Tax Administration:

IRS Could Improve Examinations by Adopting Certain Research Program Practices

GAO-13-480: Published: May 24, 2013. Publicly Released: May 24, 2013.

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What GAO Found

The Internal Revenue Service's (IRS) National Research Program (NRP) has helped test or develop practices that have been used in operational examinations of individual tax returns, according to IRS officials. These practices include, for example, helping test IRS's remote learning system and helping IRS adopt new examination support software.

However, examiners GAO interviewed cited four additional ways NRP practices could improve operational examinations.

The first two concern using more data in classification--IRS's initial review of tax returns to select issues for examination. Operational classifiers do not have access to as much tax return data as NRP classifiers. NRP transcribes more data from paper-filed tax returns. Without the additional data, operational examiners cannot make optimal decisions about what issues to classify, raising the risk of needlessly examining compliant taxpayers. To make data in operational classification better match NRP levels, examiners suggested:

  • transcribing more data from paper-filed returns, and
  • using all data from electronically filed returns.

However, additional transcription imposes costs. For example, IRS estimated that it would cost $8 million annually to transcribe more expense data from individual business tax returns. The magnitude of this type of item (for example, an estimated $103 billion was claimed in 2010 for "other expenses" alone) and the high rate of non-compliance (55 percent in the most recent data) make it likely that better targeted examinations could bring in enough added revenue to justify the cost.

Additionally, IRS could acquire more data for classification by revising its policy of treating electronically and paper-filed returns the same. However, the change would only affect classification and not examination. Examinations of paper-filed returns and electronically filed returns are based on all the data. Using more data from electronically filed returns in classification would likely reduce the chances IRS would conduct unnecessary examinations of compliant electronic returns.

The third way involves clarifying how to save examination case files electronically. Operational examiners have less specific guidance on saving case files than NRP examiners. Clarifying the key files to be saved electronically would be a way to minimize costs and could help make case sharing and other examiner duties more efficient.

The fourth way concerns leveraging NRP for examination staff development. Compared to operational examinations, NRP examinations require more detailed documentation and are broader in scope. Examiners told GAO that such NRP experiences help develop the skills of relatively new staff. However, IRS has no official guidance specifically on when NRP examinations could be used to help develop staff.

Why GAO Did This Study

One way IRS works to understand taxpayer compliance is by operating NRP, which conducts audits or examinations of individual tax returns in a research sample. NRP examinations are fewer in number but more detailed than IRS's regular, operational examinations, which focus on the tax returns most likely to have substantive noncompliance. GAO was asked to study whether NRP procedures could improve IRS's operational examinations.

In this report, GAO (1) describes the lessons on examination procedures that IRS learned from conducting NRP examinations; and (2) assesses whether additional improvements could be made to operational examinations based on IRS's NRP experience.

GAO reviewed documentation on NRP procedures and interviewed relevant officials. GAO did structured interviews with IRS examiners on ideas for improving operational examinations, reviewed IRS documents, and compared the potential impacts of the ideas to criteria, such as whether the changes would make examinations more efficient or accurate.

What GAO Recommends

GAO recommends that IRS transcribe additional data from paper-filed returns, use all electronically filed data, clarify guidance on saving examination case files electronically, and develop guidance on when examiners can work NRP cases. IRS generally agreed with the recommendations but did not specifically comment on transcribing more data from paper-filed returns.

For more information, contact James R. White at (202) 512-9110 or whitej@gao.gov.

Recommendations for Executive Action

  1. Status: Open

    Comments: As of August 2015, IRS officials said that its study on whether to transcribe more data from paper-filed returns is slated to be done by November 2015. They said they are reviewing the benefits to be derived from additional transcription while weighing the increase in the numbers of electronically filed returns. Having more data transcribed and electronically available likely will improve the classification of audits as well as the quality of the audits

    Recommendation: To increase the effectiveness of IRS's examinations individual tax returns, the Commissioner of Internal Revenue should transcribe data from paper-filed Form 1040 Schedules C and E that are not currently transcribed and make that data available to SB/SE examiners for classification. If IRS has evidence that the costs related to transcribing all such data on Schedules C and E are prohibitive, IRS could do one or both of the following actions: (1) transcribe less data by transcribing only the missing data for selected line items, such as certain, large expense line items, or (2) develop a budget proposal to fund an initiative for transcribing Schedule C and E.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Open

    Comments: As of March 30, 2015, the Internal Revenue Service said it would study expanding the use of electronic data to enhance return classification while weighing the benefits of increased information against the risks of potential impacts to electronic filing. In July 2015, IRS said it completed a study on whether to make all electronically-collected data available to examiners. IRS estimates that it is providing 80-85 percent of these electronic data to examiners. IRS did not provide a decision on whether to provide the remaining electronic data to examiners. Having more electronic data provided likely will improve the classification of audits as well as the quality of the audits.

    Recommendation: To increase the effectiveness of IRS's examinations individual tax returns, the Commissioner of Internal Revenue should make all data collected from electronically submitted Form 1040s available to examiners conducting classification.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Closed - Implemented

    Comments: In August 2014, the Internal Revenue Service (IRS) updated the Internal Revenue Manual with additional instructions on handling case files electronically. The new guidance encourages examiners to use IRS's electronic case file system, provides more specific information on which documents examiners should save electronically, and gives additional instructions on how examiners should save the documentation.

    Recommendation: To increase the effectiveness of IRS's examinations individual tax returns, the Commissioner of Internal Revenue should clarify the policy and guidance on which case files should be saved electronically for SB/SE examinations to encourage greater and consistent use of electronic case files.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  4. Status: Closed - Implemented

    Comments: In February 2015, the Internal Revenue Service updated the Internal Revenue Manual (IRM) with guidance explicitly encouraging managers to assign National Research Program cases to enhance newly trained examiners' career development. By changing the guidance, IRS will help improve the quality of examinations and service to taxpayers under examination.

    Recommendation: To increase the effectiveness of IRS's examinations individual tax returns, the Commissioner of Internal Revenue should develop official guidance to remind managers that NRP cases can be assigned to newly trained examiners, when appropriate, to enhance their career development.

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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