The federal government levies excise taxes on entities and individuals for the purpose of financing general federal activities and specific government programs. Several different bureaus and offices within Treasury collected about $59 billion of excise taxes in fiscal year 1997. The Bureau of Alcohol, Tobacco, and Firearms accounted for about $13 billion in excise taxes on alcohol, tobacco products, and firearms while the U.S. Customs Service accounted for about $1 billion in excise taxes on imported and exported goods and services. However, the majority of excise taxes are accounted for by IRS. In fiscal year 1997, IRS collected about $45 billion in excise taxes on the purchase, use, or inventory of various types of goods or services, such as gasoline and airline tickets. The various excise taxes accounted for by IRS are deposited into the general fund of the Treasury and into nine different trust funds, which are administered by six agencies or federal entities. The trust funds that received fiscal year 1997 tax revenues are shown in table 1. A list of excise taxes by trust fund is included in appendix II. Administering agencies for the trust funds receiving excise tax revenue rely on the Treasury to accurately collect and distribute federal tax revenue to the appropriate trust funds. Because it collects federal tax revenue and then distributes it to government trust funds, Treasury is considered a servicing organization by agencies administering the trust funds as well as by the auditors of these agencies. Consequently, the administering agencies and their auditors need to rely on Treasury, through its various bureaus and offices, including IRS, to properly account for and distribute the amounts transferred from the government’s general fund to the applicable trust funds. Excise taxes are deposited into the general fund as received. However, the information that ultimately determines how these receipts are actually distributed is generally submitted via the Form 720, Quarterly Federal Excise Tax Return. Because data are not available to allocate excise taxes to the appropriate trust funds when deposits are made, Treasury uses a process to estimate the initial distribution of excise taxes. This process involves the use of economic models prepared by the Office of Tax Analysis (OTA) to estimate the initial distribution of tax receipts. Treasury’s Financial Management Service (FMS) uses these estimates to prepare entries for the initial distributions to the trust funds, which are recorded by the Bureau of the Public Debt (BPD) in the books and records of the trust funds maintained by Treasury. Subsequent to this initial distribution, IRS certifies quarterly the amounts that should have been distributed to the excise tax-related trust funds based on the tax returns. FMS uses these certifications to prepare adjustments to the initial trust fund distributions. These adjustments are recorded by BPD. There is typically a 6-month lag between the quarter end and the excise tax certification by IRS. Figure 1 provides an overview of the entire process of collecting, distributing, and certifying excise tax revenue reported to the trust funds. IRS relies on a combination of manual and automated procedures to prepare its certification of excise taxes to be distributed to the trust funds. IRS calculates the trust fund distributions based on assessment information in the master file. As quarterly excise tax returns are received, IRS personnel input the liability amounts by type of excise tax, such as Diesel Fuel Tax, into its master file. The tax types are identified by IRS numbers, or abstract numbers, which are preprinted on the Form 720. It is these abstract numbers that ultimately determine how amounts are distributed to the appropriate trust funds. The assessment information by type of excise tax is electronically transmitted from the master file to IRS’ Automated Quarterly Excise Tax Listing (AQETL) system. An IRS analyst, who has sole responsibility for preparing the excise tax certifications, accesses this system, analyzes the data for reasonableness by, for example, comparing current period assessments to amounts reported in prior periods, and makes adjustments, as necessary. The analyst may identify necessary adjustments by analyzing significant variations from prior quarter reported assessment amounts. After making any needed adjustments, the analyst generates a report from the AQETL system which summarizes the assessment data by excise tax type. The analyst uses this report to prepare the certifications for all tax distributions other than taxes related to the Highway, Airport & Airway, and Inland Waterways Trust Funds. For the Highway, Airport & Airway, and Inland Waterways Trust Funds, the analyst manually enters the assessment data from the report generated from the AQETL system onto electronic spreadsheets. These spreadsheets contain distribution rates to allocate the assessments between the trust funds and the general fund based on the assessment data entered by the analyst. The distributions from these spreadsheets, and the AQETL-system report for the other taxes, become the basis for preparing the quarterly excise tax certification letters. IRS submits the certification letters to FMS, which uses it to prepare adjustments to the initial distributions based on the OTA estimates to bring them in line with the IRS certified amounts. These adjustments are sent to BPD, which records the entries in the books and records of the trust funds maintained by Treasury. Figure 2 shows IRS’ process for certifying the trust fund distributions. Excise Tax Section (Cincinnati Service Center) Review Master File and AQETL data. Research apparent errors and correct data in Master File as necessary. Review assessment information, make any adjustments in AQETL, generate AQETL report. Enter assessment data for Highway Trust Fund into electronic spreadsheet. The objective of the agreed-upon procedures work was to assist the Inspectors General of the Department of Transportation and Department of Labor in ascertaining whether the net excise tax collections and excise tax certifications reported by IRS for the fiscal year ended September 30, 1997, were supported by the underlying records. The objectives of this report are to discuss the underlying internal control weaknesses that allowed errors identified in the agreed-upon procedures work to occur and to provide recommendations for correcting these weaknesses. See appendix I for a detailed discussion on the scope and methodology used to accomplish the objectives. We conducted our work primarily from October 1997 through February 1998, with some follow-up work through June 1998, in accordance with generally accepted government auditing standards. For the majority of excise taxes reported on the Form 720, taxpayers are required to provide the purchase, use, or inventory amounts of the goods or services (e.g., number of gallons of fuel) used in determining the tax assessment. The taxpayer multiplies these amounts against the preprinted tax rates on the Form 720 to report the excise tax assessment. Thus, information contained on the tax form allows IRS to mathematically verify liability amounts reported by the taxpayer. However, we found that IRS did not require its personnel to verify that the tax assessment amounts calculated by the taxpayers and reported on the returns agree with the supporting information provided on the tax returns. This led to inconsistencies between the assessed amount and supporting information provided by taxpayers, which IRS did not detect and correct. In 13 of the 230 taxpayer returns we reviewed, either assessment amounts we recalculated based on information contained in the return differed from the tax assessment reported on the return or all the required information was not included on the return to verify the assessment amount calculated by the taxpayer. IRS procedure manuals required that IRS personnel review tax returns that contain $1 million or more in excise tax assessments for reasonableness and accuracy. The manuals provided guidance for performing the reviews; however, this guidance was too general. As a result, the types of reviews performed by IRS analysts varied. In some cases, tax calculations were verified and taxpayers were contacted if data were missing, while in other cases, the return was only scanned for reasonableness. The lack of adequate and consistent review procedures increases the likelihood that incorrect assessment amounts reported by the taxpayer on the tax return would not be detected and corrected by IRS. As a result of our agreed upon procedures work, IRS officials indicated that IRS has acted to address the internal control weaknesses discussed above. Specifically, these officials indicated that IRS implemented procedures to improve the review of tax returns over $1 million. Also, IRS now requires the math verification of all tax assessments, as applicable, and analysts are required to follow-up with taxpayers to clarify inconsistent information on tax returns. We also noted that IRS centralized its excise tax processing in the Cincinnati Service Center to improve the consistency of processing and reviewing excise tax returns and to more closely monitor refund claims. Within that center, IRS established an Excise Program Section that specializes in reviewing excise tax returns and refund claims. It is significant that many of the errors we identified during our agreed upon procedures work related to tax returns processed at other service centers prior to IRS centralizing its excise tax processing. As discussed above, taxpayers report the majority of excise taxes to IRS quarterly using the Form 720. Taxpayers record on the Form 720 assessment amounts owed for each abstract number listed on the form. IRS uses the Form 720 to input assessment information into the master files. We found errors in this input process in fiscal year 1997. Specifically, we found that all or a portion of the assessment amounts for 13 of the 230 taxpayer returns reviewed were recorded in incorrect abstract numbers in the master file. In one case, IRS incorrectly recorded assessments of $176 million from the tax return in one abstract, yet the tax return indicated that this amount should have been divided among eight different abstracts. Because the abstract numbers identify the type of excise tax (for example, Diesel Fuel Tax) to which the assessment applies and are used in the certification of amounts ultimately distributed to the various trust funds, this directly affected the accuracy of IRS’ certifications. IRS officials indicated that these errors would be corrected in subsequent certifications made in fiscal year 1998. The structure of the Form 720 itself contributed to several errors. The Form 720 tax return is a complex tax form consisting of three distinct parts and two additional schedules. Information on the schedules includes details on excise tax assessments by semimonthly period (Schedule A), and adjustments to correct errors in previously filed Form 720s and claims against previously paid taxes (Schedule C). The information on Schedule C containing the claim and adjustment data is broken down by abstract number; however, it is aggregated into one total line on page 2 of the Form 720. Consequently, taxpayers record on the Form 720 assessment amounts owed for each abstract number listed on the form but do not reflect claims and adjustments, by abstract, on pages 1 and 2 of the Form 720. To assist in processing the tax return, IRS requires its staff to copy claims and adjustments listed on Schedule C, by abstract, to pages 1 and 2 of the Form 720. This procedure provides the data entry staff with the capability of inputting assessment, claim, and adjustment amounts, by abstract, directly off the first two pages of the tax return form without having to scan the schedules for claim and adjustment amounts to be input. However, the procedure of IRS staff manually copying claim and adjustment amounts from the schedules prepared by taxpayers increases the risk of errors, and consequently the likelihood that assessment, claim, and adjustment amounts will be incorrectly recorded in the master files. Nine of the 13 errors that we identified were the result of (1) IRS personnel incorrectly copying the adjustment information from the Schedule C to pages 1 and 2 of the tax return, (2) IRS personnel failing to copy adjustment information from the Schedule C to pages 1 and 2 of the tax return, or (3) data entry personnel misreading the handwritten adjustments made by other IRS staff on the Form 720 when inputting this information into the master files. For example, in one case, a taxpayer claimed a credit of $683,000, consisting of a $685,000 decrease for gasoline tax and a $2,000 increase for aviation fuel tax. However, IRS staff incorrectly recopied the credit amounts from the Schedule C to page 1 of the Form 720, resulting in the entire amount being recorded as gasoline tax. In another case, a taxpayer claimed a credit for $681,000 for taxed diesel fuel. An IRS employee copied the abstract number unclearly to page 1 of the Form 720, and the amount was erroneously recorded as a credit to tax on dyed diesel fuel used in trains. In total, in the 13 cases, we identified $179 million of IRS errors in inputting excise tax return information to the master files. The Comptroller General’s Standards for Internal Controls in the Federal Government specifies that transactions are to be promptly recorded and properly classified. The identified errors may have been avoided had procedures been in place to verify the input process. Also, errors resulting from the need for IRS staff to transfer information from the attached schedules to pages 1 and 2 of the Form 720 for each abstract could be avoided by revising the tax return form so that taxpayers, and not IRS personnel, enter the claim and adjustment amounts by abstract from Schedule C to pages 1 and 2 of the tax return. As discussed previously, one analyst is responsible for compiling the quarterly certifications. This involves accessing quarterly the assessment information from the AQETL system, analyzing and adjusting these data as necessary and, for the Highway Trust Fund, inputting these data into an electronic spreadsheet, provided by OTA, to derive the quarterly certifications. We found that there is no supervisory review of the analyst’s work until the certification letters are prepared, at which point they are forwarded to the Branch Chief for a high-level review and signature. We found no evidence that a detailed supervisory review is performed of the documentation supporting the certifications at any point during the certification process. Finally, we found that IRS does not review the distribution rates contained on the OTA-provided spreadsheet used to allocate certain assessments between the general fund and the Highway Trust Fund. The absence of such reviews was a factor in not detecting numerous errors in the certifications performed in fiscal year 1997 with respect to the Highway Trust Fund and the general fund. IRS’ AQETL system contains the assessment data electronically transmitted from the master file. Because it is not integrated with the electronic spreadsheet used to prepare the certifications for the Highway Trust Fund, manual data entry is necessary to accomplish the calculations and summarize the information. This information is a basis for preparing the certifications. Without adequate supervisory review of these tasks, all of which are performed by one individual, there is a high risk that errors will be made and not detected and corrected. The Comptroller General’s Standards for Internal Controls in the Federal Government specifies that qualified and continuous supervision is to be provided to ensure that internal control objectives are achieved. The lack of adequate supervisory review can lead to incorrect certifications and inaccurate distributions to the trust funds. We found a number of such errors that occurred in fiscal year 1997. For example, we found that assessment amounts were (1) inadvertently omitted from the certifications and (2) did not agree with supporting documentation. In one case related to heavy vehicle use tax, the supporting schedule summarizing the tax return information reflected an assessment amount of $195 million but the amount certified was $128 million. As a result, the certified amount for the Highway Trust Fund was understated by $67 million. In another case, assessments for compressed natural gas totaling over $500,000 were omitted from the Highway Trust Fund certification. IRS officials indicated that both of these errors were corrected in a subsequent certification that was made in fiscal year 1998. However, proper supervisory review of the analyst’s work would likely have detected these errors and prevented these inaccurate distributions. IRS does not have procedures for verifying the accuracy of distribution rates contained on the electronic spreadsheet provided by OTA. These rates, many of which are based on complex formulas derived from provisions of laws, are used to allocate assessments between the general fund and the Highway Trust Fund. The lack of IRS review of the distribution rates on this spreadsheet resulted in errors in the excise tax certifications for the Highway Trust Fund going undetected. For example, we found the following problems in the electronic spreadsheet provided by OTA: incorrect application rates to allocate gasohol taxes, which resulted in an overstatement to the Highway Trust Fund and a corresponding understatement to the general fund of $89,000; misapplied application rates between the Highway Account and Mass Transit Account for diesel fuel inventory in the certifications for the quarters ending December 1996 and March 1997, which resulted in a net understatement of the Highway Account and a corresponding net overstatement of the Mass Transit Account of $19,000; and missing distribution rate formulas from the spreadsheet, which resulted in tax assessment amounts of $1,000 and $7,000 being excluded from the Highway Trust Fund certification. An IRS review of the distribution rates contained on the spreadsheet could have identified these problems and prevented the distribution errors. The errors we found in the review of the fiscal year 1997 excise tax certification process are the direct result of weaknesses in fundamental internal controls, specifically the lack of appropriate verification and review procedures, at all critical points in the excise tax certification process. These weaknesses led to taxpayer, IRS, and OTA errors going undetected and directly resulted in inaccurate distributions of excise tax revenue to the trust funds in fiscal year 1997. To strengthen internal controls over IRS’ process of inputting tax return information into the master file, we recommend that IRS: Determine if it would be cost effective to develop and implement procedures requiring either key verification of the assessment amount by excise tax type before final processing or to implement other post-input controls to verify the accuracy of assessment amounts by excise tax type on the master file. In making this determination, IRS should consider establishing a dollar threshold that would ensure coverage of 90 percent of total excise tax assessments from the tax returns. Revise the Form 720 tax return to reflect a separate column adjacent to the column for entering the tax assessment, by abstract number, for the taxpayer to report on pages 1 and 2 of the tax return claims and adjustments, by abstract number, based on the information the taxpayer reports on Schedule C. To strengthen internal controls over IRS’ process of certifying excise tax distributions to the general fund and federal trust funds, we recommend that IRS: Develop, document, and implement review procedures over the adjustment and summarization of assessment data used in the certifications. Specifically, IRS should require detailed supervisory review be performed and documented to ensure that adjustments are reasonable and adequately supported, calculations are appropriately performed, and the certification letter agrees with the supporting schedules. IRS recently changed its procedures to certify excise taxes based on estimated collections. Despite this change, review procedures are still necessary. Establish and implement specific procedures requiring that IRS personnel review the distribution rates provided by OTA prior to those rates being used in the certification of Highway Trust Fund distributions and document evidence of these reviews. In commenting on this report, the IRS Commissioner stated that overall he agreed with our findings and recommendations. The Commissioner noted actions either planned or already in process or implemented to address most of the issues raised in this report. These include (1) implementing post-input controls to include a 100 percent review of all returns with tax assessments of $1 million or more, (2) developing review procedures over the adjustment and summarization of collection data used in the certifications, including supervisory reviews prior to final certification, and (3) reviewing, as part of a recently-formed Intra-Treasury Working Group, distribution rate charts provided by OTA prior to using these rates in the certification of Highway Trust Fund distributions. However, the Commissioner disagreed with our recommendation to revise the Form 720 tax return to require taxpayers to report claims and adjustments information on pages 1 and 2 of the tax return form. He expressed concern with how the draft report characterized the tax return form and the accompanying Schedules A and C of the form. Additionally, he noted it would be inappropriate to require the taxpayer to net the tax liability by the claim and adjustment amounts reported on the accompanying Schedule C. We have modified the report to more appropriately reflect the nature of the Form 720 and its accompanying schedules. Consistent with these changes, we modified the recommendation to eliminate the reference to having the taxpayer net the tax liability, by abstract number, for any adjustments or claims, by abstract number, as reported on the accompanying Schedule C. However, we believe that revisions to the tax return form are needed because of the frequency of errors made by IRS in either copying claim and adjustment information from Schedule C to pages 1 and 2 of the tax return or in inputting information copied from the tax return to the master files. Specifically, the Form 720 tax return should be revised to reflect a separate column in which the taxpayer would report claims and adjustments from the Schedule C, by abstract number, adjacent to the column reflecting the tax assessment, by abstract number, on pages 1 and 2 of the Form 720. The complete text of the IRS Commissioner’s response to our draft report is presented in appendix IV. This report contains recommendations to you. The head of a federal agency is required by 31 U.S.C. 720 to submit a written statement on actions taken on these recommendations to the Senate Committee on Governmental Affairs and the House Committee on Government Reform and Oversight within 60 days after the date of this letter. A written statement also must be sent to the House and Senate Committees on Appropriations with the agency’s first request for appropriations made over 60 days after the date of this letter. We are sending copies of this report to Director of the Office of Management and Budget, the Secretary of the Treasury, the Secretary of Transportation, the Secretary of Labor, and the Inspectors’ General of the Department of Transportation and Department of Labor. Copies of this letter will be made available to others upon request. If you have any questions, please call me at (202) 512-9505 or Steven J. Sebastian, Assistant Director, at (202) 512-9521. The objective of the agreed-upon procedures work was to assist the Inspectors General of the Department of Transportation and Department of Labor in ascertaining whether the net excise tax collections and excise tax certifications reported by IRS for the fiscal year ended September 30, 1997, were supported by the underlying records. We did not perform work on excise taxes collected by other Treasury bureaus, such as the Customs Service and the Bureau of Alcohol, Tobacco, and Firearms. We did include in our review the Federal Aid to Wildlife Restoration Fund because IRS uses different procedures to certify this trust fund. In performing the agreed-upon procedures, we gained an understanding of the internal controls over the excise tax collection and certification process. The objectives of this report were to discuss the underlying internal control weaknesses that allowed errors identified in the agreed upon procedures work to occur and to provide recommendations for correcting these internal control weaknesses. To accomplish our objectives, we examined, on a test basis, evidence supporting the net excise tax collection amounts reported on the fiscal year 1997 Custodial Financial Statements; specifically, we used Dollar Unit Sampling to select a sample of 396 combined excise tax collection and refund transactions from the master file for the first 9 months of fiscal year 1997, using a confidence level of 80 percent, a test materiality of $400 million, and an expected error amount of $200 million. Of this total, 390 transactions represented collections and six transactions represented refunds; verified sampled excise tax transactions to source documents to determine if the transactions were accurately recorded, posted to the proper tax class, and reported in the appropriate period; performed a predictive test of excise tax revenue collections for the final 3 months of the fiscal year to determine if reported fiscal year 1997 revenue appears consistent and reasonable; reviewed IRS’ revenue receipts and refund reconciliations between its records and Treasury for fiscal year 1997, to determine whether year-end excise tax collection balances from the general ledger materially agree with IRS’ master files and Treasury records; and obtained an understanding of internal controls related to safeguarding assets, compliance with laws and regulations, and financial reporting. In addition, to assess the reliability of key data inputs and assumptions used in the excise tax certification, we: Recalculated the excise tax assessments on the 230 tax returns associated with the sample of 390 excise tax collections based on the information provided on the returns (e.g., number of gallons of fuel multiplied by the tax rate equals the assessed tax). We reviewed only 230 returns because in some instances more than one receipt transaction related to the same return. Because the sample was selected based on excise tax collections, we were not able to project any errors identified on the corresponding tax assessment amounts. Verified that the excise tax assessment amounts by abstract number on the 230 tax returns were accurately recorded in the IRS master file and in the AQETL report. Determined if the rates used to allocate assessments between selected trust funds and the general fund for the final quarter of fiscal year 1997 were adequately supported. verified the mathematical accuracy for selected excise tax certifications and traced, on a selected basis, excise tax certifications to supporting schedules. We conducted our work primarily from October 1997 through February 1998, with some follow-up work through June 1998, in accordance with generally accepted government auditing standards. Ticket tax Facilities use Air freight Aviation gasoline Aviation fuel (other than gasoline) Aviation fuel (other than gasoline) for use in commercial aviation Aviation fuel (floor stocks) Aviation gasoline (floor stocks) The following are GAO’s comments on the Internal Revenue Service’s letter dated September 25, 1998. 1. The technical comments from the Chief Counsel have been incorporated as appropriate, but the enclosure has not been included in this appendix. 2. 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Summary: Pursuant to a legislative requirement, GAO conducted a follow-up review of the Internal Revenue Service's (IRS) controls over its process for certifying excise taxes for distribution to the federal trust funds. GAO noted that: (1) IRS does not have adequate controls over its process for certifying excise taxes for distribution to the federal government trust funds; (2) the lack of fundamental internal controls resulted in errors in the certifications going undetected; (3) these errors ultimately affected the amounts distributed to the trust funds during fiscal year 1997; (4) IRS' ineffective controls over the certification process resulted in undetected: (a) mistakes by taxpayers in preparing excise tax returns; (b) input errors by IRS when entering excise tax return information in its master files; and (c) errors by IRS in preparing the excise tax certifications; (5) as a result of these errors, trust funds did not receive the appropriate amount of excise tax revenue; (6) these errors are particularly important to the Highway Trust Fund, which receives over half of the excise taxes that are accounted for by IRS; (7) these weaknesses were a contributing factor in the Department of Transportation's (DOT) Inspectors General's: (a) qualified opinion on the Highway Trust Fund financial statements; (b) disclaimer of opinion on the Federal Aviation Administration's financial statements; and (c) disclaimer of opinion on DOT's consolidated financial statements; (8) the errors GAO found relating to taxpayer mistakes, IRS data input, and certification preparation could have been detected or prevented by effective IRS procedures; and (9) IRS has taken some actions to improve certain controls over the excise tax certification process.