Tax Administration
IRS Is Implementing the National Research Program as Planned
Gao ID: GAO-03-614 June 16, 2003
The Internal Revenue Service (IRS) needs up-to-date information on voluntary compliance in order to assess and improve its programs. IRS's last detailed study of voluntary compliance was done in the late 1980s, so the compliance information IRS is using today is not current. IRS is now carrying out the National Research Program (NRP), through which IRS auditors are reviewing about 47,000 randomly selected tax year 2001 individual tax returns. In June 2002, GAO reported that NRP was necessary, that its design was sound, and that it appeared to meet IRS's goals of acquiring useful compliance data while minimizing burden on taxpayers with returns in the sample. GAO was asked to review IRS's implementation of NRP. GAO reviewed IRS's method of gathering internal and third-party data (casebuilding) and IRS's process of reviewing casebuilding materials to determine if audits are necessary (classification) and assessed IRS's plans to ensure consistent data collection while minimizing burden on taxpayers.
IRS's NRP is being implemented as planned and consequently is on track to meet the agency's objectives of obtaining quality research results while minimizing the burden on the approximately 47,000 taxpayers with returns in the NRP sample. IRS officials have completed the development and testing of NRP processes and have selected and trained staff members to carry out the program. Additionally, as the graphic illustrates, IRS is currently nearing the completion of casebuilding and has made progress in classifying NRP returns. Audits, when required, began in November 2002. As of the end of March 2003, IRS had closed 3,651 NRP cases. In accordance with IRS's plans to minimize burden on taxpayers with returns in the NRP sample, some cases have been closed without any taxpayer contact or with only limited audits. The NRP plan recognized that the initial estimates for the overall NRP sample size and the number of returns to be audited were uncertain because they were based on aging data. The overall NRP sample size will be smaller and IRS officials expect to conduct more face-to face audits than initially estimated. As IRS completes NRP casebuilding, classification, and audits, it is implementing quality assurance steps, including efforts to ensure that key audit steps are completed on all NRP audits before they are formally closed with taxpayers. This is important since the data collected from each NRP audit represent information from thousands of similar taxpayers.
GAO-03-614, Tax Administration: IRS Is Implementing the National Research Program as Planned
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Report to the Committee on Finance, U.S. Senate:
United States General Accounting Office:
GAO:
June 2003:
Tax Administration:
IRS Is Implementing the National Research Program as Planned:
GAO-03-614:
GAO Highlights:
Highlights of GAO-03-614, a report to the Committee on Finance, U.S.
Senate
Why GAO Did This Study:
The Internal Revenue Service (IRS) needs up-to-date information on
voluntary compliance in order to assess and improve its programs.
IRS‘s last detailed study of voluntary compliance was done in the late
1980s, so the compliance information IRS is using today is not
current. IRS is now carrying out the National Research Program (NRP),
through which IRS auditors are reviewing about 47,000 randomly
selected tax year 2001 individual tax returns. In June 2002, GAO
reported that NRP was necessary, that its design was sound, and that
it appeared to meet IRS‘s goals of acquiring useful compliance data
while minimizing burden on taxpayers with returns in the sample.
GAO was asked to review IRS‘s implementation of NRP. GAO reviewed
IRS‘s method of gathering internal and third-party data (casebuilding)
and IRS‘s process of reviewing casebuilding materials to determine if
audits are necessary (classification) and assessed IRS‘s plans to
ensure consistent data collection while minimizing burden on
taxpayers.
What GAO Found:
IRS‘s NRP is being implemented as planned and consequently is on track
to meet the agency‘s objectives of obtaining quality research results
while minimizing the burden on the approximately 47,000 taxpayers with
returns in the NRP sample. IRS officials have completed the
development and testing of NRP processes and have selected and trained
staff members to carry out the program. Additionally, as the graphic
illustrates, IRS is currently nearing the completion of casebuilding
and has made progress in classifying NRP returns. Audits, when
required, began in November 2002. As of the end of March 2003, IRS had
closed 3,651 NRP cases. In accordance with IRS‘s plans to minimize
burden on taxpayers with returns in the NRP sample, some cases have
been closed without any taxpayer contact or with only limited audits.
The NRP plan recognized that the initial estimates for the overall NRP
sample size and the number of returns to be audited were uncertain
because they were based on aging data. The overall NRP sample size
will be smaller and IRS officials expect to conduct more face-to-face
audits than initially estimated.
As IRS completes NRP casebuilding, classification, and audits, it is
implementing quality assurance steps, including efforts to ensure that
key audit steps are completed on all NRP audits before they are
formally closed with taxpayers. This is important since the data
collected from each NRP audit represent information from thousands of
similar taxpayers.
What GAO Recommends:
GAO is not making recommendations in this report because IRS is
following through with its sound research plans in the ongoing
implementation of NRP. Furthermore, when GAO identified quality
assurance steps that IRS could add to NRP during the course of this
review, IRS agreed with the suggestions and included the steps
www.gao.gov/cgi-bin/getrpt?GAO-03-614.
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[End of section]
Contents:
Letter:
Results in Brief:
Background:
Scope and Methodology:
IRS Completed NRP Process Testing:
NRP Staff Selection and Training Is Complete:
NRP Reviews Are Under Way:
IRS Has Implemented NRP Quality Assurance Measures:
IRS Is Taking Steps to Minimize and Assess Taxpayer Burden:
Conclusions:
Agency Comments:
Appendix I: Comments from the Internal Revenue Service:
Figures:
Figure 1: NRP Process for Measuring Voluntary Reporting Compliance:
Figure 2: NRP Work Completed and Work Remaining as of the End of March
2003:
Figure 3: NRP Implementation Progress:
Figure 4: Estimated NRP Sample by Level of Taxpayer Contact:
Abbreviations:
EQMS: Examination Quality Measurement System:
IRS: Internal Revenue Service:
NRP: National Research Program:
United States General Accounting Office:
Washington, DC 20548:
June 16, 2003:
The Honorable Charles E. Grassley
Chairman
The Honorable Max Baucus
Ranking Minority Member
Committee on Finance
United States Senate:
Understanding taxpayers' compliance with the nation's tax laws is
critical to the ability of the Internal Revenue Service (IRS) to
improve the effectiveness of its programs to enforce and promote
voluntary compliance. While IRS strives to target enforcement audits to
taxpayers who are not complying with tax laws, this has become
increasingly difficult for IRS to do because the information it uses to
identify likely noncompliant tax returns is out of date. This means
that a large and growing number of IRS enforcement audits are directed
at compliant taxpayers. IRS needs more current data on compliance to be
able to appropriately target audits to problem returns. IRS last
studied voluntary compliance with random audits of tax year 1988 tax
returns. These studies included intensive, line-by-line audits and
imposed a significant burden on taxpayers with returns in the sample.
IRS is now carrying out a detailed study of taxpayer compliance--the
National Research Program (NRP). IRS has identified a random sample of
47,000 tax year 2001 returns and has begun NRP data gathering,
including limited audits where necessary to verify information reported
by taxpayers.
NRP is intended to produce useful compliance data while minimizing the
burden on the taxpayers selected for the study. IRS designed NRP to
minimize taxpayer burden by gathering IRS and third-party information-
-a process called casebuilding--in order to limit taxpayer information
requests to items that cannot be verified without such a request.
Specially trained IRS agents then review the approximately 47,000
returns in the NRP sample and their supporting casebuilding files and
identify lines on the returns that cannot be verified without auditing
the taxpayers--a process called classification. With this approach,
some taxpayers will not be contacted at all and most others will be
asked to verify only some of the line items on their returns.
In June 2002, we reported to you our assessment of IRS's NRP
plans.[Footnote 1] At that time we determined that NRP was necessary
and that its design addressed both the need for up-to-date information
on taxpayer compliance and IRS's goal of minimizing the burden NRP
imposed on taxpayers. We also reported that IRS had important
casebuilding and classification procedures testing to complete, as well
as selection and training of IRS personnel to carry out the program.
You then asked us to assess whether IRS is implementing NRP as planned.
Accordingly, this report describes and assesses (1) IRS's completion of
NRP development and testing, (2) staff selection and training, (3)
implementation progress of the program, (4) quality assurance steps IRS
is taking to ensure consistent and accurate data collection, and (5)
steps the agency is taking to minimize burden on taxpayers with returns
in the NRP sample.
To monitor IRS's final development and implementation of NRP, we
reviewed agency documents concerning NRP design, testing, and
implementation. We also directly observed sessions of most aspects of
NRP training and two key tests of NRP procedures. We held frequent
discussions with the IRS personnel implementing the program and
conducted field office visits to several of the locations where NRP
classification is taking place. During our field visits, we met with
managers and classifiers and discussed their understanding of the
program and any implementation issues that came up. Our assessment of
NRP implementation is based on IRS's NRP plans as described in our June
2002 report.
Results in Brief:
IRS is implementing key aspects of NRP according to the plans the
agency laid out in 2002 and the program is now fully under way. IRS has
completed NRP process testing and development and has identified and
trained over 3,000 enforcement auditors to be NRP classifiers and
auditors. IRS has started carrying out NRP reviews. As of the end of
March 2003, IRS had selected a sample of about 47,000 tax year 2001
returns, completed casebuilding files for over 90 percent of them, and
classified over 70 percent of these returns. IRS had completed all NRP
work on 3,651 NRP cases.
As described in its plans, IRS has incorporated important quality
assurance measures into NRP. IRS has made data consistency checks,
regular communication with staff members carrying out NRP, and
classification and audit reviews part of NRP. IRS has also adopted
suggestions we made in the course of this study that it add additional
quality checks to NRP in the form of classification site visits and
centralized evaluation of classification review results.
Also, as IRS planned, NRP casebuilding and classification processes are
helping minimize burden on taxpayers with returns in the NRP sample by
limiting most audits to line items that cannot be verified without
directly contacting taxpayers. Additionally, while the NRP sample size
is now smaller than originally projected, the number of face-to-face
NRP audits that IRS officials expect to take place is now larger than
originally estimated. The original NRP sample size estimates were based
on now obsolete 1988 compliance study data, the only data available.
The number of expected face-to-face audits, now projected to be about
39,000, is larger than originally estimated because the estimates were
also based on the obsolete 1988 data and because IRS modified its
classification guidelines to better match the training and skill level
of the auditors selected to conduct NRP correspondence and face-to-face
audits with the issues to be covered by those audits.
In commenting on a draft of this report, the Commissioner of Internal
Revenue concurred with our findings and conclusions about IRS's
implementation of NRP. He noted that as NRP continues, IRS will
continue to emphasize delivering quality results and minimizing
taxpayer burden. The commissioner's letter is reprinted in appendix I.
Background:
IRS designed NRP to obtain new information about taxpayers' compliance
with the tax laws. While IRS is using NRP to measure voluntary filing,
reporting, and payment compliance, the majority of NRP efforts are
devoted to obtaining accurate voluntary reporting compliance data. In
measuring reporting compliance, IRS's two primary goals are to obtain
accurate information but minimize the burden on the approximately
47,000 taxpayers with returns in the NRP sample. IRS plans to use NRP
data to update return selection formulas, allow IRS to design prefiling
programs that will help taxpayers comply with the tax law, and permit
IRS to focus its limited resources on the most significant areas of
noncompliance.[Footnote 2]
NRP's reporting compliance study consists of three major processes: (1)
casebuilding--creating information files on returns selected for the
NRP sample, (2) classification--using that information to classify the
returns according to what, if any, items on the returns cannot be
verified without additional information from the taxpayers, and (3)
taxpayer audits limited to those items that cannot be independently
verified. We reported in June 2002 that NRP's design, if implemented as
planned, is likely to yield the sort of detailed information that IRS
needs to measure overall compliance, develop formulas to select likely
noncompliant returns for audit, and identify compliance problems for
the agency to address. Figure 1 shows NRP's main elements.
Figure 1: NRP Process for Measuring Voluntary Reporting Compliance:
[See PDF for image]
[End of figure]
IRS designed the casebuilding process to bring together available data
to allow the agency to establish the accuracy of information reported
by taxpayers on their returns. For each taxpayer with a return in the
NRP sample, IRS is compiling internal information, such as past years'
returns and information reported to IRS by third parties, such as
employers and banks, and information from outside databases, such as
property listings, address listings, and stock sale price data.
Classification is where IRS uses the casebuilding information to
determine whether an NRP audit is necessary and which items need to be
verified through an audit. Classifiers place NRP returns into one of
four categories: (1) accepted as filed, (2) accepted with adjustments,
(3) correspondence audit, and (4) face-to-face audit. If the
casebuilding material allows IRS to verify all of the information that
a taxpayer reported on his or her tax return, then the taxpayer will
not be contacted and the return will be classified as accepted as
filed. On returns where minor adjustments are necessary, the
adjustments will be recorded for research purposes, but the taxpayers
will not be contacted. These returns will be classified as accepted
with adjustments. NRP returns that have one or two items from a
specified list requiring examination will be classified for
correspondence audits. All other NRP returns for which the casebuilding
material does not enable IRS to independently verify the information
reported on the returns will be classified for face-to-face audits.
NRP audits will take place either through correspondence with the
taxpayers or through face-to-face audits. When classifiers determine
that an NRP return will be sent for a correspondence audit, IRS will
request that the taxpayer send documentation verifying the line items
in question. To ensure accurate and consistent data collection, NRP
audits will address all issues identified by classifiers and will not
be focused only on substantial issues or cases for which there is a
reasonable likelihood of collecting unpaid taxes, according to IRS
officials. NRP auditors also may expand the scope of the audits to
cover items that were not classified initially.
IRS plans to conduct detailed, line-by-line audits on 1,683 of the
approximately 47,000 returns in the NRP sample in order to assess the
accuracy of NRP classification and, if necessary, to adjust NRP
results--a process called calibration. One-third of the returns in the
calibration sample will be returns that were classified accepted as
filed (either with or without adjustments), one-third from those
classified for correspondence audits, and one-third from those
classified for face-to-face audits. None of the taxpayers with returns
in the calibration sample will have been audited or otherwise contacted
by IRS prior to the start of these line-by-line audits.
Scope and Methodology:
To describe IRS's implementation of NRP, we have conducted frequent
meetings with officials in IRS's NRP Office and other IRS officials as
they have implemented the program. We reviewed NRP training materials
and observed NRP classifier, correspondence examination, and field
examination training sessions. We also observed NRP process tests and
conducted site visits to IRS area offices in Baltimore, Maryland;
Brooklyn, New York; Oakland, California; Philadelphia, Pennsylvania;
and St. Paul, Minnesota, in order to observe and review NRP
classification in field offices.
We considered whether NRP is being implemented in accordance with its
design. In our report issued on June 27, 2002, we found that NRP's
design, if implemented as planned, is likely to provide IRS with the
type of information it needs to ensure overall compliance, update
workload selection formulas, and discover other compliance problems
that the agency needs to address. For this review, we also considered
whether IRS was maintaining a focus on meeting NRP's objectives of
obtaining quality research results while, at the same time, minimizing
taxpayer burden. This assessment was also based on IRS's NRP
implementation plans.
As of the completion of our work, IRS had a significant amount of NRP
implementation to carry out. Our evaluation of IRS's efforts to
implement NRP, therefore, only provides an assessment of efforts that
have taken place through the time of our work. Additionally, we did not
attempt to assess IRS's efforts to measure filing compliance and
payment compliance through NRP. Our evaluation focuses only on IRS's
efforts to obtain voluntary reporting compliance information.[Footnote
3] A more detailed description of NRP can also be found in our 2002
report.
We conducted our work from September 2002 through April 2003 in
accordance with generally accepted government auditing standards.
IRS Completed NRP Process Testing:
In addition to the two tests described in our prior report on NRP, IRS
conducted two more tests of NRP processes prior to implementing the
program. IRS tested the casebuilding and classification processes in an
NRP simulation in July 2002, and conducted another classification
process test during the initial classification training session in
September 2002. IRS used the preliminary results of both of these tests
to estimate NRP classification outcomes and to evaluate the
effectiveness of NRP training. As we recommended in our June 2002
report, IRS substantially completed this testing prior to full NRP
implementation, though final reports from the tests were not completed
until later.
In July 2002, IRS used draft NRP training materials to train 16
auditors from IRS field offices in the use of NRP casebuilding
materials to carry out the NRP classification process. The newly
trained classifiers then classified 506 tax year 2000 returns. NRP
staff members reviewed the classifiers' results and found that,
overall, the results of this NRP simulation were positive. They found
that the classifiers understood the NRP approach to classification but
that there were instances where the classifiers overlooked some of the
issues indicated by the casebuilding materials or made other errors.
In September 2002, IRS conducted another test of the NRP classification
process immediately following the initial training session using final
classification training materials. As we recommended in our June 2002
report, IRS had NRP classifiers classify previously audited tax returns
in order to compare classifiers' results with the results of actual
audits. Twenty-two newly trained classifiers classified 44 previously
audited returns, with each return classified by 5 different
classifiers. All of the earlier audits resulted in some changes. NRP
staff members then compared the classifiers' results with those of the
other classifiers and with the results of the earlier audits. NRP
officials reported that the test showed that about three-fourths of the
time the trained NRP classifiers were able to identify issues where
noncompliance was found through an audit.
IRS used preliminary results of these tests to identify and implement
improvements to NRP. For example, NRP staff members noticed early in
the course of the second test that NRP classifiers were failing to
classify some line items in accordance with NRP guidelines. Trainers
reiterated the importance of following the classification guidelines
for these items. NRP staff members also saw that the format of the form
that classifiers were to use to record their classification decisions
made it easy to make mistakes. They revised the form to make decision
recording less error-prone. IRS also used these tests to identify the
need for more stringent classification review guidelines than initially
planned in order to ensure that classifiers understand and follow the
classification guidelines.
IRS did not finish analysis and documentation of the NRP simulation and
assessment and the classification process test until after the
beginning of classification in IRS area offices. NRP classification
began at IRS area offices during November 2002, but IRS did not
finalize its report on the July 2002 NRP simulation until December
2002, and the report on the September 2002 NRP process test was
finalized in December 2002. According to NRP officials, this did not
create problems because they made changes to NRP processes and training
materials before the reports of these tests were final. Though the
final reports were not completed until later, these tests and the NRP
modifications they generated were complete before full implementation
of NRP.
NRP Staff Selection and Training Is Complete:
IRS identified and trained staff to complete NRP classification and
audits. IRS selected NRP classifiers and auditors from field offices
across the country to handle NRP cases along with the non-NRP
enforcement cases and carried out plans for special training of the
staff members tasked with NRP responsibilities. IRS delayed the
delivery of computer software training to managers and clerks involved
in NRP audits due to technical problems with NRP software. This
initially delayed the start of NRP audits, but the training is now
complete. The timing of NRP staff selection and training fit the
conclusion and recommendation in our June 2002 report that IRS should
make sure that these key steps are carried out in the appropriate
sequence and not rushed to meet an earlier, self-imposed deadline.
IRS Selected Auditors to Carry Out NRP:
IRS selected over 3,000 auditors to handle NRP cases. Most of these
auditors are assigned to the Small Business/Self Employed operating
division.[Footnote 4] IRS selected 138 Small Business/Self Employed
auditors to be NRP classifiers and about 3,500 to handle NRP face-to-
face audits. According to NRP staff members, IRS offices across the
country now have one or more auditors trained to handle the NRP cases
that come to those offices. IRS area office managers determined how
many auditors should receive NRP training based on the projected
distribution of NRP returns to their areas.
Unlike face-to-face audits, NRP correspondence audits are being handled
out of a single office. IRS selected two groups of correspondence
auditors--26 correspondence auditors--from the Wage and Investment
operating division's Kansas City office to handle NRP correspondence
audits.
IRS originally planned to select a cadre of auditors to work only on
NRP face-to-face audits. According to NRP officials, the geographic
distribution of NRP returns would have made it difficult to have a
cadre of auditors dedicated entirely to NRP examinations because they
would have had to travel extensively to carry out NRP audits. IRS
officials said that even though they did not implement the plan for a
dedicated cadre of NRP auditors, the number of full-time equivalent
employees needed for NRP--about 1,000 in fiscal year 2003--has not
changed.
NRP Classifier Training Is Complete:
In September 2002, IRS trained 138 auditors to perform NRP
classification. The classifiers learned how to apply the guidelines for
NRP classification and were shown how to use NRP casebuilding
materials. Instructors stressed the concept of "when in doubt, classify
the item" meaning that, unless the casebuilding materials explicitly
verify the line item in question, the classifier should classify the
item as needing to be verified through an audit. Instructors explained
that with a random sample such as in NRP, every return represents many
others so even small oversights on the part of classifiers or auditors
can have a substantial impact on data quality.
After the classification training, the classifiers remained at the
training location and began classifying NRP returns. Specially trained
classification reviewers reviewed most of the classified cases and
provided rapid feedback to the newly trained NRP classifiers. The
intent of this was to ensure that NRP classifiers understood and
consistently applied the NRP classification guidelines and received any
needed retraining before returning to their respective field offices
and participating in future NRP classification sessions.
NRP Auditor Training Is Complete:
IRS delivered NRP correspondence and face-to-face auditor training
during late 2002 and early 2003. Instructors provided an overview of
NRP goals and objectives, reviewed the casebuilding materials that
auditors would have at their disposal, and explained the guidelines for
NRP audits.
IRS trained about 3,500 auditors to conduct NRP face-to-face audits.
This training took place in IRS field offices across the country from
October 2002 through February 2003. Each face-to-face NRP audit
training session lasted 3 days. The training consisted of an overview
of NRP goals and objectives, an explanation of how NRP audits differ
from traditional enforcement audits, and a description of how to apply
NRP guidelines during NRP audits. Trainers stressed that, for the
purposes of consistent and accurate data collection, NRP auditors
should not focus solely on significant issues or take into
consideration the likelihood of collecting unpaid taxes when conducting
NRP audits, but should make sure that every item identified by the
classifier is carefully verified in the course of the audit.
Correspondence auditor training was similarly focused, and the 1-day
training took place in September 2002. Staff members were trained
before they began to carry out NRP tasks.
Computer Software Training for Managers and Clerks Was Delayed:
IRS needed to provide training to NRP auditors and to IRS managers and
clerks with NRP responsibilities in order for staff members to
understand how to use the computer program IRS developed to capture NRP
information. Because of some problems IRS encountered in installing the
NRP software in offices across the agency, IRS had to delay training
some clerks and managers. This led to delays in starting some NRP
audits because managers were unable to assign NRP cases to auditors and
clerks were unable to assist in loading NRP cases on NRP auditors'
laptop computers. IRS resolved these problems and finished delivering
the majority of this training by the end of January 2003.
NRP Reviews Are Under Way:
IRS is nearly finished creating NRP casebuilding files, has classified
nearly three-fourths of the NRP returns, and has begun conducting NRP
audits. As of the end of March 2003, IRS completed NRP casebuilding for
about 94 percent of the approximately 47,000 returns in the NRP sample
and about 73 percent of NRP returns have been classified. Also, for
3,651 NRP cases, IRS completed all necessary audit work. Some of these
are cases where correspondence or face-to-face audits are finished, but
most of the NRP cases closed so far--2,709--are those that did not
require audits. Cases involving audits take longer to complete, so few
have been closed thus far. IRS made substantial progress in
casebuilding and classification starting in 2002, and the number of
cases assigned to NRP auditors has been increasing quickly since
January 2003. Figure 2 shows the progress IRS has made in casebuilding,
classifying, and closing cases.
Figure 2: NRP Work Completed and Work Remaining as of the End of March
2003:
[See PDF for image]
[End of figure]
The number of completed NRP casebuilding files began to grow during the
second half of 2002, as shown in figure 3. As figure 3 also
illustrates, NRP classification began in September 2002. These were the
cases classified during sessions held immediately after classifier
training. Over 9,000 NRP returns were classified by the end of October
2002. After these sessions, classification became an area office
function, with some offices scheduling weeklong classification sessions
on a somewhat regular basis and others classifying returns as they come
into the office.
Figure 3: NRP Implementation Progress:
[See PDF for image]
Note: Casebuilding and classification data from July through September
2002 are estimates because IRS did not keep monthly records on these
processes during this period.
[End of figure]
IRS began conducting some NRP audits during November 2002, though these
audits began in earnest during the first quarter of 2003. By the end of
January 2003, IRS had assigned over 4,600 NRP cases to auditors to
begin conducting face-to-face and correspondence audits. By the end of
March 2003, about 18,000 taxpayers had been contacted regarding NRP
audits.
IRS Has Implemented NRP Quality Assurance Measures:
IRS recognizes the need for accurate NRP data and, as planned, has
built into the program several measures to ensure the quality of NRP
results. IRS designed the NRP classification process to include quality
assurance reviews and has added additional quality assurance measures
in response to suggestions we made in the course of this engagement.
The NRP audit process also includes quality assurance measures that
include both in-process and completed case reviews, with all NRP audits
reviewed before they are formally closed with the taxpayer. IRS also
built accuracy checks into the data capture steps that take place
throughout the NRP process.
IRS Is Conducting Classification Reviews on a Sample of Returns:
IRS designed NRP classification to include regular reviews of
classifiers' decisions. We found that these reviews are generally
taking place according to NRP guidelines. We also found that additional
measures could further improve NRP classification accuracy, and IRS
implemented our suggestions.
NRP guidelines specify that NRP classification reviewers review all
cases for which returns are classified as needing either no audit at
all or only correspondence audits to confirm their accuracy.
Additionally, reviewers must initially review 25 percent of the cases
classified by each auditor that are selected for face-to-face audits
until they are satisfied with the quality and consistency with NRP
guidelines of the classifier's work. After that standard has been met,
the guidelines specify that reviewers need only review approximately 10
percent of the cases that each classifier selects for face-to-face
audit.
We conducted site visits to five IRS area offices where NRP
classification was taking place and found that IRS's plans to implement
the classification steps of the program were generally well understood
by the classifiers carrying them out. Classifiers were knowledgeable
about the differences between the NRP classification process and the
classification process used in the enforcement audit environment and
supported NRP goals in general. However, we also found instances where
NRP classifiers were not consistently following NRP classification
guidelines.
Another issue we identified involved the use of the classification
review sheets that reviewers fill out when they find problems with
classifiers' decisions. We learned that there was no provision for
further review of these forms. In some cases, we found that reviewers
were not always documenting classification errors on the forms. We
discussed with NRP officials the potential benefits of using NRP
classification review sheets for more than identifying issues at the
area office level. Specifically, we suggested that classification
review sheets be forwarded from the area offices to a central location
in order to identify problems that may be occurring in different
locations around the country or other trends that the NRP Office may
need to address during the course of NRP classification. The NRP Office
agreed with our suggestion and added centralized review of
classification review sheets to its other classification quality
assurance measures.
The NRP Office adopted our suggestion that it conduct site visits to
area offices to identify NRP classification implementation issues.
Similar to the visits we conducted, NRP staff members visited area
offices and met with classifiers, reviewers, and managers to identify
issues encountered in carrying out NRP classification and possible
areas where NRP guidelines may have been misinterpreted. Among the
issues they are asking about is the usefulness of the various materials
included in the casebuilding files, information which may prove useful
in the design of the casebuilding portion of future iterations of NRP.
NRP staff members are also conducting separate reviews of completed
classification cases.
NRP Audit Quality Assurance Measures Include a Mix of In-Process and
Completed Audit Reviews:
IRS has designed NRP to include several steps to identify NRP audit
quality problems at both the individual auditor level and across the
program. Reviews include quality checks while cases are in progress and
after work is complete, and reviews by managers at different levels.
Importantly, IRS's plans call for every NRP audit to be reviewed at
least once at a point where it is still possible to return to the
taxpayer and complete additional audit steps, if necessary. These
quality assurance measures will serve to mitigate the risk of IRS
including erroneous or incomplete data in the NRP database.
NRP guidelines task group managers with reviewing one open NRP audit
for each auditor in the first 90 days of that auditor's NRP activity
and another in the first 180 days.[Footnote 5] NRP officials intend for
these in-process reviews to be extensive and timed early enough in the
program to identify individual auditors' misunderstandings of the
program, correct them on the audits under review, and prevent them on
future NRP audits.
IRS has also created Quality Review Teams both to oversee individual
audit cases and identify problems at the area office level and
systemically across NRP. These teams are made up of IRS managers and
are tasked with checking for compliance with NRP-specific and overall
IRS standards on 40 open cases and 20 closed cases for each of IRS's 15
area offices. These reviews will be repeated in each area about once
every 3 months throughout the planned 18-month NRP audit period. The
IRS standards applied by the teams to the audits they review are the
same standards employed by IRS's Examination Quality Measurement System
(EQMS).[Footnote 6] Similar to the visits NRP officials made to area
offices to review classification activities, NRP officials are also
visiting area offices to review NRP audit activities. NRP officials
said that any systemic issues identified through Quality Review Team
reviews will then be addressed across NRP.
Another NRP audit quality assurance element calls for all face-to-face
audits to be checked by group managers after work is completed but
before the cases are formally closed with the taxpayers. This review
will include assessing technical correctness, mathematical accuracy,
completeness, and adherence to procedural requirements. IRS officials
said that these requirements include adherence to the NRP-specific
requirement that audits include verification of all items identified
through the NRP classification process. These reviews also include
assessing adherence to IRS standards in areas such as audit depth and
reviewing large, unusual, or questionable items on the audited return.
We were initially concerned that IRS planned for these reviews to take
place after NRP audits were completely closed, precluding IRS from
reopening the cases or otherwise obtaining additional information from
the taxpayers even if the reviewers found that the original NRP audits
were incomplete.[Footnote 7] However, senior IRS officials informed us
in March 2003 that these reviews will take place after NRP auditors
consider their audit work to be complete but before the taxpayers are
notified that the audits are over. The officials explained that these
reviews of all NRP cases will be timed to provide an important means of
ensuring that complete and accurate audit results are entered into the
NRP database. They also explained that the importance of NRP audit
reviews has been stressed throughout NRP implementation and will be the
subject of ongoing communication with managers in the field.
It is very important that IRS conduct reviews of NRP audits before they
are closed because IRS data show that auditors do not always meet
enforcement audit quality standards. In fiscal year 2002, IRS's EQMS
found that auditors in the field did not meet the audit depth standard
about 15 percent of the time on field audits; the standard for auditing
taxpayer income was not met about 25 percent of the time on field
audits; and the standard concerning audits of large, unusual, or
questionable items was not met 40 percent of the time on field audits.
IRS officials said that accurate audit results in these areas are
critical to NRP's overall accuracy.
IRS officials pointed out that the error rate for NRP audits should be
lower than in the enforcement audit environment because NRP auditors
received special training and because the NRP classification process
will enhance NRP audit quality. For example, NRP guidelines call for
classifiers to identify large, unusual, or questionable items on
returns (the largest EQMS error category) and NRP auditors must address
all classified items. However, IRS did not implement its earlier plan
of having a selected cadre of auditors work only on NRP cases. While
NRP-specific training will serve to prevent many audit errors, NRP
audits are now being conducted by a cross section of auditors from IRS
field offices across the country and more typical of the auditors who
generated the 2002 EQMS error rates. Because every return in the NRP
sample represents many returns in the whole population of 1040 filers,
even a small number of cases closed with incomplete information could
affect the accuracy of NRP data.
IRS officials also noted that their plan to conduct early reviews of
NRP cases will identify problems with auditors' understanding of NRP
and help to keep them from recurring on subsequent NRP audits. At least
two of each NRP auditor's early cases will have extensive manager
involvement while the cases are still in progress, and other managers
will be looking at a sample of both completed and open cases to
identify problems. IRS officials believe that these measures are
sufficient to ensure NRP audit quality.
NRP Includes Data Consistency Checks:
IRS is including a series of data consistency checks in the NRP
database to verify that the information NRP auditors record in IRS's
NRP reporting system agrees with the information that IRS recorded from
the tax returns earlier in processing. NRP auditors must first record
the results of NRP audits in the report-generating software that was
modified for NRP purposes. Once auditors have recorded audit results,
NRP coordinators must use a data conversion program to transfer the
data into a format that the NRP database will accept. Following data
conversion, IRS coordinators transfer the audit data to the NRP
database.
Once the data are transferred to the NRP database, a series of data
consistency checks take place to confirm that the data IRS originally
transcribed from the tax return are consistent, within specified
tolerances, with the data that NRP auditors recorded in the NRP
reporting software. If any of the consistency checks fail for a return
in the NRP sample, the NRP area coordinator will be notified and the
mistake will need to be corrected. According to IRS officials, they
will impress upon NRP auditors the importance of entering data into the
NRP software correctly the first time because it will be time-consuming
to correct errors. NRP officials have developed a case tracking system
in order to monitor which cases still need to pass all of the
consistency tests and which tests they need to pass. IRS officials
reported that, as of early April 2003, the NRP database and related
programs were running and that completed NRP cases were being entered
into the database. They said that they were still making some
enhancements, but that the programs were fully functional.
IRS Is Taking Steps to Minimize and Assess Taxpayer Burden:
As IRS planned, NRP casebuilding and classification processes are
helping minimize the burden on taxpayers with returns in the NRP
sample. In addition, the size of the NRP sample is now smaller than IRS
expected it to be. However, the number of taxpayers who will be subject
to NRP audits has increased. IRS plans to survey taxpayers who receive
NRP audits to assess their perceptions of the burden posed by those
audits. IRS also used input from tax practitioners to identify ways to
improve interactions with taxpayers subject to NRP audits.
NRP Processes Are Helping to Reduce Taxpayer Burden:
IRS is following its plans to reduce burden on taxpayers selected as
part of the NRP sample by (1) compiling NRP casebuilding materials that
allow IRS to verify certain items on tax returns without requesting the
information from the taxpayer, (2) classifying returns according to
items that need to be verified through an audit, and (3) limiting most
NRP audits to items that cannot be verified without an audit. IRS
officials also intend to compare classification decisions with the
results of NRP audits to identify ways of improving the classification
process for future rounds of NRP. Moreover, IRS's intent in carrying
out NRP is to reduce the burden on taxpayers in general by developing
better audit selection formulas and reducing the number of audits of
fully compliant taxpayers.
The NRP casebuilding and classification processes described on page 4
are having their intended effect of reducing the burden NRP creates for
taxpayers with returns in the NRP sample. IRS has assembled IRS and
third-party data on most of the returns in the NRP sample and
classifiers have used these data to verify information on the returns,
where possible, without contacting taxpayers. The remaining
casebuilding and classification work was under way as of the end of
March 2003. The material in the casebuilding files has allowed IRS to
fully verify about 10 percent of NRP returns without any audit.
Classifiers were able to use the casebuilding material to verify all
but one or two items on another 5 percent of NRP returns, and these
were sent for correspondence audits.
Classifiers identified line items needing verification through a face-
to-face audit on about 85 percent of NRP returns classified as of the
end of March 2003. Because of the casebuilding and classification
processes IRS developed for NRP, these audits will generally be limited
to line items that cannot be verified using the information in the
casebuilding files. This is a substantial change from earlier
compliance research efforts, in which all returns were subject to
audits of every line on the return. Only the 1,683 taxpayers with
returns selected for NRP calibration audits will be subject to complete
audits of their returns.
IRS plans to use NRP results to improve future iterations of NRP. For
example, NRP officials plan to compare classification outcomes with NRP
audit results to help them to identify possible changes needed in
casebuilding materials and the NRP classification process. They have
told us that it may be possible to further reduce the number of
accurately reported line items that are subject to compliance research
audits. On the other hand, IRS may also find through NRP calibration
audits that classification missed many items that should have been
audited, so more line items should receive some form of audit in future
rounds of NRP in order for the research results to be useful. IRS also
intends to apply lessons learned in NRP classification to
classification in the enforcement audit environment.
As we noted in our prior report, NRP should also lead to reductions in
taxpayer burden in general. IRS plans to use NRP results to help
identify and reduce causes of noncompliance and to better target
enforcement audits to noncompliant taxpayers, reducing the number of
audits of fully compliant taxpayers. IRS projects that, without
improved audit selection formulas based on NRP results, the percentage
of enforcement audits that result in no tax change will be about 35
percent higher in 2005 than it was in 1993, the first year that
selection formulas from the 1988 compliance study were available.
Taxpayer burden will decrease if successful execution of NRP enables
IRS to reduce the number of these audits of compliant taxpayers.
NRP Sample Is Smaller Than IRS Initially Estimated:
The NRP sample consists of 46,860 tax returns. We reported in June 2002
that the NRP sample would consist of 49,251 returns. The current number
is smaller than the initial estimate because IRS originally estimated
the NRP sample size based on the characteristics of the filing
population that existed during the 1988 reporting compliance study.
According to IRS officials, when they applied the NRP sampling plan to
the 2001 filing population, the number of returns necessary to satisfy
the requirements for some of the NRP strata declined because filing
rates for those strata were smaller than IRS officials had
projected.[Footnote 8] The final NRP sample consists of about 2,400
fewer returns than initially planned.
IRS Estimates That NRP Classification Will Result in More Audits Than
Expected:
IRS officials are currently finding that the NRP classification results
are different than initially planned. IRS now estimates that more face-
to-face audits will take place than initially projected because (1) as
the NRP plan recognized, IRS's initial estimates were uncertain and
based on aging data and (2) the final form of NRP classification
guidelines meant more face-to-face and fewer correspondence audits.
IRS initially estimated that out of an NRP sample of over 49,000 tax
returns, classification would result in about 30,000 face-to-face
audits of selected line items, about 9,000 correspondence audits
covering no more than two line items, and about 8,000 taxpayers who
would not undergo any audit because classifiers were able to either
verify all of the items on their returns or could correct some line
items without contacting the taxpayers.
The final NRP sample is 46,860 returns, and IRS now estimates that NRP
classification will result in face-to-face audits of about 39,000
taxpayers, with approximately an additional 2,300 receiving
correspondence audits and 3,800 subject to no audit at all. IRS also
plans to conduct 1,683 line-by-line calibration audits, drawing 561
returns from each of the three classification categories--these numbers
have not changed. Figure 4 shows IRS's current estimate of how the
three NRP classification categories will be distributed.
Figure 4: Estimated NRP Sample by Level of Taxpayer Contact:
[See PDF for image]
[End of figure]
NRP officials explained that the number of face-to-face NRP audits is
higher than expected because they were relying on aging data and
preliminary classification guidelines. Our 2002 report on NRP also
noted the preliminary nature of these estimates. Initial classification
breakdown estimates were made using 14-year-old data from the 1988
Taxpayer Compliance Measurement Program study. NRP staff members said
that changes in the tax code and in the economic makeup of the filing
population since the 1988 study make the returns from that study an
unreliable tool for predicting NRP classification results, though that
was all they had to work with.
They also said that some of the change can be attributed to changes
they made in the final form of NRP classification guidelines. NRP staff
members said that they modified the NRP classification guidelines as a
result of discussions that took place between NRP staff members and
representatives from IRS's business operating divisions. They
instituted the changes to the classification guidelines in order to
better match the training and skills of the examiners selected to
conduct NRP correspondence and face-to-face audits with the types of
issues to be covered by those audits. One change is that discrepancies
between the casebuilding files and the tax returns for issues such as
Individual Retirement Account contributions and Social Security income
were removed from the list of issues that could be verified through a
correspondence audit. Another change is that the final guidelines call
for virtually all business returns to receive face-to-face audits--
initial assumptions about the classification process allowed for some
business returns to be accepted as filed or receive only correspondence
audits.
IRS Will Survey NRP Taxpayers:
IRS will survey taxpayers who are subject to NRP audits to assess
overall customer satisfaction and their perceptions of the burden
audits created for them. IRS will ask taxpayers to fill out the same
survey it uses to assess customer satisfaction in the enforcement audit
environment and compare the results for the two populations.
The surveys include issues related to taxpayer burden in the form of
questions about the amount of time taxpayers spent preparing for the
audits and the amount of time that they spent on the audits themselves.
The surveys also ask whether taxpayers receiving NRP audits believe the
information that they were asked to provide seemed reasonable and
whether they feel they received fair treatment from IRS.
After collecting the survey results, IRS will then develop a "score"
for each question on the survey that relates to burden. IRS will
compare the results from the NRP customer satisfaction survey to the
results from surveys completed after enforcement audits.
IRS Consulted with Practitioners:
IRS consulted with outside stakeholders to enhance its efforts to
minimize the burden NRP created for taxpayers with returns in the
sample. IRS consulted with members of organizations that provide
feedback to IRS on matters concerning taxpayers, including the National
Public Liaison, the Information Reporting Program Advisory Committee,
and the Internal Revenue Service Advisory Council.[Footnote 9]
According to IRS, practitioner input led to wording changes on taxpayer
notification letters and improvements to training materials, which
strengthened the emphasis on maintaining good relations with NRP-
selected taxpayers. Representatives of the National Public Liaison also
participated in the training for the staff members who were selected to
conduct NRP auditor training.
Conclusions:
IRS continues to be on track for meeting its NRP goal of obtaining
meaningful compliance data while minimizing the burden on taxpayers
with returns in the NRP sample. IRS has followed the key elements of
the plans it laid out last year and has responded to identified needs
to modify the program that have come from its own testing as well as
from outside stakeholders. Because of this, we are not making any
recommendations in this report.
We recognize that IRS efforts to gather information about NRP
implementation while the program is under way are very important to
IRS's continued success in carrying out NRP. Classification review
results, audit review results, and customer satisfaction surveys all
provide the means for IRS to make immediate adjustments to NRP now and
to enhance the design of future iterations of the program. Provisions
for 100 percent review of NRP audits before they are closed are
particularly important because even a small number of erroneous or
incomplete cases will negatively affect the quality of NRP data.
Agency Comments:
On May 22, 2003, we received written comments on a draft of this report
from the Commissioner of Internal Revenue (see app. I). The
commissioner noted the importance of NRP and IRS's continued emphasis
on minimizing taxpayer burden and delivering quality results. We also
received technical comments from NRP staff members, which we have
incorporated into this report where appropriate.
As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
after its date. At that time, we will send copies of this report to the
Secretary of the Treasury, the Commissioner of Internal Revenue, and
other interested parties. This report is also available at no charge on
GAO's Web site at http://www.gao.gov.
If you or your staffs have any questions, please contact Ralph Block at
(415) 904-2150, David Lewis at (202) 512-7176, or me at (202) 512-9110.
Thomas Gilbert was also a key contributor to this assignment.
James R. White
Director,
Tax Issues
Strategic Issues Team:
Signed by James R. White:
[End of section]
Appendix I: Comments from the Internal Revenue Service:
DEPARTMENT OF THE TREASURY INTERNAL REVENUE SERVICE WASHINGTON, D.C.
20224:
COMMISSIONER:
May 22, 2003:
Mr. James R. White
Director,
Tax Issues
United States General Accounting Office Washington, DC 20548:
Dear Mr. White:
I reviewed your draft report "Tax Administration: IRS is Implementing
the National Research Program as Planned".
The National Research Program's (NRP) approach to measuring compliance
continues to emphasize the reduction in taxpayer burden by minimizing
the number of taxpayers contacted and shifting much of the burden of
data collection from taxpayers to the IRS. The comments you shared with
us during the review process have helped us make decisions that will
improve the quality of the final NRP data.
Establishing and maintaining a compliance measurement program that
employs reliable processes and systems, minimizes taxpayer burden, and
delivers quality results is our top priority. As we move into the audit
phase of this project, we continue to emphasize these goals, with
special attention to assuring consistent, high-quality audit results,
that will better identify noncompliant taxpayers, and reduce the burden
on compliant taxpayers.
We are planning the next phase of the study, which will measure some
components of business compliance, a population we have not formally
studied for many years. The project will provide information that will
allow us to more efficiently allocate our resources for business
taxpayers and provide new information on compliance.
I appreciate the feedback GAO has provided on the National Research
Program and welcome your continued support of our efforts to measure
voluntary compliance.
Sincerely,
Mark W. Everson:
Signed by Mark W. Everson:
[End of section]
FOOTNOTES
[1] U.S. General Accounting Office, Tax Administration: New Compliance
Research Effort Is on Track, but Important Work Remains, GAO-02-769
(Washington, D.C.: June 27, 2002).
[2] IRS uses compliance research to determine the characteristics of
tax returns that are likely to be noncompliant. Screening tax returns
for those characteristics is an early step in selecting returns for
enforcement audits.
[3] There are three types of voluntary compliance measures: filing
compliance, which measures the percentage of taxpayers who file returns
in a timely manner; payment compliance, which measures the percentage
of tax payments that are paid in a timely manner; and reporting
compliance, which measures the percentage of actual tax liability that
is reported accurately on returns. Although IRS's NRP plans include
reviews of all three types of compliance, the majority of its efforts
have been devoted to development of reporting compliance measurement
procedures. Reporting compliance is also the only aspect of NRP that
will include audits of taxpayers.
[4] IRS has four business operating divisions: Wage and Investment,
Small Business/Self Employed, Large and Mid-Sized Business, and Tax
Exempt and Government Entities.
[5] Most auditors work in groups headed by group managers. Groups are
part of territories, which are part of areas. There are 15 area offices
participating in NRP.
[6] EQMS measures compliance with IRS standards in several areas,
including audit planning, timeliness, and depth and how well the
auditor considered large, unusual, or questionable items and income on
the taxpayer's return.
[7] After IRS notifies a taxpayer that an audit is closed, IRS may only
reopen the audit with the taxpayer in order to correct errors if
special circumstances, such as fraud, exist or if reopening the case
will benefit the taxpayer.
[8] The NRP sample is divided into 30 categories, each of which is
referred to as a stratum. Each stratum contains a different type of
taxpayer based on the taxpayer's total positive income and the various
schedules that the taxpayer filed.
[9] The National Public Liaison coordinates with tax practitioner
organizations, other government agencies, and IRS's formal advisory
groups to provide a forum for external feedback. The Information
Reporting Program Advisory Committee provides input to IRS on reporting
issues, and the Internal Revenue Service Advisory Council provides
input to IRS on tax administration issues.
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