TAX 

ADMINISTRATION

IRS Could Improve 

Examinations by 

Adopting Certain 

Research Program 

Practices

Report to the Committee on Finance, 

U.S. Senate

May 2013

GAO-13-480

United States Government Accountability Office
United States Government Accountability Office

Highlights of GAO-13-480, a report to the

Committee on Finance, U.S. Senate

May 2013

TAX ADMINISTRATION

IRS Could Improve Examinations by Adopting 

Certain Research Program Practices

Why GAO Did This Study

One way IRS works to understand 

taxpayer compliance is by operating 

NRP, which conducts audits or 

examinations of individual tax returns 

in a research sample. NRP 

examinations are fewer in number but 

more detailed than IRS’s regular, 

operational examinations, which focus 

on the tax returns most likely to have 

substantive noncompliance. GAO was 

asked to study whether NRP 

procedures could improve IRS’s 

operational examinations.

In this report, GAO (1) describes the 

lessons on examination procedures 

that IRS learned from conducting NRP 

examinations; and (2) assesses 

whether additional improvements could 

be made to operational examinations 

based on IRS's NRP experience. 

GAO reviewed documentation on NRP 

procedures and interviewed relevant 

officials. GAO did structured interviews 

with IRS examiners on ideas for 

improving operational examinations, 

reviewed IRS documents, and 

compared the potential impacts of the 

ideas to criteria, such as whether the 

changes would make examinations 

more efficient or accurate.

What GAO Recommends

GAO recommends that IRS 

transcribe additional data from 

paper-filed returns, use all 

electronically filed data, clarify 

guidance on saving examination 

case files electronically, and develop 

guidance on when examiners can 

work NRP cases. IRS generally 

agreed with the recommendations 

but did not specifically comment on 

transcribing more data from paperfiled returns.

What GAO Found

The Internal Revenue Service’s (IRS) National Research Program (NRP) has 

helped test or develop practices that have been used in operational examinations 

of individual tax returns, according to IRS officials. These practices include, for 

example, helping test IRS’s remote learning system and helping IRS adopt new 

examination support software.

However, examiners GAO interviewed cited four additional ways NRP practices 

could improve operational examinations. 

The first two concern using more data in classification—IRS’s initial review of tax 

returns to select issues for examination. Operational classifiers do not have 

access to as much tax return data as NRP classifiers. NRP transcribes more 

data from paper-filed tax returns. Without the additional data, operational 

examiners cannot make optimal decisions about what issues to classify, raising 

the risk of needlessly examining compliant taxpayers. To make data in 

operational classification better match NRP levels, examiners suggested: 

• transcribing more data from paper-filed returns, and 

• using all data from electronically filed returns.

However, additional transcription imposes costs. For example, IRS estimated 

that it would cost $8 million annually to transcribe more expense data from 

individual business tax returns. The magnitude of this type of item (for example, 

an estimated $103 billion was claimed in 2010 for “other expenses” alone) and 

the high rate of non-compliance (55 percent in the most recent data) make it 

likely that better targeted examinations could bring in enough added revenue to 

justify the cost. 

Additionally, IRS could acquire more data for classification by revising its policy 

of treating electronically and paper-filed returns the same. However, the change 

would only affect classification and not examination. Examinations of paper-filed

returns and electronically filed returns are based on all the data. Using more data 

from electronically filed returns in classification would likely reduce the chances 

IRS would conduct unnecessary examinations of compliant electronic returns. 

The third way involves clarifying how to save examination case files 

electronically. Operational examiners have less specific guidance on saving case 

files than NRP examiners. Clarifying the key files to be saved electronically would 

be a way to minimize costs and could help make case sharing and other 

examiner duties more efficient. 

The fourth way concerns leveraging NRP for examination staff development. 

Compared to operational examinations, NRP examinations require more detailed 

documentation and are broader in scope. Examiners told GAO that such NRP 

experiences help develop the skills of relatively new staff. However, IRS has no 

official guidance specifically on when NRP examinations could be used to help 

develop staff.

View GAO-13-480. For more information, 

contact James R. White at (202) 512-9110 or 

whitej@gao.gov.
Page i GAO-13-480 Tax Administration

Letter 1 

Background 3

IRS Officials Said that NRP Helped Improve Operational 

Examinations in Three Ways, Although No Documentation 

Exists on Effects 8

Several NRP Examination Procedures and Practices Could 

Improve Operational Examinations without Undue Cost 9

Conclusions 16

Recommendations for Executive Action 17

Agency Comments 18

Appendix I Scope and Methodology 19

Appendix II GAO Reports Regarding NRP Examination Procedures and 

Data Transcription from Paper Returns 22

Appendix III How IRS Uses National Research Program Data 24

Appendix IV Agency Comments from the Internal Revenue Service 26

Appendix V GAO Contacts and Staff Acknowledgments 30

Table

Table 1: Differences between National Research Program and 

Small Business/Self-Employed Operational Examination 

Practices for Individual Tax Returns 7

Figures

Figure 1: Small Business/Self-Employed Operational Examination 

Process 4

Contents 
Page ii GAO-13-480 Tax Administration

Figure 2: National Research Program Process for Measuring 

Voluntary Reporting Compliance 6

This is a work of the U.S. government and is not subject to copyright protection in the 

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without further permission from GAO. However, because this work may contain 

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Page 1 GAO-13-480 Tax Administration

441 G St. N.W.

Washington, DC 20548

May 24, 2013

The Honorable Max Baucus

Chairman

The Honorable Orrin Hatch

Ranking Member

Committee on Finance

United States Senate

Every year, the federal government loses hundreds of billions of dollars of 

tax revenue through the tax gap—the difference between taxes owed and 

taxes voluntarily paid on time. The Internal Revenue Service (IRS) 

estimated that the tax gap for tax year 2006 (the most recent estimate) 

totaled $450 billion and IRS enforcement programs—such as examining 

voluntary compliance on filed income tax returns—helped recoup about 

$65 billion of that figure.

Resource limitations and interest in minimizing taxpayer burden prevent 

IRS from examining anything but a small fraction of the total number of 

individual income tax returns filed for a given tax year. In fiscal year 2012, 

IRS examined 1.5 million individual tax returns, which was about 1 

percent of all individual tax returns filed in 2011. Because such a small 

percentage of individual returns are examined, IRS must ensure that the 

examinations are as efficient and effective as possible. One potential 

source for lessons learned on improving examinations could be IRS’s 

National Research Program (NRP).

IRS generates key information about individual taxpayer compliance from 

NRP, an effort by the IRS to measure compliance for strategic planning 

and budget purposes. The program involves detailed examinations of 

samples of individual tax returns that have been drawn annually since tax 

year 2006.1 While the NRP data provide crucial information for 

examination planning, IRS could do more analysis on how the procedures 

and practices that NRP examiners use for NRP examinations might help 

improve IRS’s operational examinations.

 

1

The annual sample consists of about 12,000 to 15,000 tax returns. NRP originally started 

with a much larger sample of tax year 2001 returns before switching to the rolling annual 

sample in 2006.

 
 

Page 2 GAO-13-480 Tax Administration

You asked us to determine whether lessons from NRP examinations 

could be used to improve operational examinations. In this report, we (1) 

describe the lessons on examination procedures that IRS learned from 

conducting NRP examinations and applied to operational examinations; 

and (2) assess whether additional improvements could be made to 

operational examinations based on IRS’s NRP experience.

To describe lessons IRS has already learned, we asked IRS officials what 

they saw as the main benefits that NRP had already provided operational 

examinations. Based on those responses, we gathered documentation, to 

the extent it was available, in an effort to confirm the benefits that the 

officials cited. We also gathered information from the Small 

Business/Self-Employed division (SB/SE)—which is largely responsible 

for field examinations of individual income tax returns—and interviewed 

relevant SB/SE officials to confirm the cited benefits, as well.

To assess whether additional improvements could be made, we 

conducted a series of individual and group interviews with NRP and 

operational examiners. We interviewed all but one of the NRP examiners 

who were scheduled to perform classification of NRP returns in January 

2013.2 During these interviews, we gathered feedback on ways that the 

examiners thought that NRP examination procedures could be applied to 

operational examinations. We discussed these ideas with operational 

examiners and with relevant IRS officials to determine their potential 

benefits, as well as their costs and tradeoffs. We then compared the 

ideas with criteria developed from our previous report, the Office of 

Management and Budget, and the Internal Revenue Manual, including 

whether the idea would meet an IRS need, whether it would have helped 

correctly identify misreporting, whether it would make examinations more 

efficient and whether it would reduce taxpayer burden. Where 

appropriate, we gathered documentation on costs and tradeoffs of the 

ideas to help determine the plausibility of the ideas that we collected. The 

data used in the report came from IRS sources or our previous work and 

therefore reliability had already been reviewed. We re-examined our 

earlier reviews for applicability to our engagement and determined that 

these data were also sufficiently reliable for purposes of this report.

 

2

Classification is the process of determining whether a return should be selected for 

examination, what issues should be examined, and how the examination should be 

conducted. 
 

Page 3 GAO-13-480 Tax Administration

Appendix I provides additional information on our scope and 

methodology.

We conducted this performance audit from June 2012 through May 2013 

in accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that 

the evidence obtained provides a reasonable basis for our findings and 

conclusions based on our audit objectives.

Part of SB/SE’s enforcement responsibilities includes examining 

individual tax returns to detect misreporting. As shown in figure 1, SB/SE 

starts the examination process by building an inventory of returns based 

on a computer scoring system;

3 IRS strategic enforcement priorities, such 

as high income taxpayers and abusive tax avoidance schemes; and 

examination training purposes. SB/SE examination plans also provide for 

a balanced approach for return delivery and allocation of staffing.

 

3

The scoring system, called the discriminant function, is a mathematical technique used to 

score income tax returns for examination potential. Generally, the higher the discriminant 

function score, the greater the probability of significant noncompliance. IRS uses data 

from NRP to calculate the function.

Background 

Operational Examinations 

for Tax Returns Filed by 

Individuals 
 

Page 4 GAO-13-480 Tax Administration

Figure 1: Small Business/Self-Employed Operational Examination Process

Then, in a process called classification, SB/SE examiners identify 

whether to examine an individual tax return, which tax issues on the 

return should be examined, and what examination techniques4 should be

used. Examiners who classify returns generally use a computer system 

called the Compliance Data Environment to record which issues (e.g., 

items that may have been misreported) on that return get passed on to 

examiners for official examination. The examiners who classify a tax 

return are not to be the same ones who examine the return. Generally, 

SB/SE will limit classification to a handful of issues for individual tax 

returns.

After returns have been identified for further review, an inventory is 

created from which managers assign cases to examiners or dismiss the 

 

4

In this context, technique refers to using a correspondence examination, which is done 

through mail, or field examination, in which IRS meets with taxpayers or the taxpayers’ 

representatives face-to-face.
 

Page 5 GAO-13-480 Tax Administration

case as unproductive. IRS officials said that certain examiners have the 

discretion to suggest declassifying items and the responsibility to examine 

any additional items that may not have been classified but that appear 

large, unusual, or questionable.

IRS carries out detailed research studies of individual taxpayer 

compliance through its NRP. The data for the studies come from intensive 

examinations that strive to verify information taxpayers reported or should 

have reported. In NRP, IRS selects a random sample of individual tax 

returns each year. IRS uses the NRP data to estimate the tax gap and 

update return selection formulas used in planning examinations. The data 

are also intended to be used to design and revise pre-filing programs.5

As shown in figure 2, the NRP process broadly consists of five steps: (1) 

selection of returns for examination; (2) case building, the process of 

adding information to the case file, from IRS and other sources;

6 (3) 

classification, which is done using the NRP classification system instead 

of the Compliance Data Environment; (4) data collection through 

examinations; and (5) analysis of the examination results.

 

5

See appendix II for our previous reports on the NRP and appendix III for more detail on 

how IRS uses NRP data. 

6

The NRP case building process compiles a variety of information, such as the taxpayers’ 

past years’ returns; information reported to IRS by third parties, such as employers and 

banks; and information from outside databases, such as property listings. This information 

is available to the classifier and ultimately the taxpayer.

NRP Examinations
 

Page 6 GAO-13-480 Tax Administration

Figure 2: National Research Program Process for Measuring Voluntary Reporting Compliance

NRP primarily uses field examinations but may use correspondence 

examinations in certain circumstances. Examiners must review all 

classified items, ensure that the rest of the return is correct, and record

examination activity. Information on NRP-specific activity that IRS intends 

to later analyze is compiled on Microsoft Excel worksheets in a database 

maintained specifically for NRP information.

NRP and operational examination procedures for individual tax returns 

share several attributes. For example, examiners use the same 

examination guidelines for both processes and both have a classification 

process. However, key differences exist, which are summarized in Table 

1. These differences exist partly because of the programs’ different 

objectives, as shown in the table.

NRP and SB/SE 

Operational Examination 

Differences
 

Page 7 GAO-13-480 Tax Administration

Table 1: Differences between National Research Program and Small Business/Self-Employed Operational Examination 

Practices for Individual Tax Returns

Program National Research Program Examinations

Small Business/Self-Employed Operational 

Examinations

Objective Gather data about compliance of U.S. taxpayers to 

assist IRS.

Identify federal tax misreporting and promote voluntary 

compliance.

Case building More return data are provided to examiners than is 

provided for operational classification. Examination 

case is created for examiner.

Comparatively limited transcription of return data and 

other IRS and third party information. Examiners must 

input information needed to begin a case themselves. 

Classification • Many issues are classified. 

• Examiners must examine all classified issues. 

• NRP web-based classification system used for 

processing.

• NRP transcribes additional data from paperfiled returns, which are available to classifiers.

• Fewer issues are classified on returns suspected of 

having significant noncompliance. 

• Examiners have the discretion to de-classify issues if 

they believe that the noncompliance is not apparent 

or worth pursuing in certain circumstances. 

• Compliance Data Environment used for processing.

• Less tax data from paper-filed tax returns are 

transcribed. Because of IRS policy to treat paper-filed 

returns the same as electronically filed returns, 

untranscribed data are not available to classifiers.

Computer validation NRP-specific lead sheets and case-closing check 

sheets are computer validated. An examiner 

cannot close a case without passing validation 

checks.a

No analogous computer validation of lead sheets or caseclosing check sheets is done. 

Workpaper software NRP-specific lead sheets in Microsoft Excel allow 

data recorded by examiners to be extracted for 

analysis.

Lead sheets in Microsoft Word do not enable automated 

data extraction but do enable more detailed descriptions 

of examination activity.

Source: GAO analysis of IRS interviews and documentation.

a

Lead sheets identify the steps that should be taken or considered during an examination of a specific 

issue. NRP lead sheets are more detailed than those used by operational examiners. Case-closing 

check sheets are a guideline of steps that examiners must take before they can close the case.
 

Page 8 GAO-13-480 Tax Administration

IRS officials said that techniques and practices used in the formative 

years of NRP contributed to various efforts to improve SB/SE operational 

examinations. IRS was developing NRP at the same time IRS was 

developing these efforts, which involved changing procedures, applying 

new technology, and providing better access to taxpayer data held in 

various parts of the IRS, according to an IRS official. As such, IRS 

officials said that the program provided a way to test these envisioned 

improvements to operational examinations in three ways, as discussed 

below.7

• NRP provided an opportunity to test remote learning for large 

numbers of IRS employees. NRP was a pioneer in using remote 

learning software programs that helped convince IRS management 

that the programs were viable to use.8

• The case building and classification model that NRP developed for the 

tax year 2001 Form 1040 study contributed to the standard for 

operational programs.

• NRP facilitated the move of the Report Generation Software to a 

network environment, allowing IRS to move case data electronically 

across its computer networks.9 NRP piloted the use of batching 

software in Report Generation Software to open cases and record the 

initial information available to IRS that goes into the creation of 

examination case files and the identification of issues on tax returns 

for possible examination.

Although these NRP benefits to operational examinations may have 

occurred, IRS had no documentation on the effects—positive or 

negative—of the three cited NRP activities on operational examination 

practices. IRS officials attributed the lack of corroborating documentary 

 

7

IRS listed other NRP benefits in its FY 2014 Congressional Budget Justification, 

published in April 2013. When we followed up, IRS officials stood behind the 

characterization of NRP’s benefits in our report.

8

The software programs were CENTRA, which facilitates remote learning, that allowed 

IRS to provide training at remote field sites and Articulate, a self-paced e-learning platform 

that allowed IRS to reach a large number of students in an online interactive format. 

9

The Report Generation Software is a group of computer programs that support 

examination activities such as preparing reports, performing complex computations, 

producing correspondence, and closing cases. 

IRS Officials Said that 

NRP Helped Improve 

Operational 

Examinations in 

Three Ways, Although 

No Documentation 

Exists on Effects
 

Page 9 GAO-13-480 Tax Administration

evidence to the fact that the activities cited by NRP officials took place 

about 10 years ago and were conducted by other IRS staff who were in 

different positions at the time or who are no longer with the agency. 

Further, the cited benefits could be viewed as positive side effects of 

NRP, which had the primary purpose of providing data to identify 

noncompliance and measure the tax gap, not improving operational 

examination procedures. Given that any effects on examination were 

secondary, IRS had not attempted to measure the extent and effects of 

the cited benefits.

Examiners we interviewed identified several NRP practices and 

procedures that met our criteria for offering potential improvements to 

operational examinations.10 These practices include adding additional 

transcribed and electronically filed data that NRP uses to the operational 

classification process; adopting NRP policies or guidance on saving 

electronic examination case files; and incorporating NRP returns into 

examiners’ development or training.

Examiners raised other meritorious ideas, including requiring Microsoft 

Excel for all examination workpapers, requiring the use of NRP-style lead 

sheets and case-closing check sheets, and imaging returns for use in 

classification. However, based on available evidence and a lack of 

examiner consensus, these ideas did not meet enough of our criteria to 

warrant further consideration at this time.

Successfully implementing the NRP practices that met our criteria in 

operational examinations could offer several benefits. To the extent that 

these changes to operational examinations produce the best tax returns 

and tax issues for examination, let examiners more quickly access the 

data they need, and further develop examination expertise, IRS is more 

likely to achieve benefits, including

• using classification as well as other examination resources more 

effectively,

• identifying more tax noncompliance and more unpaid taxes owed 

during examinations without using more examination resources, and

 

10Appendix I includes a detailed description of the criteria we used. 

Several NRP 

Examination 

Procedures and 

Practices Could 

Improve Operational 

Examinations without 

Undue Cost
 

Page 10 GAO-13-480 Tax Administration

• minimizing the burden imposed on taxpayers, particularly those who 

are compliant.

The NRP practices of transcribing significantly more tax return data from 

paper submissions than operations and using all available electronically 

filed data offer benefits for operational examinations and received the 

most support among examiners. In general, they supported these 

practices as ways to make operational classification and examination 

more effective. Because operational classifiers only have access to the 

types of data transcribed from paper-filed returns, examiners said that 

they could not immediately access and review all data reported on tax 

returns, which burdened taxpayers as well as made examiners less 

efficient in doing their jobs.11 Similarly, IRS officials told us for a previous 

report that having more tax return information available electronically 

would reduce burdensome examinations for compliant taxpayers, as well 

as facilitate enforcement efforts, make case resolution faster, and 

increase compliance revenue.12

Examiners who classified returns said that the lack of data in operational 

classification can cause them to classify issues that do not need to be 

examined. They said additional expense data from NRP on two Form 

1040 schedules (Schedule C Profit or Loss from Business and Schedule 

E Supplemental Income and Loss) are representative of the kind of 

additional information that could address the problem.

13 For example, 

operational classifiers might unnecessarily flag certain expense items on 

the schedules as an issue for examination simply because they do not 

have as many insights as NRP classifiers on the specific details of the 

items, causing the expenses to appear large, unusual, or questionable. 

The lack of additional return data also can make the examination process 

more burdensome for taxpayers being examined, particularly those filing 

an accurate tax return. Examiners said they sometimes had to examine a 

 

11Since our interviews with the examiners, IRS issued a memo to emphasize the 

importance of using automated information systems to enhance examination quality.

12GAO, E-Filing Tax Returns: Penalty Authority and Digitizing More Paper Return Data 

Could Increase Benefits, GAO-12-33 (Washington, D.C.: Oct. 5, 2011).

13Taxpayers use Schedule C to report business income or losses as a sole proprietor. 

Schedule E is used to report income or losses from endeavors such as real estate rentals, 

partnerships, estates, trusts, and certain corporations.

Transcribing and Using 

More Tax Return Data and 

Using All Electronically 

Filed Return Data Could 

Improve Operational 

Classification
 

Page 11 GAO-13-480 Tax Administration

tax return issue for which the data were not transcribed. In such cases, 

examiners ask taxpayers for documents to verify the reporting of a tax 

issue that would not have been examined if the return data had been 

transcribed. As one examiner we interviewed said, “When you don’t get 

everything transcribed [for classification], you could end up wasting 

taxpayers’ time and increasing their burden by asking them for more 

information, particularly for more information that had likely already been 

provided in the original return but not transcribed.” Another examiner said, 

“It is ridiculous to have to ask a taxpayer for a copy of the return if filed on 

paper.” 

One method for providing operational classifiers more tax return data is to 

transcribe more data from paper-filed returns that are not already 

captured and provide classifiers with access to the additional data 

electronically.

14 Although it may not be worthwhile for IRS to transcribe 

every piece of data from the millions of individual returns filed on paper 

each year, IRS could transcribe the tax return schedules that would have 

the greatest impact on examinations. For example, among IRS’s highest 

priorities for possible transcription are lines from Schedule C. An 

estimated 75 percent of Schedule Cs were filed electronically in tax year 

2010.

15 Additional transcription on key expense items could make a 

significant difference considering the volume and compliance impact of 

that specific item. For example, the other expenses line on the Schedule 

C is often used to claim large amounts of deductions that IRS has found 

in error. Other expenses

• was the most frequently claimed expense (among 23 expense items) 

and was claimed on an estimated 57 percent of the schedules for tax 

year 2010, 

• totaled an estimated $103 billion—the highest expense amount 

claimed and about 19 percent of all expense claims on the Schedule 

C for tax year 2010,

16 and

 

14See appendix II for a list of related GAO reports. 

15Percentage based on Statistics of Income data. The 95 percent confidence interval for 

the unrounded estimate of 74.6 percent is between 74.4 percent and 74.9 percent.

16For the $103 billion in “other expenses” estimate, the lower bound is $101 billion and the 

upper bound is $105 billion at the 95 percent confidence interval.
 

Page 12 GAO-13-480 Tax Administration

• had a noncompliance rate of 55 percent—the second highest of all the 

expense items on Schedule C, based on the NRP for tax year 2001.

These amounts claimed as expenses combined with such a high noncompliance rate mean that it might be possible to find additional 

misreporting through more precise classification to offset the added 

transcription costs. At our request, IRS estimated in 2013 that it would 

cost about $8 million annually to transcribe data about three additional 

expenses from Schedule C.17 With costs of that level, even a small 

reduction in expense noncompliance could recoup the costs of 

transcription. 

Furthermore, costs could be reduced by transcribing only the portion of 

Schedules C and E submissions that reported the greatest amounts of 

income from business operations and that had the greatest chance of 

being subjected to classification and examination. For example, IRS’s 

2012 Data Book shows that of more than 16 million business returns with 

total positive income of less than $1 million, only about 1.4 million have 

total positive income of at least $200,000 and under $1 million.18 IRS also 

could apply a similar income cutoff for Schedule E filings.

Finally, transcription costs could decline as more returns are filed 

electronically. According to data in the IRS Oversight Board’s Electronic 

Filing 2012 Annual Report to Congress, the percentage of individual tax 

returns filed electronically was an estimated 81 percent in 2012, up from 

40 percent in 2003. Electronic filing of Schedule C increased from an 

estimated 38 percent in tax year 2003 to the estimated 75 percent in tax 

year 2010.

19 If costs did not decline, IRS still has the option of making a 

request for funding a compliance program on transcription in the course 

 

17This $8 million includes the cost to keystroke the added expenses, as well as other 

costs such as for error resolution, quality review, overhead, and employee benefits for the 

three added expenses. In an earlier calculation for tax year 2008, we calculated that 

keystroke costs alone for certain, additional Schedule C and E information would be 

$768,208. 

18The more than 16 million filings do not represent all Schedule C filings. For example, it 

does not include those that also filed the Earned Income Tax Credit, and therefore does 

not match the figures used elsewhere in this report. 

19Percentages were derived from Statistics of Income reports. For the 38 percent 

estimate, the lower bound is 37.6 percent and the upper bound is 38.4 percent at a 95 

percent confidence interval.
 

Page 13 GAO-13-480 Tax Administration

of making its annual budget request. For example, for fiscal year 2013, 

IRS proposed additional funding for activities to address the tax gap.

Another option for increasing classification effectiveness is to allow 

classifiers to use all data reported on electronically filed returns. IRS 

policy limits the use of electronically filed data for classification to only the 

types of data that are transcribed from paper-filed returns to assure that 

paper-filed returns are treated the same as electronic returns. IRS could 

reverse its policy and allow use of all data filed electronically.

IRS officials—including the SB/SE commissioner and deputy 

commissioner—said they recognize that having more data may help 

make examination processes more efficient by letting examiners make 

more-informed decisions. Because of this recognition and feedback from 

examiners, IRS analyzed whether using electronically filed data led to 

better examination decisions. The analysis indicated that using more 

electronically filed data could help classifiers detect more noncompliance. 

To more rigorously test this, IRS said that it is moving forward with more 

research to analyze the effects of adding electronically filed data on the 

amount of additional tax revenue assessed, if any. However, the new 

studies will not address any changes to taxpayer behavior if IRS reversed 

its policy on using electronically filed data or the added costs of using the 

data, such as information technology costs. IRS officials said they remain 

concerned that altering their policy on using electronic data might 

adversely affect electronic filing. These studies are still underway and the 

initial results will not be available until 2014 at the earliest.

Regardless of the findings of IRS’s upcoming pilots, our findings indicate 

that using less data to select returns and tax issues for examination 

increases the likelihood that compliant taxpayers are examined, creating 

an unnecessary burden for taxpayers filing these returns. In the cases 

where taxpayers are not compliant, with more data, IRS more likely could 

identify the noncompliance.

Under NRP’s goal of moving toward fully electronic case files, examiners 

are instructed to save their work electronically. Examiners we spoke with 

endorsed how NRP communicates the policy, although challenges exist 

to implementing the end result of complete electronic case files. NRP 

guidance on electronic case files also could serve as a model to help 

improve the operational guidance on saving case files electronically, 

which some observers we interviewed found confusing.

Clarifying What Case File 

Information Should Be 

Saved Electronically Could 

Improve Operational 

Examination Effectiveness 
 

Page 14 GAO-13-480 Tax Administration

IRS’s Internal Revenue Manual states that NRP “is moving toward a fully 

electronic case file,”

20 and NRP training states that “all lead sheets and 

relevant workpapers be completed electronically and included in the 

electronic case file.” Examiners said moving toward requiring electronic 

case files for operational examinations would provide efficiency 

advantages. For example, they said electronic case files could save time 

in processing more than 100,000 audit reconsiderations that IRS works 

each year by making it easier for examiners to search the old files and 

identify what previous examiners concluded.21 IRS officials said that NRP 

conducts training, classification, and reviews remotely, taking advantage 

of all the electronically available case data.

IRS officials previously told us that savings on handling costs was one of 

the benefits of added electronic documentation.22 IRS must place 

hundreds of thousands of field examination case files into storage at a 

federal records center each year. IRS said that it spends about $5 to $9 

for each document it recalls from federal record centers. Examiners we 

spoke with also said that having electronic case files facilitates sharing 

their work with colleagues and reduces the chances that files will get lost. 

Constraints to IRS making all operational case files completely electronic 

mostly deal with the capacity of IRS’s computer systems to store 

electronic case files and to transfer the files over existing bandwidth. IRS 

officials said they have no estimates on how much it would cost to expand 

the computer resources to save all files but that it would be considerable. 

Examiners said that SB/SE’s ability to make all case files electronic is 

constrained because all of its offices do not have sufficient scanning 

technology to convert paper documents into electronic versions in a 

timely matter. IRS did not have an estimated cost for providing 

appropriate scanning technology for all of its offices.

 

20IRS’s Internal Revenue Manual, 4.22.6.1, Case Building for Individual Returns (5/20/13). 

21An audit reconsideration is the administrative process the IRS uses to reevaluate prior 

audits where the IRS assessed additional tax and it remains unpaid, or a tax credit was 

reversed. If the taxpayer disagrees with the original determination, the taxpayer must 

provide information not previously considered during the original examination. It is also the 

process the IRS uses when the taxpayer contests a Substitute for Return (i.e., a return 

that IRS generates when a taxpayer does not file) determination by filing an original 

delinquent return. 

22GAO-12-33.
 

Page 15 GAO-13-480 Tax Administration

If it were too expensive to match NRP’s level of electronic case file 

creation by expanding computer or scanning capacity, another option 

would be clarifying guidance to focus on the most important examination 

evidence. For example, NRP training materials and guidance define what 

constitutes relevant workpapers and list only four exceptions to 

documents that are permitted to be saved on paper as part of the case 

file. According to the NRP training, focusing on electronic case files 

allows subsequent researchers to interpret the examination results. 

In contrast, operational guidance on saving electronic case files is less 

clear. On one hand, the Internal Revenue Manual instructs examiners to 

electronically save any documents provided to the taxpayer’s 

representative or third parties, such as lead sheets, workpapers and other 

related documents for purposes of an audit trail, as well as workpapers 

created outside of the Report Generation Software. On the other, SB/SE 

cautions examiners against saving too much because of space 

limitations, as the average SB/SE field case file size has grown from 

about 1 megabyte in 2006 to more than 4 megabytes in 2011. IRS 

examiner guidance says that examiners should limit the size of 

documents stored in the Report Generation Software to 5 megabytes; 

anything larger should be put on DVDs or CDs. According to NRP 

coordinators we interviewed, the competing operational guidance leaves 

examiners unsure about the extent that they should save documents 

electronically. IRS officials also said that they have observed that some 

operational examiners save more workpapers than necessary to show 

how they reached their conclusions, and that the NRP guidance helps 

curb the number of documents saved. 

Examiners said that NRP provides a good opportunity for developing 

examiners who have completed IRS’s training but are relatively 

inexperienced. Compared to operational examinations and to ensure data 

quality, NRP instructs examiners to document procedures in greater detail 

than operational examinations and to classify more issues for 

examinations. These practices could help inexperienced examiners learn 

about procedures and about more issues than they would on an 

operational examination. Examiners said that if they were exposed to 

these NRP practices, they could have more insights to help them make 

decisions when doing operational examinations. 

One examiner said working NRP cases “forces agents to look at lots of 

issues and in depth.” Another examiner said that “working on NRPs gives 

IRS Does Not Provide 

Formal Guidance for 

Managers on When to Use 

NRP-Style Examinations 

as Development 

Opportunities for Recently 

Trained Staff
 

Page 16 GAO-13-480 Tax Administration

you the big picture. It helps agents become more familiar with the review 

process.” 

To an extent, examiners already may be taking advantage of NRP as a 

learning tool. Field managers provide employees with the opportunity to 

perform a limited quantity of higher graded work (like NRP cases) to 

enhance their career development. One examiner we interviewed said 

that he had conducted NRP examinations about a year after completing 

IRS’s Form 1040 training module and another said she had “cut her teeth” 

on NRP examinations, which were among the first she did. However, IRS 

has no formal guidance requiring or encouraging managers to consider 

assigning NRP examinations as a development opportunity. Costs of 

using NRP as a development tool also could be low, given that the 

returns already have been selected for the NRP sample by the time 

managers assign the work. 

Some tradeoffs from using NRP examinations to help develop newer 

operational examiners warrant consideration. First, for data analysis 

purposes, the NRP director said he prefers that experienced examiners 

work NRP cases. Second, he said that IRS adjusts its tax gap figures by 

an econometric technique that takes examiner skills and experience into 

account. Managers would have to take care not to assign NRP cases to 

examiners who were not ready to handle them. Examiners we interviewed 

said that while NRP examinations are more detailed, the size of an NRP 

case, which generally may have many classified issues, could overwhelm 

new examiners. 

On the other hand, concerns about problems caused by using less 

experienced examiners in NRP might not apply in all cases. NRP 

coordinators told us that in their experience, newer but fully trained 

examiners are conscientious about following the NRP examination 

procedures as much if not more than examiners with many years of 

experience. Also, to the extent that using newly trained examiners for 

NRP cases might affect the econometric technique, IRS could ensure that 

newly trained examiners who did NRP cases stayed in the pool of 

examiners working cases in future years. 

SB/SE’s examination program is a key effort in reducing the nation’s 

persistent tax gap for individual returns. Improving examination 

procedures helps IRS to better detect noncompliance, promote voluntary 

compliance, and minimize the cost of examinations for IRS and 

taxpayers. IRS annually makes a considerable investment in NRP, but 

Conclusions 
 

Page 17 GAO-13-480 Tax Administration

opportunities exist for IRS to improve operational examinations by 

applying NRP practices. To the extent that IRS does not pursue these 

opportunities to maximize its NRP investment, IRS is missing a chance to 

improve operational examinations by better classifying returns, identifying 

more noncompliance, and reducing taxpayer burdens. 

In particular, lessons from NRP suggest that transcribing data filed on 

paper and using electronically submitted data for Schedules C and E 

could enhance the efficiency of the operational classification process. 

Although adding these data would entail costs, the evidence does not 

necessarily indicate that those costs are great enough to outweigh the 

benefits or that it would not be beneficial for IRS to request funding for 

added transcription. Similarly, more consistently saving electronic case 

files can provide IRS examiners with easier access to a wider swath of 

information and reduce taxpayer burden by finding critical documents 

more quickly both during the examination and during follow up work, such 

as for examination reconsiderations as well as for other IRS staff who 

need access for analysis or research of examination trends. Given cost 

concerns about expanding IRS’s information system capacity, space 

constraints could be addressed by having clearer guidance on what files 

are essential to be electronically saved rather than saving all of them. 

Clarifying the guidance also could reduce examiners’ confusion. Finally, 

IRS could encourage newly-trained examiners to enhance their 

development by working selected individual NRP cases, better ensuring 

that they gain insights that will help them do better operational 

examinations. 

To increase the effectiveness of IRS’s examinations individual tax returns, 

GAO recommends that the Commissioner of Internal Revenue take the 

following four actions.

• Transcribe data from paper-filed Form 1040 Schedules C and E that 

are not currently transcribed and make that data available to SB/SE 

examiners for classification. If IRS has evidence that the costs related 

to transcribing all such data on Schedules C and E are prohibitive, 

IRS could do one or both of the following actions: 

• transcribe less data by transcribing only the missing data for 

selected line items, such as certain, large expense line items, or

• develop a budget proposal to fund an initiative for transcribing 

Schedule C and E.

• Make all data collected from electronically submitted Form 1040s 

available to examiners conducting classification.

Recommendations for 

Executive Action
 

Page 18 GAO-13-480 Tax Administration

• Clarify the policy and guidance on which case files should be saved 

electronically for SB/SE examinations to encourage greater and 

consistent use of electronic case files.

• Develop official guidance to remind managers that NRP cases can be 

assigned to newly trained examiners, when appropriate, to enhance 

their career development.

We requested written comments from the Acting Commissioner of 

Internal Revenue and received comments from the Deputy Commissioner 

for Services and Enforcement on May 9, 2013. The Deputy 

Commissioner said that IRS agreed to study the possibility of increasing 

data transcription but did not comment more specifically. IRS also agreed 

that making electronically collected data available for classification would 

be beneficial, saying it intends to look at expanding the use of 

electronically submitted returns to enhance classification and possibly 

other areas as well. The agency also agreed to clarify its policy on when 

case files should be saved electronically and agreed to expand guidance 

to remind managers that they may assign NRP cases to newly trained 

examiners when appropriate to enhance their career development. IRS 

provided technical comments on the draft, which were incorporated as 

appropriate. We also made other clarifying changes. 

We have sent copies of this report to the Department of the Treasury, 

IRS, and other interested parties. This report also will be available at no 

charge on GAO’s web site at http://www.gao.gov. If you or your staff have 

any questions about this report, please contact me at (202) 512-9110 or 

whitej@gao.gov. Contact points for our Offices of Congressional 

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

Key contributors to this report are listed in appendix V.

James R. White

Director, Tax Issues

Strategic Issues

Agency Comments
Appendix I: Scope and Methodology

Page 19 GAO-13-480 Tax Administration

To describe lessons that IRS has already implemented, we interviewed 

National Research Program (NRP) on what it saw as the main benefits 

that NRP had already provided operational examinations. Based on those 

responses, we gathered documentation, to the extent it was available, to 

confirm the benefits that the officials cited. We also gathered information

from the Small Business/Self-Employed division (SB/SE) by interviewing 

relevant SB/SE officials to confirm the cited benefits as well.

To assess the ways that NRP practices and procedures might improve 

operational examinations, we used a two step process. First, we identified 

potential ways that NRP might improve operational examinations by 

interviewing key IRS officials. Then, in the second step, we compared 

those ideas against a set of criteria to determine whether the ideas 

warranted further action.

We held exploratory small-group discussions with NRP examiners who 

also had operational audit experience to obtain preliminary views on NRP 

practices and procedures that potentially could help improve operational 

examinations. We conducted these exploratory interviews around the 

Washington, D.C., area. Based on these discussions and other research 

on NRP, we identified a set of topics and developed a set of specific, 

close-ended questions that addressed those topics. We used a structured 

interview technique with groups of IRS examiners where we asked those 

questions as well as provided the group participants opportunities to 

further explain their response choice or to say more about each topic.

The structured interview groups comprised either examiners who were

NRP classifiers, or operational examiners who had experience with 

operational classification using the Compliance Data Environment 

software, which is what operational examiners use to conduct 

classification. We focused on examiners with classification experience 

because: a) they had the broadest experience with the examination 

process, b) were considered to be experts by IRS, and c) our exploratory 

discussions indicated that some of the NRP benefits to operational audits 

might center on classification. To choose NRP classifiers, we reviewed a 

list of examiners who were scheduled to conduct NRP classification in 

January 2013 that IRS sent us. Operational classifiers were chosen in 

cooperation with SB/SE liaisons. A criterion we used in requesting 

participants was that they had experience using the Compliance Data 

Environment system, so that we could compare the NRP classifiers’ 

experiences with operational classifiers’ experiences. In total, we 

conducted seven interview sessions with groups that ranged in size from 

three to seven participants at a time, as well as an individual interview. 

Appendix I: Scope and Methodology
Appendix I: Scope and Methodology

Page 20 GAO-13-480 Tax Administration

The participants for each interview group were assigned randomly from 

the list IRS provided. We interviewed all but one of the examiners who 

were scheduled to participate in the January 2013 classification detail. 

We discussed the examiners’ statements and comments with NRP 

coordinators who attended the January 2013 NRP classification detail 

and IRS management to obtain their perspective on these same topics 

and reaction to views expressed in our group interviews. 

Because our interviews included all but one of the entire population of 

NRP classifiers for the January 2013 detail, their responses can be seen 

as representative of these NRP classifiers’ views on the matters we 

discussed. The views we obtained from operational classifiers are not a 

representative sample of all operational classifiers and thus reflect only 

the views of that group.

To assess which revenue agent ideas warranted further action, we 

derived the following criteria.

• Would the change be likely to help examiners correctly identify more 

noncompliance?

• Is it likely to make the examination more efficient—i.e., reduce the 

cost of conducting an examination, or increase benefits for the same 

cost or increase benefits commensurate with justifiable or no increase 

in costs?

• Is it likely to reduce taxpayer burden?

• Would the change meet any other IRS need?

These criteria generally are based on our 2005 report, Understanding the 

Tax Reform Debate (GAO-05-1009SP),1 Office of Management and 

Budget Circular A-94,2 and the Internal Revenue Manual.3 IRS officials 

agreed that these criteria were valid. As noted in our 2005 report, the 

criteria may conflict with each other, and as a result, there often are tradeoffs to consider among the criteria when evaluating a particular proposal.

 

1

GAO, Understanding the Tax Reform Debate: Background, Criteria, and Questions, 

GAO-05-1009SP (Washington, D.C.: September 2005). 

2

Office of Management and Budget, Circular A-94 Guidelines and Discount Rates for 

Benefit-Cost Analysis of Federal Programs (Washington, D.C; September 2005).

3

A redacted version of the Internal Revenue Manual is available online at 

http://www.irs.gov/irm. 
Appendix I: Scope and Methodology

Page 21 GAO-13-480 Tax Administration

In those cases, we used our professional judgment in weighing the 

relative importance of these criteria in making our recommendations.
Appendix II: GAO Reports Regarding NRP 

Examination Procedures and Data 

Transcription from Paper Returns

Page 22 GAO-13-480 Tax Administration

The following lists our prior reports regarding National Research Program 

(NRP) examination procedures.

1. Tax Policy and Administration: Using Data from the Internal Revenue 

Service’s National Research Program to Identify Potential 

Opportunities to Reduce the Tax Gap (GAO-07-423R).

To ensure that IRS maximizes its return on investment from future NRP 

studies, we recommended that IRS should develop a plan for capturing 

complete NRP examination case files that (1) determines the most cost 

effective means for capturing information electronically and (2) lays out a 

schedule for when it will begin to capture information electronically. IRS 

completed a study of capturing electronic information for National 

Research Program (NRP) examination cases in December 2008. For the 

tax year 2006 NRP study of individual tax returns, IRS recommended that 

examiners complete work papers electronically, and mandated electronic 

work papers for the tax year 2007 study. In a December 2008 document, 

IRS said that it will require all IRS developed documentation to be in 

electronic form, but will not scan taxpayer-provided documentation. 

Because of IRS’s actions, we consider these recommendations 

implemented.

2. Tax Administration: New Compliance Research Effort Is on Track, but 

Important Work Remains (GAO-02-769).

We recommended that the IRS Commissioner should ensure that testing 

and modification of NRP case building and classification procedures are 

complete before IRS begins cadre training, classifying NRP returns, or 

making any taxpayer contacts. IRS should use some previously audited, 

non-Earned Income Tax Credit tax returns to evaluate NRP classification 

procedures and classifier training. We also recommended that the IRS 

Commissioner should implement plans to select and appropriately train 

the cadre of examiners and other staff before NRP classification begins. 

In our June 2003 report on the progress of IRS’s NRP implementation,1

we reported that the timing of IRS’s NRP staff selection and training 

satisfied this recommendation.

3. Tax Administration: Alternative Strategies to Obtain Compliance Data

(GAO/GGD-96-89).

 

1

See GAO, Tax Administration: IRS Implementing the National Research Program as 

Planned, GAO-03-614 (Washington, D.C.: June 16, 2003).

Appendix II: GAO Reports Regarding NRP 

Examination Procedures and Data 

Transcription from Paper Returns
Appendix II: GAO Reports Regarding NRP 

Examination Procedures and Data 

Transcription from Paper Returns

Page 23 GAO-13-480 Tax Administration

In our 1996 report on the precursor to NRP, the Taxpayer Compliance 

Measurement Program (TCMP), we recommended that IRS identify a 

short-term alternative strategy to minimize the negative effects of the 

compliance information that is likely to be lost because TCMP was 

postponed, and develop a cost-effective, long-term strategy to ensure the 

continued availability of reliable compliance data. We identified several 

alternatives to the traditional TCMP that would meet some of the data 

needs that were lost when TCMP was postponed, including (1) 

conducting multiyear TCMP audits on smaller samples and combining the 

results; (2) using operational audit data; and (3) conducting a mini TCMP 

to identify compliance issues, with a more focused TCMP audit on the 

identified issues. IRS started the NRP program in 2001, using tax returns 

filed for that tax year. The 2007 NRP study was the first of an ongoing 

series of annual individual studies using a multi-year rolling methodology.

The following reports include discussions of conducting full transcriptions 

of tax returns.

1. Tax Administration: 2007 Filing Season Continues Trend of 

Improvement, but Opportunities to Reduce Costs and Increase Tax 

Compliance Should Be Evaluated (GAO-08-38).

Full transcription could increase the effectiveness of compliance 

programs. According to IRS officials, transcribing and posting more 

comprehensive information from individual income tax returns could 

facilitate the audit process, expedite contacts for faster resolution, reduce 

handling costs, allow for improved case selection, and potentially better 

define specific tax gap issues.

2. E-Filing Tax Returns: Penalty Authority and Digitizing More Paper 

Return Data Could Increase Benefits (GAO-12-33).

In this report, we noted that E-filing provides important benefits to 

taxpayers, including faster refunds and more accurate returns. It provides 

a low-cost option for IRS to improve enforcement operations and services 

to taxpayers. To help increase electronic filing and to better target IRS’s 

efforts, we recommend that IRS determine the relative costs and benefits 

of transcribing different individual lines of tax return data. IRS should also 

quantify the benefits of transcribing individual lines and compare them to 

the individual costs. This analysis could inform budget decisions by 

allowing IRS to compare the option of additional transcription against any 

work foregone. As part of this report, we calculated the costs of 

transcribing data lines from paper-filed returns.
Appendix III: How IRS Uses National Research 

Program Data

Page 24 GAO-13-480 Tax Administration

The National Research Program (NRP) data provide IRS with data for 

operational and strategic purposes. On an operational level, analysis of 

NRP data provides insights into how well the IRS meets its day-to-day 

operating compliance obligations. These concern the enforcement 

activities associated with compelling non-compliant taxpayers to meet 

their tax obligations. On a strategic level, compliance measures 

developed as part of NRP also support IRS’s strategic goal of improving 

taxpayers’ voluntary compliance with the tax laws. IRS uses these 

measures to benchmark the effectiveness of programs to promote 

voluntary compliance.

More specific examples of how IRS uses of NRP data include:

• identifying where compliance problems are occurring, so that IRS can 

improve utilization of limited resources to address those problems;

• updating the discriminant function1 and other computerized 

examination workload selection formulas;

• gaining insights into the causes of reporting errors to provide 

improved taxpayer service;

2

• updating estimates of the tax gap;

3 and

• studying compliance issues and characteristics of a subset of 

taxpayers who were examined by NRP.

 

1

The discriminant function is a computer program IRS uses to score returns for audit 

potential, to increase the likelihood that noncompliant taxpayers are selected for 

examination. 

2

For example, where NRP examinations turn up systematic compliance errors on 

particular items for otherwise compliant taxpayers, the IRS may address the source of 

these errors through redesigned forms, better communications, improved taxpayer 

education, or proposing legislative changes. NRP data helps IRS assess the effectiveness 

of compliance programs and treatments it is using.

3

The tax gap estimate is an aggregate of estimates for the three primary types of 

noncompliance: (1) underreporting of tax liabilities on tax returns; (2) underpayment of 

taxes due from filed returns; and (3) nonfiling, which refers to the failure to file a required 

tax return altogether or on time. 

Appendix III: How IRS Uses National 

Research Program Data
Appendix III: How IRS Uses National Research 

Program Data

Page 25 GAO-13-480 Tax Administration

In addition to IRS, we have used NRP data for research purposes. For 

example, we used the NRP data set as part of our analysis of tax 

compliance by sole proprietorships study.4

 

 

4

See GAO, Tax Gap: Limiting Sole Proprietor Loss Deductions Could Improve 

Compliance but Would Also Limit Some Legitimate Losses, GAO-09-815 (Washington, 

D.C.: Sept. 10, 2009).
Appendix IV: Agency Comments from the 

Internal Revenue Service

Page 26 GAO-13-480 Tax Administration

Appendix IV: Agency Comments from the 

Internal Revenue Service
Appendix IV: Agency Comments from the 

Internal Revenue Service

Page 27 GAO-13-480 Tax Administration
Appendix IV: Agency Comments from the 

Internal Revenue Service

Page 28 GAO-13-480 Tax Administration
Appendix IV: Agency Comments from the 

Internal Revenue Service

Page 29 GAO-13-480 Tax Administration
Appendix V: GAO Contacts and Staff 

Acknowledgments

Page 30 GAO-13-480 Tax Administration

James R. White, (202) 512-9110 or whitej@gao.gov

In addition to the contact named above, Tom Short, Assistant Director; 

Tom Beall; Amy Bowser, Eric Gorman; George Guttman; Sarah McGrath, 

Robert Gebhart, and Donna Miller made key contributions to this report.

Appendix V: GAO Contacts and Staff 

Acknowledgments 

GAO Contact 

Ackinowledgments 

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