Tax Administration: IRS Is Implementing the National Research Program as Planned
Published: 2003-06-16T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Internal Revenue Service (IRS) needs up-to-date information on voluntary compliance in order to assess and improve its programs. IRS's last detailed study of voluntary compliance was done in the late 1980s, so the compliance information IRS is using today is not current. IRS is now carrying out the National Research Program (NRP), through which IRS auditors are reviewing about 47,000 randomly selected tax year 2001 individual tax returns. In June 2002, GAO reported that NRP was necessary, that its design was sound, and that it appeared to meet IRS's goals of acquiring useful compliance data while minimizing burden on taxpayers with returns in the sample. GAO was asked to review IRS's implementation of NRP. GAO reviewed IRS's method of gathering internal and third-party data (casebuilding) and IRS's process of reviewing casebuilding materials to determine if audits are necessary (classification) and assessed IRS's plans to ensure consistent data collection while minimizing burden on taxpayers.
section_title: What GAO Found
paragraphs: IRS's NRP is being implemented as planned and consequently is on track to meet the agency's objectives of obtaining quality research results while minimizing the burden on the approximately 47,000 taxpayers with returns in the NRP sample. IRS officials have completed the development and testing of NRP processes and have selected and trained staff members to carry out the program. Additionally, as the graphic illustrates, IRS is currently nearing the completion of casebuilding and has made progress in classifying NRP returns. Audits, when required, began in November 2002. As of the end of March 2003, IRS had closed 3,651 NRP cases. In accordance with IRS's plans to minimize burden on taxpayers with returns in the NRP sample, some cases have been closed without any taxpayer contact or with only limited audits. The NRP plan recognized that the initial estimates for the overall NRP sample size and the number of returns to be audited were uncertain because they were based on aging data. The overall NRP sample size will be smaller and IRS officials expect to conduct more face-to face audits than initially estimated. As IRS completes NRP casebuilding, classification, and audits, it is implementing quality assurance steps, including efforts to ensure that key audit steps are completed on all NRP audits before they are formally closed with taxpayers. This is important since the data collected from each NRP audit represent information from thousands of similar taxpayers.

section_title: Letter
paragraphs: Understanding taxpayers’ compliance with the nation’s tax laws is critical  to the ability of the Internal Revenue Service (IRS) to improve the  effectiveness of its programs to enforce and promote voluntary  compliance. While IRS strives to target enforcement audits to taxpayers  who are not complying with tax laws, this has become increasingly  difficult for IRS to do because the information it uses to identify likely  noncompliant tax returns is out of date. This means that a large and  growing number of IRS enforcement audits are directed at compliant  taxpayers. IRS needs more current data on compliance to be able to  appropriately target audits to problem returns. IRS last studied voluntary  compliance with random audits of tax year 1988 tax returns. These studies  included intensive, line-by-line audits and imposed a significant burden on  taxpayers with returns in the sample.
IRS is now carrying out a detailed study of taxpayer compliance—the  National Research Program (NRP). IRS has identified a random sample of  47,000 tax year 2001 returns and has begun NRP data gathering, including  limited audits where necessary to verify information reported by  taxpayers.
NRP is intended to produce useful compliance data while minimizing the  burden on the taxpayers selected for the study. IRS designed NRP to  minimize taxpayer burden by gathering IRS and third-party information—a  process called casebuilding—in order to limit taxpayer information  requests to items that cannot be verified without such a request. Specially  trained IRS agents then review the approximately 47,000 returns in the  NRP sample and their supporting casebuilding files and identify lines on  the returns that cannot be verified without auditing the taxpayers—a  process called classification. With this approach, some taxpayers will not  be contacted at all and most others will be asked to verify only some of the  line items on their returns.
In June 2002, we reported to you our assessment of IRS’s NRP plans. At  that time we determined that NRP was necessary and that its design  addressed both the need for up-to-date information on taxpayer  compliance and IRS’s goal of minimizing the burden NRP imposed on  taxpayers. We also reported that IRS had important casebuilding and  classification procedures testing to complete, as well as selection and  training of IRS personnel to carry out the program. You then asked us to  assess whether IRS is implementing NRP as planned. Accordingly, this  report describes and assesses (1) IRS’s completion of NRP development  and testing, (2) staff selection and training, (3) implementation progress of  the program, (4) quality assurance steps IRS is taking to ensure consistent  and accurate data collection, and (5) steps the agency is taking to  minimize burden on taxpayers with returns in the NRP sample.
To monitor IRS’s final development and implementation of NRP, we  reviewed agency documents concerning NRP design, testing, and  implementation. We also directly observed sessions of most aspects of  NRP training and two key tests of NRP procedures. We held frequent  discussions with the IRS personnel implementing the program and  conducted field office visits to several of the locations where NRP  classification is taking place. During our field visits, we met with managers  and classifiers and discussed their understanding of the program and any  implementation issues that came up. Our assessment of NRP  implementation is based on IRS’s NRP plans as described in our June 2002  report.
subsections: section_title: Background
paragraphs: IRS designed NRP to obtain new information about taxpayers’ compliance  with the tax laws. While IRS is using NRP to measure voluntary filing,  reporting, and payment compliance, the majority of NRP efforts are  devoted to obtaining accurate voluntary reporting compliance data. In  measuring reporting compliance, IRS’s two primary goals are to obtain  accurate information but minimize the burden on the approximately  47,000 taxpayers with returns in the NRP sample. IRS plans to use NRP  data to update return selection formulas, allow IRS to design prefiling  programs that will help taxpayers comply with the tax law, and permit IRS  to focus its limited resources on the most significant areas of  noncompliance.
NRP’s reporting compliance study consists of three major processes:       (1) casebuilding—creating information files on returns selected for the  NRP sample, (2) classification—using that information to classify the  returns according to what, if any, items on the returns cannot be verified  without additional information from the taxpayers, and (3) taxpayer audits  limited to those items that cannot be independently verified. We reported  in June 2002 that NRP’s design, if implemented as planned, is likely to  yield the sort of detailed information that IRS needs to measure overall  compliance, develop formulas to select likely noncompliant returns for  audit, and identify compliance problems for the agency to address. Figure  1 shows NRP’s main elements.
IRS designed the casebuilding process to bring together available data to  allow the agency to establish the accuracy of information reported by  taxpayers on their returns. For each taxpayer with a return in the NRP  sample, IRS is compiling internal information, such as past years’ returns  and information reported to IRS by third parties, such as employers and  banks, and information from outside databases, such as property listings,  address listings, and stock sale price data.
Classification is where IRS uses the casebuilding information to determine  whether an NRP audit is necessary and which items need to be verified  through an audit. Classifiers place NRP returns into one of four categories:  (1) accepted as filed, (2) accepted with adjustments, (3) correspondence  audit, and (4) face-to-face audit. If the casebuilding material allows IRS to  verify all of the information that a taxpayer reported on his or her tax  return, then the taxpayer will not be contacted and the return will be  classified as accepted as filed. On returns where minor adjustments are  necessary, the adjustments will be recorded for research purposes, but the  taxpayers will not be contacted. These returns will be classified as  accepted with adjustments. NRP returns that have one or two items from a  specified list requiring examination will be classified for correspondence  audits. All other NRP returns for which the casebuilding material does not  enable IRS to independently verify the information reported on the returns  will be classified for face-to-face audits.
NRP audits will take place either through correspondence with the  taxpayers or through face-to-face audits. When classifiers determine that  an NRP return will be sent for a correspondence audit, IRS will request  that the taxpayer send documentation verifying the line items in question.  To ensure accurate and consistent data collection, NRP audits will address  all issues identified by classifiers and will not be focused only on  substantial issues or cases for which there is a reasonable likelihood of  collecting unpaid taxes, according to IRS officials. NRP auditors also may  expand the scope of the audits to cover items that were not classified  initially.
IRS plans to conduct detailed, line-by-line audits on 1,683 of the  approximately 47,000 returns in the NRP sample in order to assess the  accuracy of NRP classification and, if necessary, to adjust NRP results—a  process called calibration. One-third of the returns in the calibration  sample will be returns that were classified accepted as filed (either with or  without adjustments), one-third from those classified for correspondence  audits, and one-third from those classified for face-to-face audits. None of  the taxpayers with returns in the calibration sample will have been audited  or otherwise contacted by IRS prior to the start of these line-by-line audits.
section_title: Scope and Methodology
paragraphs: To describe IRS’s implementation of NRP, we have conducted frequent  meetings with officials in IRS’s NRP Office and other IRS officials as they  have implemented the program. We reviewed NRP training materials and  observed NRP classifier, correspondence examination, and field  examination training sessions. We also observed NRP process tests and  conducted site visits to IRS area offices in Baltimore, Maryland; Brooklyn,  New York; Oakland, California; Philadelphia, Pennsylvania; and St. Paul,  Minnesota, in order to observe and review NRP classification in field  offices.
We considered whether NRP is being implemented in accordance with its  design. In our report issued on June 27, 2002, we found that NRP’s design,  if implemented as planned, is likely to provide IRS with the type of  information it needs to ensure overall compliance, update workload  selection formulas, and discover other compliance problems that the  agency needs to address. For this review, we also considered whether IRS  was maintaining a focus on meeting NRP’s objectives of obtaining quality  research results while, at the same time, minimizing taxpayer burden. This  assessment was also based on IRS’s NRP implementation plans.
As of the completion of our work, IRS had a significant amount of NRP  implementation to carry out. Our evaluation of IRS’s efforts to implement  NRP, therefore, only provides an assessment of efforts that have taken  place through the time of our work. Additionally, we did not attempt to  assess IRS’s efforts to measure filing compliance and payment compliance  through NRP. Our evaluation focuses only on IRS’s efforts to obtain  voluntary reporting compliance information. A more detailed description  of NRP can also be found in our 2002 report.
We conducted our work from September 2002 through April 2003 in  accordance with generally accepted government auditing standards.
section_title: IRS Completed NRP Process Testing
paragraphs: In addition to the two tests described in our prior report on NRP, IRS  conducted two more tests of NRP processes prior to implementing the  program. IRS tested the casebuilding and classification processes in an  NRP simulation in July 2002, and conducted another classification process  test during the initial classification training session in September 2002. IRS  used the preliminary results of both of these tests to estimate NRP  classification outcomes and to evaluate the effectiveness of NRP training.  As we recommended in our June 2002 report, IRS substantially completed  this testing prior to full NRP implementation, though final reports from the  tests were not completed until later.
In July 2002, IRS used draft NRP training materials to train 16 auditors  from IRS field offices in the use of NRP casebuilding materials to carry out  the NRP classification process. The newly trained classifiers then  classified 506 tax year 2000 returns. NRP staff members reviewed the  classifiers’ results and found that, overall, the results of this NRP  simulation were positive. They found that the classifiers understood the  NRP approach to classification but that there were instances where the  classifiers overlooked some of the issues indicated by the casebuilding  materials or made other errors.
In September 2002, IRS conducted another test of the NRP classification  process immediately following the initial training session using final  classification training materials. As we recommended in our June 2002  report, IRS had NRP classifiers classify previously audited tax returns in  order to compare classifiers’ results with the results of actual audits.  Twenty-two newly trained classifiers classified 44 previously audited  returns, with each return classified by 5 different classifiers. All of the  earlier audits resulted in some changes. NRP staff members then  compared the classifiers’ results with those of the other classifiers and  with the results of the earlier audits. NRP officials reported that the test  showed that about three-fourths of the time the trained NRP classifiers  were able to identify issues where noncompliance was found through an  audit.
IRS used preliminary results of these tests to identify and implement  improvements to NRP. For example, NRP staff members noticed early in  the course of the second test that NRP classifiers were failing to classify  some line items in accordance with NRP guidelines. Trainers reiterated the  importance of following the classification guidelines for these items. NRP  staff members also saw that the format of the form that classifiers were to  use to record their classification decisions made it easy to make mistakes.  They revised the form to make decision recording less error-prone. IRS  also used these tests to identify the need for more stringent classification  review guidelines than initially planned in order to ensure that classifiers  understand and follow the classification guidelines.
IRS did not finish analysis and documentation of the NRP simulation and  assessment and the classification process test until after the beginning of  classification in IRS area offices. NRP classification began at IRS area  offices during November 2002, but IRS did not finalize its report on the  July 2002 NRP simulation until December 2002, and the report on the  September 2002 NRP process test was finalized in December 2002.  According to NRP officials, this did not create problems because they  made changes to NRP processes and training materials before the reports  of these tests were final. Though the final reports were not completed until  later, these tests and the NRP modifications they generated were complete  before full implementation of NRP.
section_title: NRP Staff Selection and Training Is Complete
paragraphs: IRS identified and trained staff to complete NRP classification and audits.  IRS selected NRP classifiers and auditors from field offices across the  country to handle NRP cases along with the non-NRP enforcement cases  and carried out plans for special training of the staff members tasked with  NRP responsibilities. IRS delayed the delivery of computer software  training to managers and clerks involved in NRP audits due to technical  problems with NRP software. This initially delayed the start of NRP audits,  but the training is now complete. The timing of NRP staff selection and  training fit the conclusion and recommendation in our June 2002 report  that IRS should make sure that these key steps are carried out in the  appropriate sequence and not rushed to meet an earlier, self-imposed  deadline.
subsections: section_title: IRS Selected Auditors to Carry Out NRP
paragraphs: IRS selected over 3,000 auditors to handle NRP cases. Most of these  auditors are assigned to the Small Business/Self Employed operating  division. IRS selected 138 Small Business/Self Employed auditors to be  NRP classifiers and about 3,500 to handle NRP face-to-face audits.  According to NRP staff members, IRS offices across the country now have  one or more auditors trained to handle the NRP cases that come to those  offices. IRS area office managers determined how many auditors should  receive NRP training based on the projected distribution of NRP returns to  their areas.
Unlike face-to-face audits, NRP correspondence audits are being handled  out of a single office. IRS selected two groups of correspondence  auditors—26 correspondence auditors—from the Wage and Investment  operating division’s Kansas City office to handle NRP correspondence  audits.
IRS originally planned to select a cadre of auditors to work only on NRP  face-to-face audits. According to NRP officials, the geographic distribution  of NRP returns would have made it difficult to have a cadre of auditors  dedicated entirely to NRP examinations because they would have had to  travel extensively to carry out NRP audits. IRS officials said that even  though they did not implement the plan for a dedicated cadre of NRP  auditors, the number of full-time equivalent employees needed for NRP— about 1,000 in fiscal year 2003—has not changed.
section_title: NRP Classifier Training Is Complete
paragraphs: In September 2002, IRS trained 138 auditors to perform NRP classification.  The classifiers learned how to apply the guidelines for NRP classification  and were shown how to use NRP casebuilding materials. Instructors  stressed the concept of “when in doubt, classify the item” meaning that,  unless the casebuilding materials explicitly verify the line item in question,  the classifier should classify the item as needing to be verified through an  audit. Instructors explained that with a random sample such as in NRP,  every return represents many others so even small oversights on the part  of classifiers or auditors can have a substantial impact on data quality.
After the classification training, the classifiers remained at the training  location and began classifying NRP returns. Specially trained classification  reviewers reviewed most of the classified cases and provided rapid  feedback to the newly trained NRP classifiers. The intent of this was to  ensure that NRP classifiers understood and consistently applied the NRP  classification guidelines and received any needed retraining before  returning to their respective field offices and participating in future NRP  classification sessions.
section_title: NRP Auditor Training Is Complete
paragraphs: IRS delivered NRP correspondence and face-to-face auditor training  during late 2002 and early 2003. Instructors provided an overview of NRP  goals and objectives, reviewed the casebuilding materials that auditors  would have at their disposal, and explained the guidelines for NRP audits.
IRS trained about 3,500 auditors to conduct NRP face-to-face audits. This  training took place in IRS field offices across the country from October  2002 through February 2003. Each face-to-face NRP audit training session  lasted 3 days. The training consisted of an overview of NRP goals and  objectives, an explanation of how NRP audits differ from traditional  enforcement audits, and a description of how to apply NRP guidelines  during NRP audits. Trainers stressed that, for the purposes of consistent  and accurate data collection, NRP auditors should not focus solely on  significant issues or take into consideration the likelihood of collecting  unpaid taxes when conducting NRP audits, but should make sure that  every item identified by the classifier is carefully verified in the course of  the audit. Correspondence auditor training was similarly focused, and the  1-day training took place in September 2002. Staff members were trained  before they began to carry out NRP tasks.
section_title: Computer Software Training for Managers and Clerks Was Delayed
paragraphs: IRS needed to provide training to NRP auditors and to IRS managers and  clerks with NRP responsibilities in order for staff members to understand  how to use the computer program IRS developed to capture NRP  information. Because of some problems IRS encountered in installing the  NRP software in offices across the agency, IRS had to delay training some  clerks and managers. This led to delays in starting some NRP audits  because managers were unable to assign NRP cases to auditors and clerks  were unable to assist in loading NRP cases on NRP auditors’ laptop  computers. IRS resolved these problems and finished delivering the  majority of this training by the end of January 2003.
section_title: NRP Reviews Are Under Way
paragraphs: IRS is nearly finished creating NRP casebuilding files, has classified nearly  three-fourths of the NRP returns, and has begun conducting NRP audits.  As of the end of March 2003, IRS completed NRP casebuilding for about 94  percent of the approximately 47,000 returns in the NRP sample and about  73 percent of NRP returns have been classified. Also, for 3,651 NRP cases,  IRS completed all necessary audit work. Some of these are cases where  correspondence or face-to-face audits are finished, but most of the NRP  cases closed so far—2,709—are those that did not require audits. Cases  involving audits take longer to complete, so few have been closed thus far.  IRS made substantial progress in casebuilding and classification starting in  2002, and the number of cases assigned to NRP auditors has been  increasing quickly since January 2003. Figure 2 shows the progress IRS has  made in casebuilding, classifying, and closing cases.
The number of completed NRP casebuilding files began to grow during the  second half of 2002, as shown in figure 3. As figure 3 also illustrates, NRP  classification began in September 2002. These were the cases classified  during sessions held immediately after classifier training. Over 9,000 NRP  returns were classified by the end of October 2002. After these sessions,  classification became an area office function, with some offices scheduling  weeklong classification sessions on a somewhat regular basis and others  classifying returns as they come into the office.
IRS began conducting some NRP audits during November 2002, though  these audits began in earnest during the first quarter of 2003. By the end of  January 2003, IRS had assigned over 4,600 NRP cases to auditors to begin  conducting face-to-face and correspondence audits. By the end of March  2003, about 18,000 taxpayers had been contacted regarding NRP audits.
section_title: IRS Has Implemented NRP Quality Assurance Measures
paragraphs: IRS recognizes the need for accurate NRP data and, as planned, has built  into the program several measures to ensure the quality of NRP results.  IRS designed the NRP classification process to include quality assurance  reviews and has added additional quality assurance measures in response  to suggestions we made in the course of this engagement. The NRP audit  process also includes quality assurance measures that include both in- process and completed case reviews, with all NRP audits reviewed before  they are formally closed with the taxpayer. IRS also built accuracy checks  into the data capture steps that take place throughout the NRP process.
subsections: section_title: IRS Is Conducting Classification Reviews on a Sample of Returns
paragraphs: IRS designed NRP classification to include regular reviews of classifiers’  decisions. We found that these reviews are generally taking place  according to NRP guidelines. We also found that additional measures  could further improve NRP classification accuracy, and IRS implemented  our suggestions.
NRP guidelines specify that NRP classification reviewers review all cases  for which returns are classified as needing either no audit at all or only   correspondence audits to confirm their accuracy. Additionally, reviewers  must initially review 25 percent of the cases classified by each auditor that  are selected for face-to-face audits until they are satisfied with the quality  and consistency with NRP guidelines of the classifier’s work. After that  standard has been met, the guidelines specify that reviewers need only  review approximately 10 percent of the cases that each classifier selects  for face-to-face audit.
We conducted site visits to five IRS area offices where NRP classification  was taking place and found that IRS’s plans to implement the classification  steps of the program were generally well understood by the classifiers  carrying them out. Classifiers were knowledgeable about the differences  between the NRP classification process and the classification process  used in the enforcement audit environment and supported NRP goals in  general. However, we also found instances where NRP classifiers were not  consistently following NRP classification guidelines.
Another issue we identified involved the use of the classification review  sheets that reviewers fill out when they find problems with classifiers’  decisions. We learned that there was no provision for further review of  these forms. In some cases, we found that reviewers were not always  documenting classification errors on the forms. We discussed with NRP  officials the potential benefits of using NRP classification review sheets  for more than identifying issues at the area office level. Specifically, we  suggested that classification review sheets be forwarded from the area  offices to a central location in order to identify problems that may be  occurring in different locations around the country or other trends that the  NRP Office may need to address during the course of NRP classification.  The NRP Office agreed with our suggestion and added centralized review  of classification review sheets to its other classification quality assurance  measures.
The NRP Office adopted our suggestion that it conduct site visits to area  offices to identify NRP classification implementation issues. Similar to the  visits we conducted, NRP staff members visited area offices and met with  classifiers, reviewers, and managers to identify issues encountered in  carrying out NRP classification and possible areas where NRP guidelines  may have been misinterpreted. Among the issues they are asking about is  the usefulness of the various materials included in the casebuilding files,  information which may prove useful in the design of the casebuilding  portion of future iterations of NRP. NRP staff members are also  conducting separate reviews of completed classification cases.
section_title: NRP Audit Quality Assurance Measures Include a Mix of In- Process and Completed Audit Reviews
paragraphs: IRS has designed NRP to include several steps to identify NRP audit  quality problems at both the individual auditor level and across the  program. Reviews include quality checks while cases are in progress and  after work is complete, and reviews by managers at different levels.  Importantly, IRS’s plans call for every NRP audit to be reviewed at least  once at a point where it is still possible to return to the taxpayer and  complete additional audit steps, if necessary. These quality assurance  measures will serve to mitigate the risk of IRS including erroneous or  incomplete data in the NRP database.
NRP guidelines task group managers with reviewing one open NRP audit  for each auditor in the first 90 days of that auditor’s NRP activity and  another in the first 180 days. NRP officials intend for these in-process  reviews to be extensive and timed early enough in the program to identify  individual auditors’ misunderstandings of the program, correct them on  the audits under review, and prevent them on future NRP audits.
IRS has also created Quality Review Teams both to oversee individual  audit cases and identify problems at the area office level and systemically  across NRP. These teams are made up of IRS managers and are tasked  with checking for compliance with NRP-specific and overall IRS standards  on 40 open cases and 20 closed cases for each of IRS’s 15 area offices.  These reviews will be repeated in each area about once every 3 months  throughout the planned 18-month NRP audit period. The IRS standards  applied by the teams to the audits they review are the same standards  employed by IRS’s Examination Quality Measurement System (EQMS).
Similar to the visits NRP officials made to area offices to review  classification activities, NRP officials are also visiting area offices to  review NRP audit activities.  NRP officials said that any systemic issues  identified through Quality Review Team reviews will then be addressed  across NRP.
Another NRP audit quality assurance element calls for all face-to-face  audits to be checked by group managers after work is completed but  before the cases are formally closed with the taxpayers. This review will  include assessing technical correctness, mathematical accuracy,  completeness, and adherence to procedural requirements. IRS officials  said that these requirements include adherence to the NRP-specific  requirement that audits include verification of all items identified through  the NRP classification process. These reviews also include assessing  adherence to IRS standards in areas such as audit depth and reviewing  large, unusual, or questionable items on the audited return. We were  initially concerned that IRS planned for these reviews to take place after  NRP audits were completely closed, precluding IRS from reopening the  cases or otherwise obtaining additional information from the taxpayers  even if the reviewers found that the original NRP audits were incomplete.  However, senior IRS officials informed us in March 2003 that these  reviews will take place after NRP auditors consider their audit work to be  complete but before the taxpayers are notified that the audits are over.  The officials explained that these reviews of all NRP cases will be timed to  provide an important means of ensuring that complete and accurate audit  results are entered into the NRP database. They also explained that the  importance of NRP audit reviews has been stressed throughout NRP  implementation and will be the subject of ongoing communication with  managers in the field.
It is very important that IRS conduct reviews of NRP audits before they  are closed because IRS data show that auditors do not always meet  enforcement audit quality standards. In fiscal year 2002, IRS’s EQMS found  that auditors in the field did not meet the audit depth standard about 15  percent of the time on field audits; the standard for auditing taxpayer  income was not met about 25 percent of the time on field audits; and the  standard concerning audits of large, unusual, or questionable items was  not met 40 percent of the time on field audits. IRS officials said that  accurate audit results in these areas are critical to NRP’s overall accuracy.
IRS officials pointed out that the error rate for NRP audits should be lower  than in the enforcement audit environment because NRP auditors received  special training and because the NRP classification process will enhance  NRP audit quality. For example, NRP guidelines call for classifiers to  identify large, unusual, or questionable items on returns (the largest EQMS  error category) and NRP auditors must address all classified items.   However, IRS did not implement its earlier plan of having a selected cadre  of auditors work only on NRP cases. While NRP-specific training will serve  to prevent many audit errors, NRP audits are now being conducted by a  cross section of auditors from IRS field offices across the country and  more typical of the auditors who generated the 2002 EQMS error rates.  Because every return in the NRP sample represents many returns in the  whole population of 1040 filers, even a small number of cases closed with  incomplete information could affect the accuracy of NRP data.
IRS officials also noted that their plan to conduct early reviews of NRP  cases will identify problems with auditors’ understanding of NRP and help  to keep them from recurring on subsequent NRP audits. At least two of  each NRP auditor’s early cases will have extensive manager involvement  while the cases are still in progress, and other managers will be looking at  a sample of both completed and open cases to identify problems. IRS  officials believe that these measures are sufficient to ensure NRP audit  quality.
section_title: NRP Includes Data Consistency Checks
paragraphs: IRS is including a series of data consistency checks in the NRP database to  verify that the information NRP auditors record in IRS’s NRP reporting  system agrees with the information that IRS recorded from the tax returns  earlier in processing. NRP auditors must first record the results of NRP  audits in the report-generating software that was modified for NRP  purposes. Once auditors have recorded audit results, NRP coordinators  must use a data conversion program to transfer the data into a format that  the NRP database will accept. Following data conversion, IRS  coordinators transfer the audit data to the NRP database.
Once the data are transferred to the NRP database, a series of data  consistency checks take place to confirm that the data IRS originally  transcribed from the tax return are consistent, within specified tolerances,  with the data that NRP auditors recorded in the NRP reporting software. If  any of the consistency checks fail for a return in the NRP sample, the NRP  area coordinator will be notified and the mistake will need to be corrected.  According to IRS officials, they will impress upon NRP auditors the  importance of entering data into the NRP software correctly the first time  because it will be time-consuming to correct errors. NRP officials have  developed a case tracking system in order to monitor which cases still  need to pass all of the consistency tests and which tests they need to pass.  IRS officials reported that, as of early April 2003, the NRP database and  related programs were running and that completed NRP cases were being  entered into the database. They said that they were still making some  enhancements, but that the programs were fully functional.
section_title: IRS Is Taking Steps to Minimize and Assess Taxpayer Burden
paragraphs: As IRS planned, NRP casebuilding and classification processes are helping  minimize the burden on taxpayers with returns in the NRP sample. In  addition, the size of the NRP sample is now smaller than IRS expected it to  be. However, the number of taxpayers who will be subject to NRP audits  has increased. IRS plans to survey taxpayers who receive NRP audits to  assess their perceptions of the burden posed by those audits. IRS also  used input from tax practitioners to identify ways to improve interactions  with taxpayers subject to NRP audits.
subsections: section_title: NRP Processes Are Helping to Reduce Taxpayer Burden
paragraphs: IRS is following its plans to reduce burden on taxpayers selected as part of  the NRP sample by (1) compiling NRP casebuilding materials that allow  IRS to verify certain items on tax returns without requesting the  information from the taxpayer, (2) classifying returns according to items  that need to be verified through an audit, and (3) limiting most NRP audits  to items that cannot be verified without an audit. IRS officials also intend  to compare classification decisions with the results of NRP audits to  identify ways of improving the classification process for future rounds of  NRP. Moreover, IRS’s intent in carrying out NRP is to reduce the burden  on taxpayers in general by developing better audit selection formulas and  reducing the number of audits of fully compliant taxpayers.
The NRP casebuilding and classification processes described on page 4  are having their intended effect of reducing the burden NRP creates for  taxpayers with returns in the NRP sample. IRS has assembled IRS and  third-party data on most of the returns in the NRP sample and classifiers  have used these data to verify information on the returns, where possible,  without contacting taxpayers. The remaining casebuilding and  classification work was under way as of the end of March 2003. The  material in the casebuilding files has allowed IRS to fully verify about 10  percent of NRP returns without any audit. Classifiers were able to use the  casebuilding material to verify all but one or two items on another 5  percent of NRP returns, and these were sent for correspondence audits.
Classifiers identified line items needing verification through a face-to-face  audit on about 85 percent of NRP returns classified as of the end of March  2003. Because of the casebuilding and classification processes IRS  developed for NRP, these audits will generally be limited to line items that  cannot be verified using the information in the casebuilding files. This is a  substantial change from earlier compliance research efforts, in which all  returns were subject to audits of every line on the return. Only the 1,683  taxpayers with returns selected for NRP calibration audits will be subject  to complete audits of their returns.
IRS plans to use NRP results to improve future iterations of NRP. For  example, NRP officials plan to compare classification outcomes with NRP  audit results to help them to identify possible changes needed in  casebuilding materials and the NRP classification process. They have told  us that it may be possible to further reduce the number of accurately  reported line items that are subject to compliance research audits. On the  other hand, IRS may also find through NRP calibration audits that  classification missed many items that should have been audited, so more  line items should receive some form of audit in future rounds of NRP in  order for the research results to be useful.  IRS also intends to apply  lessons learned in NRP classification to classification in the enforcement  audit environment.
As we noted in our prior report, NRP should also lead to reductions in  taxpayer burden in general. IRS plans to use NRP results to help identify  and reduce causes of noncompliance and to better target enforcement  audits to noncompliant taxpayers, reducing the number of audits of fully  compliant taxpayers. IRS projects that, without improved audit selection  formulas based on NRP results, the percentage of enforcement audits that  result in no tax change will be about 35 percent higher in 2005 than it was  in 1993, the first year that selection formulas from the 1988 compliance  study were available. Taxpayer burden will decrease if successful  execution of NRP enables IRS to reduce the number of these audits of  compliant taxpayers.
section_title: NRP Sample Is Smaller Than IRS Initially Estimated
paragraphs: The NRP sample consists of 46,860 tax returns. We reported in June 2002  that the NRP sample would consist of 49,251 returns. The current number  is smaller than the initial estimate because IRS originally estimated the  NRP sample size based on the characteristics of the filing population that  existed during the 1988 reporting compliance study. According to IRS  officials, when they applied the NRP sampling plan to the 2001 filing  population, the number of returns necessary to satisfy the requirements  for some of the NRP strata declined because filing rates for those strata  were smaller than IRS officials had projected. The final NRP sample  consists of about 2,400 fewer returns than initially planned.
section_title: IRS Estimates That NRP Classification Will Result in More Audits Than Expected
paragraphs: IRS officials are currently finding that the NRP classification results are  different than initially planned. IRS now estimates that more face-to-face  audits will take place than initially projected because (1) as the NRP plan  recognized, IRS’s initial estimates were uncertain and based on aging data  and (2) the final form of NRP classification guidelines meant more face-to- face and fewer correspondence audits.
IRS initially estimated that out of an NRP sample of over 49,000 tax  returns, classification would result in about 30,000 face-to-face audits of  selected line items, about 9,000 correspondence audits covering no more  than two line items, and about 8,000 taxpayers who would not undergo  any audit because classifiers were able to either verify all of the items on  their returns or could correct some line items without contacting the  taxpayers.
The final NRP sample is 46,860 returns, and IRS now estimates that NRP  classification will result in face-to-face audits of about 39,000 taxpayers,  with approximately an additional 2,300 receiving correspondence audits  and 3,800 subject to no audit at all. IRS also plans to conduct 1,683 line-by- line calibration audits, drawing 561 returns from each of the three  classification categories—these numbers have not changed. Figure 4  shows IRS’s current estimate of how the three NRP classification  categories will be distributed.
NRP officials explained that the number of face-to-face NRP audits is  higher than expected because they were relying on aging data and  preliminary classification guidelines. Our 2002 report on NRP also noted  the preliminary nature of these estimates. Initial classification breakdown  estimates were made using 14-year-old data from the 1988 Taxpayer  Compliance Measurement Program study. NRP staff members said that  changes in the tax code and in the economic makeup of the filing  population since the 1988 study make the returns from that study an  unreliable tool for predicting NRP classification results, though that was  all they had to work with.
They also said that some of the change can be attributed to changes they  made in the final form of NRP classification guidelines. NRP staff  members said that they modified the NRP classification guidelines as a  result of discussions that took place between NRP staff members and  representatives from IRS’s business operating divisions. They instituted  the changes to the classification guidelines in order to better match the  training and skills of the examiners selected to conduct NRP  correspondence and face-to-face audits with the types of issues to be  covered by those audits. One change is that discrepancies between the  casebuilding files and the tax returns for issues such as Individual  Retirement Account contributions and Social Security income were  removed from the list of issues that could be verified through a  correspondence audit. Another change is that the final guidelines call for  virtually all business returns to receive face-to-face audits—initial  assumptions about the classification process allowed for some business  returns to be accepted as filed or receive only correspondence audits.
section_title: IRS Will Survey NRP Taxpayers
paragraphs: IRS will survey taxpayers who are subject to NRP audits to assess overall  customer satisfaction and their perceptions of the burden audits created  for them. IRS will ask taxpayers to fill out the same survey it uses to assess  customer satisfaction in the enforcement audit environment and compare  the results for the two populations.
The surveys include issues related to taxpayer burden in the form of  questions about the amount of time taxpayers spent preparing for the  audits and the amount of time that they spent on the audits themselves.  The surveys also ask whether taxpayers receiving NRP audits believe the  information that they were asked to provide seemed reasonable and  whether they feel they received fair treatment from IRS.
After collecting the survey results, IRS will then develop a “score” for each  question on the survey that relates to burden. IRS will compare the results  from the NRP customer satisfaction survey to the results from surveys  completed after enforcement audits.
section_title: IRS Consulted with Practitioners
paragraphs: IRS consulted with outside stakeholders to enhance its efforts to minimize  the burden NRP created for taxpayers with returns in the sample. IRS  consulted with members of organizations that provide feedback to IRS on  matters concerning taxpayers, including the National Public Liaison, the  Information Reporting Program Advisory Committee, and the Internal  Revenue Service Advisory Council. According to IRS, practitioner input  led to wording changes on taxpayer notification letters and improvements  to training materials, which strengthened the emphasis on maintaining  good relations with NRP-selected taxpayers. Representatives of the  National Public Liaison also participated in the training for the staff  members who were selected to conduct NRP auditor training.
section_title: Conclusions
paragraphs: IRS continues to be on track for meeting its NRP goal of obtaining  meaningful compliance data while minimizing the burden on taxpayers  with returns in the NRP sample. IRS has followed the key elements of the  plans it laid out last year and has responded to identified needs to modify  the program that have come from its own testing as well as from outside  stakeholders. Because of this, we are not making any recommendations in  this report.
We recognize that IRS efforts to gather information about NRP  implementation while the program is under way are very important to  IRS’s continued success in carrying out NRP. Classification review results,  audit review results, and customer satisfaction surveys all provide the  means for IRS to make immediate adjustments to NRP now and to  enhance the design of future iterations of the program. Provisions for 100  percent review of NRP audits before they are closed are particularly  important because even a small number of erroneous or incomplete cases  will negatively affect the quality of NRP data.
section_title: Agency Comments
paragraphs: On May 22, 2003, we received written comments on a draft of this report  from the Commissioner of Internal Revenue (see app. I).  The  commissioner noted the importance of NRP and IRS’s continued emphasis  on minimizing taxpayer burden and delivering quality results.  We also  received technical comments from NRP staff members, which we have  incorporated into this report where appropriate.
As agreed with your offices, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days after its  date. At that time, we will send copies of this report to the Secretary of the  Treasury, the Commissioner of Internal Revenue, and other interested  parties. This report is also available at no charge on GAO’s Web site at  http://www.gao.gov.
If you or your staffs have any questions, please contact Ralph Block at  (415) 904-2150, David Lewis at (202) 512-7176, or me at (202) 512-9110.  Thomas Gilbert was also a key contributor to this assignment.
section_title: Appendix I: Comments from the Internal Revenue Service