IRS EXAMINATION 

SELECTION

IRS Should Strengthen 

Internal Controls for 

Exempt Organization 

Selection

Statement of Jay McTigue, Director, Strategic 

Issues

Testimony 

Before the Subcommittee on

Oversight, Committee on 

Ways & Means,

House of Representatives

For Release on Delivery 

Expected at time, 10:00 a.m. 

Thursday, July 23, 2015

GAO-15-753T

United States Government Accountability Office
Letter

Page 1 GAO-15-753T 

Chairman Roskam, Ranking Member Lewis, and Members of the 

Subcommittee:

Thank you for the opportunity to discuss our report on Internal Revenue 

Service (IRS) selection of tax-exempt organizations for examination, 

which is being released today.1

The Exempt Organizations (EO) unit within the Tax Exempt and 

Government Entities (TE/GE) division at IRS reviews organizations’

applications for tax-exempt status to determine whether to grant status 

and oversees existing exempt organizations’ compliance with the tax 

code. One way through which EO oversees exempt organizations’

compliance is through examinations, which are reviews of an 

organization’s activities and finances. Examinations can result in 

assessment of taxes or revocation of tax-exempt status, among other 

things. EO uses various processes to select exempt organizations for 

possible examination. For example, EO processes referrals of exempt 

organization noncompliance from third parties, such as the public, and 

other parts of IRS. In fiscal year 2014, IRS closed 8,084 examinations of 

exempt organizations.

The 1.6 million tax-exempt organizations 

in the United States—ranging from small social services groups to large 

nonprofit health systems— play a major role in our economy and provide 

a range of important services.

My remarks today highlight the key findings of our report on IRS selection 

of exempt organizations for examination. Specifically, this testimony 

assesses the adequacy of EO’s controls over the various processes it 

uses to select exempt organizations.

To conduct this work, we reviewed IRS criteria, processes, and controls 

for selecting organizations for examination, and spoke with IRS officials; 

assessed whether IRS controls followed Standards for Internal Control in 

the Federal Government; 2

 1

GAO, IRS Examination Selection: Internal Controls for Exempt Organization Selection 

Should Be Strengthened, 

reviewed random probability samples from 

examination files; and tested populations and random probability samples 

from three databases used in EO examination selection to determine the 

GAO-15-514 (Washington, D.C.: July 13, 2015).

2

GAO, Standards for Internal Control in the Federal Government, GAO-AIMD-00-21.3.1

(Washington, D.C.: November 1999).

Letter
Page 2 GAO-15-753T 

adequacy of EO’s internal control implementation (for files closed in fiscal 

year 2014). We also conducted eight focus groups on internal controls 

topics with EO staff who conduct research or make examination selection 

decisions. Our report includes a detailed explanation of the methods used 

to conduct our work. The work on which this testimony is based was 

performed in accordance with generally accepted government auditing 

standards.

In brief, Mr. Chairman, our analysis found that EO has various controls 

(see figure 1) intended to help ensure that it selects exempt organizations 

for examination in a way that adheres to TE/GE’s mission of “applying the 

tax law with integrity and fairness to all.” We found that some of EO’s 

internal controls are adequate, and align with established selection 

standards; however, there were several areas where EO’s controls were 

not well designed or implemented, and we made 10 recommendations for 

improvement.

Figure 1: Using Internal Controls in Selecting Exempt Organizations for 

Examination

In terms of what is working well, we found that the design and 

implementation of some EO examination selection controls aligned with 
Page 3 GAO-15-753T 

effective internal control standards. For example, EO maintains welldocumented procedures for several examination selection processes in 

the Internal Revenue Manual, IRS’s primary, official source of instructions 

to staff. Staff cannot deviate from procedures in the Internal Revenue 

Manual without executive management approval. In focus groups, EO 

staff generally told us that these procedures were valuable tools to help 

them administer the tax law.

However, there are several areas where EO’s controls were not well 

designed or implemented. The control deficiencies we found increase the 

risk that EO could select organizations for examination in an unfair 

manner. Examples of internal control deficiencies we found include the 

following.

• Staff could deviate from procedures for some selection 

processes without executive management approval. We found 

that procedures for some processes—such as applying selection 

criteria to organizations under consideration for review—are not 

included in the Internal Revenue Manual, as required by IRS policy. 

As a result, those procedures are not covered by the same control 

standards as the Internal Revenue Manual. For example, deviations 

from the Internal Revenue Manual are only allowed with approval by 

executive management and with appropriate communication to 

employees, whereas these standards do not explicitly apply to other 

documents. Reliance on procedures that are outside of the Internal 

Revenue Manual creates the risk that EO staff could deviate from 

procedures without executive management approval. This could result 

in unfair selection of organizations’ returns for examination. Excluding 

these procedures from the Internal Revenue Manual also reduces

transparency, since they would be available to the public if they were 

in the Internal Revenue Manual.

• EO management does not consistently monitor selection 

decisions. We found that IRS does not consistently monitor 

examinations and database files to ensure that selection decisions are 

documented and approved in order to help ensure fairness. In our 

review of examination selection files, we found that some selection 

procedures were not consistently followed. For example, referrals that 

deal with political activity allegations or with what IRS has identified as 

sensitive allegations or organizations are reviewed by a three-person 

committee. Four out of fifteen committee referrals we reviewed that 

were selected for examination were missing a required description of 

the allegation for the committee. Also, an estimated 12 to 34 percent 

of cases where EO initially selected an organization for examination, 
Page 4 GAO-15-753T 

but the examiner ultimately decided not to perform the examination, 

were missing documentation of management approval of the final 

decision, as required in the Internal Revenue Manual. According to 

internal control standards, controls should be designed to assure that 

ongoing monitoring occurs in the course of normal operations. Taken 

as a whole, the deficiencies we found point to insufficient monitoring 

of case processing.

• Certain types of referrals are reviewed by only one individual.

Five individuals, known as classifiers, determine the examination 

potential of referrals. Each classifier is responsible for reviewing 

specific types of referrals. For example, one classifier reviews high 

profile referrals (referrals that are sensitive or may attract media 

attention) and church referrals; another reviews referrals related to 

political activity. The classifier serves as an initial gatekeeper for 

determining whether a referral is reviewed by a committee. Aside from 

general referrals, the classifiers are not cross-trained to review other 

types of referrals. According to EO officials, classifiers are not crosstrained due to resource shortages. Internal control standards dictate 

that key duties and responsibilities should be divided among different 

people to reduce the risk of error. Spreading classification 

responsibilities for sensitive referrals to more than one classifier could 

help decrease the potential influence of any one classifier. Even if 

other safeguards are in place, having the same individual initially 

classify all political activity or all high profile and church referrals 

increases the potential for error or unfairness; for example, the 

classifier could choose not to forward particular kinds of organizations.

In conclusion, EO is faced with the challenging task of overseeing the 

diverse population of exempt organizations and with enforcing their 

compliance with the tax laws. EO’s reliance on a variety of processes to 

select organizations’ returns for examination underscores the importance 

of having a robust internal control system to ensure selection fairness and 

integrity. Although EO has some controls in place that are consistent with 

internal control standards, and has implemented some of these controls 

successfully, there are several areas where EO’s control system could be 

strengthened. Many of these deficiencies pose a risk that could lead to 

selecting (or not selecting) returns for examination based on criteria or 

practices that fall short of TE/GE’s mission of ensuring fairness and 

integrity. To help mitigate this risk, we recommended that IRS take 10 

actions to improve selection control design and implementation, such as: 

ensuring that all selection procedures are included in the Internal 

Revenue Manual and thus subject to executive management approval; 

developing additional examination selection monitoring procedures; and 
Page 5 GAO-15-753T 

implementing a system to ensure that political activity, high profile, and 

church referrals are not always reviewed by the same classifier. IRS 

generally agreed with the recommendations.

Chairman Roskam, Ranking Member Lewis, and members of the 

Subcommittee, this concludes my prepared remarks. I look forward to 

answering any questions that you may have at this time.

For questions about this statement, please contact me at (202) 512-9110 

or mctiguej@gao.gov. Contact points for our Offices of Congressional 

Relations and Public Affairs may be found on the last page of this 

statement. Individuals making key contributions to this testimony were 

Jeff Arkin, Assistant Director; Deirdre Duffy; Meredith Moles; Amy 

Radovich; and Lindsay Swenson.

GAO Contact and 

Staff 

Acknowledgments

(451163)
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