IRS Return Selection: Improved Planning, Internal Controls, and Data Would Enhance Large Business Division Efforts to Implement New Compliance Approach
Published: 2017-03-28T00:00:00

Fast Facts:
The IRS's Large Business and International division audits large partnerships and corporations (worth at least $10 million) and wealthy individuals—which sometimes poses compliance challenges. For example, the underreported income tax of corporations alone was about $28 million annually between 2008 and 2010.
This division is implementing a new approach to compliance that focuses on specific issues, such as partnerships that underreport certain types of income. We found that the IRS has made progress in implementing this approach but recommended that it fully address all the project planning principles necessary to effectively implement it.

Highlights:
section_title: Why GAO Did This Study
paragraphs: LB&I audits large partnerships and corporations with $10 million or more in assets and high wealth individuals. These entities pose compliance challenges. For example, IRS reported that the gross underreported income tax of large corporations alone averaged an estimated $28 billion annually between 2008 and 2010, the most recent data. It is important for LB&I to have adequate controls for its audit procedures and to properly plan and implement its new approach to address noncompliance.
GAO was asked to evaluate how IRS selects returns and is implementing its new compliance approach. Among other objectives, this report (1) assesses the extent that LB&I's documented procedures and policies for its audit selection methods generally reflected relevant internal control principles, (2) assesses the extent that LB&I has a standard process to monitor audit selection decisions, and (3) assesses the extent that LB&I has planned and implemented its new approach to address compliance.
GAO reviewed LB&I procedures and policies for eight selection methods that involved the use of discretion and its plans for implementing a new compliance approach. Given the status of LB&I's plans for and implementation of its new approach, GAO did not assess LB&I's decision to create the approach. GAO held focus groups with LB&I staff responsible for selecting audits, and interviewed IRS official
section_title: What GAO Found
paragraphs: The Internal Revenue Service's (IRS) Large Business and International division (LB&I) uses a variety of methods, such as computer models and staff reviews of returns, to identify tax returns for audit consideration. From the returns identified, managers and auditors in LB&I field offices select the returns to be audited. For the eight methods LB&I uses for identifying and selecting tax returns for audit (selection methods) that GAO analyzed, LB&I documentation on its procedures and policies generally reflected 4 of the 10 internal control principles GAO reviewed. For example:
Related to the internal control principle of demonstrating commitment to integrity and ethical values, LB&I auditors who identify tax returns for audit consideration are prohibited from auditing those returns themselves or assigning them to specific individuals for audit. In addition, all LB&I staff completed a required training on ethics and impartiality in 2015, the latest available data.
Related to the internal control principle of demonstrating a commitment to competence, LB&I's procedures and manuals generally documented its training to help assure the competence of staff involved in audit selection. This training included courses on basic skills as well as instruction on more specific topics.
However, for the other 6 internal control principles GAO reviewed, there were gaps in documentation that limit LB&I's assurance that its selection methods are being implemented as designed and are supporting its objectives. For example:
Related to the internal control principle of identifying, analyzing, and responding to risk, LB&I documentation did not specify procedures or a process for how to respond to changing circumstances, such as a change in the law, in selecting returns for audit.
Related to the internal control principle of reporting on issues and remediating related deficiencies, LB&I documentation indicated that problems identified with selection methods were discussed in meetings, but not that corrective action was taken to address them.
GAO also found that LB&I has monitoring directives, but it does not have a standard process for monitoring field staff's audit selection decisions. Without such a process, LB&I lacks reasonable assurance that decisions are made consistently.
LB&I is in the process of implementing a new approach for addressing taxpayer compliance, including how it identifies tax returns for audit. LB&I plans to implement what officials call “campaigns,” which are projects focused on a specific compliance-related issue, such as partnerships underreporting certain income, rather than projects focused on the characteristics of whole tax returns. According to LB&I officials, campaigns could include conducting audits as well as other efforts, such as reaching out to taxpayers and tax professionals, issuing guidance, and participating in industry events. LB&I officials said certain audit selection methods that existed prior to the development of campaigns will operate while LB&I implements its campaign approach, and campaigns may subsume some of those methods.
GAO found that LB&I made some progress in implementing its new compliance approach, such as by involving stakeholders in plans and implementing the process for submitting proposals for campaigns. However, LB&I has not fully met five project planning principles set forth in prior GAO work (see table below). Until it fully meets these principles, LB&I management lacks reasonable assurance that its new compliance approach will succeed in accomplishing its overall objectives of encouraging voluntary compliance and fair treatment of taxpayers.
section_title: What GAO Recommends
paragraphs: GAO recommends that IRS address documentation gaps in its selection method procedures and policies related to six internal control principles, develop a standard process to monitor field staff's audit selection decisions, and take seven actions to fully address planning principles in its efforts to implement its new compliance approach. In commenting a draft of this report, IRS agreed with all of the recommendations.

section_title: Letter
paragraphs: The Internal Revenue Service’s (IRS) Large Business and International  Division (LB&I) serves large partnerships and large corporations with $10  million or more in assets, which filed about 353,000 tax returns in fiscal  year 2015. As we previously have reported, large corporations and large  partnerships may pose significant compliance challenges. For example,  underreported taxable income from large corporations alone accounted  for $28 billion of the $458 billion estimated average annual gross tax  gap—the difference between taxes owed and those paid voluntarily and  on time–for tax years 2008 to 2010, the most recent years that IRS has  measured. The $28 billion represented 6 percent of the overall gross tax  gap. LB&I also serves individuals with high wealth and international  interests, both of which IRS considers to be high risk.
LB&I’s enforcement responsibilities include auditing tax returns to detect  when taxpayers misreport tax obligations. Audits can help reduce the tax gap by identifying noncompliance in reporting and by enhancing voluntary  compliance. If taxpayers perceive that IRS unfairly selects returns for  audit, their confidence in IRS could be undermined and voluntary  compliance could be undercut. The mission of IRS, as well as LB&I, calls  for ensuring compliance and fairly applying the tax law when selecting  which tax returns merit an audit. LB&I is in the process of changing the  way it addresses compliance including how it identifies tax returns for  audit and is moving toward implementing issue-based projects it calls  campaigns.
Noncompliance associated with large partnerships and corporations as  well as the sheer volume of tax revenue at stake speak to the importance  of IRS maintaining appropriate internal controls over its audit selection  methods. An effective internal control system can help federal agencies  achieve their missions and objectives and improve accountability. As set  forth in Standards for Internal Control in the Federal Government, also  known as the Green Book, internal controls comprise the plans, methods,  and procedures used to meet an entity’s mission, goals, and objectives,  which support performance-based management. The Green Book lists  17 internal control principles to help agency program managers achieve  desired results. The principles also provide reasonable assurance that  program objectives are being achieved through, among other things,  effective and efficient use of resources. Internal control is not one event,  but rather a series of actions and activities that occur throughout an  entity’s operations and on an ongoing basis. Two examples of internal  control standards are establishing clearly defined objectives and a  commitment to documenting significant events.
To better understand how LB&I selects tax returns for audit, you asked us  to review LB&I audit selection standards and internal controls. This  report (1) assesses the extent to which LB&I’s documented procedures  and policies on audit selection methods generally reflect relevant internal  control principles; (2) assesses the extent to which LB&I has a standard  process to monitor audit selection decisions; (3) describes statistical  information on audit starts and closures for LB&I’s selection methods,  including LB&I’s use of audit referrals, and assesses how IRS evaluates  its audit results from its selection methods; and (4) assesses to what  extent LB&I has planned and implemented its new approach to address  compliance.
To assess the extent to which LB&I documented procedures and policies  generally reflect relevant internal control principles, we reviewed LB&I  documentation and interviewed relevant officials to understand the  processes and procedures that LB&I uses to determine which tax returns  to audit. Based on LB&I officials’ input and our review of relevant  documentation, we narrowed our review to a subset of eight of LB&I’s  selection methods that required its staff to use discretion in selecting tax  returns to audit and that continued to operate at the conclusion of our  work. We assessed whether these processes and procedures generally  reflected 10 internal control principles, such as defining objectives to  identify risk and define risk tolerances and demonstrating commitment to  integrity and ethical values, which we determined were relevant to our  review.
To assess the extent to which LB&I has a standard process to monitor its  audit selection decisions, we reviewed IRS documentation on procedures  that auditors and audit managers were to follow in selecting cases and  assessed whether LB&I’s quality assurance program addressed  monitoring of selection decisions, using criteria from federal standards on  internal controls on monitoring. We also conducted non-generalizable  focus groups with randomly selected auditors and audit managers on  audit selection issues.
To describe LB&I audit statistics as well as assess how IRS evaluates  audit results by selection methods, we acquired a copy of LB&I’s audit  operations database, called A-CIS, and calculated statistics on audit  starts and closures and use of referrals for fiscal years 2011 through  2015. To assess the reliability of the A-CIS data, we reviewed the data  dictionary and related documentation, interviewed IRS officials  knowledgeable about the data, and performed electronic tests. Based on  these steps, we determined the data we generated on starts and closures  were sufficiently reliable for the purposes of our reporting objective. For  the assessment, we compared documentation on LB&I reports on  selection method performance with federal internal control standards.
To assess LB&I’s planning and implementation of its new approach for  addressing compliance, we reviewed LB&I’s plans for implementing this  approach for selecting tax returns by issue and assessed those plans  against five project planning principles we used in our prior work. Given  the status of LB&I’s plans for and implementation of its new approach, we  did not assess LB&I’s decision to create the approach.
We conducted this performance audit from January 2016 to March 2017  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.
subsections: section_title: Background
paragraphs: LB&I is responsible for the tax compliance of partnerships and S and C  corporations with assets of $10 million or more, as well as individuals with  high wealth or international tax implications. LB&I reports that its  taxpayers typically employ large numbers of workers, deal with  complicated issues involving tax law and accounting principles, and  conduct their operations in an expanding global environment. According  to IRS, these LB&I taxpayers filed 352,264 corporate and partnership tax  returns in fiscal year 2015.
LB&I’s stated mission is to provide taxpayers “quality service by helping  them understand and meet their tax responsibilities and by applying the  tax law with integrity and fairness to all.” In supporting that mission,  LB&I audits tax returns to determine whether taxpayers correctly report  information such as income, expenses, and credits. During an audit, LB&I  staff review a taxpayer’s books and records. The objective of audits, in  turn, is to promote the highest degree of voluntary taxpayer compliance.  In 2015, IRS reported that LB&I completed audits on more than 11  percent of large corporations—those with assets in excess of $10 million.  By comparison, the rate was 0.9 percent for all other corporations and 0.8  percent for individual returns.
LB&I has nine audit components focusing on five practice areas and four  geographical areas. Figure 1 shows LB&I’s organizational structure for  audit activities. Each practice area has Planning and Special Programs  (PSP) staff, who are responsible for controlling, monitoring, and assigning  audit inventory to field groups.
The term “selection methods” refers to all of the programs that LB&I uses  to identify and review tax returns to include in the pool of possible audits,  as well as the decisions made to audit tax returns by auditors and audit  managers in LB&I field offices. LB&I uses a variety of methods to select  returns for audit. Appendix 2 contains more detail on the selection  methods that LB&I officials provided to us, including the methods that we  focus on in this report.
Figure 2 provides a conceptual overview, based on our analysis of LB&I  documentation and interviews with relevant officials, of how LB&I narrows  the pool of tax returns for audit consideration, including how LB&I uses its  audit selection methods. After a tax return is filed with IRS, selection  methods that involve computerized scoring models and filters identify tax  returns that are likely to have compliance issues. According to LB&I  officials, the higher the score, the greater the likelihood that a tax change  will result from an audit. Computerized selection methods also may  identify tax returns with specific compliance concerns, such as a  particular value or combination of values reported on certain tax return  lines. According to IRS documentation, LB&I picks returns with specific  issues for compliance initiative projects (CIP) or returns that are  mandated for audit, such as refund returns that are subject to Joint  Committee on Taxation review. IRS also has a program, in which LB&I  participates, to identify tax returns with known abusive tax schemes. LB&I  officials said that they give additional scrutiny to individual tax returns with  certain international tax issues. After returns are scored by computers or  pulled for special projects and mandatory work, LB&I conducts another  review called classification, in which LB&I staff identify whether the return  merits an audit as well as specific issues for audit consideration. This  portion of the process is focused on identifying potential audit issues on  returns that are already considered at risk for noncompliance.
After the identified returns have been classified or otherwise reviewed for  specific tax issues, they are listed in a queue for audit managers to assign  to auditors, as shown in the bottom of the funnel in figure 2. Auditors in  the field assess whether the queued returns have large, unusual or  questionable (LUQ) features. According to LB&I officials, other factors  that guide which returns from the queue are selected include targets set  in LB&I’s annual audit plan, which prioritizes tax return types and tax  issues as well as resources and auditor’s skills and experience. Even if a  return is ultimately selected for audit, auditors or their managers may  decide upon closer examination not to proceed with the audit, a process  called surveying. In addition to the process shown in figure 2, LB&I may  initiate an audit based on taxpayers’ requests to amend their own returns,  a special type of audit LB&I calls a claim. LB&I also may begin an audit  based on facts from an ongoing audit, called a related pick up.
Once selected, LB&I audits fall into two categories, Coordinated Industry  Cases (CIC) or Industry Cases (IC). According to LB&I officials, the CIC  program puts large enterprises under continual audits. LB&I categorizes  tax returns as CIC based on factors that include assets, gross receipts,  and operating entities. CIC taxpayers are audited by a team of LB&I staff  while IC returns usually are audited by a single auditor. Generally, LB&I  officials said they use their most experienced and highest graded auditors  to review the tax return of LB&I taxpayers to address issues that are often  complex, involving multiple years and potentially ambiguous laws,  regulations, or related guidance in determining the correct tax treatment.  Auditors may be assisted by specialists to help review technical issues,  such as transactions that are international in scope and raise valuation  issues.
LB&I is in the process of changing the way it addresses compliance  including how it identifies tax returns for audit and is moving toward  implementing issue-based projects it calls “campaigns.” According to  LB&I, a campaign is a compliance project focused on a specific  compliance issue, such as partnerships underreporting income, rather  than on using characteristics of the whole tax return for audit  consideration. According to LB&I officials, campaigns could consist of an  audit, or a less burdensome treatment, such as letters asking taxpayers  to consider changing how they report the issue or additional guidance to  help taxpayers accurately report the issue on their returns. LB&I first  released its plan for adopting campaigns in late 2014 and announced the  initial 13 issues for campaigns in January 2017. According to its plan,  LB&I developed the campaign approach because of an increasingly  difficult tax environment in which its budget and resources are shrinking  and tax laws are growing more complex.
While LB&I implements campaigns, officials said the existing selection  methods it uses will continue to operate until LB&I decides whether to  replace them. LB&I officials also said that existing selection methods may  be repurposed to operate within campaigns, as well. For example, they  said that a computer filtering effort previously conducted as a standalone  project could be used to identify tax returns for audit under a specific  campaign. LB&I officials said they have no set date for terminating the  selection methods and starting the campaign process because  developing the campaign process is iterative.
section_title: LB&I Documentation on Audit Selection Methods We Reviewed Generally Reflected Some, but Not All, Internal Control Principles
paragraphs: In reviewing LB&I’s methods for identifying and selecting tax returns for  audit, we determined that LB&I’s related documentation generally  reflected 4 of the 10 internal control principles we reviewed but was  incomplete for the remaining 6 principles. Without complete  documentation, LB&I lacks reasonable assurance that selection methods  are being implemented as designed and therefore whether its return  selection processes and procedures are supporting its objectives.
subsections: section_title: Documentation Generally Reflected Internal Control Principles on Ethics, Organizational Structure, Commitment to Competence, and Implementation of Control Activities for Selection Methods Reviewed
subsections: section_title: Internal Control Principles that LB&I Documentation Generally Reflected in Audit Selection Methods Reviewed
paragraphs: LB&I has documented a commitment to promoting ethical behavior  among staff, which provides some high-level assurance that the way it  selects returns for audit may contribute to its strategic goal of treating  taxpayers with integrity and fairness. For example, classifiers who identify  whether a tax return should be considered for audit and which items on  the return merit audit attention are prohibited from auditing those returns  and from assigning them to specific auditors. Also, IRS’s ethics training  and an annual certification of that training help to assure that IRS staff  members are aware of the need to act ethically and impartially. All LB&I  staff were certified as successfully completing the training in 2015, the  latest available data.
In addition, LB&I provided documentation to indicate that all of the  selection methods we reviewed have a defined structure, and designated  persons have the necessary responsibility and delegated authority to do  their jobs in meeting the selection objectives. The documentation for all of  the reviewed selection methods showed which LB&I staff members have  been assigned responsibility for selecting returns for audit and have been  delegated authority by management to oversee the process, including  identifying and reviewing the potential returns and then selecting returns  for audit. For example, once the Global High Wealth (GHW) unit identifies  an individual taxpayer for possible audit, the related returns, such as  partnership and S corporation returns, are linked together, and a classifier  is responsible for assessing the compliance risk on the return. A manager  is tasked with overseeing this work before it is sent to the field for audit.
LB&I documented its commitment to competence for staff members  involved with audit selection. Congress enacted and the President signed  a statute in 2004 that gives federal agencies additional flexibility to help  recruit new staff and retain employees with needed skills by providing  enhanced recruitment and retention bonus authority. With many LB&I  employees close to retirement age or considering moving on and hiring  limited by budget constraints, LB&I officials said these provisions provide  them with additional tools to help meet its human capital needs and  assure the necessary skills are retained by its selection workforce.
In terms of training, LB&I’s procedures and manuals generally  documented its training to help assure the competence of staff involved in  audit selection. IRS has courses to teach key staff about needed basic  skills. For example, revenue agents—among the highest graded IRS  auditors—are taught to look for returns with LUQ items that may merit an  audit. In addition, the documentation showed training to instruct these  auditors and other staff about specific knowledge to consider when  reviewing returns for potential audit.
Finally, LB&I generally has documented the goals of and responsibilities  related to the selection methods we reviewed to assure that the  objectives and related risks are addressed. The documentation across  the selection methods generally identified who is responsible for  reviewing procedures to assure that the goals of the selection method are  met. For example, the filtering selection method has detailed  documentation describing the use of filters to identify the returns with the  highest compliance risk, and the role of managers in reviewing the returns  that have been selected.
section_title: LB&I Documentation for Selected Methods We Reviewed Did Not Generally Reflect Six Other Internal Control Principles We Reviewed
paragraphs: Table 1 shows gaps in the documentation related to 6 of the internal  control principles for all of the audit selection methods we reviewed. For  all six principles we reviewed, the documentation showed some support  for adherence for most of the selection methods.
In summary, LB&I provided documentation showing that the reviewed  selection methods generally reflected the six specified internal control  principles to some extent. The evidence provided, however, did not  completely document adherence to all parts of each principle. The gaps in  documentation on these six principles leave LB&I vulnerable to  inconsistently selecting tax returns for audit, or the perception of it.  Throughout our work, LB&I officials sought clarification on what kind of  documentation would generally reflect the internal controls principles and  acknowledged that they would look to add additional documentation.  Without complete documentation, LB&I cannot be assured that its existing  audit selection methods are being used consistently.
section_title: LB&I Does Not Have a Standard Process for Monitoring Audit Selection Decisions
paragraphs: LB&I does not have a process to monitor the final decisions about which  tax returns will be audited. In general, field managers and their auditors  make the ultimate audit selection decisions about the tax returns, which  generally have been reviewed by other IRS staff for audit consideration.  Although our discussions with LB&I staff indicated that some of these  audit selection decisions may be reviewed at the discretion of the  managers, LB&I’s procedures do not document a systematic, standard  process to regularly monitor field audit decisions. In addition, LB&I does  not have standardized criteria to explain the reasons for selecting a return  for audit, which would be necessary to regularly monitor audit selection  decisions.
Lacking a standard monitoring process for audit selection decisions is not  consistent with internal control standards for monitoring. Under internal  control principle 16, management should establish and operate activities  to monitor the internal control system and evaluate the results. Such monitoring may be built into the operations and activities and done  continually which could assist LB&I respond to change and help ensure  that the controls align with changing objectives, laws, and risks. It  assesses the quality of performance and points to corrective actions  necessary to achieve the objectives.
LB&I uses an audit monitoring system, but its review procedures and  steps do not cover audit selection decisions. The LB&I Quality  Measurement System (LQMS) is used to routinely monitor the  examinations and adherence to technical audit standards. LB&I reviewers  analyze a sample of tax returns that were audited and rate the quality of  those audits. The technical standards include actions taken after a return  has been assigned to an auditor, including planning the audit steps,  implementing those steps to collect evidence, and developing audit  findings. However, these monitoring activities and standards do not  assess the quality of audit selection decisions or whether the decision  processes have deficiencies that need to be addressed. According to  officials responsible for the LQMS program, LB&I previously included a  sample of surveyed returns in its annual review; however this was  discontinued several years ago and officials could not recollect why this  decision was made.
LQMS does not cover the selection decisions because the system was  designed to measure the quality of the actual audit activities. The results  of LQMS reviews are a part of the Balanced Measurement System, which  measures customer satisfaction, employee engagement, and business  results, including performance goals related to audits such as their  quality.
LB&I also has reviews that cover field operations, but these reviews do  not require monitoring audit selection decisions. For example, managers  in each IRS territory are required to conduct one operational review each  year of field audit managers to facilitate discussion and feedback on  routine group operations. Each territory review is developed at the  discretion of the manager and is non-standardized. One LB&I executive  we interviewed indicated that when he did these territory reviews, he  sometimes asked about how selection decisions were made. However he  acknowledged that he chose to ask those questions and that other  territory managers may do their reviews differently. LB&I staff members  also conduct Process and Issue Assessments that focus on providing  management a better understanding of the processes and procedures  being used and the issues being developed in audit, but these reviews do  not cover audit selection decisions.
During our focus groups, we discussed who reviews and approves the  audit selection decisions as well as gives feedback on the quality of the  decisions. A number of managers in our focus groups concurred that,  they have the authority to make most final selection decisions. Our  focus groups with auditors did not indicate that auditors regularly receive  feedback on their recommendations to managers on selecting or  surveying specific tax returns, although auditors who participated in the  groups commented that they sometimes received such feedback.
By not monitoring the processes used in the field offices to select specific  tax returns for audit, LB&I management risks relying on processes that  may lead to inconsistent selection decisions. The lack of routine  monitoring of selection decisions also can hinder LB&I management from  identifying deficiencies in these processes and evaluating them for  remediation. Furthermore, there is a risk that selection decisions may be  perceived as not supporting the mission to apply the tax law with integrity  and fairness to all taxpayers.
section_title: Audit Starts and Closures Declined Overall from Fiscal Years 2011 through 2015, but Data on Audit Results in Terms of Dollars Cannot Be Clearly Aligned with All Selection Methods
subsections: section_title: Audit Starts and Closures Declined Overall and Referrals Accounted for Small Portion of Starts and Closures
paragraphs: Based on our analysis of IRS data, LB&I audit starts and closures across  all selection methods generally declined between fiscal years 2011 and  2015, from 37,443 audit starts in 2011 to 34,180 in 2015 and 65,794  closures in 2011 to 34,763 in 2015 (see figure 3). IRS officials told us that  reductions in staffing over the 5-year period contributed to the overall  downward trend in starts and closures. Despite the overall downward  trend, audit starts increased between fiscal years 2012 and 2013. IRS  officials explained that the increase in audit starts in fiscal year 2013 was  caused by an influx of returns in the 2011 and 2012 offshore voluntary  disclosure programs.
As previously discussed, LB&I uses various selection methods to identify  returns for audit. Figure 4 shows that the 7 methods on which our  analysis focused accounted for more than half of all LB&I audit starts and  closures between fiscal years 2011 and 2015 while the remaining audit  starts and closures come from many other selection methods.  Compared to the seven methods, these other methods do not require the  same level of professional judgment by LB&I staff when selecting returns  for audit. For example, the audits can arise from taxpayer claims (such  as when a taxpayer requests to be audited for a refund); mandatory work  (such as audits to be reviewed by the Joint Committee on Taxation); or  related pick-ups (when an auditor begins auditing another tax return  based on what is observed in a different audit). Specifically, two selection  methods in our analysis collectively accounted for the bulk of LB&I starts  and closures. The Other Miscellaneous International Individual  Compliance (IIC) method accounted for 30 percent of audit starts and 35  percent of audit closures, while the Offshore IIC method accounted for 21  percent of starts and of closures. The remaining 5 selection methods in  our analysis together accounted for only about 1 percent of closures and  5 percent of audit starts. For a statistical summary of LB&I audit starts  and closures by selection method, see appendix III.
As illustrated in table 2, the number of audit starts and closures  associated with internal and external referrals generally increased over  the 5-year period from fiscal year 2011 to 2015, but referrals accounted  for a very small portion of LB&I’s starts and closures overall. For  example, in fiscal year 2015, LB&I had just under 35,000 audit closures,  of which 40 closures—or less than one percent of LB&I audit closures— resulted from referrals.
section_title: LB&I Tracks Results for Some of Its Selection Methods but Does Not Clearly Identify All Audit Selection Methods and Align Selection Methods with Audit Results
paragraphs: Federal Internal Control Standards state that quality information is vital to  achieving agency objectives. These standards further define quality  information as being appropriate, current, complete, accurate, and  accessible. Management should use quality information to make informed  decisions and evaluate performance in achieving key objectives.
Unlike our analyses of the data on audit starts and closures, when we  tried to analyze LB&I’s audit results data by each selection method, we  encountered difficulties that prevented us from easily analyzing the  results. An initial difficulty was that LB&I’s selection methods were not  clearly defined or documented. LB&I officials originally identified 14  methods that they used to select returns for audit; however, we found a  large portion of the division’s full audit inventory could not be categorized  within those 14 methods.
We worked closely with IRS data managers to identify the correct project  and tracking codes and categorize the data by selection method; these  steps enabled us to generate reliable data on audit starts and closures.  However, other difficulties unrelated to our ability to sort the data by  selection method prevented us from analyzing and comparing data on  audit results, such as additional tax dollars recommended, for the  selection methods. For example:
LB&I does not have project or tracking codes for DAS. DAS can only  be identified in the data by a source code, while the selection methods  can only be identified with project and tracking codes, causing overlap  between DAS and other selection methods in the data and prevent  direct comparison between DAS and the other LB&I selection  methods in terms of the related audit results.
The data cannot link a selection method used for entities such as  partnerships and S corporations that pass through their tax liabilities  to their partners and shareholders. As such, analyzing the results of  the selection method’s effect on changes to tax liability cannot easily  be done.
The data do not account for net operating losses (NOL), which makes  the results of the audit difficult to assess.
Linkages between the cost of an audit—such as auditors’  compensation and contractor fees—and audit results were not readily  available. This information would be needed to calculate cost-benefit  information to compare selection methods.
LB&I does periodically track data on results for its selection methods, but  we could not rely on that data to support our analysis. For example, LB&I  produces a monthly report to track data and performance measures for 9  of the 14 selection methods it originally identified as using. According to  LB&I officials, this report is used to analyze the performance of certain  selection methods against a baseline of audit results for Industry Case  (IC) returns and determine whether a particular method is achieving its  objectives. Examples of the measures that LB&I tracks in its monthly  report include: number of audits closed; additional tax dollars recommended overall and per audit hour; agreed recommended dollars (dollar amounts in additional tax  recommended that taxpayers agreed with); no-change rate (percentage of audits closed without changing the  amount of taxes currently owed); and audit cycle time (the time that returns are under audit).
While an IRS official told us that the monthly report helps inform decisions  on which selection methods to use, several limitations prevent it from  being used to compare how LB&I’s selection methods perform. Such  comparisons would help inform decisions on whether one method is  achieving better audit results in terms of adjustments made and hours  invested than another method, if given more resources. Such limitations  with the report include:
The data for certain selection methods are not mutually exclusive,  meaning comparing methods could be made more complicated by  duplication. For example, IRS officials told us that data in the report  for the Form 1065 and 1120-S modeling programs overlap, as well as  data on GHW selection results.
The report excludes key selection methods. Specifically, the two  methods that account for the bulk of LB&I’s audit work—Offshore IIC  and Other Miscellaneous IIC—for fiscal years 2011 through 2015 are  excluded. It also excluded the Compliance and Workload Delivery  method, which was included in the initial list of methods that LB&I said  it uses.
While LB&I staff review the report informally, it has no documented  guidance or criteria for how to assess the performance of its workload  selection methods in order to make decisions or take actions.
The audit results are not arrayed to easily review other potentially  important considerations, such as ratios of direct revenue yield per  dollar of cost across LB&I selection methods.
Without data that aligns the selection methods to the audit results, LB&I  has less assurance that it is allocating its limited resources most  effectively as it selects more returns to audit. LB&I officials acknowledged  that being able to more easily identify selection methods within the audit  inventory would enhance IRS’ ability to assess audit results by selection  method, an assessment that could be used to inform decision making, as  discussed later in the report.
section_title: LB&I Efforts to Plan and Implement New Compliance Approach to Audits Remain Incomplete
paragraphs: LB&I plans to conduct issue-based projects it calls “campaigns” to  address taxpayer compliance. Campaigns may involve audits of tax  returns or other types of compliance efforts, such as taxpayer outreach or  tax form changes. According to LB&I, ideas for campaigns come from  staff members who submit proposals, a process which started during our  work. As part of this submission, staff must identify campaign goals,  metrics, training, and resource needs. A governing board called the  Compliance Integration Council (the Council) is to decide which  campaigns are initiated and monitor campaign results. If the campaign  includes audits, LB&I may use the same or similar audit selection  methods, as discussed previously in this report. The concept for  campaigns was established in a plan released in 2014; however, as  discussed below, LB&I has not fully implemented that plan as of March  2017 and had not started work on any of the 13 campaigns announced in  January 2017.
Using our prior work, we identified 5 key principles for effectively planning  new projects and initiatives like LB&I’s new compliance approach  involving campaigns, as shown in the first column of figure 5. Although  LB&I has made progress in meeting all 5 principles, Figure 5 shows which  parts of each of the five principles that LB&I plans did not meet as of  December 2016.
Generally, LB&I officials said that planning and implementing campaigns  was an iterative process without a baseline for how long the process  would take, and, consequently, they adapted as they worked toward  fulfilling the five principles. However, by not fully meeting all of the  principles, LB&I lacks reasonable assurance that its new compliance  approach will succeed in accomplishing LB&I’s overall audit objective of  encouraging voluntary compliance and fair treatment of taxpayers.
subsections: section_title: LB&I Did Not Document a Clear Timetable with Deadlines for Carrying Out Its Plan or Establish Metrics for Measuring Progress toward Its Overall Goals
paragraphs: LB&I’s plan contains a conceptual roadmap for standing up the operation  of its new compliance approach involving campaigns and includes  elements such as compliance risk identification and resource allocation.  An LB&I executive said that some of LB&I’s plans have been completed  already, such as restructuring, implementing the campaign submission  process, and revising audit position descriptions. As noted earlier, LB&I  announced an initial list of 13 campaigns in January 2017, and LB&I  officials said they will continue to consider new campaigns in the future.
The plan does not, however, contain specific dates for implementing the  new compliance approach. The absence of specific dates is not  consistent with the project planning principles that call for having a plan  with a schedule. Elements of the plan that have no specific timetable  include establishing criteria for choosing upcoming campaigns or  eliminating existing selection methods that campaigns are meant to  replace. The plan also has no specific timetable for approving proposed  campaigns. LB&I officials said this was because they are transitioning  from the traditional selection methods to the campaign approach. The  officials said implementing the new campaign approach is iterative in  order to make adjustments as they gain experience with campaigns. In  March 2017 LB&I officials said they were working on a timeline they  believe will be consistent with the project planning principles. Without  specific timetables however, LB&I is less assured that it will stay on track  in executing its plan.
IRS officials told us that the overall goal for campaigns is preventing  noncompliance. LB&I’s guiding principles also specifically say that LB&I  will maintain a flexible well-trained workforce, select better work, use an  effective mix of compliance techniques (such as audits), and employ a  robust feedback loop. However, LB&I’s plan has not established metrics  for measuring progress toward those overall goals, although individual  campaign projects are to include measurable goals. Without metrics to  track progress across campaigns, LB&I is limited in its ability to determine  whether its new approach is meeting its stated goals.
section_title: LB&I Did Not Initially Evaluate Human Resource Needs for Implementing Its New Compliance Approach, and Lacks a Documented Plan for Such Analysis Moving Forward
paragraphs: LB&I’s plan discusses the need to assess human resources in three  ways: skill assessment (ensuring that staff have the proper skills);  workforce visibility (ensuring that management understands staff  capability and capacity), and issue finalization (the process of deciding  which issues will be audited by staff). For example, the plan is intended to  “provide a comprehensive, real-time understanding of workforce  capability and capacity.”
However, inconsistent with the planning principles, LB&I officials did not  evaluate human resource needs to implement the campaign approach  overall in its plan, in part because LB&I did not have the ability to  measure the resource investment. Based on our discussion with LB&I  officials on ways to track resource investments, LB&I approved in January  2017 repurposing an old database code to allow them to analyze staff  time charged to preparing campaigns. According to LB&I officials, the  data was not available as of March 2017 but they said they plan to use  the data to conduct return on investment analysis, though no plan is  documented. Developing and documenting a plan for analyzing how staff  time is being used on campaign activities can better position LB&I to  determine how it is using resources as it implements its new approach to  compliance.
section_title: LB&I Did Not Document How Stakeholder Input Was Used or the Lessons Learned through Evaluating Past Performance
paragraphs: LB&I’s plan cites a variety of IRS stakeholders involved in developing the  campaign process, consistent with planning principles. For example,  stakeholders included two commissioners, directors from the field, the  General Counsel’s office, and IRS’s finance and technology offices, as  well as executives for topical areas, such as the financial services  industry, natural resources construction, and GHW. LB&I officials also  said that these discussions covered past audit performance based on the  available data that LB&I had been generating, including Business  Performance Reviews (BPR), which list results by several measures for  the division overall, and monthly reports that compare certain selection  method results with results from audits selected primarily through DAS.
However, LB&I officials said the discussions with stakeholders to  formulate the campaign approach were not meant to be formal, and the  stakeholder input and any lessons learned from evaluating past  performance were not specifically documented, as called for in internal  control standards. Without the documentation of those discussions and  evaluations, LB&I cannot demonstrate that it has leveraged lessons  learned and contributions made by stakeholders and those evaluations  for future reference.
section_title: LB&I Plans to Monitor Individual Campaign Performance but Its Plan Does Not Cover Monitoring Across Campaigns or Identify Criteria for Choosing Selection Methods for Particular Projects
paragraphs: According to its plans, LB&I intends to monitor how individual campaigns  progress. If implemented, these division-level monitoring efforts would  help align campaigns with LB&I audit goals. In particular, LB&I plans to  make evaluating issue selection part of its performance feedback loop to  refine key models and decision points to improve issue selection, as  shown in the “adapt” portion of figure 6.
The system of analysis that LB&I plans partially satisfies the fourth project  planning principle by setting up a monitoring process on the performance  of individual campaigns. However, these plans do not address evaluating  the performance of selection methods used across campaigns.  Furthermore, the data analyses that LB&I has used to monitor the  performance of its selection methods are not sufficient to compare results  from campaigns using audits because of data problems discussed earlier.  For example, the reports used to monitor selection methods had  overlapping categories and the selection methods themselves were not  always clearly identified in the data. LB&I officials said that the way LB&I  captures audit data makes it challenging to compare audit results.  Without analyzing and monitoring results by selection methods across  campaigns, LB&I faces a greater risk of not using the most effective  selection method within its campaigns.
LB&I’s plan also did not include measuring costs, such as auditor pay,  travel expenses, and specialists that could be compared to the  effectiveness of a selection method used in a specific campaign. Nor  does the plan include an estimate for how much LB&I would spend on  campaigns overall. According to LB&&I officials, this level of detail was  not deemed necessary when the plan was written. In 2012, we found that  IRS could more effectively target audit resources by measuring the  marginal benefit and costs of auditing certain tax returns. Research by  IRS and other experts has found that although it may be complex, a  marginal cost-benefit analysis could help IRS allocate resources to  increase net revenues.
LB&I faces several challenges in its efforts to monitor progress. First, the  planned database for monitoring individual campaigns is the Issue Based  Management Information System (IBMIS), which is populated with data  from the Issue Management System (IMS), Audit Information  Management System, and the Specialist Referral System. The Treasury  Inspector General for Tax Administration (TIGTA) last year found  reliability issues with IMS. In response to TIGTA, an LB&I compliance  executive said the division had assembled a team to fix the IMS issues  TIGTA identified and plans to improve the issue codes needed for  evaluation, though those efforts were not complete as of January 2017.  LB&I cannot be assured that it will draw appropriate conclusions about  improving compliance through campaigns until the underlying data are in  better order.
Furthermore, as previously discussed, LB&I officials said existing  selection methods will continue to operate until LB&I decides whether to  replace them or repurpose them to operate within campaigns. If LB&I  chooses to discontinue any selection methods once campaigns are fully  implemented, it would not make sense to compare them to other  methods. LB&I officials also said some selection methods should not be  compared. For example, they said it may not be appropriate to compare  selection methods used to choose an audit of a large corporation that  may take years and require multiple staff members with the audit of a  high wealth individual that takes less time and fewer resources. The  range of taxpayers covered by methods also differs. For example, the tax  shelters rely on disclosures from the public, making the possible universe  of coverage small compared to DAS, which is applied to all Form 1120  submissions.
LB&I officials said they had received more than 700 campaign proposals  by December 2016, but IRS has not developed criteria for choosing the  most effective audit selection methods for campaigns with audits beyond  the discretion of the Council, which IRS deemed sufficient. As of March  2017, LB&I said that they are developing such criteria. Without criteria to  choose audit selection methods for campaigns using audits, LB&I lacks  reasonable assurance the campaigns will meet LB&I’s audit objectives.
section_title: LB&I Intends to Address Potential Risks but Plans Lack a Specific Timetable and Metrics for Risk Mitigation
paragraphs: LB&I officials said they held internal discussions about potential risks and  have a plan stating LB&I intends to analyze risks as the campaigns are  implemented. Areas of risk that LB&I has identified include an  increasingly difficult environment in which its budget and resources are  shrinking, tax laws are growing more complex, and taxpayers who are  continuing to evolve. In addition, part of the Council’s mission in  overseeing and analyzing campaigns is to discuss and make decisions on  risks.
While LB&I’s plans to assess risk associated with campaigns show  progress toward meeting the fifth project planning principle, LB&I officials  did not provide us with documentation to support how the planned risks  will be assessed and mitigated. Given the data limitations LB&I faced  when it was developing the plan, officials would have been challenged to  analyze the risks identified.
To mitigate specific risks, LB&I plans to identify and develop staff with  needed skills, create a function to conduct environmental scans, and  develop the ability to gather, manage, and analyze data. These plans for  analyzing and mitigating risks, however, lack a set timetable, and do not  include specific metrics for assessing whether progress is being made  toward goals. Without these metrics and a timetable for developing them,  LB&I will be less assured that it is addressing risks faced by audit-focused  campaigns.
section_title: Conclusions
paragraphs: LB&I has documented policies and procedures that generally reflect 4 of  the 10 internal control principles that we reviewed. However, gaps in  documentation related to six of the principles leave LB&I without  reasonable assurance that its selection methods are being implemented  as designed and whether tax return selection supports the division’s audit  objectives Ensuring that policies and procedures of audit selection  methods are fully documented will continue to be important for LB&I as it  implements its new campaign approach for selecting audits. Similarly,  LB&I’s lack of a standard process for monitoring field-level selection  decisions, the most direct step in audit selection, may hinder  management’s ability to identify any inconsistencies across decisions and  remediate any deficiencies in its audit processes.
LB&I’s efforts to plan and implement its new compliance approach have  partially met five key principles for effectively planning projects. However,  opportunities exist to make improvements. In particular, LB&I has not fully  established a specific timetable for implementing its new approach overall  or completed plans to monitor those projects overall—only individual  projects. LB&I also faces challenges in ensuring that data to conduct the  monitoring is sufficient to assess any selection methods used in the new  compliance approach moving forward. Without taking the steps to fully  meet all five planning principles in implementing its new approach, LB&I  management will lack reasonable assurance that its new compliance  approach will succeed in accomplishing LB&I’s overall audit objective of  encouraging voluntary compliance and fair treatment of taxpayers.
section_title: Recommendations for Executive Action
paragraphs: As LB&I finishes implementing its new approach and decides which  selection methods will be used with the campaigns, we recommend that  the Commissioner of Internal Revenue ensure that the documentation  gaps in policies and procedures are addressed for the following six  internal control principles for the selection methods that will be used: define objectives to identify risk and define risk tolerances;  identify, analyze, and respond to risks to achieving the objectives; design control activities to achieve objectives and respond to risks; use quality information to achieve objectives;  communicate internally the necessary quality information about the  objectives; and evaluate issues and remediate identified internal control deficiencies  on a timely basis.
Also in accordance with federal internal control standards, we  recommend that the Commissioner direct LB&I to adopt a standard  process for monitoring audit selection decisions in the field, such as by  modifying the existing quality control system.
To further ensure that the new campaigns under LB&I’s new approach for  addressing tax compliance are implemented successfully, we recommend  that the Commissioner take these actions:  create a timetable with specific dates for implementing its new  compliance approach; establish metrics to help determine whether the campaign effort  overall meets LB&I’s goals;  finalize and document plans to evaluate the human resources  expended on campaign activities; document lessons learned from stakeholder input and past monitor overall performance across future campaigns, not just  individual compliance projects, and in doing so ensure that the data  used for monitoring accounts for the costs beyond the auditor’s time  can clearly be linked with specific selection methods, including the  Discriminant Analysis System (DAS) method, to the extent that the  selection methods continue to operate; develop and document criteria to use in choosing selection methods  for campaigns using audits; and  set a timetable to analyze and mitigate risks and document specific  metrics for assessing mitigation of identified risks.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to the Commissioner of Internal  Revenue for review and comment. On March 9, 2017, the Deputy  Commissioner for Services and Enforcement provided written comments  stating that IRS agreed with all of the GAO’s recommendations and is  identifying the specific actions to be taken to effectively implement them.  In the letter, which is reprinted in appendix V, the Deputy Commissioner  said that the GAO report properly highlights the importance of addressing  documentation, both in the traditional selection processes, as well as the  new campaign process; developing a standard process to monitor audit  selection systems; and fully addressing project planning principles in  implementing the campaign approach. The Deputy Commissioner also  said that LB&I has begun taking steps to improve its documentation and  monitoring processes and that GAO’s findings, along with the  implementation of its recommendations, will improve this process. Lastly,  the Deputy Commissioner said that IRS will provide a more detailed  description of its actions, responsible officials, and implementation  timelines in its response to the final report. At that time, we will review  these details in determining IRS’s progress in implementing our  recommendations.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to the Chairmen and  Ranking Members of other Senate and House committees and  subcommittees that have appropriation, authorization, and oversight  responsibilities for IRS. We will also send copies of the report to the  Secretary of the Treasury, Commissioner of Internal Revenue, and other  interested parties. In addition, this report is available at no charge on the  GAO website at http://www.gao.gov.
If you or your staff have any questions or wish to discuss the material in  this report further, please contact me at (202) 512-9110 or  mctiguej@gao.gov. Contact points for our Offices of Congressional  Relations and Public Affairs may be found on the last page of this report.  Key contributors to this report are listed in appendix VI.
section_title: Appendix I: Objectives Scope and Methodology
paragraphs: This report (1) assesses the extent to which the Large Business and  International (LB&I) division’s documented procedures and policies on  audit selection methods generally reflect relevant internal control  principles; (2) assesses the extent to which LB&I has a standard process  to monitor audit selection decisions; (3) describes statistical information  on audit starts and closures for LB&I’s selection methods, including  LB&I’s use of audit referrals, and assesses how the Internal Revenue  Service (IRS) evaluates its audit results from its selection methods; and  (4) assesses to what extent LB&I has planned and implemented its new  approach to address compliance.
To assess the extent to which LB&I documented procedures and policies  generally reflect relevant internal control principles, we reviewed the  various LB&I’s selection methods and related internal controls that are  intended to help LB&I achieve its stated goal for audits to promote  voluntary compliance. We also reviewed IRS’s Strategic Plan FY2014- 2017, Internal Revenue Manual (IRM) sections related to LB&I’s mission  statement and statement for audits, LB&I’s fiscal year 2016 Business  Performance Review, and other IRS documentation related to LB&I’s  audit selection process.
At the start of our work, LB&I provided a list of its 14 audit selection  methods which are listed in appendix II. Based on LB&I officials’ input and  our review of relevant documentation, we decided to focus our analysis  on whether eight of these selection methods meet the relevant internal  controls standards. Our decisions, to which LB&I officials agreed, include  the following.
Our analysis excluded three selection methods that were shut down  during our work. LB&I has ceased operating the 1065 and 1120-S  modeling program selection methods and merged the international  risk assessment program (IRAP) with filtering. LB&I officials said they  made these decisions based on experience with the programs and on  the expected nature of new selection methods that LB&I is  developing.
We also excluded the compliance and workload delivery (CWD) and  foreign payment program (FPP) selection methods because neither  method involves decisions about whether to select tax returns for  audit. Rather, their workload consists of referrals from other parts of  IRS, or returns that are mandatory to audit.
We combined the Form 8886 disclosures and Form 8918 material  advisor disclosures into one return selection method because they are  handled by the same office—the Office of Tax Shelter Analysis  (OTSA).
For the remaining 8 selection methods, we compared relevant LB&I  procedures with 10 internal control principles from Standards for Internal  Control in the Federal Government (Standards). We assessed whether  documentation on LB&I’s selection methods generally reflected the 10  internal control principles by reviewing documentation and interviewing  LB&I officials familiar with the return selection methods. The internal  control principles we used for our evaluation are noted below.
Principle 1: Demonstrate commitment to integrity and ethical values
Principle 3: Establish structure, assign, responsibility, and delegate  authority to achieve objectives.
Principle 4: Demonstrate commitment to competence through  recruiting, training and development, and retention.
Principle 6: Define objectives to identify risk and define risk  tolerances.
Principle 7: Identify, analyze, and respond to risks to achieving the  objectives.
Principle 10: Design control activities to achieve objectives and  respond to risks.
Principle 12: Implement control activities through policies and reviews.
Principle 13: Use quality information to achieve objectives.
Principle 14: Communicate internally the necessary quality  information about objectives.
Principle 17: Evaluate issues and remediate deficiencies.
We selected these 10 principles based on our previous work on IRS audit  selection and our review of Green Book internal controls. We consulted  with GAO stakeholders with knowledge about the principles and  evaluation methodology. We shared our identification of the relevant  principles with LB&I officials, who agreed with the criteria. We also  discussed the type of documentation we were seeking to support the  internal controls with LB&I. We had three GAO analysts independently  review LB&I’s documentation and reach consensus on whether the  documented policies and procedures generally reflect the principles.
To assess the extent to which LB&I had a standard process to monitor  audit selection decisions, we reviewed documentation on the standards  for audit selection from the IRM, as well as documentation on the LB&I  Quality Measurement System, which LB&I officials told us was the  primary method to assess how well auditors follow IRS standards. We  also interviewed relevant LB&I officials on practices in selecting audits in  the field. Additionally, we held seven focus groups—three with field audit  managers and four with field auditors—to collect examples of field staff’s  experiences following audit standards. We acquired complete lists of field  auditors and managers and randomly selected focus group participants  from those lists. The selected participants are a nonprobability sample,  and their views cannot be generalized to their respective populations. The  focus groups were conducted by telephone and were facilitated by a GAO  methodologist. We compiled the comments made during the focus group  and identified common themes. For our assessment, we compared the  documentation we reviewed and the information we collected from  interviews and focus groups with the Green Book internal control on  monitoring.
To describe statistical information on audit starts and closures from  LB&I’s audit selection methods, we acquired the complete dataset from  A-CIS, an IRS system used to track LB&I audit activity, for fiscal years  2011 through 2015, the most recent complete data available during our  analysis. We identified the codes corresponding to the 14 selection  methods that LB&I officials told us they use to help select tax returns for  audit, with the exception of IRAP for which LB&I did not have any codes.  We worked with IRS data managers and identified 35 other selection  methods within LB&I’s audit inventory, which we determined to be outside  of the scope of this review and refer to as “Other Methods” for  comparative purposes in this report (see Appendix II for examples of  other selection methods). We made other scoping decisions to ultimately  arrive at the seven selection methods on which we focused our data  analysis.
We removed the Discriminant Analysis System (DAS) because it is  identified in the data using source codes, which are not comparable  with the project and tracking codes used for the other selection  methods.
For consistency with our internal controls analysis, we combined the  codes for Form 8886 disclosures and Form 8918 material advisor  disclosures and presented those results as one return selection  method, Tax Shelters.
We did not include the CWD and FPP programs as we determined  they do not require the professional judgment of LB&I staff in making  audit selection decisions.
Lastly, the results we present do not include the Compliance Initiative  Projects (CIP) and Coordinated Industry Cases (CIC) as selection  methods because the majority of the audit results were too small to  report without revealing taxpayer information.
We used the codes to measure the annual number of starts and closures  for these 7 remaining selection methods: 1065 Modeling, 1120-S  Modeling, Tax Shelters, LB&I Filtering, Global High Wealth (GHW),  Offshore IIC, and Other Miscellaneous IIC. In addition, to describe LB&I’s  use of audit referrals, IRS identified the coding for two groups of audit  referrals that LB&I receives—internal and external—and we used these  codes to count the number of audits that listed these referrals by source  codes. We assessed the reliability of the data by reviewing existing  information, including the A-CIS data dictionary and related  documentation and conducted interviews with LB&I officials  knowledgeable about the data. In addition, we compared our results to  selected system control totals provided by IRS, and had our code and  results confirmed by relevant IRS data experts. We also ran summary  statistics for each selection method. Based on these steps, we  determined that the data we generated were sufficiently reliable for  calculating statistics on audit starts and closures.
To assess how IRS evaluates its audit results from its selection methods,  we reviewed a monthly tracking report on LB&I’s individual selection  methods that LB&I officials told us they used to monitor selection  methods. We also interviewed relevant LB&I officials. We compared  LB&I’s report with the Green Book internal control Principle 13: Use  Quality Information.
To assess the extent to which LB&I planned and implemented its new  approach for addressing compliance, we reviewed our prior work on  projects similar to what LB&I had designed with campaigns. Based on  our review of those reports, we determined the project planning principles  listed in table 3 below were appropriate for our analysis because of their  applicability to planning new approaches or projects. IRS agreed with  these principles during April 2016. We reviewed LB&I’s plans to stand up  campaigns and interviewed relevant officials then compared the  information to the principles outlined in table 3. Given the status of LB&I’s  plans, we did not assess LB&I’s decision to create the approach.
To determine whether LB&I met the principles, two analysts  independently compared the evidence with the criteria and recorded their  assessments. A third analyst also reviewed the evidence and acted as a  tie-breaker, if needed. The statements that analysts could make based on  the evidence are “meets” or “does not meet.”
To keep our conclusions as clear as possible, our definitions of the two  assessments are as follows.
Meets: The documented evidence supports all aspects of the criterion.
Did not meet: The evidence did not support all aspects of the criterion,  including cases in which some aspect of the criterion is met, but we  did not have enough evidence to conclude that all aspects were met.
We conducted this performance audit from January 2016 to March 2017  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.
section_title: Appendix II: Description of Large Business and International (LB&I) Selection Methods and Other Methods
subsections: section_title: Selection Methods
paragraphs: LB&I officials initially identified fourteen selection methods that LB&I uses  to help select tax returns for audit. The list of those selection methods,  including definitions, follows:  Discriminant Analysis System (DAS): DAS is a mathematical system  that LB&I uses to identify corporate (Form 1120) returns that may merit  selection for audit. DAS prioritizes returns based on their probability of  being profitable to audit. DAS computes a score that allows LB&I to rank  the returns.  1065 Modeling: The partnership (Form 1065) computer model combines  results from mathematical formulas and business rules to identify  partnership returns for audit consideration.  1120-S Modeling: As with the 1065 model, the S corporation (Form 1120  S) computer model combines results from mathematical formulas and  business rule to identify S corporation returns for audit consideration.
Form 8886 Disclosures: The Office of Tax Shelter Analysis (OTSA) in  LB&I reviews this disclosure form for potentially abusive tax avoidance;  taxpayers are to disclose particular transactions that may indicate such  abuse.
Form 8918 Material Advisor Disclosures: OTSA in LB&I reviews this  disclosure form, which is to be filed by those who promote tax shelters,  for inappropriate shelter schemes to lower tax liability.
LB&I Filtering: Computer programs that LB&I staff develop to identify  particular issues that have a tendency towards noncompliance on tax  returns for audit consideration.
International Risk Assessment Program (IRAP): IRAP is a program to  identify particular international tax planning strategies that may pose a  compliance risk.
Coordinated Industry Case classification process: LB&I staff assign  points to certain characteristics on a tax return to identify whether certain  large corporate taxpayers should be under continuous audit.
Global High Wealth (GHW): LB&I teams use computerized models to  identify high wealth individuals with audit potential because of various  ownership and investment interests.
Compliance and Workload Delivery: This is a process that identifies  and classifies returns for potential audit based on issues that LB&I lists in  its annual letter on audit priorities due to a compliance risk.
Offshore International Individual Compliance: LB&I identifies  individual tax returns with potential international compliance issues based  on information received from third party information, such as banks  complying with Internal Revenue Service (IRS) issued summonses for  customer records  Other Miscellaneous: Tax returns that are referred by the Whistleblower  program for possible audit on the basis of information received from a  whistleblower.
Compliance Initiative Projects: LB&I staff identifies returns filed by  specific types of taxpayers such as those engaging in certain activities to  collect data about potential areas of noncompliance.
Foreign Payment Program: A program responsible for coordinating all  foreign payment functions such as income tax withholding and  information reporting by third parties on payments made to taxpayers.
Since the start of our engagement, LB&I has ceased operating the 1065  and 1120-S modeling programs and merged IRAP with filtering.  According to LB&I officials, they made these decisions based on their  experience with the programs and on the expected nature of new  selection methods that LB&I is developing. We have excluded these three  methods from our analyses of documented policies and procedures and  calculations of audit starts and closures. We also excluded the  compliance and workload delivery and foreign payment programs  because we confirmed with IRS officials that neither of these programs  include returns that require the discretion of LB&I officials in making an  audit selection decision. Rather, their workload consists of referrals from  other IRS divisions, or returns that are mandatory to audit. We also  combined the Form 8886 disclosures and Form 8918 material advisor  disclosures into one return selection method because they are handled by  the same office—OTSA.
section_title: Other Methods
section_title: Appendix III: Statistical Summary of Large Business and International (LB&I) Audit Selection Method Performance Indicators
subsections: section_title: Total- Selection Methods in GAO Analysis Total - Other Methods Total - All Methods
section_title: Appendix IV: List of Announced Campaign Compliance Projects
paragraphs: In January 2017, the Large Business and International (LB&I) division  announced the following 13 compliance projects or “campaigns” that it will  conduct.  1.  Internal Revenue Code (IRC) 48C Energy Credit: LB&I said that  this campaign will help ensure that the credit is claimed only by those  taxpayers whose advanced energy projects were approved by the  Department of Energy (DOE), and who have been allocated a credit  by IRS. These credits must be pre-approved through application to  the DOE. LB&I said that the treatment stream for this campaign will be  soft letters and issue-focused audits.  2.  Offshore Voluntary Disclosure Program (OVDP) Declines- Withdrawals: OVDP allows U.S. taxpayers to voluntarily resolve past  non-compliance related to unreported offshore income and failure to  file foreign information returns, according to LB&I. In the campaign,  LB&I said it will address OVDP applicants who applied for pre- clearance into the program but were either denied access to OVDP or  withdrew from the program. LB&I said that IRS will address continued  noncompliance through a variety of treatment streams, including  audits.  3.  Domestic Production Activities Deduction, Multi-Channel Video  Program Distributors (MVPD) and TV Broadcasters: MVPDs and  TV broadcasters have claimed that “groups” of channels or programs  are a qualified film eligible for the IRC Section 199 deduction for  income attributable to domestic production activities, according to  LB&I. They are asserting that they are the producers of a qualified film  when distributing channels and subscriptions packages that include  third-party produced content. Additionally, LB&I said that MVPD  taxpayers maintain that they provide online access to computer  software for the customers’ direct use. LB&I said that it has developed  a strategy to identify taxpayers affected by these issues and will  develop training to aid auditors and that the campaign will include  potential published guidance and issue-based audits  4.  Micro-Captive Insurance: LB&I said that this campaign addresses  transactions in which a taxpayer attempts to reduce aggregate taxable  income by using a contract with a related company that the parties  treat as an insurance contract with a captive insurance company (i.e.,  an insurance company organized primarily to provide insurance  protection to its owners or persons related to its owners). LB&I said  that it has developed a training strategy for this campaign and the  treatment stream will be issue-based audits.  5.  Related Party Transactions: LB&I said that this campaign focuses  on transactions between commonly-controlled entities that provide a  means to transfer funds from a corporation to related pass through  entities or shareholders. LB&I said it is seeking to determine the level  of compliance in related party transactions and that the treatment  stream for this campaign is expected to be issue-based audits.  6.  Deferred Variable Annuity Reserves and Life Insurance Reserves  Industry Issue Resolution (IIR): The IRS and Chief Counsel will  develop guidance to address uncertainties about reserves for deferred  variable annuities and for life insurance and related tax issues,  according to LB&I. The campaign’s objective is to collaborate with  industry stakeholders. Chief Counsel and the Department of the  Treasury are to develop published guidance that provides certainty to  taxpayers regarding these related issues.  7.  Basket Transactions: This campaign addresses structured financial  transactions in which a taxpayer attempts to defer and treat ordinary  income and short-term capital gain as long-term capital gain,  according to LB&I. LB&I said that it has developed a training strategy  for this campaign. The treatment streams will be issue-based audits,  soft letters, and outreach.  8.  Land Developers - Completed Contract Method (CCM): Large land  developers that construct in residential communities may be  improperly using CCM accounting, according to LB&I. In some cases,  developers are improperly deferring all gain until the entire  development is completed. LB&I will provide training for auditors  doing follow-up audits when warranted. The treatment stream also will  include development of a practice unit and issuance of soft letters.  9.  The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)  Linkage Plan Strategy: As partnerships have become larger and  more complex, LB&I has revised processes to assess tax on  investors, according to LB&I. With recent legal changes, LB&I plans to  focus on developing new procedures and technology to work  collaboratively with auditors conducting TEFRA partnership audits to  identify, link, and assess tax to the investors that pose the most  significant compliance risk.  10. S Corporation Losses Claimed in Excess of Basis: S corporation  shareholders report income, losses and other items passed through  their corporation, according to LB&I. While the law limits losses and  deductions to their cost basis in the corporation, LB&I said that it has  found that shareholders claim losses and deductions in excess of their  basis. LB&I also said that it has developed technical content for this  campaign that will aid auditors. According to LB&I, the treatment  streams for this campaign will be issue-based audits, soft letters  encouraging voluntary self-correction, stakeholder outreach, and a  new form for shareholders to assist in properly computing their basis.  11. Repatriation: LB&I said that it is aware of different structures being  used by taxpayers for purposes of tax free repatriation of funds into  the United States. LB&I has determined that many of the taxpayers do  not properly report repatriations as taxable events on their filed  returns. LB&I said that it plans to improve issue selection filters for  conducting audits on identified, high-risk repatriation issues,  increasing taxpayer compliance.  12. Form 1120-F Non-Filer: Foreign companies doing business in the  U.S. are often required to file Form 1120-F, according to LB&I, data  suggest that many of these companies are not meeting their filing  obligations. In this campaign, LB&I said that it will use various external  data sources to identify these foreign companies and encourage them  to file their required returns. The treatment stream will involve soft  letter outreach, according to LB&I. If the companies do not take  appropriate action, LB&I will conduct audits to determine the correct  tax liability.  13. Inbound Distributor: According to LB&I, U.S. distributors of goods  from foreign-related parties have incurred losses or understated  profits in their U.S. tax return reporting; these amounts are not  commensurate with the functions performed and risks assumed. In  many cases, the U.S. taxpayer would be entitled to higher returns in  arms-length transactions. LB&I said that it has developed a training  strategy that will aid auditors as they examine this in issue-based  audits.
section_title: Appendix V: Comments from the Internal Revenue Service
section_title: Appendix VI: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
paragraphs: James R. McTigue, Jr. (202) 512-9110 or mctiguej@gao.gov.
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Tom Short (Assistant Director);  Ann Czapiewski; Steven Flint; Robert Gebhart; Eric Gorman; George  Guttman; John Hussey; Shirley Jones; Edward Nannenhorn; Ellen  Rominger; Cynthia Saunders; Andrew J. Stephens; and Mackenzie  Verniero made significant contributions to this review.