either not filing or filing fraudulent

income tax returns.

Ozone depleting chemicals 06/17/92 - 12/30/93 To determine whether taxpayers were filing correct income tax returns and

complying with the excise tax laws on chemicals.

Fraud referral follow-up 06/17/92 - 03/31/94 To determine whether taxpayers who had been referred for fraud penalties

in prior years were complying with the tax laws.

Self-prepared business

returns

06/22/92 - 12/31/93 To determine whether the complexity of the Internal Revenue Code

contributed to the level of noncompliance among business taxpayers who

prepared their own tax returns.

Nude dancers 06/29/92 - 04/01/94 To determine whether nude dancers complied with tax laws and filed

income tax returns. A potential issue identified from a televised news report

was that many dancers reportedly earned $50,000 and up annually and

never filed tax returns.

Asbestos removal 08/03/92 - 10/31/94 To determine whether taxpayers who removed asbestos from properties

they own were in compliance with tax law. A potential issue was that

asbestos removal costs were deducted instead of capitalized. Tax law

prohibits the deduction of costs associated with permanent improvements

that increase the value of any property. Asbestos removal enhances market

value.

Auto salvage auctions 08/06/92 - 10/03/94 To increase compliance in filed tax returns and reported income from the

sale of salvage automobiles by used car dealers and repair shops.

(continued)

Page 17 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Appendix I 

Summary of IGP Activity in the Georgia

District, Fiscal Years 1994-1996

Project Dates Purpose

Unmatched information

returns

08/31/92 - 06/30/95 To determine whether amounts that were reflected on mismatched

information returns were reported by the taxpayer.

Accounting and legal

professions

09/10/92 - 09/30/95 To determine whether individuals in the accounting and legal professions

were filing correct income tax returns and complying with the tax laws.

Laundromats 10/10/92 - 02/06/96 To identify those laundromats that understated cash sales. Potential issues

included whether the understatement was due to incomplete or fraudulent

records of daily cash receipts. The project also focused on unreported

income, nondeductible expenses, gains and losses in connection with the

sale of laundromats, loans to and from shareholders, and unfilled income

tax returns.

Livestock sold by gentlemen

farmers

11/02/92 - 05/02/94 To identify gentlemen farmers who failed to report income from the sale of

livestock through stockyards.

Original issue discount (OID)

exclusions on bonds

11/04/92 - 12/31/96 To determine whether taxpayers who were holders of bonds issued by a

certain corporation were correctly reporting income. IRS found that some

taxpayers included OID income as taxable interest income on their returns

but then backed out the same income as an ordinary loss from unpaid

accrued interest thus excluding the income. The taxpayers claimed that the

corporation became insolvent and was incapable of paying the interest.

Medical transportation 11/24/92 - 06/30/96 To increase compliance among individuals who generated income by

furnishing medical transportation to Medicaid patients. A potential issue

was that these individuals substantially overstated their business expenses

or claimed expenditures of a personal nature as business expenses.

Peanut and other crop quotas 02/09/93 - 07/31/94 To increase compliance among individuals who failed to report or

underreported income from the sale of crop quotas for peanuts, tobacco,

and other products. The project also focused on those individuals who

improperly treated crop quotas as depreciable or amortizable assets. Crop

quotas that may be sold can be obtained from the Agricultural Stabilization

and Conservation Service.

Water transportation

companies

02/24/93 - 12/31/93 To determine (1) the level of compliance in the water transportation industry

and (2) whether these companies were bona fide companies, tax shelters,

or hobby losses.

Employee versus

independent contractor

(registered representative)

05/12/93 - 09/30/94 To determine whether securities firms treated their salespersons as

employees or as independent contractors. According to IRS, the Securities

and Exchange Commission has a regulatory interest in assuring that all

broker-dealers maintain the control and supervision required under the

Securities and Exchange Act. The control required would indicate that the

salesmen should be considered employees.

Video stores 05/24/93 - 09/30/95 To determine whether video stores were correctly following tax law

requirements, which state that video cassettes should be depreciated using

either the straight-line or income forecast method of depreciation.

Financial products 06/01/93 - 09/30/94 To identify taxpayers who were involved in the use of financial products

(options, swaps, futures contracts, etc.) and determine whether proper

characterization of gains or losses was made in accordance with tax laws.

Discharge of indebtedness 09/02/93 - 08/31/94 To determine whether taxpayers properly included their discharge of

indebtedness in income. A potential issue was that taxpayers had

mortgages secured by bonds issued by their counties. When the bonds

were paid off early, the county notified the mortgage company and the

remaining mortgage was forgiven. Tax laws require that taxpayers include

this discharge of debt in income in the year the discharge occurs.

(continued)

Page 18 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Appendix I 

Summary of IGP Activity in the Georgia

District, Fiscal Years 1994-1996

Project Dates Purpose

Timber sales 11/02/93 - 11/18/94 To determine whether individuals who sold timber were reporting income

from such sales. Form 1099s are not required to be issued to payees by

purchasers of timber.

Nonfiler partnerships 12/02/93 - 12/31/95 To encourage all partnership entities that had ceased filing tax returns to file

income tax returns and comply with the tax laws.

Lottery businesses 12/14/93 - 06/22/94 To determine whether business owners were filing correct income tax

returns and complying with the tax laws. The project focused on those

business owners who filed applications with the state to sell lottery tickets

but were refused permission to sell the tickets as a result of their failing to

meet state criteria.

Georgia nonfilers 02/01/94 - 01/31/96 To determine whether Georgia taxpayers were filing federal income tax

returns. The project focused on three different segments of Georgia

taxpayers who were potential federal nonfilers: (1) taxpayers who filed

under the Georgia Amnesty program, (2) taxpayers who applied for

licenses to sell lottery tickets, and (3) taxpayers identified with state sales

tax information.

Farm credit association

members

02/04/94 - 09/30/94 To determine whether farmers who did business with farm credit

associations, and who submitted crop checks as payment on their loan

accounts, complied with the tax law requirements of reporting receipts as

part of gross income.

Title VII discrimination

settlements

03/14/94 - 03/10/95 To determine whether taxpayers who received awards based on a

discrimination complaint were including the correct amount in income.

Vaccine floor stock

compliance

04/20/94 - 04/30/96 To determine the level of compliance in reporting the vaccine floor stock tax

that was due 2/28/94. This was a one-time tax.

Mortuaries and funeral homes 04/20/94 - 05/31/96 To determine the degree to which the funeral home industry was in

compliance with federal tax law requirements for funeral home income and

information return (forms W-2 and 1099) reporting and proper matching of

income with expenses.

Underground storage tank

cleanup costs

05/04/94 - 10/13/94 To identify noncompliance with the tax treatment of underground storage

tank cleanup costs (capital versus current expenses).

Depreciation on 

tax-exempt bonds

07/14/94 - 07/27/95 To ensure depreciation compliance by taxpayers who received private

tax-exempt activity industrial development bonds. A potential issue was that

taxpayers often used the other-method and life depreciation methods

instead of the straight-line alternative and required-life depreciation

methods that are required by tax law.

Debenture conversions 07/14/94 - 07/31/95 To determine whether income (gains) from the conversion of debentures

was reported in accordance with the tax law requirements.

Source: IRS data for 1994-96.

Page 19 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Appendix I 

Summary of IGP Activity in the Georgia

District, Fiscal Years 1994-1996

Table I.3: Results of Georgia District IGPs Closed by June 1997

Project

Returns

audited

Tax amount

per audit

hour

Tax amount

per audited

return

Total

amount of

taxes plus

penalties

Percent

of no

change

returns

Bail bond companies 142 $578 $10,874 $1,544,105 22%

Automobile dealers 516 16,363 521,320 269,001,321 12

Corporate employee embezzlement 18 6,662 154,342 2,778,147 0

Construction revisited 105 848 12,605 1,323,563 8

Timber sales 9 240 1,441 12,969 33

Construction of personal residence 25 540 18,934 473,351 12

Child care providers 24 957 3,826 91,824 13

Poultry industry 7 8 164 1,148 57

Hazardous waste sites 27 589 18,379 496,222 22

Customizing shops (vans and cars) 5 81 2,045 10,226 60

Advertising industry 46 720 15,833 728,318 23

Casino report 80 497 18,887 1,510,960 20

Ozone depleting chemicals 90 1,096 1,096 98,640 1

Fraud referral follow-up 21 519 4,031 84,658 19

Self-prepared business returns 24 418 14,704 352,899 20

Nude dancers 0 n/a n/a n/a n/a

Asbestos removal a a a a a

Auto salvage auctions 21 768 30,702 644,742 23

Unmatched Information returns 25 1,957 12,210 305,250 0

Accounting and legal professions 19 609 13,694 260,180 37

Laundromats 139 206 4,023 559,254 25

Livestock sold by gentlemen farmers 6 78 1,400 8,400 33

Original issue discount (OID) exclusions on bonds 60 6,975 153,440 9,206,400 13

Medical transportation 53 930 12,332 653,573 0

Peanut and other crop quotas 0 n/a n/a n/a n/a

Water transportation companies 0 n/a n/a n/a n/a

Employee versus independent contractor (registered

representative) a a a a a

Video stores 21 576 8,554 179,628 14

Financial products 16 705 13,309 212,946 31

Discharge of indebtedness 0 n/a n/a n/a n/a

Timber sales 21 265 2,118 44,478 24

Nonfiler partnerships 0 n/a n/a n/a n/a

Lottery businesses 0 n/a n/a n/a n/a

Georgia nonfilers 234 1,036 6,218 1,455,012 0

(continued)

Page 20 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Appendix I 

Summary of IGP Activity in the Georgia

District, Fiscal Years 1994-1996

Project

Returns

audited

Tax amount

per audit

hour

Tax amount

per audited

return

Total

amount of

taxes plus

penalties

Percent

of no

change

returns

Farm credit association members 0 n/a n/a n/a n/a

Title VII discrimination settlements 0 n/a n/a n/a n/a

Vaccine floor stock compliance 10 1,463 11,701 117,010 60

Mortuaries and funeral homes 31 335 7,527 233,325 23

Underground storage tank cleanup costs 14 1,228 13,506 189,090 7

Depreciation on tax-exempt bonds a a a a a

Debenture conversions 0 n/a n/a n/a n/a

Note 1: All tax amounts are the taxes recommended in the audits and may include some

penalties, if any.

Note 2: As reflected by the zeros in the table above, IRS auditors may sometimes find during the

information gathering phase of the IGP that initial data indicate a smaller/lesser compliance

problem than originally expected or that data collected do not warrant further study of the

taxpayer group. As a result, the IGP is terminated without any returns audited.

Note 3: n/a = not applicable.

aIRS disclosure rules preclude us from revealing audit information when fewer than four taxpayers

are involved.

Source: GAO analysis of IRS data.

Page 21 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Appendix II 

Comments From the Internal Revenue

Service

Page 22 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Appendix III 

Major Contributors to This Report

General Government

Division, Washington,

D.C.

Tom Short, Assistant Director

Elwood D. White, Evaluator

Atlanta Field Office Michelle E. Bowsky, Evaluator-in-Charge

H. Dean Perkins, Evaluator

(268816) Page 23 GAO/GGD-98-39 IRS’ Use of Information Gathering Projects
Ordering Information

The first copy of each GAO report and testimony is free.

Additional copies are $2 each. Orders should be sent to the

following address, accompanied by a check or money order

made out to the Superintendent of Documents, when

necessary. VISA and MasterCard credit cards are accepted, also.

Orders for 100 or more copies to be mailed to a single address

are discounted 25 percent.

Orders by mail:

U.S. General Accounting Office

P.O. Box 37050

Washington, DC 20013

or visit:

Room 1100

700 4th St. NW (corner of 4th and G Sts. NW)

U.S. General Accounting Office

Washington, DC

Orders may also be placed by calling (202) 512-6000 

or by using fax number (202) 512-6061, or TDD (202) 512-2537.

Each day, GAO issues a list of newly available reports and

testimony. To receive facsimile copies of the daily list or any

list from the past 30 days, please call (202) 512-6000 using a

touchtone phone. A recorded menu will provide information on

how to obtain these lists.

For information on how to access GAO reports on the INTERNET,

send an e-mail message with "info" in the body to:

info@www.gao.gov

or visit GAO’s World Wide Web Home Page at:

http://www.gao.gov

PRINTED ON RECYCLED PAPER
United States

General Accounting Office

Washington, D.C. 20548-0001

Official Business

Penalty for Private Use $300

Address Correction Requested

Bulk Rate

Postage & Fees Paid

GAO

Permit No. G100