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. 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. 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.