Financial Audit
IRS's Fiscal Years 2005 and 2004 Financial Statements Gao ID: GAO-06-137 November 10, 2005Because of the significance of Internal Revenue Service (IRS) collections to federal receipts and, in turn, to the consolidated financial statements of the U.S. government, which GAO is required to audit, and Congress's interest in financial management at IRS, GAO audits IRS's financial statements annually to determine whether (1) the financial statements IRS prepares are reliable and (2) IRS management maintained effective internal controls. We also test IRS's compliance with selected provisions of significant laws and regulations and its financial management systems' compliance with the Federal Financial Management Improvement Act of 1996 (FFMIA).
In GAO's opinion, IRS's fiscal years 2005 and 2004 financial statements were fairly presented in all material respects. Because of serious internal control and financial management systems deficiencies, however, IRS again had to rely extensively on resource-intensive compensating processes to prepare its financial statements. Due to these serious internal control and financial management deficiencies, IRS did not, in GAO's opinion, maintain effective internal controls over financial reporting (including safeguarding of assets) or compliance with laws and regulations, and thus did not provide reasonable assurance that losses, misstatements, and noncompliance with laws material in relation to the financial statements would be prevented or detected on a timely basis. IRS has continued to make great strides in addressing its financial management challenges and has substantially mitigated several material weaknesses in its internal controls. In fiscal year 2005, IRS successfully implemented the first phase, or release, of its new Integrated Financial System (IFS), which is intended to replace the outdated financial management systems IRS used in recent years to process and report administrative (nontax) transactions. This first phase of IFS provides for improved audit trails and more timely information for such activities and transactions as travel, purchases of goods and services, and budgetary activities. In addition, IRS continued to make progress in its efforts to address its weaknesses in controls over hard-copy taxpayer receipts and data and over property and equipment. However, GAO continues to consider issues related to IRS's controls over financial reporting, management of unpaid assessments, collection of revenue and issuance of tax refunds, and information security to be material weaknesses. In addition, IRS was not always in compliance with a law concerning the timely release of tax liens. IRS's most serious financial management weaknesses are rooted in its continued reliance on outdated automated systems. The lack of a sound financial management system that can produce timely, accurate, and useful information needed for day-to-day decisions continues to present a serious challenge to IRS management. While implementation of the first phase of IFS during fiscal year 2005 was noteworthy, it is still several years away from achieving its full potential, which is contingent on future system releases and development of a means to integrate the new system with the systems IRS uses to support its tax administration activities. IRS's present financial management systems, which do not substantially comply with FFMIA, inhibit IRS's ability to address the financial management and operational issues that affect its ability to fulfill its responsibilities as the nation's tax collector. Further, the continued and serious weaknesses in information security have significant implications for the reliability of information produced by the new financial management system being implemented. Solving IRS's financial management problems depends largely on the ultimate success of IRS's ongoing systems modernization effort.
GAO-06-137, Financial Audit: IRS's Fiscal Years 2005 and 2004 Financial Statements
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Report to the Secretary of the Treasury:
November 2005:
Financial Audit:
IRS's Fiscal Years 2005 and 2004 Financial Statements:
GAO-06-137:
GAO Highlights:
Highlights of GAO-06-137, a report to the Secretary of the Treasury:
Why GAO Did This Study:
Because of the significance of Internal Revenue Service (IRS)
collections to federal receipts and, in turn, to the consolidated
financial statements of the U.S. government, which GAO is required to
audit, and Congress‘s interest in financial management at IRS, GAO
audits IRS‘s financial statements annually to determine whether (1) the
financial statements IRS prepares are reliable and (2) IRS management
maintained effective internal controls. We also test IRS‘s compliance
with selected provisions of significant laws and regulations and its
financial management systems‘ compliance with the Federal Financial
Management Improvement Act of 1996 (FFMIA).
What GAO Found:
In GAO‘s opinion, IRS‘s fiscal years 2005 and 2004 financial statements
were fairly presented in all material respects. Because of serious
internal control and financial management systems deficiencies,
however, IRS again had to rely extensively on resource-intensive
compensating processes to prepare its financial statements. Due to
these serious internal control and financial management deficiencies,
IRS did not, in GAO‘s opinion, maintain effective internal controls
over financial reporting (including safeguarding of assets) or
compliance with laws and regulations, and thus did not provide
reasonable assurance that losses, misstatements, and noncompliance with
laws material in relation to the financial statements would be
prevented or detected on a timely basis.
IRS has continued to make great strides in addressing its financial
management challenges and has substantially mitigated several material
weaknesses in its internal controls. In fiscal year 2005, IRS
successfully implemented the first phase, or release, of its new
Integrated Financial System (IFS), which is intended to replace the
outdated financial management systems IRS used in recent years to
process and report administrative (nontax) transactions. This first
phase of IFS provides for improved audit trails and more timely
information for such activities and transactions as travel, purchases
of goods and services, and budgetary activities. In addition, IRS
continued to make progress in its efforts to address its weaknesses in
controls over hard-copy taxpayer receipts and data and over property
and equipment. However, GAO continues to consider issues related to
IRS‘s controls over financial reporting, management of unpaid
assessments, collection of revenue and issuance of tax refunds, and
information security to be material weaknesses. In addition, IRS was
not always in compliance with a law concerning the timely release of
tax liens.
IRS‘s most serious financial management weaknesses are rooted in its
continued reliance on outdated automated systems. The lack of a sound
financial management system that can produce timely, accurate, and
useful information needed for day-to-day decisions continues to present
a serious challenge to IRS management. While implementation of the
first phase of IFS during fiscal year 2005 was noteworthy, it is still
several years away from achieving its full potential, which is
contingent on future system releases and development of a means to
integrate the new system with the systems IRS uses to support its tax
administration activities. IRS‘s present financial management systems,
which do not substantially comply with FFMIA, inhibit IRS‘s ability to
address the financial management and operational issues that affect its
ability to fulfill its responsibilities as the nation‘s tax collector.
Further, the continued and serious weaknesses in information security
have significant implications for the reliability of information
produced by the new financial management system being implemented.
Solving IRS‘s financial management problems depends largely on the
ultimate success of IRS‘s ongoing systems modernization effort.
What GAO Recommends:
In prior audits, GAO made recommendations to IRS to address issues that
continued to persist during this year‘s audit. GAO will monitor IRS‘s
progress in implementing the 84 recommendations that remain open as of
the date of this report. IRS agreed with the report‘s findings, noting
that it fairly presented IRS‘s progress and challenges. IRS cited its
implementation of the first phase of its new financial systems and its
planned initiatives to address its financial management challenges. IRS
noted that it had established a strong commitment to improve financial
management and to aggressively pursue process and systems improvements.
www.gao.gov/cgi-bin/getrpt?GAO-06-137.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Steven J. Sebastian at
(202) 512-3406 or sebastians@gao.gov.
[End of section]
Contents:
Letter:
Auditor's Report:
Opinion on IRS's Financial Statements:
Opinion on Internal Controls:
Compliance with Laws and Regulations and FFMIA Requirements:
Consistency of Other Information:
Objectives, Scope, and Methodology:
Agency Comments and Our Evaluation:
Management Discussion and Analysis:
Financial Statements:
Balance Sheets:
Statements of Net Cost:
Statements of Changes in Net Position:
Statements of Budgetary Resources:
Statements of Financing:
Statements of Custodial Activity:
Notes to the Financial Statements:
Supplemental Information:
Appendixes:
Appendix I: Material Weaknesses, Reportable Conditions, and Compliance
Issues:
Material Weaknesses:
Reportable Conditions:
Compliance Issues:
Appendix II: Details on Audit Methodology:
Appendix III: Comments from the Internal Revenue Service:
Abbreviations:
CADE: Customer Account Data Engine:
CAP: Custodial Accounting Project:
CFO Act: Chief Financial Officers Act of 1990:
EITC: earned income tax credit:
FFMIA: Federal Financial Management Improvement Act of 1996:
FFMSR: Federal Financial Management System Requirements:
FIA: Federal Managers' Financial Integrity Act of 1982:
FISMA: Federal Information Security Management Act of 2002:
FMS: Financial Management Service:
IFS: Integrated Financial System:
IRS: Internal Revenue Service:
JFMIP: Joint Financial Management Improvement Program:
OMB: Office of Management and Budget:
P&E: property and equipment:
Letter November 10, 2005:
The Honorable John W. Snow:
The Secretary of the Treasury:
Dear Mr. Secretary:
The accompanying report presents the results of our audits of the
financial statements of the Internal Revenue Service (IRS) as of, and
for the fiscal years ending, September 30, 2005 and 2004. We performed
our audits in accordance with the Chief Financial Officers (CFO) Act of
1990, as expanded by the Government Management Reform Act of 1994. This
report contains our (1) unqualified opinions on IRS's financial
statements, (2) opinion that IRS's internal controls were not effective
as of September 30, 2005, and (3) conclusion that IRS was not in
compliance with one provision of the laws and regulations we tested and
that IRS's financial management systems were not in substantial
compliance with the requirements of the Federal Financial Management
Improvement Act of 1996.
Our unqualified opinions on IRS's fiscal years 2005 and 2004 financial
statements were made possible by the continued extraordinary efforts of
IRS senior management and staff to compensate for serious internal
control and financial management systems deficiencies. IRS is currently
in the midst of a major business systems modernization effort that is
ultimately intended to resolve its most serious financial systems
challenges. However, this effort is not scheduled to be completed for
several years. Until the modernization is accomplished, preparing
reliable financial statements will continue to be a difficult challenge
for IRS, requiring continued use of extraordinary compensating
measures. To date, these measures have proved successful: for the sixth
consecutive year, IRS has received an unqualified opinion on its
financial statements and, for the fourth consecutive year, the audit
was completed and the report issued by November 15.
Over the last several years, IRS has made great strides in addressing
its financial management challenges and has resolved or substantially
mitigated several material weaknesses in its internal controls.
However, IRS's most serious financial management weaknesses are rooted
in its continued reliance on outdated automated systems, whose numerous
limitations render IRS unable to develop cost-based performance or
other information to support informed decision making throughout the
year. Solving these problems depends largely on the ultimate success of
IRS's ongoing systems modernization effort. In 1995, we designated
financial management and systems modernization at IRS as high-risk
areas.[Footnote 1] However, because resolution of IRS's most serious
and intractable financial management issues largely depends on the
success of IRS's business systems modernization efforts, in 2005 we
combined these two previous high-risk areas into one Business Systems
Modernization high-risk area.[Footnote 2]
During fiscal year 2005, IRS successfully implemented the first phase,
or release, of its new Integrated Financial System (IFS), which is
intended to replace the outdated financial management system that IRS
used in recent years to process and report administrative transactions.
This first phase of IFS provides for improved audit trails and more
timely information for such activities and transactions as travel,
purchases of goods and services, and budgetary activities. However,
full operational capability of IFS is several years away, and is
contingent on the successful implementation of future system releases.
Additionally, IRS will need to address how IFS will ultimately be
integrated with those systems that support financial management of its
tax administration functions to fully resolve many of its long-standing
financial management challenges.
Among the most serious financial management issues still remaining to
be addressed are the continued significant weaknesses in IRS's
information security. Consequently, as IRS continues its efforts to
modernize its financial and operational systems, it is critical that
IRS take actions to establish and maintain more effective information
security controls on a continuing basis, through an ongoing cycle of
risk management activities, to protect the processing, storage, and
transmission of financial and sensitive data. Until IRS successfully
manages its information security risks, management will not have
assurance over the integrity and reliability of the information
generated from the new financial management system, and IRS's
opportunities for further improvements in financial management will be
limited.
We commend IRS for the improvements it has continued to make in its
financial processes and operations. Nonetheless, IRS management and
staff will continue to be challenged to sustain the level of effort
needed to produce reliable financial statements until the agency is
able to fully address the underlying systems and internal control
issues that have made this process so time consuming and resource
intensive. As we previously reported, IRS continues to lack accurate,
useful, and timely financial information and sound controls with which
to make fully informed decisions and to ensure ongoing accountability,
which is a primary objective of the CFO Act. IRS has made significant
progress in addressing its serious control and systems deficiencies and
improving financial management during the past 9 years. It is important
that these financial management initiatives continue in order to
achieve comprehensive and lasting financial management reform.
The agency also continues to face a significant challenge in
strengthening its enforcement of the nation's tax laws, another
challenge at IRS that we have designated as high risk.[Footnote 3] In
recent years, the resources IRS has been able to dedicate to enforcing
the tax laws have not kept pace with the increases it has seen in its
enforcement workload. At the same time, IRS faces significant
compliance-related issues, including combating abusive tax shelters and
tax schemes, on which it is placing a high priority. Critical to IRS's
efforts in improving enforcement and, ultimately, taxpayer compliance,
is the need to have current information on the rate of compliance, both
overall and by type of taxpayer. IRS recently completed a study of the
rate of compliance with the nation's tax laws by individuals and some
small business taxpayers, and is exploring approaches to developing
compliance estimates for other groups of taxpayers. It is critical that
such efforts be continued as, without current information on
noncompliance, the challenge of targeting IRS enforcement resources to
areas where they would prove most effective is problematic.
The accompanying report also discusses other significant issues that we
considered in performing our audit and in forming our conclusions,
which we believe should be brought to the attention of IRS management
and users of IRS's financial statements.
We are sending copies of this report to the Chairmen and Ranking
Minority Members of the Senate Committee on Appropriations; Senate
Committee on Finance; Senate Committee on Homeland Security and
Governmental Affairs; Senate Committee on the Budget; Subcommittee on
Transportation, Treasury, the Judiciary, Housing and Urban Development
and Related Agencies, Senate Committee on Appropriations; Subcommittee
on Taxation and IRS Oversight, Senate Committee on Finance;
Subcommittee on Oversight of Government Management, the Federal
Workforce, and the District of Columbia, Senate Committee on Homeland
Security and Governmental Affairs; House Committee on Appropriations;
House Committee on Ways and Means; House Committee on Government
Reform; House Committee on the Budget; Subcommittee on Transportation,
Treasury, and Housing and Urban Development, the Judiciary, and the
District of Columbia, House Committee on Appropriations; Subcommittee
on Government Management, Finance, and Accountability, House Committee
on Government Reform; and Subcommittee on Oversight, House Committee on
Ways and Means. We are also sending copies of this report to the
Chairman and Vice Chairman of the Joint Committee on Taxation, the
Commissioner of Internal Revenue, the Director of the Office of
Management and Budget, the Chairman of the IRS Oversight Board, and
other interested parties. Copies will be made available to others upon
request. In addition, the report is available at no charge on GAO's Web
site at [Hyperlink, http://www.gao.gov].
This report was prepared under the direction of Steven J. Sebastian,
Director, Financial Management and Assurance, who can be reached at
(202) 512-3406 or [Hyperlink, sebastians@gao.gov]. If I can be of
further assistance, please call me at (202) 512-5500. Contact points
for our Offices of Congressional Relations and Public Affairs may be
found on the last page of this report.
Sincerely yours,
Signed by:
David M. Walker:
Comptroller General of the United States:
[End of section]
Auditor's Report To the Commissioner of Internal Revenue:
In accordance with the Chief Financial Officers (CFO) Act of 1990, as
expanded by the Government Management Reform Act of 1994,[Footnote 4]
this report presents the results of our audits of the financial
statements of the Internal Revenue Service (IRS) for fiscal years 2005
and 2004. The financial statements report the assets, liabilities, net
position, net costs, changes in net position, budgetary resources,
reconciliation of net costs to budgetary obligations, and custodial
activity related to IRS's administration of its responsibilities for
implementing federal tax legislation. The financial statements do not
include an estimate of the amount of taxes that are owed the federal
government but have not been reported by taxpayers or identified by
IRS, often referred to as the tax gap,[Footnote 5] nor do they include
information on tax expenditures.[Footnote 6]
In its role as the nation's tax collector, IRS has a demanding
responsibility in collecting taxes, processing tax returns, and
enforcing the nation's tax laws. IRS is a large and complex
organization, adding unique operational challenges for management. IRS
employs tens of thousands of people in 10 service center campuses,
three computing centers, and numerous other field offices throughout
the United States. In each of fiscal years 2005 and 2004, IRS collected
about $2.3 trillion and $2.0 trillion, respectively, in tax payments,
processed hundreds of millions of tax and information returns, and paid
about $267 billion and $278 billion, respectively, in refunds to
taxpayers.
One of the largest obstacles continuing to face IRS management is the
agency's lack of an integrated financial management system capable of
producing the accurate, useful, and timely information IRS managers
need to assist in making day-to-day decisions. While progress is being
made to modernize its financial management capabilities, IRS
nonetheless continued to confront many of the pervasive internal
control weaknesses that we have reported each year since we began
auditing its financial statements in fiscal year 1992,[Footnote 7]
though it continued to make strides in addressing its financial
management challenges. In fiscal year 2005, for the sixth consecutive
year, IRS was able to produce financial statements covering its tax
custodial and administrative activities that are fairly stated in all
material respects. Moreover, for the fourth consecutive year, IRS was
able to issue its final audited financial statements only a month and a
half after the end of the fiscal year.
IRS's continued success in meeting this reporting date is a major
accomplishment and, for fiscal year 2005, was all the more notable
because IRS met this date while implementing the first phase of its new
financial management system, which is ultimately expected to resolve
its most serious financial management challenges. Nevertheless, many of
IRS's long-standing systems and internal control weaknesses continued
to exist, necessitating continued reliance on costly compensating
processes, statistical estimates, external contractors, substantial
adjustments, and monumental human efforts to prepare a set of reliable
financial statements. These costly efforts would not be necessary if
IRS's systems and controls operated effectively.
During fiscal year 2005, IRS continued to make progress in its efforts
to address its weaknesses in controls over financial reporting,
property and equipment (P&E), and hard-copy taxpayer receipts and data.
For example, as a result of its implementation of the first phase of
its new financial management system, IRS improved the timeliness and
accuracy of its recording of P&E acquisitions. Additionally, IRS
implemented several initiatives to improve the safeguarding of, and
accountability for, hardcopy taxpayer receipts and data at lockbox
banks and taxpayer assistance centers. However, control deficiencies in
P&E and physical security over taxpayer receipts and data continued to
represent reportable conditions,[Footnote 8] requiring further
attention by IRS management. Additionally, we continue to consider
issues related to controls over financial reporting, management of
unpaid assessments, and collection of revenue and issuance of tax
refunds to be material weaknesses.[Footnote 9] These weaknesses are
caused primarily by IRS's continued reliance on outdated automated
systems to provide the financial information that management relies on
to make decisions. In addition, we continue to consider issues related
to information security to be a material weakness. The persistent,
serious deficiencies in information security increase the risk that
confidential IRS and taxpayer information will be compromised and have
serious implications related to the reliability of financial management
information produced by IRS's systems.
IRS has made progress in improving its financial management, and the
process changes IRS has instituted in the last several years represent
good financial management practices. However, IRS's most serious
remaining problems are caused by its inadequate automated systems, and
these problems will continue to exist until its systems are replaced.
In the interim, opportunities for further improvement will be limited.
Until its systems are replaced, IRS will continue to be challenged to
sustain the level of effort needed to produce reliable financial
statements timely. Perhaps more important, IRS will continue to rely on
processes that cannot produce the accurate, useful, and timely
financial and performance information IRS needs for decision making on
an ongoing basis, which is a primary objective of the CFO Act. These
processes also cannot fully address the underlying financial management
and operational issues that adversely affect IRS's ability to
effectively fulfill its responsibilities as the nation's tax collector.
IRS is currently installing a new financial management system intended
to resolve many of the issues discussed in this report. During fiscal
year 2005, IRS implemented a major component of this system--the first
release of the Integrated Financial System (IFS). IFS is intended to
replace the outdated financial management system IRS has used in recent
years to process and report administrative transactions such as
procurement and utilization of budgetary resources, and to provide IRS
with a general ledger system that complies with the U.S. Government
Standard General Ledger. During the fiscal year, IRS converted
financial data from its previous financial system to IFS, verified that
the information was converted properly, and closely monitored the
conversion in an effort to ensure a successful transition to this first
release of IFS. Replacing a financial system of this magnitude is an
inherently difficult and complex effort that entails significant risks.
IRS recognized this, and devoted significant resources to mitigate
those risks. This, and earlier decisions to delay implementation to
address issues that arose during the design of the system, enabled IRS
to successfully implement the first phase of IFS with minimal
disruptions to its financial activities.
While IRS's progress with respect to the implementation of this first
phase of IFS is noteworthy, it is important to recognize that
substantial work remains to be done to complete the modernizing of
IRS's financial management systems so as to achieve sound financial
management. Presently, IFS serves as IRS's core financial management
system for its administrative activities, and includes such
functionality as accounts payable, accounts receivable, budget
formulation and execution, and the general ledger. While IFS contains
cost accounting capability, it will be several years before such
capabilities can be fully and successfully utilized. Additionally,
IRS's effort to bring the system online experienced significant
problems and delays in the past, and this, coupled with funding
constraints, led to a decision to indefinitely defer future releases of
IFS, including those related to property management, procurement, and
performance management functions.
IRS also will have to address how IFS will ultimately be integrated
with those systems that support financial management of IRS's tax
administration functions, including its collection of tax revenue
receipts, disbursement of tax refunds, and identification, management,
and collection of outstanding federal taxes. During fiscal year 2005,
IRS expanded processing of the less complex individual tax returns
through the first phase, or release, of the Customer Account Data
Engine (CADE), which is the system being designed to replace IRS's
master files.[Footnote 10] CADE was to eventually provide tax
information to IFS for reporting purposes through the Custodial
Accounting Project (CAP), a system which was to support management
needs for information related to tax operations for purposes of day-to-
day decision making, performance management, and reporting. However,
significant delays and problems, as well as budget constraints,
resulted in first the deferral, and later the cancellation, of CAP. At
this time, IRS is exploring options to implement alternative systems
that would perform the functions that CAP had been intended to perform,
but it remains unclear when IRS's new financial management systems will
be fully implemented. Additionally, continuing and newly identified
weaknesses in IRS's information security raise serious concerns about
the integrity of information that will be generated from these
modernized systems, as well as about future modernization efforts that
support the preparation of IRS's financial statements.
Opinion on IRS's Financial Statements:
IRS's financial statements, including the accompanying notes, present
fairly, in all material respects, in conformity with U.S. generally
accepted accounting principles, IRS's assets, liabilities, net
position, net costs, changes in net position, budgetary resources,
reconciliation of net costs to budgetary activity, and custodial
activity as of, and for the fiscal years ended, September 30, 2005, and
September 30, 2004.
However, misstatements may nevertheless occur in other financial
information reported by IRS as a result of the internal control
weaknesses described in this report.
IRS's financial statements include tax revenues collected during the
fiscal year as well as the total unpaid taxes for which IRS, the
taxpayer, or courts agree on the amounts owed. Cumulative unpaid tax
assessments for which there is no future collection potential or for
which there is no agreement on the amounts owed are not reported in the
financial statements. Rather, they are reported as write-offs and
compliance assessments, respectively, in supplemental information to
IRS's financial statements. Also, in conformity with U.S. generally
accepted accounting principles, to the extent that taxes owed in
accordance with the nation's tax laws are not reported by taxpayers and
are not identified through IRS's various enforcement programs, they are
not reported in the financial statements nor in supplemental
information to the financial statements. Additionally, in conformity
with U.S. generally accepted accounting principles, tax expenditures,
which represent the amount of revenue the government forgoes resulting
from federal tax provisions that grant special tax relief for certain
kinds of behavior by taxpayers or for taxpayers in special
circumstances, are not reported in the financial statements.
Opinion on Internal Controls:
Because of the material weaknesses in internal controls discussed
below, IRS did not maintain effective internal controls over financial
reporting (including safeguarding of assets) or compliance with laws
and regulations, and thus did not provide reasonable assurance that
losses, misstatements, and noncompliance with laws material in relation
to the financial statements would be prevented or detected on a timely
basis. Our opinion is based on criteria established under 31 U.S.C. §
3512 (c), (d), commonly referred to as the Federal Managers' Financial
Integrity Act of 1982 (FIA), and Office of Management and Budget (OMB)
Circular No. A-123, Management Accountability and Control (revised June
21, 1995).[Footnote 11]
Despite its material weaknesses in internal controls and its systems
deficiencies, IRS was able to prepare financial statements that were
fairly stated in all material respects for fiscal years 2005 and 2004.
Nonetheless, IRS continues to face the following key issues that
represent material weaknesses in internal controls:
* weaknesses in controls over the financial reporting process,
resulting in IRS not (1) being able to prepare reliable financial
statements without extensive compensating procedures and (2) having
current and reliable ongoing information to support management decision
making and to prepare cost-based performance measures;
* weaknesses in controls over unpaid tax assessments, resulting in
IRS's inability to properly manage unpaid assessments and leading to
increased taxpayer burden;
* weaknesses in controls over the identification and collection of tax
revenues due the federal government and over the issuance of tax
refunds, resulting in lost revenue to the federal government and
potentially billions of dollars in improper payments; and:
* weaknesses in information security controls, resulting in increased
risk of unauthorized individuals being allowed to access, alter, or
abuse proprietary IRS programs and electronic data and taxpayer
information.
The material weaknesses in internal controls noted above may adversely
affect any decision by IRS's management that is based, in whole or in
part, on information that is inaccurate because of these weaknesses. In
addition, unaudited financial information reported by IRS, including
performance information, may also contain misstatements resulting from
these weaknesses.
In addition to the material weaknesses discussed above, we identified
two reportable conditions, which, although not material weaknesses,
represent significant deficiencies in the design or operation of
internal controls that could adversely affect IRS's ability to meet the
internal control objectives described in this report. These conditions
concern deficiencies in (1) controls over hard-copy tax receipts and
taxpayer data, which increase the government's and taxpayers' risk of
loss or inappropriate disclosure of taxpayer data, and (2) controls
over P&E, which preclude IRS from readily reconciling its property
records to its financial records.
We have reported on these material weaknesses and reportable conditions
in prior audits and have provided IRS recommendations to address these
issues. Eighty-four of these recommendations were still open as of the
date of this report.[Footnote 12] IRS continues to make strides in
resolving these matters. We will follow up in future audits to monitor
IRS's progress in implementing these recommendations. For more details
on these issues, see appendix I.
Compliance with Laws and Regulations and FFMIA Requirements:
Our tests of compliance with selected provisions of laws and
regulations disclosed one area of noncompliance that is reportable
under U.S. generally accepted government auditing standards and OMB
guidance. This area relates to IRS not timely releasing federal tax
liens against taxpayers' property.
Except as noted above, our tests for compliance with laws and
regulations disclosed no other instances of noncompliance that would be
reportable under U.S. generally accepted government auditing standards
or OMB audit guidance. However, the objective of our audit was not to
provide an opinion on overall compliance with laws and regulations.
Accordingly, we do not express such an opinion.
We also found that IRS's financial management systems did not
substantially comply with the requirements of the Federal Financial
Management Improvement Act of 1996 (FFMIA).[Footnote 13]
For more details on these issues, see appendix I.
Consistency of Other Information:
IRS's Management Discussion and Analysis and required supplemental
information contain a wide range of data, some of which are not
directly related to the financial statements. We did not audit and do
not express an opinion on this information. However, we compared this
information for consistency with the financial statements and discussed
the methods of measurement and presentation with IRS officials. Based
on this limited work, we found no material inconsistencies with the
financial statements or nonconformance with OMB guidance. Under OMB
guidance for the financial statements of federal agencies, agencies are
asked to strive to develop and report objective measures that to the
extent possible, provide information about the cost-effectiveness of
their programs. We found, however, that because of the noted internal
control and systems limitations, IRS cannot report reliable cost-based
performance measures relating to its various programs consistent with
the Government Performance and Results Act of 1993.[Footnote 14]
Objectives, Scope, and Methodology:
Management is responsible for (1) preparing the annual financial
statements in conformity with U.S. generally accepted accounting
principles; (2) establishing, maintaining, and assessing internal
control to provide reasonable assurance that the broad control
objectives of 31 U.S.C. § 3512 (c), (d) (FIA) are met; (3) ensuring
that IRS's financial management systems substantially comply with the
requirements of FFMIA; and (4) complying with applicable laws and
regulations.
We are responsible for obtaining reasonable assurance about whether (1)
the financial statements are presented fairly, in all material
respects, in conformity with U.S. generally accepted accounting
principles and (2) management maintained effective internal controls,
the objectives of which are the following:
* Financial reporting--transactions are properly recorded, processed,
and summarized to permit the preparation of financial statements in
conformity with U.S. generally accepted accounting principles and
assets are safeguarded against loss from unauthorized acquisition, use,
and disposition.
* Compliance with laws and regulations--transactions are executed in
accordance with laws governing the use of budget authority and with
other laws and regulations that could have a direct and material effect
on the financial statements and any other laws, regulations, and
governmentwide policies identified by OMB audit guidance.
We are also responsible for (1) testing whether IRS's financial
management systems substantially comply with the three FFMIA
requirements, (2) testing compliance with selected provisions of laws
and regulations that have a direct and material effect on the financial
statements and laws for which OMB audit guidance requires testing, and
(3) performing limited procedures with respect to certain other
information appearing in these annual financial statements. For more
details on our methodology and the laws and regulations we tested, see
appendix II.
We did not evaluate all internal controls relevant to operating
objectives as broadly defined by FIA, such as controls relevant to
preparing statistical reports and ensuring efficient operations. We
limited our internal control testing to testing controls over financial
reporting and compliance with laws and regulations.
We did not test compliance with all laws and regulations applicable to
IRS. We limited our tests of compliance to those laws and regulations
that had a direct and material effect on the financial statements or
that were required to be tested by OMB audit guidance that we deemed
applicable to IRS's financial statements for the fiscal years ended
September 30, 2005 and 2004. We caution that noncompliance may occur
and not be detected by these tests and that such testing may not be
sufficient for other purposes.
We performed our work in accordance with U.S. generally accepted
government auditing standards and OMB audit guidance.
Agency Comments and Our Evaluation:
In responding to this report, IRS agreed that the report fairly
presents the agency's financial management progress and remaining
management and systems challenges. IRS noted that the agency's
dedication to financial management improvement enabled it to achieve,
for the sixth consecutive year, an unqualified opinion on its financial
statements. Additionally, IRS cited a number of financial management
improvements it had undertaken during fiscal year 2005, the most
notable of which was its successful deployment of the initial release
of its Integrated Financial System (IFS). In addition to the
implementation of IFS, IRS noted other financial management
improvements, such as (1) implementation of a crosswalk to convert the
Interim Revenue Accounting Control System trial balance accounts into a
format compliant with the United States Standard General Ledger, (2)
centralization of all Small Business/Self-Employed Automated Trust Fund
Recovery Penalty (TFRP) work to two campuses to improve efficiency and
reduce TFRP assessment errors by improving the cross-referencing and
posting of the payment process, and (3) development of Security and
Internal Control Performance Measures for physical security, courier,
personal security, and internal controls over receipts and receipt
processing at lockbox banks.
In its response, IRS also agreed with our findings and opinions related
to information security, and indicated that it had developed an action
plan to address deficiencies in access controls, rules of behavior,
contingency planning and disaster recovery, audit trails, training, and
certification and accreditation. IRS also recognized the need to
continue to address identified problems and remain focused on its
modernization efforts. IRS noted that the agency had established a deep
and continuing commitment to improving financial management and its
intention to aggressively pursue appropriate actions to improve
processes and systems.
The complete text of IRS's response is included in appendix III.
Signed by:
David M. Walker:
Comptroller General of the United States:
October 31, 2005:
[End of section]
Management Discussion and Analysis:
INTERNAL REVENUE SERVICE:
Management Discussion and Analysis For the Fiscal Year Ended September
30, 2005:
I. Introduction:
The Internal Revenue Service (IRS) administers America's tax laws and
collects the revenues that fund most government operations and public
services. To do so, the IRS helps taxpayers comply with the tax system
and ensures that those who are unwilling to comply pay their fair
share. In a constantly evolving economy, this mission requires not only
a sharp focus on service and enforcement, but also an increasingly
flexible agency, one capable of smooth adjustment to 21st century
change.
The IRS' five-year Strategic Plan provides the blueprint to meet this
challenge. This plan focuses on three key goals: improving taxpayer
service, enhancing enforcement of the tax law and modernizing the IRS
through its people, processes and technology. Fiscal Year (FY) 2005
witnessed the IRS making significant progress toward each of these
goals.
The way taxpayers pay their taxes and access IRS information is
changing. This year, for the first time, more than half of all
taxpayers filed electronically and more than five million of these
taxpayers filed for free though the Free File Alliance. Additionally,
tens of millions of taxpayers visited the IRS website to obtain forms,
publications and answers to their many tax questions. In FY 2005, as in
prior years, IRS employees made millions of contacts with American
taxpayers and businesses, improving service to them by reducing
response times to taxpayer inquiries, improving communications with
taxpayers, providing taxpayers and their paid prepares with needed
resources and reducing the paperwork burden.
The IRS has also increased enforcement with the aim of improving
taxpayer compliance. The FY 2005 performance results confirm that the
IRS is striking the right balance between service and enforcement. For
FY 2005, the IRS met or exceeded the targets in 17 of its 21 [NOTE 1]
measures (81% compared to 67% in FY 2004). Of particular note are the
IRS' efforts to enhance criminal enforcement, use of civil injunctions
to stop abusive tax schemes and investigate promoters and users of tax
shelters. Two major settlement initiatives involving the use of abusive
tax shelters generated over $4.7 billion in revenue. IRS enforcement
actions also contribute to national security and homeland defense; the
IRS has a unique role in combating the use of charitable organizations
to raise funds for terrorist organizations.
Business systems modernization remains a high priority for the IRS. A
robust, secure and up-to-date infrastructure will improve services-both
to taxpayers and to other government agencies-and will strengthen
enforcement by giving IRS employees better tools. In FY 2005, the IRS
implemented its new Integrated Financial System (IFS), designed to
provide the IRS with more accurate and timely financial information and
improved compliance with legislative and regulatory requirements. The
major components of IFS are accounts payable, accounts receivable,
budget formulation, budget execution, general ledger, financial
statements and cost accounting. Today there are thousands of
procurement commitments, obligations and receipt/acceptance documents
being processed through the new IFS system. Another success includes
the Customer Account Data Engine (CADE), the IRS' modernized database;
CADE posted over 1.4 million returns for filing season 2005 and
generated over $427 million in refunds.
NOTE:
[1] Data for the Earned Income Tax Credit measure will not be available
until the close of Calendar Year 2005 and two information systems
measures were discontinued this year.
During FY 2006, the IRS will continue to seek efficiencies in
delivering taxpayer service, bolster its enforcement efforts to improve
compliance with the tax laws and modernize its infrastructure. The IRS
will continue to research and evaluate information regarding taxpayer
service needs, priorities, and preferences in order to improve delivery
services. In the area of enforcement, the IRS will expand enforcement
by targeting its case work and enforcement activities to more
effectively deliver results and drive down the tax gap. Finally, the
IRS will continue its modernization with the further development of
CADE; Modernized e-File (MeF); and the Filing and Payment Compliance
system, a system that analyzes tax collection cases to determine
uncontested cases that no longer require IRS involvement and can be
turned over to private collection agencies.
Mission and Goals:
Provide America's taxpayers top-quality service by helping them
understand and meet their tax responsibilities and by applying the tax
law with integrity and fairness to all.
This mission statement reflects the IRS' priorities of supporting
taxpayers in fulfilling their tax obligations, providing high quality
services and information and applying and enforcing the tax laws with
the highest standards of fairness and integrity.
In fulfilling its mission, the IRS focuses on achieving three
overarching strategic goals:
Improve Taxpayer Service:
Enhance Enforcement of the Tax Law:
Modernize the IRS through Its People, Processes and Technology:
Each strategic goal is supported by operational objectives and annual
performance measures. The operational objectives reflect IRS' business
priorities; the performance measures reflect the IRS' plans to evaluate
its ongoing success in meeting its stated objectives.
Organization:
The IRS continues to transform its programs and activities to keep pace
with the changing environment, taxpayer demands and new mandates. The
IRS' primary operations are supported by four business units centered
on unique groups of taxpayers: individual taxpayers, small business
owners, corporations and tax-exempt and government entities. The IRS
Commissioner and two Deputy Commissioners have oversight for all agency
operations, as described on the following pages.
Direct Reports to the Commissioner:
A number of business units and functions report directly to the IRS
Commissioner. They set policies, provide leadership and direction for
the Internal Revenue Service and provide support for strategic decision-
making activities needed to fulfill the IRS' mission in administering
the nation's tax laws.
* The Office of Appeals resolves tax controversies between taxpayers
and the IRS without litigation on a basis that is fair and impartial to
both the Government and the taxpayer. Appeals provides an independent
channel for taxpayers who wish to dispute a recommended enforcement
action.
* Taxpayer Advocate Service (TAS) helps taxpayers resolve problems that
have not been resolved through regular IRS channels. TAS is an
independent function headed by the National Taxpayer Advocate. Each
state and IRS Service Center has at least one local Taxpayer Advocate
who operates independently and reports directly to the National
Taxpayer Advocate. Local Taxpayer Advocates work directly with
operating divisions to identify and recommend solutions to systemic
problems.
* Communication and Liaison (C&L) oversees and manages the IRS'
external communications activities with the news media, members of
Congress and their staffs, tax professionals and practitioners as well
as internal communications with employees. C&L also coordinates
marketing and advertising activities on behalf of the IRS and
establishes policies and guidelines governing communications throughout
the IRS.
* The Office of Chief Counsel provides correct and impartial
interpretation of the Internal Revenue laws and the highest quality
legal advice and representation for the Internal Revenue Service. The
Chief Counsel's principal customers are the IRS Commissioner, the
operating divisions, the functional units and the Department of the
Treasury and the Department of Justice. Litigation and legal advice are
the largest programs provided by Chief Counsel field office attorneys
and support staff. Published guidance, advance case resolution and
legal advice are the largest programs provided by attorneys and support
staff in the National Office.
* Research, Analysis, and Statistics (RAS) supports IRS senior
management, operating divisions, functional units, and various research
organizations, the Department of the Treasury and the general public by
producing studies, program evaluations and statistical analyses of
taxpayer trends and data and by providing research and reference tools
for front line IRS employees.
* Equal Employment Opportunity and Diversity (EEO&D) educates IRS
employees about diversity and helps them understand their EEO rights
and responsibilities, ensuring that the IRS applies civil rights laws
with integrity and fairness to all.
Deputy Commissioner for Services and Enforcement:
IRS tax operations are aligned into four Operating Divisions, Criminal
Investigations and the Office of Professional Responsibility, each
focusing on specific taxpayer constituencies and business issues. They
report to the Deputy Commissioner for Services and Enforcement.
* Wage and Investment Division (W&I) manages tax processing and
customer service for all individual and business taxpayers and provides
compliance services to individual taxpayers. Employees at nine campuses
perform tax processing services. Twenty five sites provide account
management services. Employees at five campuses perform compliance
services, which tend to focus on dependent exemptions, credits, filing
status and personal deductions. W&I's field operations provide
information, support and assistance to taxpayers in fulfilling their
tax obligations.
In FY 2005, the IRS consolidated its Customer Account Services (CAS)
units, making better use of resources and streamlining and enhancing
communications. Consolidating the top level management structure
allowed the IRS to continue the successes of high levels of service,
decreased inventory and cycle times and deployment of successful web
applications for customers while eliminating redundancies and
duplication.
* Small Business and Self Employed Division (SB/SE) serves partially or
fully self-employed individuals with income from rents, royalties,
pensions, annuities, partnerships, estates and trusts; small
businesses, including corporations and partnerships, with assets up to
$10 million; and others who file employment, excise, estate, gift,
fiduciary and international tax returns. SB/SE has the largest
compliance and enforcement presence in the Service, allocating 93% of
its resources to compliance activities. SB/SE is aligned along
functional lines of Examination, Collection, Specialty Tax Programs,
Compliance Services/Campus Operations and Fraud/Bank Secrecy Act to
provide a more focused approach to program delivery by making the best
use of existing knowledge and experience, ensuring end-to-end
accountability and leveraging the specialized expertise of the
workforce.
* Large and Mid-Size Business Division (LMSB) is the branch of the IRS
charged with administering taxes for the largest corporations and
partnership entities in the United States - multinational businesses
with assets of over $10 million. LMSB serves about 54,600 corporate
taxpayers and related entities with a combined annual tax liability
approaching $200 billion. Its workforce is structured around five
"industry" groupings that include Communications; Technology and Media;
Financial Services; Heavy Manufacturing and Transportation; Natural
Resources and Construction; and Retailers, Food, Pharmaceuticals and
Healthcare. Operating within this structure, LMSB is able to provide
taxpayers with specialized, focused support on specific tax issues.
LMSB's six thousand person workforce consists largely of field-based
employees, including revenue agents, international examiners, field
specialists, technical experts and various support personnel.
Collectively, they deal with tax issues ranking among the most complex
addressed by any division in the Internal Revenue Service.
* Tax-Exempt and Government Entities Division (TE/GE) serves a wide
range of customers including small local community organizations,
municipalities, major universities, pension funds, state governments,
Indian tribal governments and tax exempt bond issuers. TE/GE
administers and enforces a variety of complex laws governing tax-exempt
organizations and entities. TE/GE employees ensure that these tax-
exempt entities properly adhere to applicable statutes.
* Criminal Investigation (CI) enforces the criminal provisions of
Internal Revenue Code and related statutes. Tax investigations
encompass a wide variety of sophisticated schemes including abusive tax
schemes, employment tax fraud, refund crimes and the failure to file
required returns (non-filers). Further, Ci's unique statutory
jurisdiction and expertise enable it to investigate diverse crimes
including money laundering, corporate fraud, narcotics related crimes
and terrorist financing. Criminal Investigation is organized in 31
field offices grouped in five areas. Each field office is headed by a
Special Agent in Charge (SAC) who reports to a Director of Field
Operations (DFO) responsible to the National Headquarters. Successful
prosecutions are important to the success of the Service's overall
compliance strategies.
* Office of Professional Responsibility (OPR) fosters excellence in tax
professional services to taxpayers by setting, communicating and
enforcing standards of competence, integrity and conduct.
Deputy Commissioner for Operations Support:
IRS support functions are aligned into five support units. Each
provides specific services, systems and processes that support tax
operations. Support units also help facilitate efficiency improvements
and implementation of best practices throughout the IRS. The support
units report to the Deputy Commissioner for Operations Support.
* Chief Information Officer (CIO) leads the Modernization and
Information Technology Services (MITS) organization, which delivers
information technology solutions that anticipate and meet enterprise-
wide needs by empowering employees to deliver customer-centered,
systems, products, services and support. The CIO advises the Deputy
Commissioner for Operations Support on strategic technology planning,
data administration, technology standards and privacy assurance and
telecommunications issues.
* Agency-Wide Shared Services (AWSS) delivers shared services
throughout the IRS, including space acquisition and management,
acquisition planning and the Employee Resource Center.
* Human Capital Officer (HCO) supports all IRS Divisions and Functions
in attracting, motivating and retaining quality employees to meet the
needs of America's taxpayers and the tax administration system. HCO
also oversees labor relations programs and various human resources
functions, including the employee pre-complaint processing and
prevention, and alternative dispute resolution services.
* Chief Financial Officer (CFO) oversees the IRS' financial management,
financial systems, strategic planning, performance measurement and
internal controls. The CFO accounts for over $2 trillion in taxpayer
receipts and the IRS' $10 billion annual operating budget.
* Mission Assurance (MA) is responsible for the protection of taxpayer
data and information systems and the continuing security of IRS
personnel and facilities.
The organizational chart below shows these reporting relationships.
[See PDF for image]
[End of figure]
II. Performance Goals and Results:
The IRS uses performance measures to determine its effectiveness in
meeting its three strategic goals. The FY 2005 performance information
that follows is organized by the IRS' strategic goals, highlighting
successes and challenges.
Strategic Goal 1: Improve Taxpayer Service:
Objectives:
* Improve service options for the tax-paying public;
* Facilitate participation in the tax system by all sectors of the
public;
* Simplify the tax process.
Major Results, Accomplishments, and Challenges:
Taxpayer Service and Burden Reduction:
Assisting the public to understand their tax reporting and payment
obligations is the cornerstone of taxpayer compliance. For FY 2005, the
IRS met or exceeded performance for all (8 of 8) of its performance
targets related to taxpayer service. The following highlights the IRS'
performance in FY 2005:
* Processed more than 130 million individual returns and issued more
than 99 million refunds totaling over $210 billion during the 2005
filing season (Tax Year 2004).
* Achieved an 82.6% level of service on answering toll-free calls from
taxpayers, above the target of 82%.
* Answered 33.4 million assistor telephone calls and completed nearly
25.7 million automated calls.
* Correctly responded to 89% of tax law questions and 91.5% of account
questions received via the telephone.
For FY 2005, the IRS set a record for the number of returns filed
electronically. For the first time, more than half (68 million) of all
individual taxpayers filed electronically, representing an 11% increase
over FY 2004. The IRS also received a higher satisfaction rating from e-
filers. The 2004 NOP World rating was 52%, an increase from 49% in 2003
and a substantial increase over its lowest point of 32% in 1998. For FY
2005, the IRS exceeded all of its performance targets related to
electronic filing including:
* Home computer usage to prepare and e-file tax returns increased 17.3%
to more than 17.1 million returns.
* Tax preparation professional use of e-file increased 11%, with 47.6
million filing electronically.
* In its third year, the Free File Alliance, the public private
partnership between the IRS and a consortium of tax software companies,
saw 5 million taxpayers use the free service, a 43% increase from last
year.
The IRS now requires many businesses and tax-exempt organizations to
file their returns electronically. The IRS introduced new forms for
filing extensions for corporations and information returns for private
foundations to the suite of electronic forms offered. The IRS
electronically received more than 143,000 business returns from nearly
6,000 participating providers, twice the number participating in FY
2004.
The IRS remains committed to making it easier for all taxpayers to
understand their filing requirements. The IRS simplified tax forms and
instructions to allow taxpayers to fulfill their reporting obligations
more quickly and with less frustration. As an example, Schedule C-EZ
was designed to allow taxpayers with a small home business to report
business expenses at a higher threshold and in a simplified format. By
giving taxpayers an alternative to the more complex Schedule C, more
than 500,000 small business owners were able to save time and money in
meeting reporting requirements. Similar design and procedural changes
were made in partnership returns, unemployment tax deposits and
quarterly withholding tax reporting requirements. The simplified forms
and procedures also assist taxpayers by decreasing pre-filing
preparation errors and reducing the need for post-filing error notices.
Internet access to online forms and publications makes it easier for
taxpayers to secure forms and find instructions. More than 4.8 billion
"hits" registered in FY 2005 on the award-winning website, IRS.gov, a
20% increase over FY 2004. This increase was largely due to improved
website functionality and an expanded selection of electronically-
provided services. Internet tools such as the "IRS Withholding
Calculator' give the taxpayer self-service access to information
previously reported in a lengthy publication. More than 22 million
taxpayers used the popular "Where's my Refund?" application to check on
the status of their refunds this past filing season, 49% more than last
year. A new feature of the refund inquiry application allowed taxpayers
to generate replacement checks if the first one was lost or
undeliverable due to an out-of-date address. The IRS also expanded
electronic tax products for businesses through increased marketing and
business e-file programs. In addition, the IRS expanded the suite of
products and services geared toward Spanish speaking taxpayers
including new marketing flyers, tax forms, and publications; toll free
assistance; and accessibility through web links.
The IRS is striving to make the Earned Income Tax Credit (EITC) easier
to claim by eligible taxpayers. In FY 2005, the IRS deployed the EITC
Assistant on IRS.gov. EITC Assistant is a web-based application to help
taxpayers determine eligibility, filing status and estimated EITC
amount. The EITC Assistant is available in English and Spanish and
reflects the EITC tax law changes, including new income limits for EITC
eligibility as well as the option to include nontaxable combat pay in
earned income for the earned income credit. The IRS also deployed
telephone and web self-service applications on IRS.gov to help
taxpayers determine their certification status and explain
determinations made during the certification process. IRS enhanced the
EITC Online Toolkit for tax professionals and launched EITC messages on
Housing and Urban Development (HUD) kiosks in over 100 locations
nationwide.
Modernizing the IRS' antiquated business systems and identifying new
opportunities to provide taxpayers with e-Government functionality are
key components of taxpayer service. A robust and secure infrastructure
will improve services - both to taxpayers and other government agencies
and will give the IRS the speed, security, and functionality to keep
pace with a modern and increasingly electronic economy.
The IRS continues to provide alternative services to assist taxpayers
that do not have Internet access or are not in close proximity to
established walk-in Taxpayer Assistance Centers. The IRS, through its
partners, operates 38 self-help kiosks in 20 states and increases
service options during the filing season by offering service in
alternate locations such as shopping malls, libraries and other
government offices. The Volunteer Income Tax Assistance (VITA) and Tax
Counseling for the Elderly (TCE) partner programs provide Internet
access to participants as part of their services. In FY 2005, the
VITA/TCE partnerships experienced a 10% (71% to 78%) increase over FY
2004 in e-file usage with almost 86% of VITA returns and nearly 70% of
TCE returns filed electronically.
During FY 2006, the IRS will continue to seek alternative, less costly
ways to address the challenge of improving taxpayer service. The
following discussion addresses two of the most significant challenges
for the IRS.
Delivering cost effective and efficient services needed to meet the
demands of diverse taxpayer segments remains a challenge for the IRS,
particularly in today's constrained budget environment. The IRS will
employ highly integrated and targeted service, balancing accessibility
and ease of use to reduce taxpayers' burden in complying with the tax
laws through continued research and evaluation of taxpayer service
needs, priorities, and preferences for obtaining information or
services. The IRS will seek opportunities to invest in technology,
process improvement and training to achieve consistent quality of
service with reduced unit delivery costs.
Achieving the goal of having taxpayers submit 80% of all filings,
information, and returns, electronically by FY 2007 remains a
significant challenge. While the e-filing rate continues to increase,
it is only this past year in FY 2005, that more than half of all
individual tax returns were filed electronically. The IRS is
considering mandating e-filing for certain groups, by regulation or
legislation, to ensure increased e-filing. Also, the Administration's
proposal to extend the April filing date for electronically-filed tax
returns to April 30, if enacted, may also increase electronic filing.
But without a legislative change to mandate electronic filing, the
challenge remains one of identifying options to encourage more of the
taxpaying public to e-file. For example, many taxpayers use tax
preparation software to prepare their returns, but then print out and
mail in the return. The IRS must develop additional strategies to
induce more of these taxpayers and preparers to take the next step and
file electronically.
Hurricane Katrina Support:
IRS assisted taxpayers following the wake of Hurricane Katrina by
granting tax filing and payment relief to all affected taxpayers. Over
4,100 IRS employees helped FEMA register hurricane victims by opening a
dedicated toll-free disaster phone line and providing a special
information section on the IRS web site. As of September 30, 2005, IRS
employees have answered more than 706,246 registration calls for FEMA,
more than 30,000 calls on the special IRS toll-free line and provided
over 163,864 disaster relief kits.
Following are key indicators the Service uses to measure success in
improving taxpayer service from the IRS Strategic Plan for 2005 through
2009.
Customer Satisfaction Data:
The IRS determines its customers' overall level of satisfaction of its
programs and services primarily through telephone and mail surveys.
Data are also captured for the IRS by the University of Michigan
Business School's National Quality Research Center for the American
Customer Satisfaction Index and by NOP World, formerly Roper Starch
Worldwide, a public opinion polling firm.
On the 2004 American Customer Satisfaction Index Survey (ACSI), the IRS
received an overall score of 64 out of a possible 100 for All
Individual Tax Filers, a 25% increase over the 1999 score of 51. This
survey reports satisfaction with IRS variables, such as timeliness,
accessibility, courtesy and professionalism. Individual taxpayers are
significantly more satisfied with the e-file return process than with
paper filing. The 2004 annual rating for IRS in the NOP World
favorability survey (the percentage of the public that has a favorable
opinion of the IRS as compared with most federal agencies) was 52%, up
from 49% in 2003 and a substantial increase over its lowest point of
32% in 1998.
Rate of Accuracy:
Customer Accuracy measures how often customers received the correct
answer to their inquiry and/or had their case resolved correctly based
upon all available information and Internal Revenue Manual (IRM)
required actions.
The IRS exceeded its performance targets for both Toll Free Tax Law and
Toll Free Account accuracy measures in FY 2005, with Tax Law measuring
89% and Accounts measuring 91.5%. Improvements in the scores are
attributed to numerous process changes implemented in FY 2005 such as
an improved Probe and Response Guide, the roll-out of Contact Recording
(recording of calls for manager/employee feedback) and training
assistors on the full scope of accounts-related inquiries.
Level of Service:
The IRS measures Level of Service as the relative success rate of
taxpayers that call for toll-free services seeking assistance from a
Customer Service Representative (CSR). Improved efforts in training and
modernizing raised the level of service for those taxpayers who want to
speak to an assistor to 82.6%. The IRS will continue to staff toll free
call sites to achieve the CSR Level of Service target of 82% based on
the number of calls it expects to answer.
Rate of Electronic Interaction:
The IRS measures the rate of interaction for both individual and
business returns. For the first time, over half of individual returns
were filed electronically, an 11% increase from the previous year. FY
2005 performance for business returns achieved a 17.8% participation
rate and is expected to grow further as more filing choices are
developed for business tax return filers.
Timeliness of Responding to Customer Inquiries:
The IRS measures the time taxpayers wait on the telephone when calling
the IRS about their accounts, inquiring about tax laws when preparing
tax returns, as well as the time from account creation to disposition
for taxpayers needing account resolution assistance. Additional
measures calculate the response time for those taxpayers who
communicate electronically with the IRS.
In FY 2005, the IRS customer assistance call centers received over 59
million calls. Improvement efforts such as replacing paper processes
with electronic ones reduced calls and lessened the need for contacting
the IRS. This, plus quality control revisions, raised the level of
service for the taxpayers who speak to an assistor to an unusually high
87% in FY 2004. For FY 2005, the IRS achieved the target of 82%, a
reasonable target that is more in line with previous performance while
continuing to reflect gradual improvement. Although the average time
callers spent waiting for telephone assistance has dropped steadily
over the last few years, the IRS experienced an increase in call
waiting times based on increased demand and its plan to stabilize
resources dedicated to telephone services.
IRS measures reported in the IRS, annual performance budget and
included in the Treasury Performance Reporting System are discussed
below.
1. Customer Service Representative (CSR) Level of Service:
Description: The measure is reported as the percentage of taxpayers
that are calling IRS toll-free services and speak to an assistor.
[See PDF for image]
[End of table]
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: The IRS will continue to properly staff toll free call
sites in order to maintain the CSR Level of Service target of 82% based
on the number of calls it expects to answer.
2. Customer Contacts Resolved per Staff Year:
Description: The number of Customer Contacts resolved in relation to
time expended based on staff usage.
[See PDF for image]
[End of table]
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: The IRS expects performance to continue to increase as
more taxpayers choose to use automated and electronic means to contact
the IRS instead of traditional, less efficient methods such as paper
correspondence and speaking to live assistors.
3. Percent of Eligible Taxpayers Who File for EITC:
Description: The number of taxpayers who actually claim the Earned
Income Tax Credit (EITC) compared to the number of taxpayers who appear
to be eligible for the EITC.
[See PDF for image]
[End of table]
FY 2005 Performance: Data to calculate the actual results will be
available after the close of Calendar Year (CY) 2005 for TY 2004.
Future Plans: The IRS is refining the methodology for estimating the
percent of eligible taxpayers claiming EITC by developing an advanced
regression alternative. The IRS is also considering researching an
alternative methodology to compare current population survey data and
EITC tax data. Once the analysis is complete, the IRS will assess each
methodology and make a decision on the best method to use in estimating
participation.
4. Customer Accuracy - Toll-Free Tax Law:
Description: The percentage of a live assistor giving the correct
answer with the correct resolution to taxpayers' tax law inquiries. It
measures how often the customer received the correct answer to their
tax law inquiry and/or had their case resolved correctly based upon all
available information and Internal Revenue Manual (IRM) required
actions.
[See PDF for image]
[End of table]
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: The type and complexity of tax law questions changes each
year as new and often complex tax laws are enacted.
5. Customer Accuracy-Toll-Free Accounts:
Description: Percentage of a live assistor giving the correct answer
with the correct resolution to the taxpayer. It measures how often the
customer received the correct answer to their account inquiry and/or
had their case resolved correctly based upon all available information
and Internal Revenue Manual (IRM) required actions.
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[End of table]
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: Incremental improvement in performance is expected in FY
2006 and beyond with the implementation of Contact Recording
deployment.
6. Timeliness of Critical Filing Season Tax Products to the Public:
Description: The percentage of Critical Filing Season tax products made
available to the public in a timely fashion. Critical Filing Season tax
products are those forms, schedules, instructions, publications, tax
packages and certain notices normally filed between January 1 through
April 15 that are mailed to taxpayers. This measure contains two
components: (1) percentage of paper tax products shipped no later than
December 19 (December 27 for tax packages) and (2) the percentage of
scheduled electronic tax products available on the Internet no later
than the first five business days of January 2005.
Timeliness of Critical Filing Season Tax Products to the Public:
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FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: The IRS expects performance to increase slightly for FY
2006 as a result of efficiencies from locating IRS employees on-site at
print vendors' facilities to monitor the quality and timeliness of
printed tax products and implementing tighter inventory control by
holding managers to higher standards for better determining tax
products publication status.
7. Timeliness of Critical Other Tax Products to the Public:
Description: The percentage of Critical Other Tax Products, paper and
electronic, made available to the public timely. Critical Other Tax
Products are business tax products, Tax Exempt and Government Entities
and miscellaneous tax products. This measure contains two components:
(1) percentage of paper tax products that meet the scheduled start to
ship date within five business days of the actual start to ship date
and (2) percentage of scheduled electronic tax products that is
available on the Internet within five business days of the ok-to-print
date. The intent is to have the tax products available to the public 30
days before the form is required to be filed:
Timeliness of Critical Other Tax Products to the Public:
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FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: The IRS expects performance to increase for FY 2006.
Standardized and measurable processes will be used to manage the
quality and timeliness of tax product revision resulting from new or
late legislation.
8. Percent Individual Returns Processed Electronically:
Description: Number of electronically filed individual tax returns
divided by the total individual returns filed. Includes all returns
where electronic filing is permitted (practitioner e-file, Telefile,
VITA [Volunteer Income Tax Assistance], On-Line Filing, Federal/State
returns, etc.).
Percent Individual Returns Processed Electronically:
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[End of table]
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: E-file participation rates are expected to increase to
over 55% in 2006, based on current experience, historical growth,
increased advertising, marketing and expanded e-file programs,
including free Internet filing through the Free File Alliance.
9. Percent Business Returns Processed Electronically:
Description: The percentage of total number of business returns
accepted electronically (posted to Business Master File) divided by the
total returns received through all sources at IRS sites.
Percent Business Returns Processed Electronically:
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[End of table]
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: The IRS expects the percent of business filers to
increase in the future due to increased marketing; expanded business e-
file programs, including the acceptance of new forms and schedules
attached to employer, estates and trusts, and partnership tax returns;
acceptance of amended returns; and acceptance of the new annualized
employment tax return.
Strategic Goal 2: Enhance Enforcement of the Tax Law:
Objectives:
* Discourage and deter non-compliance with emphasis on corrosive
activity by corporations, high-income individual taxpayers and other
contributors to the Tax Gap:
* Ensure that attorneys, accountants and other tax practitioners adhere
to professional standards and follow the law:
* Detect and deter domestic and offshore-based tax and financial
criminal activity:
* Deter abuse within Tax-Exempt and Governmental Entities and misuse of
such entities by third parties for tax-avoidance or other unintended
purposes:
Major Results, Accomplishments, and Challenges:
Tax Revenue Collected:
The majority of the revenue the IRS collects is paid voluntarily. In FY
2005, the IRS collected more than two trillion dollars in revenue with
a record $47.3 billion collected through enforcement activities, a 9.7%
increase from FY 2004. The $47.3 billion in enforcement revenue was
collected through concerted efforts by the IRS to detect and deter non-
compliance with the tax code.
Reducing the tax gap (the difference between what taxpayers should pay
and what they actually pay) is at the heart of the IRS' renewed
emphasis on enforcement and serves as a means to reducing our nation's
deficit. The tax gap measures the extent to which taxpayers do not pay
their correct tax liability on time, either because they do not file a
required tax return on time, do not pay on time the amount of tax that
they report on their timely return, or most importantly, fail to
accurately report their correct tax liability on their timely return.
Underreporting of income taxes, employment taxes and other taxes
represents about 80% of the tax gap as noted in the March 2005 release
of the IRS' preliminary tax gap estimates for Tax Year 2001. The single
largest sub-component of underreporting involves the individual income
tax, with individuals understating their incomes, taking improper
deductions, overstating business expenses or erroneously claiming
credits. The National Research Program (NRP) study further confirmed
that the majority of understated income comes from business activities,
not wage or investment income. By the end of December 2005, the IRS
expects to provide detailed estimates of individual income tax non-
compliance based largely on an analysis of the NRP data.
The IRS is primarily focusing its attention on corrosive activities
conducted by corporations, high income taxpayers and other major
contributors to the tax gap. The IRS will use data collected from the
NRP study on individual taxpayers to ensure its audits of individuals
are focused on the most noncompliant returns. Targeting high-risk
taxpayers should improve IRS efficiency and reduce the burden on
compliant taxpayers. It will also increase and focus the IRS'
enforcement presence where it is most needed.
Reducing the tax gap is the IRS' most significant challenge. In FY
2006, the IRS will continue to target its case work and enforcement
activities to more effectively deliver results and drive down the tax
gap. The IRS will focus its analysis of tax information and data from
compliance research studies to better define and quantify the tax gap.
The IRS will use the results of these efforts to better understand and
counter the methods and means of those taxpayers who fail to report or
pay what they owe.
Enforcement Activities:
The IRS met or achieved 69% (9 of 13) of its enforcement-related
performance targets in FY 2005. These results were achieved through
streamlining and centralizing work processes, improving workload
selection techniques and increasing managerial involvement in casework.
The IRS emphasized efficiency and implemented initiatives to reduce
cycle time, such as refining case selection criteria. Closely
monitoring resources and inventories, a focus on case quality and the
use of embedded quality reports and data to drive improvement efforts
also contributed to this success. As a result, the IRS completed over
215,000 high-income audits (taxpayers earning $100,000 or more) in FY
2005, 10% more than the previous year and more than twice as many than
in FY 2001. Total audits of all taxpayers exceeded 1 million in 2005
for the second consecutive year, a 20% increase from FY 2004.
The IRS audited 81% more small business and 15% more corporations in FY
2005, a significant achievement given the size (more than $10 million)
and complexity of these corporate entities. The IRS also expanded
examination coverage by increasing its focus on identification of
limited non-compliant corporate returns and the development of
strategies to address issues at the entity level instead of the return
level. A reinforced focus on case quality helped the IRS deliver
improved business results for the second consecutive year.
Prominent settlement initiatives (offered to taxpayers before the IRS
initiated an audit) generated more than $4.7 billion in additional
revenue in FY 2005. One significant tax shelter case worth noting was
the Son of Boss, in which more than 1,200 qualified taxpayers elected
to participate in a settlement offer. The taxes, interest and penalties
collected from the Son of Boss settlement offer have exceeded $3.7
billion. A second settlement initiative is underway, in cooperation
with the Securities and Exchange Commission. This abusive tax
transaction involves the transfer of executive stock options or
restricted family stock to family-controlled entities for the personal
benefit of executives. At least 42 companies and 700 executives
participated in this abusive practice, resulting in the collection of
$1 billion through September 2005.
The IRS increased audit coverage of those responsible for the promotion
and use of abusive tax schemes and avoidance transactions. During the
past five years, the IRS identified more than 200,000 questionable
returns prepared by practitioners on behalf of their clients. These
returns claimed over $700 million in refunds. Since August 2002, the
IRS completed more than 98,000 audits and assessed more than $200
million in additional tax as a result of the on-going return preparer
investigations.
The IRS Criminal Investigation Division (CID) leveraged its
Counterterrorism Program effectively to achieve its core mission, while
simultaneously supporting the war on terrorism. The IRS participated in
interagency counter-terrorism efforts, providing technical assistance
in terrorism-related investigations, examining foreign grants, and
matching third party information. The IRS also undertook a study of tax-
exempt organizations with foreign grants and operations to determine
how well internationally-oriented U.S. charities are protecting their
assets from diversion and compliance with tax laws. In FY 2005, CID
recommended 86 cases for prosecution, of which 67 resulted in
indictments or other forms of action. Approximately 50% of CID's
inventory of terrorism related cases has a tax related violation under
investigation.
In FY 2005, the IRS also improved its collection performance by
improving workload selection techniques, reengineering outdated
processes to account for improved case selection tools, deploying
centralized processing to reduce overhead in the internal support
functions and increased managerial presence in review of case
decisions. Improved case selection tools including risk-based modeling
are a critical component for ensuring timely processing of appropriate
cases of the Collection Program's inventory. For example, employment
taxes (also known as trust fund or payroll) are at high risk for non-
compliance and one of IRS' collection priorities due to rapid
pyramiding of quarterly employment tax liabilities. Risk based modeling
reveals the best opportunity for bringing an employer with multiple
delinquent quarters (pyramiding) back into full compliance is early
intervention. Collection's inventory delivery system factored
pyramiding into case assignment rules, ensuring earlier assignment of
cases meeting these criteria and to stem growth in the overall
collection inventory. The IRS also reduced its inventory growth through
timely and appropriate filing of Notices of Federal Tax Lien. Educating
taxpayers about lien subordination, discharge, posting bonds or other
collateral where appropriate has aided taxpayers in satisfying their
outstanding liabilities, increasing compliance. As a result of these
efforts, the IRS collected 14% more revenue and closed 12% more cases
compared to FY 2004.
Moving forward in FY 2006 and beyond, the IRS will continue to identity
effective enforcement strategies necessary to target growing and
increasingly complex corrosive tax schemes.
An enforcement priority for the IRS is to deter and prevent abusive tax
avoidance transactions or tax motivated transactions that are corrosive
to the equity and the fairness of the tax law for all taxpayers.
Vigorous enforcement of the criminal provisions of the Internal Revenue
Code, coupled with appropriate civil sanctions, materially contributes
to maintaining voluntary compliance and public confidence in the
fairness of the tax system. Tax shelter promoters continue to modify
schemes, making it difficult to detect patterns and identify
participants on a timely basis. Because these types of transactions
present unacceptable tax avoidance behavior, the IRS needs to continue
efforts to identify them timely and to make the public aware of the
IRS' concerns.
Recent trends indicate that the tax shelter population will continue to
expand to small to mid-size corporations where the issues will be more
difficult to identify and examine. Large corporate taxpayers are
increasingly engaging in structured transactions designed individually
for them, thereby avoiding some of the provisions allowing early
identification. These structured transactions involve highly complex
fact patterns and large dollar issues. Promoters of tax shelters are
migrating from the large accounting firms to firms and businesses that
specialize in tax shelters. These promoters are less compliant for
registration and less stable in their business operations, making it
more difficult to pursue them for information and for penalties.
The number of fraudulent refund claims continues to escalate. For the
2005 processing year, the IRS identified approximately $451 million of
fraudulent refund claims for individuals. Return preparer fraud
continues to be one of the IRS' key investigative priorities as well.
The current inventory of return preparer investigations represents a
five-year high. As of August 2005, subject criminal investigation
initiations increased approximately 22% over the same time period in
2004. For tax return processing year 2005, IRS fraud detection centers
identified more than 33,000 questionable client returns associated with
unscrupulous tax return preparers, claiming approximately $103 million
in refunds. Key to effective detection and deterrence of these
fraudulent claims is the need to invest in new technology.
Following are the key indicators the Service uses to measure success in
enhancing enforcement of the tax law from the IRS Strategic Plan for
2005 through 2009.
Percent of Priority Guidance List Items Published:
The 2004-2005 Guidance Priority List (GPL) included 283 projects,
focusing resources on guidance items most important to taxpayers and
tax administration. Sixty-six additional items were added during the
course of the plan year (July 1, 2004-June 30, 2005). The IRS' 2005
goal was to publish 76% of the Guidance Priority List; final
performance shows 211 items were published, 75% of the original and 60%
of the final GPL.
The IRS did not meet its goal in part due to a shift in priorities
necessitated by enactment (October 2004) of the American Jobs Creation
Act of 2004 (AJCA) which required immediate implementation. The AJCA
made sweeping changes in corporate and international taxation and 97%
of the provisions were effective before, on, or within six months of
the date of enactment. One hundred seventy eight new provisions
required IRS to issue guidance to help taxpayers understand key
concepts of the act.
The Office of Chief Counsel will continue to monitor and prepare for
legislation resulting from the President's tax reform initiative.
Fundamental reform would affect all aspects of the economy and all
taxpayers. The IRS and Counsel will support the Treasury Department in
its efforts to craft and evaluate different reform options by assessing
administrative and technical issues.
Percent of Americans Who Think it is OK to Cheat on Taxes:
The IRS Oversight Board conducts an annual NOP World survey to assess
the public's perceptions about tax compliance. The survey was initially
conducted in 1999 and has been repeated each year since 2001. Results
from the 2005 survey are expected in January 2006. In 2004, 86% of
taxpayers (up five points from 2003), continued to believe that it is
"not at all" acceptable to cheat on income taxes. More taxpayers (73%,
up 4 points from 2003 and down 8 points from the 1999 high point)
completely agreed that it is everyone's civic duty to pay their fair
share of taxes and that everyone who cheats should be held accountable
(62%, up 2 points from 2003).
Average Cycle Time:
A measure of the length of time from receipt of a case for audit or
collection until the audit or collection activity is completed; average
cycle time is computed on audits of individuals, small and large
business entities and tax-exempt entities.
The IRS' principal strategy is reducing the Months-In-Group cycle time;
i.e., the portion of the overall cycle time when the return is actually
under examination within a field group. Over the past two years, the
IRS has realized an 18% improvement in Industry Months-In-Group cycle
time and a 15% improvement in Coordinated Industry Months-In-Group
cycle time. Several new initiatives, such as the Appeals/LMSB Joint
Cycle Time Measure, increased Fast Track Appeals, more limited scope
examinations and electronic filing, are underway or in place to reduce
overall cycle time.
The mix of examination inventory is complex, with growing numbers of
tax shelter, partnership and joint committee returns, which have longer
cycle times than less risky return categories. The IRS uses several
strategies, such as Modernized e-Filing, better return risk assessment
and Months-in-Group cycle time to counteract the negative influence of
these long cycle time, high-risk return categories on overall cycle
times.
The IRS' Field Collection organization has made great strides in
reducing cycle time in FY 2005. For non-payment cases, the cycle time
was reduced from 42 weeks to 36 weeks, a 16% reduction.
Rate of Reporting Compliance:
The Rate of Reporting Compliance or the Voluntary Reporting Rate (VRR)
is defined as the amount of individual income tax that is reported on
timely-filed returns for a given tax year, expressed as a percentage of
the amount of tax liability that should have been reported on those
returns. The IRS has made preliminary estimates of the Tax Year 2001
VRR based on the recently completed National Research Program study of
individual income tax reporting compliance. Preliminary estimates range
from 82% to 85%, roughly consistent with estimates from similar studies
for earlier years. Final estimates are due at the end of 2005.
Estimates of the amount of Tax Year 2001 individual income tax that was
underreported range from $150 billion to $187 billion.
Rate of Filing Compliance:
The timely filing rate is the percentage of required returns that are
filed timely for a given tax year. This rate for individual taxpayers
is computed by dividing the estimated number of required returns filed
on time for a given tax year by the estimated number of all individual
returns required to be filed for that year. The IRS' latest estimate of
the timely filing rate was 88.9% for Tax Year 2001.
Rate of Payment Compliance:
The voluntary payment compliance rate is the percentage of the total
tax liability reported on timely filed returns that is paid in a timely
manner. The voluntary payment compliance rate is 98.9 percent for Tax
Year 2003, which is a slight improvement over Tax Year 2002.
IRS measures reported in the IRS, annual performance budget and
included in the Treasury Performance Reporting System are discussed
below.
1. Examination Coverage - Individual:
Description: The sum of all individual returns closed for Field
Examination, Office Examination, Correspondence Examination and
Automated Underreporter programs divided by the total individual return
filings for the prior calendar year.
Examination Coverage - Individual:
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[End of table]
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: The IRS will use the National Research Program (NRP)
results for developing improved analytics and workload identification
and selection of the types of cases it selects for review and
examination. Additionally, based on the NRP data, the IRS will
highlight requisite skill sets and determine if a fundamental change in
recruitment and training processes should be explored. Areas of
emphasis include Abusive Promotions, High Income Taxpayers, Schedule C
filers and Fraud.
2. Examination Quality - Field:
Description: The score awarded to a reviewed Field Examination case by
a Quality Reviewer using the Examination Quality Measurement System
(EQMS) quality standards.
Examination Quality - Field:
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[End of table]
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: The IRS will continue to focus on improving the quality
of all facets of the examination process, including timeliness of
actions, proper consideration of related and multi-year returns,
appropriate use of income probes, fraud indications are properly
pursued and developed, and application of report writing procedures to
improve future performance. In FY2006, Field Examination is converting
to the Embedded Quality (EQ) system of measuring quality. EQ directly
links the examiners Critical Job Elements to the quality measurement
system, improving the relationship between individual performance and
organizational objectives.
3. Examination Quality-Office:
Description: The score awarded to a reviewed Office Examination case by
a Quality Reviewer using the Examination Quality Measurement System
(EQMS) quality standards.
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[End of table]
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: The IRS will continue to focus on improving the quality
of all facets of the examination process, including timeliness of
actions, proper consideration of related and multi-year returns,
appropriate use of income probes, appropriate fraud indications are
properly pursued and developed. In FY2006, Field Examination is
converting to the Embedded Quality (EQ) system of measuring quality. EQ
directly links the examiners Critical Job Elements to the quality
measurement system, improving the relationship between individual
performance and organizational objectives.
4. Examination Coverage - Business:
Description: Large and Mid Size Business "customer base" returns
(returns filed by large corporations), examined and closed during the
current Fiscal Year, divided by filing of the same type returns for the
preceding calendar year.
Examination Coverage - Business:
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: The IRS plans to expand examination coverage for
corporations through innovative approaches such as pre-filing
initiatives (such as the Compliance Assurance Process), Limited Issue
Focus Examinations (LIFE) and the Currency Initiative. Through improved
modeling and the use of targeted specialized teams, the IRS will focus
its resources on the issues that pose the greatest compliance risk and
begin to identity enterprises that appear to be non-compliant.
5. Examination Efficiency-Individual:
Description: The sum of all individual returns closed (Field
Examination, Correspondence Examination and Automated Underreporter)
divided by the total FTEs expended in relation to those individual
returns.
Examination Efficiency -Individual:
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[End of table]
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: Future strategies to improve performance include
improvements to the work stream through better case identification and
classification, including leveraging NRP data to improve Exam's ability
to select the best workload for examination. Emphasis will continue to
be placed on multi-year non-compliance, reduced cycle time, streamlined
automation and utilization of risk analysis/assessment in all business
processes.
6. Examination Quality-Industry:
Description: The average of the percentage of critical elements passed
on Industry cases reviewed.
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[End of table]
FY 2005 Performance: Target Not Achieved. The IRS did not meet its FY
2005 target due to several factors related to the examination planning
process, specifically identification of material issues. Contributors
to the lower rate include lack of documentation of the initial risk
analysis in which material issues are considered and documentation of
mandatory referrals to specialists. While improved from last year, the
preparation and proper use of the Administrative Procedures Document
(documentation regarding exam techniques such as interviews;
reconciliation of books to tax returns; inspection of prior, subsequent
and related tax returns; and tour of taxpayers' business) continues to
be a concern. Revenue Agents and managers are not including the
document in the case file or properly sign it as required. Preparation
and inclusion of the No-Change report in the file when a case is closed
without adjustment is an area that continues to affect quality scores.
Future Plans: To facilitate immediate corrective action and eliminate
recurring errors, LQMS reviewers will provide written feedback on all
reviewed cases to the case manager and agent who worked the
examination. The written feedback provided will provide a detailed
explanation of the results for each quality element and will stress
areas that warrant improvement so field teams will correct identified
process deficiencies in future examinations. Specific tools have been
developed to address quality improvement, such as media devices
(training materials on compact disc) that highlight the necessary
actions needed to improve quality and identity partnering opportunities
with industry contacts, the training office and the Case Quality
Improvement Council.
7. Examination Quality-Coordinated Industry:
Description: The average of the percentage of critical elements passed
on Coordinated Industry cases reviewed.
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[End of table]
FY 2005 Performance: Target Not Achieved. The IRS did not meet its 2005
target despite renewed focus on identification of material issues
during the planning process and documentation of them during the
initial risk analysis. Root cause analysis revealed filing and
compliance requirements for corporate directors and officers are not
being verified and documented. In addition, procedures used during the
examination are not being identified and documented during the planning
process, a critical element of case quality. While improved from last
year, adherence to the requirements outlined in the Administrative
Procedures Document, continues to be a concern. Revenue Agents and
managers are still failing to complete the document or provide a copy
of the document to the reviewer during the opening review conference.
Also, Examination teams need to ensure the taxpayer's and the IRS'
position is fully documented in the case file.
Future Plans: To facilitate immediate corrective action and eliminate
recurring errors, LQMS reviewers will provide written feedback on all
reviewed cases to the case manager and agent who worked the
examination. The feedback will detail the results for each quality
element and will stress areas that warrant improvement so field teams
will correct identified process deficiencies in future examinations.
Specific tools have been developed to address quality improvement, such
as media devices (training materials on compact disc) that highlight
the necessary actions needed to improve quality and partnering
opportunities with industry contacts, the training office and the Case
Quality Improvement Council.
8. Collection Coverage - Units:
Description: The volume of collection work disposed (closed) compared
to the volume of collection work available.
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[End of table]
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: Building on more effective case selection and refinement
of Business Master File (BMF) case selection criteria is expected to
result in improvements in case cycle time, freeing up resources that
will be devoted to casework. In addition, a newly established Corporate
Collection Governance Board of senior leaders from collection operating
units in the IRS will guide development of new strategies and
approaches to collection techniques including sponsoring a study on the
effects of the collection notice stream.
9. Collection Efficiency - Units:
Description: Total work (delinquent accounts, investigations, offer- in-
compromise, automated substitution for return) disposed (closed) over
the total FTE (full-time equivalent) realized in field collection and
in campus collection.
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[End of table]
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: To further reduce case cycle time, the IRS will focus on
two key quality timeliness attributes: (1) reducing activity lapses and
taking timely follow-up actions and (2) reengineering efforts being
piloted such as a pre-populated financial statement and automated
adjustments. In addition, a newly established Corporate Collection
Governance Board of senior leaders from the collection operating units
in the IRS will develop strategies and approaches to the collection
activities including sponsoring a study on the effects of the
collection notice stream.
10. Field Collection Quality of Cases Handled in Person:
Description: The score awarded to a reviewed Collection case by a third-
party reviewer who uses the Collection Quality Measurement System
(CQMS) quality standards. CQMS composite score is computed based on 19
quality standards taken from the CQMS check sheet. Each standard has a
value of four points. However, four of these standards have been
designated as critical and are weighted more heavily. Failure to meet
any one of the critical standard results in the deduction of 24 points
from the overall composite score.
Field Collection Quality of Cases Handled in Person:
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[End of table]
FY 2005 Performance: Target Not Achieved. The IRS did not meet its FY
2005 target. Although performance improved in standards such as
Publication One, Rights Notification and Case File Documentation,
declines in other standards overshadowed gains. Also impacting the
overall score was the IRS' emphasis on getting the inventory current by
focusing on aged case inventories. Because older cases have increased
chance for errors due to increased handling time, the need for
repetitive actions such as re-issue of notices, and potential for more
activity lapses, older cases adversely impact quality scores.
Future Plans: The IRS is currently piloting the Embedded Quality (EQ)
System to replace CQMS beginning in FY 2006. EQ creates a way of doing
business that builds commitment and capability among all individuals to
continually improve customer service, employee satisfaction and
business results by aligning quality measures and individual
performance. EQ standards are linked directly to employee Critical Job
Elements (CJEs) enabling employees to see how individual performance
impacts objectives. EQ results will be baselined during FY 2006.
The IRS will place specific attention on quality attributes of setting
clear action dates, setting clear expectations for taxpayers, timely
follow-up actions and reducing activity lapses to improve quality and
increase efficiency.
11. Automated Collection System (ACS) Accuracy:
Description: Captures the percent of taxpayers who receive the correct
answer to their ACS question.
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[End of table]
FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: The IRS' focus on process and performance reviews coupled
with the feedback loop and identification of training needs will
continue to drive accuracy scores up and help improve the taxpayer's
experience.
12. Criminal Investigations Completed:
Description: Cumulative count of the number of all Subject Criminal
Investigations (SCI) completed during the fiscal year by IRS Criminal
Investigation Division. It includes investigations that resulted in a
criminal prosecution recommendation to the Department of Justice as
well as investigations that were discontinued due to a lack of evidence
or to a finding that the original allegation was false.
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FY 2005 Performance: Target Achieved. The IRS met/exceeded the FY 2005
target.
Future Plans: Criminal Investigation will continue to aggressively
enforce the criminal statutes of the Internal Revenue Code (IRC), the
Bank Secrecy Act and the anti-money laundering statutes by devoting
resources and special emphasis on investigations that have a strong tax
administration nexus. Criminal Investigation will maintain
relationships with key shareholders to continue to improve the fraud
referral program and to facilitate the identification of areas of non-
compliance adversely impacting tax administration. Specific priorities
encompass such serious or chronic compliance challenges as abusive tax
schemes and shelters, high income non-filers, employment tax fraud and
refund crimes. Furthermore, the critical national law enforcement
priorities of Corporate Fraud and Terrorism continue to be important
areas of emphasis.
Through its Refund Crimes Program, CI will continue to identify and
pursue fraudulent return preparer and questionable refund schemes
involving individual as well as business returns. CI will also increase
its efficiency in verifying wages and identifying questionable claims
by fully utilizing the National New Hire Database (maintained by the
Department of Health and Human Services).
13. TE/GE Determination Case Closures:
Description: Cases established and closed on the Tax Exempt and
Government Entities Determination System (EDS) regardless of type of
case or type of closing (e.g. employee plan, exempt organization or
government entity):
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[End of table]
FY 2005 Performance: Target Not Achieved. The IRS fell short of its FY
2005 target due to increased responsibility for certain correspondence
previously worked out of the call site and a substantial investment in
training this year. To mitigate these impacts, the Exempt Organization
office has taken steps to maximize the number of cases that can be
closed on merit with minimal additional information requests.
Future Plans: The IRS targeted additional resources late in FY 2005 to
hire 26 new revenue agents for determination work. These new resources
are expected to help offset the increased workload in FY 2006.
The IRS is restructuring the Employee Plan determination letter process
to stabilize the receipt flow. Although the mix of receipts will change
annually, the new approach will dramatically reduce the workload swings
previously experienced in this program, improving program management
and eliminating the need to pull resources from enforcement activities
to support determination work during peak periods. The IRS is also
developing a new interactive application for determination requests
that will improve the quality of determination requests and enable the
electronic filing of these applications.
Strategic Goal 3: Modernize the IRS through its people, processes and
technology:
Objectives:
* Increase organizational capacity to enable full engagement and
maximum productivity of employees:
* Modernize information systems to improve service and enforcement:
* Ensure the safety and security of people, facilities and information:
* Modernize business processes and align the infrastructure support to
maximize resources devoted to front-line operations:
Major Results, Accomplishments and Challenges:
Ensuring Organizational Effectiveness:
The IRS faces high expectations for the level of service and
enforcement required for the fair and uniform application of tax laws.
Each year, IRS employees contact millions of taxpayers. In each of
these contacts, the IRS strives to maintain a level of professionalism
and integrity that will assure taxpayers of competent, efficient and
respectful treatment. The IRS is improving accuracy of responses to
taxpayer inquiries, increasing the clarity of communications and
providing taxpayers and their paid preparers with requested resources
on a timely basis.
Workforce planning is a significant challenge. With a diverse
population of more than 100,000 employees and more than 700 duty
stations across the country, the IRS works continuously to ensure that
its employees are in the right place at the right time and have the
skills and competencies needed to accomplish the IRS mission. The
expansion of pay-for-performance provides a higher degree of
accountability in the workforce and numerous training and leadership
programs improve the overall level of professionalism. The IRS
established a trained core recruitment group that is responsible for
attracting excellence in potential employees. This cadre works to
maintain partnerships with many colleges and universities and attends
campus and commercial events around the country to promote the benefits
of becoming an IRS employee.
The IRS continued its workforce restructuring to achieve both the
optimum mix of skills within the IRS and the optimum number of
employees that directly support tax processing, administration and
compliance functions. The IRS continues to ensure an adequate talent
pool to administer the tax law as a primary component in maintaining
the integrity and excellence of the workforce. In FY 2005, the IRS
achieved efficiencies in filing technology and in overhead functions.
More importantly, the percentage of the IRS workforce engaged in
compliance-related work increased from 48% to 50% of the workforce in
FY 2005. This shift was possible because of cost reductions provided by
increased electronic filing and through the restructuring of
administrative areas. While the number of IRS employees has decreased
overall, the IRS has been able to maintain or increase employment in
the key compliance occupations of revenue agents, revenue officers, and
special agents.
The IRS recognizes that its workforce is maturing and that significant
numbers of employees will soon be eligible to retire. Analysis of
workforce data shows that the most problematic area is the projected
attrition of senior leadership. To ensure continuity of leadership, the
IRS launched a comprehensive leadership succession planning initiative.
The first phase of the initiative included an assessment of 103
executives to measure and benchmark competency strengths and
weaknesses. Additional efforts to address the aging workforce challenge
include hiring initiatives to ensure that the IRS maintains the
appropriate level of employees in mission-critical occupations
necessary to achieve its mission.
Modernization:
The IRS successfully deployed the new Integrated Financial System (IFS)
at the start of FY 2005. The IFS serves as the "core" administrative
financial management system. The major components of IFS are accounts
payable, accounts receivable, budget formulation, budget execution,
general ledger, financial statements and cost accounting. The IFS is a
fully integrated, customized commercial off-the-shelf (COTS) software
package designed to provide IRS with more accurate and timely financial
and cost information and improved compliance with legislative and
regulatory requirements. Today there are thousands of procurement
commitments, obligations and receipt/acceptance documents being
processed through the new IFS system. The IRS successfully maintained
its record of submitting the monthly SF-224 and the monthly Treasury
Information Executive Repository (TIER) files to Treasury on time since
going live.
The IRS Business Systems Modernization (BSM) program improved its
success in delivering projects, attaining cost and schedule targets,
realizing benefits to taxpayers and improving BSM program management
capabilities. After re-baselining in late 2004, the BSM program
delivered most projects and releases in FY 2005 on time, on budget and
met or exceeded the scope of expectations.
In FY 2005, the IRS modernization efforts focused on three key tax
administration systems that provided additional benefits to taxpayers
and IRS employees, specifically: the Customer Account Data Engine
(CADE) project; Modernized e-File; and Filing and Payment Compliance
(F&PC).
CADE replaces the IRS' antiquated system called the Master File, which
is the repository of taxpayer information. CADE allows faster refunds
(CADE processes refunds on a daily basis), improved taxpayer service,
faster issue detection, more timely account settlement, and a robust
foundation for integrated and flexible modernized systems. More than
1.4 million returns were posted with more than $427 million in refunds
generated. Next year, CADE should be able to process over twice as many
returns. It will be the single authoritative repository for account and
return data.
Modernized e-File (MeF) deployed Form 7004 (filing extension for
corporations) as well as Form 990PF (information return for private
foundations). This allowed the IRS to establish regulations requiring
large corporations and tax-exempt organizations to electronically file
their income tax or annual information returns. Through September 2005,
MeF is processing 1120 and 990 returns at higher-than-expected volumes
while still achieving performance goals -a significant reduction in
burden and time for corporate and tax-exempt taxpayers.
The IRS completed architecture engineering analysis and development of
a limited functionality release for Filing & Payment Compliance (F&PC)
Release 1.1 designed to separate complex cases requiring direct IRS
involvement from those that can be handled by private collection
agencies (PCAs). This release will provide initial capabilities for
competitive outsourcing of collection activities in FY 2006.
In 2004, Congress passed the American Jobs Creation Act, a provision of
which allows the IRS to use Private Collection Agencies (PCAs). The
current volume of delinquent taxpayers exceeds the IRS' capacity and
results in a serious backlog of collection cases that cannot be
adequately addressed with current resources. This backlog represents
lost revenue opportunities and undermines the fairness of the tax
system. The legislation authorized the IRS to augment its collection
efforts by using PCAs to pursue undisputed, uncollectible tax
liabilities. PCAs will not have enforcement authority and will only
contact delinquent taxpayers to arrange voluntary, full-payment
installment agreements.
In FY 2005, the IRS implemented new network management software, an off-
the-shelf product called "CiscoWorks." Results of the new network
management tools include:
* Improved service and network performance to all customers through
reduced configuration errors, enhanced security and network management
capabilities;
* Streamlined access to troubleshooting reports that a year ago would
usually have required multiple logons and hours of time;
* Reduced cost of audits;
* Increased efficiency through improved configuration controls; and:
* Assurance of stable and predictable network performance for all
business units.
To address its modernization challenges, the IRS updated a strategic
vision for the BSM's future beyond 2007 and setting goals for the year
2010 that align with and support the IRS Strategic Plan. The FY 2006
BSM portfolio will focus on delivery of three major tax administration
projects (highlighted below), along with infrastructure initiatives and
continued improvement to program management operations. Each Tax
Administration project will address a core IRS strategic priority.
Program operations will continue to focus on improving program
performance; improving and streamlining management process disciplines;
and ensuring delivery of projects on time, on budget, and on scope by
taking a greater ownership and leadership role in managing the BSM
program.
* The IRS will expand CADE to increase the number of tax returns
processed and taxpayers served, targeting 33 million returns to be
processed during 2007.
* Modernized e-File (MeF) continues engineering development to prepare
for the expanding taxpayer base served through combined Federal and
State processing of tax returns. BSM also continues working on access
capabilities for disabled taxpayers through e-Services upgrade of the
PeopleSoft Commercial Off-the-Shelf application.
* The IRS will develop the first release of the Filing and Payment
Compliance system to analyze tax collection cases to determine
uncontested cases that no longer require direct IRS involvement and can
be turned over to private collection agencies.
Following are the key indicators the Service uses to measure success in
modernizing the IRS through its people, processes and technology from
the IRS Strategic Plan for 2005 through 2009.
Level of Employee Engagement:
The Level of Employee Engagement measures the number of IRS employees
who feel they are in the right job, are managed well and are
productive. Data used to determine this result is taken from the IRS'
annual employee satisfaction survey.
In 2005, more than 57,000 employees participated in the annual Employee
Engagement Survey. The scores improved on all questions. The IRS uses
the response to the following question, "Considering everything, how
satisfied are you with your job?" as a broad indicator of employee
satisfaction. In 2005, over 64% of employees were very satisfied or
extremely satisfied with their job compared to 60% in 2004.
The IRS continued its strong improvement on survey items especially the
categories of receiving recognition and feedback on progress. The IRS
will provide results of "SURVEY2005" to employees for discussions in
workgroups, with subsequent action plans developed to ensure continued
improved working conditions. Responses to questions about training and
development also continued to improve.
For the second year in a row, over 65% of employees who took the survey
reported that they participated in team feedback and action planning
sessions. Team feedback and action planning sessions are a crucial part
of the employee satisfaction process. Employees who participated in
these meetings also reported much higher levels of satisfaction than
employees who did not. Each IRS business unit is encouraged to identify
one or two specific areas of the survey that will be the focus of
concentrated improvement actions. In prior years, this approach proved
to be very beneficial for a number of business units.
The addition to the employee scholarship program targeted at key
staffing needs reinforces the IRS' commitment to employee development.
The Human Resources Investment Fund (HRIF), established in response to
earlier employee feedback about training needs, also continues as a
complement to the scholarship program.
Index of Employee Perceptions of Performance Management System:
This is an index based on how employees responded to specific questions
on the Federal Human Capital Survey (FHCS) conducted annually by the
Office of Personnel Management. The questions relate to employee
perceptions regarding how well the organization rewards good
performance and addresses poor performance. The IRS has developed
target levels for this index and a 2005 goal from which to assess its
current performance. The IRS has not received the results of the latest
survey as of the date of this report.
Ratio of Mission-Critical Occupations (MCO) Employees to Non-MCO
Employees This is the proportion of staff employed in mission critical
areas, those that support tax processing, administration and
compliance, compared to non-mission critical areas. This indicator will
help the IRS determine if its staffing and employee development
initiatives result in the appropriate level of talent assigned to MCOs
in support of the IRS' mission and goals. The IRS has developed target
levels for this indicator which it uses to assess its actual
performance.
The target MCO/non-MCO ratio for FY 2005 is 64%. The ratio reported at
the end of FY 2005 was 62.9%.
Benchmark IT Services and Development to Private Industry Standards for
Cost, Scheduling, and Functionality:
MITS has developed performance measures that will be monitored from the
CIO level down to the operational levels. These measures will provide
comprehensive management information to executives to monitor success
at meeting performance targets keyed to industry best practices. This
measures development effort has been far more comprehensive than any
ever conducted in MITS and includes over 250 measures and metrics at
various organizational levels. In addition, MITS established a
comprehensive time reporting system/work planning and control system
and has undertaken the development of a comprehensive cost accounting
system. Presently, the IRS is halfway through the decomposition phase
on this effort and will ultimately quantify the relationship between
all MITS products and services and their related costs.
IRS measures reported in the IRS' annual performance budget and
included in the Treasury Performance Reporting System are discussed
below.
1. Contracted Program Cost and Schedule Variance:
Description: Contracted Program Cost and Schedule Variance measures the
improvement in the program's ability to accurately estimate cost and
period of performance. The measure is derived from the program's two
efficiency measures: Fiscal Year Estimated Contract Cost Variance and
Fiscal Year Contract Period of Performance Variance. By calculating the
efficiency rating (percentage) for the current fiscal year and
comparing it to the efficiency rating of the previous fiscal year, the
measure compares the two performance ratings for cost and period of
performance estimation, individually, to determine the degree of
improvement. The measure is reported as the lower of the two ratings.
As long as the reported rating is at or above the target, the program
is improving satisfactorily.
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[End of table]
FY 2005 Performance: Discontinued The IRS has discontinued this measure
and will no longer report on it either internally or externally.
Future Plans: In FY 2006, this performance measure will be split into
two measures: Contracted Program Costs Variance and Contracted Program
Schedule Variance.
2. Contracted Requirements Stability and Contracted Requirements
Delivered:
Description: Contracted Requirements Stability and Contracted
Requirements Delivered measures the improvements in the program's
ability, first, to stabilize the growth of requirements during the life
of a project/release and, second, to deliver those requirements for
which it has contracted. The measure is derived from the program's two
outcome measures: Contract Business Requirements Stability and Contract
Business Requirements Delivered.
[See PDF for image]
[End of table]
FY 2005 Performance: Discontinued. The IRS has discontinued this
measure and will no longer report on it either internally or
externally.
Future Plans: Business Systems Modernization is committed to managing
the cost and schedule of its projects, although the methodology for
their respective calculations is under revision.
New Measures:
The following measures are reported for the first time in the FY 2005
MD&A:
* Timeliness of Critical Other Tax Products to the Public;
* Percent Business Returns Processed Electronically;
* Examination Coverage - Individual;
* Examination Coverage - Business;
* Examination Efficiency-Individual;
* Collection Coverage-Units Collection Efficiency-Units;
* Field Collection Quality of Cases Handled in Person.
Discontinued Measures:
In the first quarter of FY 2005, the Department of the Treasury
launched a process to streamline its current set of performance
measures. Its purpose was to increase the value of the information
provided to stakeholders, respond to congressional requests, focus
priorities and reduce administrative burden. Results of the process
indicated a 60-70% reduction in the number of performance measures
overall at the Treasury level. At the bureau level, measures that are
no longer included in the budget submission are classified as
"discontinued," and are indicated as such. These measures are only
discontinued for external reporting purposes; the IRS will continue to
internally collect and monitor these measures.
* Customer Accuracy-Customer Accounts Resolved (Adjustments);
* Percent Tickets Resolved on Time;
* Field Assistance Accuracy of Tax Law Contacts;
* Percent Resolution at First Contact;
* Toll Free Customer Satisfaction;
* Field Assistance Customer Satisfaction;
* Field TDA Closures;
* Field TDI Closures;
* Field Collection Customer Satisfaction;
* Compliance Services Collection Operation Accuracy;
* ACS (TDA and TDI Closures);
* ACS Customer Satisfaction;
* Automated Underreporter Case Accuracy;
* Automated Underreporter-Cases Closed;
* Correspondence Examination non EITC Returns Examined;
* Correspondence Exam - Customer Satisfaction;
* Correspondence Exam Accuracy;
* Business Returns Examined;
* Individual Returns Examined (> $100,000 and < $100,000);
* Examination Customer Satisfaction (SBSE);
* Examination Customer Satisfaction (LMSB);
* EP/EO Examination Case Quality;
* EP/EO Customer Satisfaction;
* Number of TEGE Compliance Contacts;
* Appeals Closure to Receipt Ratio;
* Taxpayer Advocate Closure to Receipt Ratio;
* Contracted Program Cost & Schedule Variance (* not reported
internally or externally);
* Contracted Requirements Stability & Contracted Requirements Delivered
(*).
III. System Controls and Legal Compliance:
Federal Managers' Financial Integrity Act (FMFIA):
During FY 2005, the Internal Revenue Service (IRS) complied with the
control requirements of the Federal Managers' Financial Integrity Act
(FMFIA) and the Reports Consolidation Act of 2000. The IRS also
complied with the review requirements of the Federal Financial
Management Improvement Act (FFMIA). The systems of management controls
for the IRS organizations are designed to ensure that:
* Programs achieve their intended results;
* Resources are used consistent with the overall mission;
* Programs and resources are free from waste, fraud, and mismanagement;
* Laws and regulations are followed;
* Controls are sufficient to minimize improper and erroneous payments;
* Performance information is reliable;
* System security is in substantial compliance with all relevant
requirements;
* Continuity of operations planning in critical areas is sufficient to
reduce risk to reasonable levels.
The number of open material weaknesses for IRS is five. Because the IRS
has remaining material weaknesses and the IRS' financial management
systems do not substantially comply with FFMIA, the IRS provides
qualified assurance that the above listed systems of management control
objectives were achieved by the IRS during FY 2005. This assurance is
provided relative to Sections 2 and 4 of FMFIA.
The material weaknesses are:
* Collection of Unpaid Taxes;
* Improve Modernization Management Controls and Processes;
* Financial Accounting of Revenue-Custodial;
* Earned Income Tax Credit Non-Compliance;
* Computer Security;
* Federal Financial Management Improvement Act (FFMIA);
* As of September 30, 2005, the Service's financial management systems
did not substantially comply with the FFMIA. Remediation Plans for
Custodial and Administrative Financial Systems are in place to resolve
this condition. The IRS has improved its financial management systems'
compliance with FFMIA. In FY 2005, the IRS implemented the Integrated
Financial System which corrected many administrative accounting
deficiencies. The IRS developed a plan to improve custodial accounting
through the Custodial Detail Data Base project.
Laws and Regulations:
As of September 30, 2005, the IRS did not always comply with section
6325 of the Internal Revenue Code regarding the release of federal tax
liens. An action plan to address the non compliance issue is being
monitored by the Financial and Management Controls Executive Steering
Committee.
Reports Consolidation Act of 2000:
In accordance with the Reports Consolidation Act of 2000, the IRS
provides assurance that the critical performance measures are reliable.
Internal Revenue Manual 1.5, "Managing Statistics in a Balanced
Measurement System Handbook," provides a detailed measures template
that documents each measure's definition, formula, reliability, and
reporting frequency. These controls ensure the data are consistently
and accurately collected over time.
Continuity of Operations:
During FY 2005, the IRS took action to enhance the compliance of IRS
computer systems with the Federal Information Security Management Act
(FISMA). The IRS established FISMA project offices in each business
unit and focused attention on resolution of the computer security
material weakness and other system security weaknesses. Substantial
progress was made in this area, as over 90 percent of IRS general
support systems completed full certification and accreditation by
September 1, 2005. In addition, the IRS initiated a major effort to
update the security documentation and complete rigorous security
testing on all Service systems. This effort will continue through FY
2006.
Limitations of the Financial Statements:
The principal financial statements have been prepared to report the
financial position and results of operations of the entity, pursuant to
the requirements of 31 U.S.C. 3515(b). While the statements have been
prepared from the books and records of the entity in accordance with
generally accepted accounting principles (GAAP) for Federal entities
and the format prescribed by the Office of Management and Budget, the
statements are in addition to the financial reports used to monitor and
control budgetary resources, which are prepared from the same books and
records. The statements should be read with the realization that they
are for a component of the U.S. Government, a sovereign entity.
IV. Future Challenges:
As the IRS begins FY 2006, it is faced with challenges, both from
within and outside of its organization. The following discussion
identifies some of the most significant challenges.
Abusive Tax Shelters:
Abusive Tax Avoidance Transactions (ATAT) remain a challenge and a high
enforcement priority for the IRS. These tax motivated transactions are
corrosive to the equity and the fairness of the tax law for all
taxpayers. Specifically, the prevalence and proliferation of ATAT
impacts the achievement of the IRS' mission, goals, objectives, and the
success of its major strategies by impeding the IRS' ability to make
gains in compliance and interfering with allocation of workforce
resources. Vigorous enforcement of the criminal provisions of the
Internal Revenue Code, coupled with appropriate civil sanctions,
materially contributes to maintaining voluntary compliance and public
confidence in the fairness of the tax system.
Tax shelter promoters continue to modify schemes, making it difficult
to detect patterns and identify participants on a timely basis. Because
these types of transactions present unacceptable tax avoidance
behavior, the IRS needs to continue efforts to identify them timely and
to make the public aware of the IRS' concerns.
Recent trends indicate that the tax shelter population will continue to
expand to small to mid-size corporations where the issues will be more
difficult to identify and examine. Large corporate taxpayers are
increasingly engaging in structured transactions designed for them
individually thereby avoiding some of the provisions allowing early
identification. These structured transactions involve highly complex
fact patterns and large dollar issues. Promoters of tax shelters are
migrating from the large accounting firms to firms and businesses that
specialize in tax shelters. These promoters (boutique promoters) are
less compliant for registration and less stable in their business
operations, making it more difficult to pursue them for information and
for penalties.
Taxpayer Service Challenges:
Delivering cost effectively and efficiently valued and effective
information and services to taxpayers while meeting demands to reduce
the complexity of tax law, be responsive to large and diverse taxpayer
segments, and provide preferred means of delivery within budget
limitations remains a challenge for the IRS. A successful approach will
employ highly integrated and targeted service avenues, balancing
accessibility, ease of use, content complexity, and delivery cost. The
IRS will continue to research and evaluate information regarding
taxpayer service needs, priorities, and preferences in order to improve
delivery services that support taxpayer preferable approaches for
obtaining information or services. The IRS will seek opportunities to
invest in technology, process improvement, and training to achieve
consistent repeatable quality service with reduced unit delivery costs.
The IRS' long-term service measures will include the impact on taxpayer
qualitative experience and behavior.
Technology Modernization Projects:
From FY 2002 to FY 2005, the IRS has taken steps to balance the scope
and pace of its technology modernization program with the management
capacity of the IRS and the modernization contractor consortium. Since
then, the IRS improved both its cost and scheduling performance
including those projects that were not re-baselined. While these
improvements do not completely eliminate all risk, they mitigate a
major risk and demonstrate that the steps the IRS took in 2004 to
improve program performance are having a positive impact. As a result,
FY 2004 and FY 2005 marked a reverse in trend of cost overruns that
plagued the IRS in previous years.
In FY 2005, Business Systems Modernization (BSM) continues to build and
improve upon its 2004 success by delivering projects, attaining cost
and schedule targets, realizing benefits to taxpayers, and improving
BSM program management capabilities. With the exception of the
Integrated Financial System, BSM delivered the majority of projects and
releases planned on time, within budget, and met or exceeded scope
expectations.
Customer Account Data Engine continues to develop the expansion of the
number of tax returns processed and taxpayers served, targeting 33
million returns to be processed during 2007. Modernized e-File (MeF)
continues engineering development in preparation for expansion of the
taxpayer base served through combined Federal and State processing of
tax returns. BSM also continues working on access capabilities for
disabled taxpayers through e-Services upgrade of the PeopleSoft
Commercial Off-the-Shelf application from Version 8.1 to 8.8. BSM will
develop the first release of the Filing and Payment Compliance system
to analyze tax collection cases to determine uncontested cases that no
longer require direct IRS involvement and can be turned over to private
collection agencies.
The FY 2006 BSM portfolio will focus on delivery of three major tax
administration projects (CADE, MeF and F&PC), along with infrastructure
initiatives and continued improvement to program management operations.
Each Tax Administration project will address a core IRS strategic
priority. Program operations will continue to focus on improving
program performance, improving and streamlining management process
disciplines, and ensuring delivery of projects on time, on budget, and
on scope by taking a greater ownership and leadership role in managing
the BSM program.
In addition, the IRS is developing a vision for BSM's future beyond
2007 and setting goals for the year 2010 that align with and support
the IRS Strategic Plan. The IRS established a team of IT and business
specialists to develop an IT modernization roadmap showing how the IRS
can effectively meet IT modernization goals in an incremental approach
that provides near-term value.
Achieving 80 Percent e-Filing:
Achieving the goal of having taxpayers submit 80% of all filings,
information, and returns, electronically by FY 2007 continues to be a
significant challenge. While the e-filing rate continues to increase,
it is only this past year in FY 2005, that more than half of all
individual tax returns were filed electronically. The IRS is
considering mandating e-filing for certain groups, by regulation or
legislation, to ensure increased e-filing. Also, the Administration's
proposal to extend the April filing date for electronically-filed tax
returns to April 30, if enacted, may also increase electronic filing.
But without a legislative change to mandate electronic filing, the
challenge remains one of identifying options to encourage more of the
taxpaying public to e-file. For example, many taxpayers use tax
preparation software to prepare their returns, but then print out and
mail in the return. The IRS needs to induce more of these taxpayers and
preparers to take the next step and file electronically.
The Tax Gap:
Reducing the tax gap is at the heart of the IRS' renewed emphasis on
enforcement. The IRS will continue to expand enforcement by targeting
its case work and enforcement activities to more effectively deliver
results and drive down the tax gap. The IRS will continue to analyze
tax information and data from compliance research studies to better
define and quantify the tax gap. The IRS will use the results of these
efforts to better understand and counter the methods and means of those
taxpayers who fail to report or pay what they owe. The IRS is focusing
on discouraging and deterring non-compliance with the emphasis on
corrosive activity by corporations, high-income individual taxpayers,
and other contributors to the tax gap.
The Complexity of the Tax Code:
The December 2004 Report to Congress required by the Internal Revenue
Service Restructuring and Reform Act of 1998 identifies the complexity
of the Internal Revenue Code as the most serious problem facing
taxpayers and the IRS alike. The Code contains well over a million
words, bedeviling individual taxpayers with provisions such as the
alternative minimum tax and the earned income tax credit. Business
taxpayers must grapple with a patchwork of rules that cover the
depreciation of equipment; numerous and overlapping filing requirements
for employment taxes; and vague factors that govern the classification
of workers as either employees or independent contractors. The IRS must
explain the Code in a way that taxpayers can understand.
Tax Reform:
In January 2005, President Bush established an Advisory Panel on
Federal Tax Reform to devise options to reform the tax code and make it
simpler, fairer, and more pro-growth to benefit all Americans. The
Advisory Panel will submit to the Secretary of the Treasury a report
containing revenue neutral policy options for reforming the Federal
Internal Revenue Code. These options will:
* Simplify the tax laws to reduce the costs of compliance and to make
it easier for taxpayers to plan for the future and manage their
affairs;
* Share the burdens and benefits of the tax system in an appropriately
fair and progressive manner while recognizing the importance of
homeownership and charity in American society; and:
* Promote long-run economic growth, higher wages and job creation by
encouraging work effort and increased saving and investment to
strengthen the competitiveness of the United States in the global
marketplace.
Major Management Challenges and High-Risk Areas:
Over the last several years the Government Accountability Office (GAO),
the Treasury Inspector General for Tax Administration (TIGTA) and the
Office of the Inspector General (OIG) for Treasury have identified
several Management Challenges and High-Risk Areas facing the IRS. The
IRS has identified specific steps and actions to address these issues
through its existing program activities. Measures of these program
activities serve to show progress in addressing the management
challenges and high-risk areas. A crosswalk showing the relationship
between management challenges and the IRS Operating Divisions is shown
below.
[See PDF for image]
[End of table]
The following pages summarize each Management Challenge and High-Risk
issue, FY 2005 accomplishments, and actions identified for completion
in FY 2006 and beyond:
IRS Business Systems Modernization:
Issue: Bring the IRS' business systems and financial systems to a level
that provides management current and reliable information to support
informed decision making. GAO in its FY 2005 High Risk series has
consolidated IRS Business Systems Modernization and IRS Financial
Management into one Business Systems Modernization high-risk area.
Actions Taken:
* Customer Account Data Engine (CADE) (implemented in 2004) expanded
its capacity, processing more than 1.4 million of the basic 1040 EZ tax
returns during the 2005 filing season. Further expanded functionality
will accept returns received with an address change, allowing more
returns to be processed through CADE.
* Completed architecture engineering analysis and development of a
limited functionality release for Filing & Payment Compliance (F&PC)
Release 1.1 designed to separate complex cases requiring direct IRS
involvement from those that can be handled by private collection
agencies (PCAs). This release will provide initial capabilities for
competitive outsourcing of collection activities in FY 2006.
* Implemented the Integrated Financial System (IFS) as the IRS internal
accounting system of record. IFS replaced the IRS' core legacy
financial systems. Version 4.6C deployed expenditure controls, some of
IRS' accounts payable, accounts receivable, general ledger, budget
formulation, purchasing controls, 3-year rolling forecast, and
statements of net cost.
* Deployed Modernized e-File (MeF) Release 3.1 which processed 7004
(corporations), 990PF (tax-exempt organizations) and tax law changes
for filing season 2004. In FY 2005, MeF processed 1120 and 990 returns
at higher than expected volumes while still achieving performance
goals. The MeF platform speeds turnaround time for tax return
submissions and uses the latest, secure Internet technology. This
project is key to achieving the 80% e-filing goal mandated by Congress
and is an integral part of the Administration's move towards an all-
electronic government.
* Completed Modernized e-File re-sequencing plan to support Disaster
Recovery requirements.
* Developed and published e-Strategy for Growth: Expanding e-Government
for Taxpayers and Their Representatives. This product serves as a
strategy providing IRS' plans for electronic tax administration and
will be used as a communication tool for both internal and external
customers.
Actions Planned or Underway:
* Modernized e-File (MeF) will become the primary interface for all
business filings. During FY 2006, MeF will deliver electronic filing
capabilities for 1065 forms (Partnership Income), enabling nearly 2.7
million small business and self-employed taxpayers to be served. MeF
will remedy Legacy electronic filing limitations (e- File) which do not
allow partnerships to comply with the Taxpayer Relief Act of 1997
without having to seek waivers to avoid financial penalties.
* The Filing & Payment Compliance (F&PC) project is a key element of
the Enforcement strategy, which will develop systems to analyze tax
collection cases and separate cases requiring direct IRS involvement
from those that can be handled by private collection agencies (PCAs).
In FY 2006, the F&PC will stand up initial capabilities for competitive
outsourcing of collection activities.
* The Customer Account Data Engine (CADE) will continue to move the IRS
towards realizing its Technology Modernization strategy by establishing
phased replacement of components that can no longer sustain today's tax
laws, policy and taxpayer needs. In FY 2006, CADE will expand the type
and number of 1040 family of returns processed on modernized systems
beyond the current base of 1040EZ forms. This will provide key taxpayer
benefits such as processing refunds faster, submitting daily postings
of transactions and updating accounts, which will significantly improve
customer service.
* Continue process improvement and development of metrics for software
development.
* Modernize infrastructure components per Enterprise Architecture.
* Maintain the successful track record on on-schedule, on-budget
release upgrades for the major modernization application to include
CADE, IFS, MeF and e-Services.
* Accelerate modernization to maximize modernization potential and
promote operational efficiencies and strengthen transition of Business
Systems Modernization (BSM) systems into the operating environment.
Tax Compliance Initiatives:
Issue: Administer programs to deal with tax gap issues especially those
resulting from corporate and high-income individual taxpayers as well
as domestic and off-shore tax and financial criminal activity.
Actions Taken:
* Addressed key areas of noncompliance with enhanced enforcement of tax
laws through:
- Increased examinations of the small business corporate segment by
81%;
- Increased examination and collection on the high-income non-filer
segment;
- Initiated settlement initiatives, such as Son of Boss, which alone
resulted in the collection of $3.7 billion in enforcement revenue in FY
2005;
- Partnered with states on abusive transactions leads;
- Initiated educational outreach with practitioners through e-File
seminars and professional responsibility (Circular 230) presentations;
and:
- Standardized criteria for obtaining state revenue agent reports and
established centralized classification point for making IRS assessments
based on the data.
* Deployed new Automated Underreporter (AUR) EITC selection methodology
including business rules for selecting and excluding EITC cases in AUR
and including Schedule C cases.
* Strengthened Field Assistance enforcement programs to increase
voluntary compliance and reduce the risk of noncompliance. During the
third quarter of FY 2005, an additional 245 Tax Resolution
Representatives (TRR) and their managers were trained for Collection
case work.
* Developed new models for Individual Master File (IMF) to assist in
selecting the most productive work. This effort eliminates duplicate
selection codes, facilitates the identification of the "Next Best Case"
for case creation, and simplifies programming.
* Continued to identify flow-through entities used to disguise
questionable structured transactions by high-income taxpayers.
Identified those engaging in abusive tax practices through enforcement,
full implementation of K-1 matching, education and research.
* Continued the enhancements of risk-based compliance approaches by:
- Coding new algorithms that help determine the most appropriate
treatment for cases identified by the Dependent Database so the IRS can
more effectively select inventory for specific and appropriate
treatment streams, and:
- Focusing on long-term solutions that meet legal requirements, are
compatible with technological capabilities, and have the greatest
potential to deter non-compliance. (Ongoing).
* Released updated tax gap estimates for Individual Income Tax
Reporting Compliance. Preliminary findings indicate that the gross tax
gap was between $312 billion and $353 billion in Tax Year (TY) 2001.
Underreporting noncompliance is the largest component of the tax gap
and accounts for more than 80% of the total, with non-filing and
underpayment at about 10% each. Individual income tax is the single
largest source of the tax gap, accounting for about two-thirds of the
total. For individual underreporting, more than 80% stems from
understated income, not overstated deductions.
* Delivered final TY 2003 Voluntary Payment Compliance Rates (VPCR) by
type of tax, tax year and operating division. The VPCR, which is the
percentage of the total tax liability reported on timely-filed returns
that is paid in a timely manner, provides a valid assessment of the
overall level of payment compliance and facilitates the proper
allocation of resources for enforcement activities.
* Provided an estimate of the overall improper payment level (overclaim
estimates) for EITC based on National Research Program individual
reporting compliance data. Data will be used to help refine and
evaluate EITC initiatives to reduce inappropriate claims and improve
the program's effectiveness.
* Established the Office of Fraud/Bank Secrecy Act (BSA) which has end-
to-end accountability for BSA policy formation, operations and data
management, recognizing the importance of the IRS' role in the fight
against terrorism and money laundering. Over 300 examiners and managers
are trained and dedicated full-time to the BSA program.
* Completed a model Federal and State Memorandum of Understanding
(MOU), which provides both the IRS and the participating state the
opportunity to leverage resources for BSA examinations, outreach and
training.
* Expanded examinations of self-employment income by earners in U.S.
Possessions (Puerto Rico, Guam, etc ... ), closing over 10,000 Form
1040s in FY 2005.
* Made efficiency gains in the Offer-In-Compromise (OIC) program.
Declining receipts and improvements in timely closures of OIC permitted
reassignment of approximately a quarter of field offer specialists back
to the general collection program.
* Focused criminal enforcement resources on key areas of noncompliance,
including the promotion of abusive schemes such as offshore accounts to
hide or improperly reduce income, the use of abusive corporate tax
avoidance transactions and high-income individuals underreporting of
income and/or failure to file returns.
Actions Planned or Underway:
* Upgrade the Bank Secrecy Act (BSA) workload database to provide a
more complete record of these institutions and to better predict which
entities have a greater probability of non-compliance.
* Continue the enhancements of risk-based compliance approaches by
implementing major programming changes to inventory and incorporating
cost-benefit of Dependent Database selection process. (01/2006).
* Finalize plans for Tax Year 2006 Earned Income Tax Credit (EITC)
compliance study to assess changes in taxpayer EITC filing volume and
track EITC return math error accuracy.
* Charter EITC research efforts to identify ways to reduce EITC
erroneous payments, as well as identify trends in the diverse EITC
taxpayer population. Use the results of these studies for strategic
planning of the EITC program. (Ongoing).
* Develop enhancements to the multifunctional non-filer strategy that
will target outreach and compliance efforts; develop alternative
treatments to influence non-filing taxpayer behavior and promote
compliance. (09/2006).
* Continue the Federal Employee/Retiree Delinquency Initiative (FERDI)
to reduce non-compliance of federal employees and retirees. (Ongoing
through 09/2006).
* Utilize Individual Master File (IMF) data to track production, return
characteristics and error information on volunteer-prepared returns.
(Ongoing through 09/2006).
* Perform a study to establish the compliance characteristics of
volunteer-prepared returns. (09/2006).
* Initiate a Qualitative Assessment Study that analyzes the effects on
taxpayer attitudes towards EITC participation and compliance. (09/
2006).
* Initiate an 1120-S full reporting compliance study to analyze the
accuracy of S-corporation tax returns and estimate the voluntary
reporting compliance of subchapter S-corporations. (Ongoing).
* Enhance data exchange opportunities and implement national
initiatives with state taxing organizations to leverage limited
government resources.
* Focus on securing State Income Tax Levy program (SITLP) agreements
with remaining non-participating income tax states.
* Enter into tip reporting agreements with more than 90% of gaming
casinos. (12/2005).
Strengthen Information Security; Security of the IRS:
Issue: Strengthening the security infrastructure and the applications
that guard sensitive data.
Actions Taken:
* Updated and strengthened security plans for tax payment lockbox sites
for tax payment processing at the IRS campuses.
* Completed certifications and accreditations of IRS redefined General
Support Systems (GSS); took steps to thoroughly review the security
controls of its networks and other critical information technology
assets and to correct any weaknesses that exist.
* Improved Federal Information Security Management Act of 2002
reporting process to fully and actively engage business management in
meeting and reporting on security requirements for the systems within
their purview.
* Participated with the Department of the Treasury in disaster
simulations designed to test continuity of operations plans.
* Provided executives, managers and staff (including personnel with
essential security roles) with relevant security-related training.
* Implemented program-level security controls disseminated by Mission
Assurance & Security Services.
* Established a multi-agency working group including representatives
from the Department of the Treasury, the Federal Trade Commission
(FTC), the Social Security Administration (SSA) and the Department of
Homeland Security (DHS) to better enable Federal agencies to provide
consistent information and services to assist victims of identity
theft:
- Collaborated with the Social Security Administration (SSA) to improve
a multi-agency process called "Scramble SSN" to dramatically reduce the
time required to resolve duplicate Social Security Number (SSN) usage;
- Updated information used in correspondence with taxpayers who are
impacted by identity theft including interim updates on the status of
their case;
- Developed standards for documentation to be used to validate the
identity of the taxpayer, the taxpayer's address and the fact of the
theft that are consistent with those established by the FTC and the
SSA;
- Established tracking codes to monitor taxpayer cases impacted by
identity theft to develop or enhance outreach activities and
communication vehicles;
- Established process to protect the SSNs of IRS employees by
eliminating the use of the SSN as a unique employee identifier on IRS
systems; and:
- Established an Identity Theft Program office to update internal
processes impacted by identity theft, to reduce taxpayer burden and to
provide consistent treatment among taxpayers.
* Completed build out of the incident command structure.
* Expanded the IRS' ability to respond to emergencies through more
frequent exercise of Continuity of Operations Plan (COOP) and other
emergency response actions.
* Completed business resumption plans in response to changes in threat
conditions.
* Fully supported government-wide and Departmental emergency response
initiatives.
Actions Planned or Underway:
* Complete mitigation of General Support Services (GSS) weaknesses
identified during certification and other review activities sufficient
to upgrade GSS with Interim Authority to Operate status to Full
Authority to Operate. (09/2006).
* Conduct certification and accreditation update activities to meet
government-wide guidelines for percentage of information systems
certified. (09/2006).
* Define an enterprise-wide strategy for IT systems disaster recovery,
including implementation of strategic testing of disaster recovery
plans. (09/2006).
* Develop a back-up for the IRS incident response capability to reduce
geographic vulnerability. (09/2006).
* Continue to improve Federal Information Security Management Act
(FISMA) compliance by further increasing business owner participation
in all areas including monitoring, review, mitigation and reporting
activities. (Ongoing).
* Develop a physical security technology "roadmap" for the IRS to
improve uniformity and cost effectiveness of security technologies at
IRS sites. (05/2006).
* Support Homeland Security Presidential Directive 12 (HSPD-12), which
mandates a uniform approach to employee authentication and access
government-wide. HSPD-12 requirements contain a timeline for all
agencies to follow and requirements for meeting the objectives of the
Directive. (Multi-year).
* Continue to refine both the IRS' Continuity of Operations Plan (COOP)
activities and the IRS' contribution to Department/government-wide COOP
activities. (09/2006).
Establish Measures Comparable Over Time and Collect Sufficient
Performance Data; Integrating Performance and Financial Management:
Issue: Establish long-term goals and integrate performance into
decision-making and resource allocation processes to completely achieve
an integrated performance budget.
Actions Taken:
* The IRS budget submission for FY 2007 includes programmatic long-term
goals (LTG) that combined with the program-related efficiency and
outcome measures will be used as indicators of the program's long-term
objectives. In FY 2005, the IRS aligned its budget programs with the
objectives outlined in the IRS Strategic Plan 2005 through 2009.
* Draft long-term goals, indicating optimal performance and targets
through FY 2009, were developed for each Taxpayer Service program and
for a majority of the Enforcement programs.
* The IRS' Integrated Financial System (IFS) was deployed in FY 2005 to
provide timely access to accurate and consistent financial data
including cost data that is used to develop cost-based performance
measures. The IRS cost module has captured data for 10 months of FY
2005 enabling the IRS to view direct expense data (labor, supplies,
travel, etc), FTE and on-rolls data captured at the lowest cost center
(group or work unit) level. In addition, the IRS developed and
implemented allocation methodology to distribute support costs to the
operational business units.
* The IRS completed three Program Assessment Rating Tool (PART)
evaluations for the FY 2007 budget cycle: examination, criminal
investigation and submission processing. All three programs received
"moderately effective" ratings from OMB.
* The Chief Financial Officer and Modernization & Information
Technology Services have proposed and developed a concept of enhancing
the current Financial Management Information System (FMIS) to
substantially comply with the requirements of FFMIA.
Actions Planned or Underway:
* The IRS will continue to analyze the cost data obtained through the
Integrated Financial System to further develop robust cost-based
performance measures for its major programs.
* In FY 2006 the IRS will introduce a suite of enterprise-wide goals
which link directly to the IRS Strategic Plan goals of Improve Taxpayer
Service, Enhance Enforcement of the Tax Laws, and Modernize the IRS
Through People, Processes and Technology. The enterprise-wide goals
will be consistent with the measures represented in the IRS budget. The
new goals are intended to provide focus and rigor to measuring the
outcome of the nation's self-assessment tax system: Improve Voluntary
Compliance in all areas.
* For the FY 2008 budget cycle, the IRS will submit its non-revenue
generating programs to OMB for a PART assessment. Based on the
performance improvements the IRS has shown for the collection program,
the IRS plans to request reassessment and removal of the prior PART
rating of "Results Not Demonstrated."
* Financial Management Information System (FMIS) enhancements are
planned through four releases beginning in 2006. FMIS is currently
working on Release 1, which is the development of the Unpaid Assessment
and Trust Fund Recovery Penalty (TFRP) data base.
Complexity of the Tax Law:
Issue: Simplifying the tax process by developing legislative
recommendations to clarify tax instructions or forms and computer
modernization.
Actions Taken:
* Provided Congress with legislative recommendations in the upcoming
National Taxpayer Advocate 2004 Annual Report to Congress (December 31,
2004), including elimination of the Alternative Minimum Tax;
simplification of provisions to encourage education; and simplification
of provisions to encourage retirement savings.
* Finalized the Taxpayer Rights Impact Statement, which is an
assessment of an IRS program or policy by the National Taxpayer
Advocate with respect to its impact on taxpayer rights.
* Participated in research initiatives such as "Abusive Tax Schemes:
The 'Tipping Point' Study;" The Impact of Representation on the Outcome
of Earned Income Tax Credit (EITC) Audits, Federal Case Registry Study;
EITC Certification Test; EITC Pre-certification Test; EITC
Recertification; Downstream Effects of Compliance Initiatives.
Actions Planned or Underway:
* Continue to work with the Treasury Department on revisions to the
regulations under Internal Revenue Code 7216, relating to the use and
disclosure of tax return information by tax returns preparers.
(Ongoing).
* Examine the possibility of a Unified Family Credit that will combine
the provisions of the EITC, Child Tax Credit, and Dependency Exemption,
thereby further reducing taxpayer compliance burdens associated with
claiming these provisions. (Ongoing).
* Legislative proposal to issue regulations specifying returns that
must be filed electronically. Expanding the scope of returns that are
required to be filed electronically would help the IRS meet its 80%
goal set by Congress.
* Legislation is being proposed to issue regulations that would extend
the due date to file and pay individual taxes by April 30th, provided
the taxpayer files the return electronically and pays the entire
balance due electronically by the due date.
* Legislation is being proposed to expand authority of the IRS to
require businesses (including corporations, partnerships and other
business entities) and exempt organizations to file their returns
electronically.
Providing Quality Customer Service Operations:
Issue: Providing top quality service to every taxpayer in every
transaction is an integral part of the IRS' strategic and modernization
plans.
Actions Taken:
* Established new Queuing Management (Q-Matic) codes to enhance the
data captured at the walk-in sites to provide additional feedback on
outreach efforts involved in the EITC Qualifying Child Certification
Test. This will enable the IRS to learn about taxpayer problems with
certification as well as the potential burden a certification
requirement could impose on IRS field assistance sites.
* Completed Phase 1 of Q-Matic to facilitate customer traffic and
workload planning.
* Developed the electronic installment agreement initiative to enable
taxpayers meeting certain criteria to request and set-up their own
installment agreements over the Internet on IRS.gov.
* Completed a successful pilot of Contact Recording initiative to
enable synchronized voice/data recordings to monitor face-to-face
interactions in Taxpayer Assistance Centers (TACs) to assess quality as
well as trends.
* Completed 108 Taxpayer Assistance Center Model projects, thus far, to
retrofit TACs to provide adequate space to accommodate customer
traffic, provide modernized workstations, integrate technology
enhancements, improve privacy and enhance security.
* Deployed new Automated UnderReporter (AUR) EITC selection methodology
to more precisely select cases that have a high probability of
misreported income.
* Revised the e-Services incentive products minimum returns filed
threshold to five (down from 100) for all return types supported by e-
File or Modernized e-File (MeF) to allow more Electronic Return
Originators (EROs) to use electronic incentive products such as
Disclosure Authorization, Transcript Delivery System and Electronic
Account Resolution.
* Improved and enhanced the availability of online services such as
Internet Employer Identification Number (EIN), Centralized
Authorization File (CAF), and Practitioner Priority Services (PPS).
* Continued work with private industry providers to expand Free File.
* Enhanced research to maximize the best use of resources for the
Volunteer Income Tax Assistance (VITA) site identification, partnership
development and return preparation.
* Expanded Internet Refund-Fact of Filing to include Refund Trace and
Change of Address capabilities for lost and/or stolen refunds.
Actions Planned or Underway:
* Expand the web-based learning program (Link and Learn Taxes) that
provides online training in tax return preparation. (Ongoing through
09/2006).
* Refine "Life Cycle Products" line of publications designed to educate
taxpayers about the tax impact of significant life events. (Ongoing
through 09/2006).
* Incorporate multi-year Volunteer Return Preparation Program (VRPP)-
Quality Improvement Process (QIP) plan to promote quality assurance for
the VITA program. (Ongoing through 09/2006).
* Utilizing pilot models developed in FY 2005 to implement a national
rural strategy that provides outreach, free tax return preparation and/
or financial literacy education to rural America. (09/2006).
* Continue expansion of Internet Refund Fact of Filing (IRFOF)
application to reduce toll-free demand and offer customers alternative
methods of service. (09/2006).
* Develop a TeleFile and Internet electronic funds withdrawal (Direct
Debit) application for notice payments. (09/2006).
* Develop an electronic funds withdrawal (Direct Debit) application for
installment agreements. (09/2006).
* Complete Phase II rollout of Queuing Management (Q-Matic) which will
automate the process of tracking employee activity and contribute to
improve customer traffic and workload planning. (09/2006).
* Continue to educate EITC taxpayers through partnerships with key
stakeholders and a public service campaign. (Ongoing).
* Assess the overall EITC marketing/awareness campaigns that target the
eligible EITC non-claimant population and refine/refocus as necessary
to improve compliance and increase overall participation. (Ongoing).
* Continue to improve the quality and clarity of computer-generated
notices issued to taxpayers to reduce the number of telephone contacts
and make it easier for taxpayers to understand and comply with their
tax requirements. (Ongoing).
* Establish the Virtual Translation Office to develop new and revised
Spanish-language tax products. (09/2006).
* Continue conducting surveys and focus groups to obtain feedback from
taxpayers and tax practitioners about ways to improve tax forms,
instructions and publications. (Ongoing).
* Complete an additional 25 TAC Model projects. (09/2006).
* Roll-out Contact Recording in the TACs piloted in 2005 to an
additional 100 locations in FY 2006 and continuing through FY 2008
until all TACs are equipped with contact recording.
Processing Returns and Implementing Tax Law Changes During the Filing
Season Issue: Tax law changes from prior years that have not been
correctly implemented.
Actions Taken:
* Developed secure access for taxpayers who file electronically to
enable them to review their account electronically.
* Deployed the Transcript Delivery System (TDS) to improve efficiency
by implementing a "One-click process" for servicing transcript
requests. From May to September 2005, 610,000 transcripts were mailed
to taxpayers.
* Completed the ramp-down of the Memphis Submission Processing Center
(MSPC).
* Ensured the Corporate Filing Season Readiness Process is operational
for filing seasons 2005 and 2006 and covers all aspects of the filing
season, including the Annual Readiness Certification. Filing Season
2005 was timely certified and the Filing Season Readiness committee is
in place for filing season 2006.
* Set a record for electronic filing, reaching 68 returns, an increase
of approximately 11% from 2004.
Actions Planned or Underway:
* Automate the financial statement of net cost in IFS.
* Pilot an automated adjustment document to make a change or correction
to a taxpayer account, reducing adjustment time and increasing the
quality of required adjustments.
* Pilot Embedded Quality Review System (EQRS), establishing common
attributes and review tools for evaluating organizational performance
and individual performance.
* Begin development of strategies to smoothly transition and
consolidate the Philadelphia Submission Processing Center. (Multi-year
initiative).
* Complete deployment of Transcript Delivery System (TDS) by December
2005.
Taxpayer Protection and Rights:
Issue: The IRS has made significant progress in complying with RRA '98
and most provisions have been implemented. Significant management
attention is still required to ensure that all issues situations have
been addressed.
Actions Taken:
* Reduced procedural barriers by making refinements to both third party
notification and collection due process procedures.
* Administered an EITC survey as part of the EITC Qualifying Child
Certification Test, consisting of questions regarding the time and cost
associated with the certification and making an EITC claim. The survey
was conducted to gather information to better understand claimants'
experience with the certification process and to determine the impact
of EITC certification on taxpayer participation in the EITC program.
* Implemented several EITC notice redesign efforts (CP-75 notice
series, initial audit contact letters, Publication 3498-A, The
Examination Process: Examinations by Main. The redesign of the notices
will enable taxpayers to better understand their responsibilities and
entitlements under a very complicated section of tax law.
* Improved the CP 09 (Earned Income Credit-You May Be Entitled to EIC)
and 027 (EIC Potential for Taxpayer Without Qualifying Children), which
notifies taxpayers who have not claimed EITC that they may be eligible.
Simplified the CP 09 and 027 language to improve understanding and
improved the determination checklist to make the notices more user
friendly.
* Improved the EITC recertification and two-and ten-year ban notices,
making them easier to understand and clearly explaining the
consequences of the two-and ten-year bans, including the tax years to
which the bans apply.
* Implemented a solution for encrypting electronic return data during
the transmission process from electronic return transmitters.
* Developed a new workload methodology that will focus on those areas
of the filing population constituting the greatest increase in
compliance risk with a high probability of unreported income. This
strategy will promote fairness of our tax system by identifying
potential noncompliance from taxpayers who would not otherwise be
subject to matching document reviews.
* Rolled out the Taxpayer Assistance Center (TAC) model, as it is
critical to maintaining taxpayers' privacy and confidentiality,
particularly as the IRS becomes more involved in compliance activities.
* Reviewed IRS training to ensure that employees, particularly in
compliance functions, are properly and regularly trained on the
protection of taxpayer rights.
* Pursued abuses in the consumer credit counseling industry, targeting
for audit 60 firms representing 50% of revenue in this industry.
Actions Planned or Underway:
* Focus on taxpayer groups that are at higher risk of noncompliance to
maintain confidence in the integrity of the tax administration program.
(Ongoing).
* Continue to educate EITC taxpayers through partnerships with key
stakeholders and a public service campaign. As of June 2005, the public
education campaign, through the media and grassroots community
partnerships, generated almost one billion potential contacts.
(Ongoing).
* Continue efforts to enhance EITC systemically generated notices.
* Ensure protection of taxpayer information entered at return
preparation sites and local offices. (Ongoing).
* Refine procedures to certify compliance with requirements of Title VI
of the Civil Rights Act of 1964 to provide equal access and non-
discriminatory services to all eligible taxpayers. (Ongoing).
* Work under auspices of the Electronic Tax Administration Policy
Council (ETAPC) to establish security policy and address issues.
Complete additional reviews requested by ETAPC of the authentication
methods. Continue to implement new website functionality requested by
the Business Operating Divisions. (Ongoing).
* Continue systems modernization efforts to enhance the IRS' security
program. (Ongoing).
* Develop and implement the Taxpayer Rights Impact Statement to help
the IRS incorporate awareness and consideration of taxpayer rights into
its program planning and implementation. (Ongoing).
* Work with preparers to design a program that enables the majority of
taxpayers to feel confident that their preparers are competent to
prepare their taxes and that the IRS will take appropriate enforcement
action on preparers when they perform negligently or recklessly.
(Ongoing).
* Advocate enforcement of existing penalties for paid preparers as well
as the strengthening and enhancement of penalties by Congress.
(Ongoing):
Human Capital:
Issue: The IRS' ability to meet program requirements and the
expectations of both external and internal customers.
Actions Taken:
* Streamlining operations resulted in moving personnel from non-
enforcement to enforcement positions during FY 2005 and cost savings
from centralizing case processing will be directed to enforcement hires
for FY 2006.
* Submitted to the IRS Oversight Board the final draft of the 2005-2009
Human Capital Strategic Plan, the primary guidance vehicle for
strategic management of human capital in the IRS.
* Implemented an IRS-wide human capital governance structure, including
representatives from the IRS business units, support functions and
specialized units, that provides a forum for all IRS entities to
jointly address and propose solutions to human capital issues and
challenges resulting from the implementation of large-scale human
capital programs, policies and initiatives and ensures consistent and
fair treatment of employees impacted by workforce change initiatives.
* Continued work on Mission Critical Occupations (MCOs):
- Refined competency models for MCOs as part of the IRS' ongoing effort
to improve its ability to field a workforce with the full range of
competencies necessary for high quality performance;
- Implemented an automated recruitment solution, CareerConnector, for
external hiring of selected MCOs, increasing the IRS' ability to fill
vacancies within 45 days from the vacancy announcement; and:
- Improved the talent pool of external Mission Critical Occupation
hires and provided management greater flexibility to select the most
qualified candidates through the expanded use of category ratings to
stratify the available applicant pool and also simulated job situation
assessments.
* Implemented an IRS-wide Enterprise Learning Management System (ELMS),
a web-based application that managers, employees, and the Learning and
Education community will use to manage training and development.
* Negotiated a new recruitment marketing contract because previous
contract, including option years, had expired. Maintained an active
print and internet media campaign, produced new multi-media job
previews and updated the IRS Careers website. A recruiter cadre
continued to foster partnering relationships with over 200 colleges and
universities across the country as part of the IRS' ongoing effort to
improve recruiting performance, particularly the recruitment of
applicants to fill Mission Critical Occupations.
* To support workforce restructuring initiatives and to mitigate impact
on employees involved in restructuring, the IRS used all available
tools, including VERA (early outs) and VSIP (buyouts) and relocation
bonuses throughout the year to support workforce restructuring
initiatives and to mitigate impact on employees involved in
restructuring.
* Developed a Human Capital Office (HCO) Concept of Operations that
articulates HCO's vision, mission, values and role in the IRS human
capital community as well as HCO's various Lines of Business, i.e.,
major categories of human capital work within the IRS.
* Executed Service Level Agreements with customers which describe the
services HCO has agreed to provide, HCO and customer commitments
relating to delivery of HCO services and how HCO's performance will be
measured.
* Evaluated each new human capital initiative for workforce impact to
determine effective and appropriate mitigation strategies to address
the results.
* Implemented a multi-year recruitment and marketing strategy that
includes the expansion of the Internet employment website, a complete
print media advertising campaign, market research and an extensive
Internet media advertising campaign.
* Used competency models and occupational studies to identify and
target competencies necessary for successful performance in all
frontline occupations; targeted competencies in the recruitment and
hiring process and the individual and employee training process to
address skill gaps.
* Developed a Career-Pathing process that focuses on training,
application, assessment and feedback to provide opportunities to
develop technical expertise needed for senior professional positions.
* Expanded QuickHire, an Internet-based tool that automates the hiring
process, to include additional occupations.
Actions Planned or Underway:
* Deploy the Learning Content Management System (LCMS) to permit more
efficient development of training materials and ensure more consistency
in training across the Service. (09/2006).
* Complete the conversion of all its Mission Critical Occupation (MCO)
application processes to the CareerConnector system and begin the
conversion of the non-MCO occupations. (09/2006).
* Complete development of the Human Capital Strategic Implementation
Plan (HCSIP) to:
- Identify specific human capital programs and initiatives for the next
two years needed to execute the strategies and achieve the goals
outlined in the Human Capital Strategic Plan;
- Provide accountability for performance of programs and initiatives
through a systematic corporate monitoring and reporting process; and:
- Integrate the budget process with human capital strategies.
(Ongoing).
* Conduct a study of all leadership courses (Executive Readiness
Program, Senior Manager Course/Senior Manager Readiness Program, and
Frontline Manager Course) to focus on delivering content in an
effective and efficient manner as well as identifying and attracting
"high talent"and "high potential" for leadership development. (09/
2006).
* Design continuous training for managers using tailored case studies,
simulations in training and work-out sessions to provide hands-on
experience to realize the "stepping stone" approach. (Ongoing).
* Continue the selective use of Voluntary Employee Retirement Authority
(early-outs) and Voluntary Separation Incentive Payments (buyouts) to
support organizational restructuring and workforce reshaping
initiatives. (Ongoing).
* Extend partnerships with key colleges and universities. (Ongoing).
* Improve recruiting performance through expansion of category ratings
and the increased use of simulations in assessing job applicants-
particularly in front-line occupations. (Ongoing):
Enforcement of Tax Laws:
Issue: Address the evolving challenge of unpaid taxes and continuing
Earned Income Credit noncompliance.
Actions Taken:
* Improved collection processes resulted in increases in productivity,
dollars collected, enforcement activity and customer satisfaction along
with decreases of time between return filing and assignment and
decrease of time between assignment and case closure. Adoption of clear
guiding principles including revisions to key Internal Revenue Manual
sections on enforcement activity, coupled with improved electronic
research and guidance tools and enhancement of managerial consultations
contributed to overall improvements.
* Implemented key recommendations identified by the Federal Tax
Compliance Task Force (FCTC) to improve the levy process for Department
of Defense (DoD) Contractors through the Federal Payment Levy Program.
Actions include:
- Implemented 100% levy actions on 100% of the largest DoD payment file
in April and the remaining DoD payment systems in July 2005;
- Increased data exchanges with DoD resulting in the acceleration of
7,550 Collection Due Process notices; and:
- Added additional DoD payment systems to the Treasury Offset Program
(TOP). To date, 18 of the 20 Defense Finance and Accounting Service
(DFAS) Commercial Pay Systems have been implemented, which represents
99.7% of the total annual disbursements.
* Improved Automated Collection System (ACS) levy process by
identifying new sources from Electronic Filed Returns, State Employment
Commissions and through Information Return Master File and the
Remittance Processing System.
* Partnered with 27 states to levy individual state refunds for
outstanding federal income tax liabilities through the State Income Tax
Levy Program (SITLP). An encryption software purchase for states will
allow transmission of levy payment into the Electronic Federal Tax
Payment System (EFTPS).
* Developed a multi-year strategy through the Federal Employee Retiree
Delinquency Program (FERDI) to provide outreach and education to assist
military retirees with understanding their obligations and improving
compliance.
* Other than the Earned Income Tax Credit (EITC) Program, the IRS has
no high-risk programs that require baseline and annual error rate
measures or the development of a reduction plan with annual targets.
Therefore, the IRS' focus on eliminating improper payments is placed on
the Earned Income Tax Credit Program. EITC is a refundable federal
income tax credit for low-income working individuals and families. In
FY 2004, nearly 22 million people received almost $38 billion from the
credit, making the EITC the nation's largest anti-poverty program.
* To better administer EITC, the IRS developed a detailed, long-term
EITC business plan in the form of a Concept of Operations with a focus
on a balanced EITC Program - one that reduces erroneous payments while
increasing participation by eligible taxpayers. In keeping with the
goals of the EITC program throughout FY 2005 and into FY 2006, the IRS
will implement new, technology-enabled business process improvements as
well as continue to test and evaluate new approaches to reduce improper
payments. The IRS will use these tests to make data driven decisions
about improvements to each segment of the program including customer
service, outreach and compliance.
* The EITC business plan is consistent with the IRS Commissioner's five-
point initiative announced in June of 2003 to reduce burden on
taxpayers, improve the IRS audit processes, increase outreach efforts,
address unreported income and test new approaches to reducing EITC
error. The IRS' continued efforts to improve EITC compliance activities
have enabled it to decrease the amount of time it takes to complete an
EITC examination by 6.4%, or 12 days and to reduce the volume of aged
EITC cases in inventory by 38% during last year.
* As part of the Commissioner's initiative, in FY 2005, the IRS
continued several tests to evaluate new ways of reducing erroneous EITC
payments while maintaining participation by eligible taxpayers:
- Qualifying Child Test: Requires certain EITC claimants to certify
that they meet the qualifying child residency requirement before paying
out the refund. Initial testing results showed that a certification
requirement had a significant effect on improper EITC claims;
- Filing Status Test: Reviews filing status claims to ensure they are
correct. The IRS selected claimants whose filing status had changed to
one that increased the value of the credit (generally, from married
filing joint to head of household). The first test indicated that the
IRS needed to modify its selection methodology to ensure a better focus
on non-compliant taxpayers; and:
- Misreporting Income (Automated Underreporter) Test: Enhances error
detection through the Automated Underreporter program. This test
focused on improved selection methodologies and showed successes in a
lower no change rate and changes to the credit.
* Based on the results of the Misreporting Income (Automated
Underreporter) test, in early FY 2005 the IRS implemented the improved
selection methodologies for Automated Underreporter cases. During 2006,
the IRS will complete the last part of the Qualifying Child test and
evaluate the effects of the Filing Status and Qualifying Child tests on
reducing erroneous EITC payments and maintaining participation by
eligible taxpayers before making decisions to implement either on a
broader scale.
* Other FY 2005/FY 2006 activities include a program to focus education
and compliance efforts, as appropriate, on EITC paid preparers. As a
part of the EITC Return Preparer Strategy, the IRS completed over 400
due diligence compliance visits to paid tax preparers with a
probability/record of preparing erroneous EITC returns. The IRS has
also implemented the selection of amended EITC returns for examination
using the Dependent Database.
* The IRS is also striving to make the EITC easier to claim by eligible
taxpayers. To reduce taxpayer burden, the IRS is improving
communications to taxpayers, making the credit clearer and easier to
understand and providing potential claimants and their paid preparers
with resources to help them determine whether they are eligible. During
FY 2005, the IRS launched the EITC Assistant, a web-based eligibility
calculator on irs.gov; implemented enhancements to the EITC Online
Toolkit for tax professionals for FY 2005 and FY 2006; delivered EITC
messages on Housing and Urban Development kiosks in 106 locations
nationwide; and distributed EITC educational materials to 3,300 Western
Union agent locations in New York, Los Angeles, Atlanta, and San
Antonio. Also in FY 2005, IRS partnerships and coalitions prepared
nearly two million tax returns for low-income families, in addition to
making countless taxpayer contacts through an array of EITC educational
products and messages.
Actions Planned or Underway:
* Launch final portion of the qualifying child certification test.
* Complete compliance analysis of TY 2001 returns claiming EITC
(National Research Program).
* Develop and distribute materials to educate taxpayers and
practitioners on EITC eligibility rules and compliance issues.
* Test and report the results of the National Directory of New Hires
database match.
* Plan for a FY 2007 compliance study.
* Continue to leverage partnership opportunities with states that offer
tax credits comparable to EITC.
* Implement new Automated Case Selection and Assignment and Decision
Support Tools. (01/2006).
* Implement new Amended Returns process. (03/2006).
* Launch additional Risk-Based Scoring Strategy and inventory
management capability to improve selection and assignment of EITC
returns for examination. (03/2006).
* Enhance methodology to improve the selection of EITC amended returns
for examination.
* Expand the Questionable Refund Program to include prisoner returns.
The IRS will continue to coordinate with prison officials to acquire
complete and accurate information on the prison population to maximize
the effectiveness of its automated systems in promptly identifying
questionable returns filed by inmates. Furthermore, the IRS will ensure
all Fraud Detection Centers have procedures in place to coordinate
fraud prevention efforts with the prisons in the states they serve.
* Enhance IRS' Electronic Fraud Detection System to improve its
efficiency in detecting fraudulent refund schemes involving individual
as well as business returns.
* Integrate the Decision Support Tool into the Reporting Compliance
Case Resolution workflow. (06/2006).
* Develop joint W&I and SB/SE Reporting Compliance Concept of
Operations and system concept for coordinated workload management and
resolution system to manage and move case inventory (this replaced
EITC's Corporate Inventory Management Routing & Integration project).
(12/ 2005).
* Identify new ways to administer EITC by partnering with states (New
York, Massachusetts, and New Jersey) through the use of proactive
research initiatives. (12/2005).
* Use data-driven scoring and selection methods to select cases for
examination and apply the right compliance treatments to address
taxpayers. (01/2006).
* Test new selection tools to determine more effective compliance
treatments for return preparers. (03/2006).
* Initiate research to assess changes in taxpayer EITC filing volume
and track EITC return math error accuracy through outreach campaigns
and volunteer tax return preparation. (Ongoing).
* Develop multi-year return preparer strategy that addresses paid
preparer non-compliance and gather data on the effects of these efforts
on paid preparers as well as taxpayers. (Ongoing).
* Test the use of a National Directory of New Hires (NDNH) database
match in the IRS' Criminal Investigation EITC Fraud Detection Centers.
(12/2006).
Bring Treasury's Financial Management Systems into compliance with
Federal Financial Management Improvement Act (FFMIA) of 1996:
Issue: The IRS' financial management systems remain a challenge,
despite producing combined financial statements covering tax custodial
and administrative activities for the seventh consecutive year. Also,
the IRS has achieved an unqualified audit opinion from the Government
Accountability Office (GAO) on all financial statements since FY 2000.
IRS' current financial systems alone cannot produce reliable
information necessary to prepare financial statements in accordance
with federal accounting standards. The data produced from the current
financial system has to be reconciled with other subsidiary systems to
produce reliable financial statements. The IRS lacks the timely,
accurate, and useful information needed to make informed management
decisions on an ongoing basis.
Actions Taken:
* Custodial Accounting Project (CAP) was shutdown due to funding
shortfalls.
* Implemented the Integrated Financial System (IFS) as the IRS'
internal accounting system of record.
* The IRS developed a strategy concept to enhance the current Financial
Management Information System (FMIS) to be compliant with FFMIA
requirements.
* FMIS enhancement concept was accepted by the Financial and Management
Controls Executive Steering Committee and has been presented to
Treasury CFO, OMB, and GAO.
* The IRS developed a less costly alternative strategy to downgrade
custodial reporting weakness via implementation of new custodial
database project.
Actions Planned or Underway:
* FMIS enhancements are planned to be accomplished through four
releases beginning in 2006 through 2008.
* MITS is currently developing on Release 1 which is the Unpaid
Assessment and Trust Fund Recovery Penalty (TFRP) database and sub-
ledger functions.
* Full funding requirements for the FMIS enhancements have been
included in the FY 2007 E-300 submission.
Success is measured by a set of key milestones for each project
identified in the detailed project plans developed for all Tier A
projects. Success is also measured by the Office of Management and
Budget through the President's Management Agenda. The IRS receives
scores for both Plan and Status on a quarterly basis.
V. Financial Highlights:
Stewardship Information Analysis:
a. Overview of Revenue and Administrative Accounts:
The IRS' financial statements and footnotes received an unqualified
audit opinion for the sixth consecutive year for administrative
accounts and the ninth consecutive year for revenue accounts.
Administrative accounts reflect resources used and expenses incurred in
administering the tax laws. Revenue accounts reflect net taxes
receivable and net taxes collected to support the federal government.
The Balance Sheet reflects total assets of $27 billion. Of these
assets, 77.8% are Federal Taxes Receivable. These receivables are the
amounts expected to be collected from past due accounts. The increase
in assets of $1.4 billion is primarily attributable to increases in the
amounts due from Treasury for tax refunds due taxpayers, taxpayer
deposits for unpaid assessments and federal taxes receivable. The
majority of the liabilities, 83.7%, consist of amounts due to Treasury
related to Federal Taxes Receivable.
The Statement of Custodial Activity shows that IRS programs resulted in
$2.267 trillion in Federal receipts. IRS collections constitute 96% of
the Federal Government receipts, as shown in the chart below.
Total Federal Receipts - (Percent):
[See PDF for image] - graphic text:
Pie chart with two items.
IRS Collections: 96%;
Non-IRS Collections: 4%.
[End of figure]
b. Financing Sources:
The IRS receives the majority of its funding through annual and multi-
year appropriations which are available for use within certain
specified statutory limits. There are three major and two minor
operating appropriations. The Processing, Assistance and Management
appropriation funds the processing of tax returns and related
documents, assistance for taxpayers in the filing of their returns and
paying taxes due, matching information with returns, conducting
internal audit reviews and security investigations and managing
financial resources. The Tax Law Enforcement appropriation provides
funds for the examination of tax returns and the administrative and
judicial settlement of taxpayer appeals of examination findings, as
well as providing resources for expanded customer service and
education, strengthened enforcement and enhanced research to reduce
valid claims and erroneous filings associated with the Earned Income
Tax Credit (EITC) program. The Information Services appropriation funds
costs for data processing and information and telecommunications
support for the Service's activities. The Business Systems
Modernization Account is the most significant of the minor operating
appropriations and funds capital asset acquisitions of information
technology systems. The Health Coverage Tax Credit appropriation (HCTC)
funds necessary expenses to implement the program.
[See PDF for image]
[End of figure]
Besides appropriations, the Service utilizes other financing sources.
These include net transfers from other federal agencies, User Fees for
direct services provided to customers (for example, installment fees,
photocopy fees, and letter rulings and determinations fees) and imputed
financing (subsidies from other federal funds that cover specific
expenses such as retirement benefits).
c. Use of Resources:
The Statement of Net Cost reflects the use of resources in carrying out
the agency's major programs.
How the Service Used Its Resources - (Percent):
[See PDF for image]
[End of figure]
The major programs are Pre-filing, Filing and Account Services,
Compliance and Administration of Tax Credit Programs (EITC and HCTC).
Pre-filing activities include taxpayer education and outreach, pre-
filing agreements and tax publication issuance and distribution. Filing
and Account Services activities include the filing of tax returns,
current account status and processing of taxpayer information.
Compliance activities include document matching, audits, and criminal
investigation activities. Administration of the Tax Credit programs
includes EITC pre-filing, filing and account services, and compliance
activities and HCTC health insurance tax credit program activities.
Revenue and Refund Trend Information:
Federal tax revenues are collected through six major classifications:
individual income, corporate income, excise taxes, estate and gift
taxes, railroad retirement, and Federal unemployment taxes. Overall
revenue receipts ($2.267 trillion) for FY 2005 increased by
approximately 12% from FY2004 to FY2005. Individual income taxes, which
include both FICA and SECA taxes, increased by 10%. Corporate income
taxes increased by 33%. Collections from all other tax sources
increased 3% from FY2004 to FY2005.
Gross combined individual income tax and employment tax withholding
increased as wages and salaries grew. Gross combined individual non-
withheld and SECA receipts increased due to the increase in final
payments on calendar year 2004 liabilities. Contributing factors
include the higher 2004 incomes, lower 2004 deductions and a higher
effective tax rate on 2004 taxable income reported in Fiscal Year 2005.
Net corporate receipts increased due to the growth in gross corporate
tax receipts and the decrease in refunds. Net IRS excise tax receipts
increased in line with the expansion of the economy.
Federal tax refund activity, which includes tax, interest, payments for
Earned Income Tax Credit and Child Care Tax Credit in excess of the tax
liability was $267 billion. In fiscal year 2005, the Service issued $62
million in advance payments of the Earned Income Tax Credit. Overall
refund disbursements decreased by 4%u from FY2004 to FY2005.
Analysis of Unpaid Assessments Most Unpaid Assessments Are Not
Receivables and Are Largely Uncollectible:
This unpaid assessment balance represents assessments resulting from
taxpayers filing returns without sufficient payment; as well as from
the Service's enforcement programs such as Examination, Underreporter,
Substitute for Return and Combined Annual Wage Reporting. As reflected
in the supplemental information to the IRS' fiscal year 2005 Financial
Statements, the unpaid assessment balance was about $230 billion as of
September 30, 2005.
Under federal accounting standards, unpaid assessments require taxpayer
or court agreement to be considered federal taxes receivable.
Assessments not agreed to by taxpayers or the courts are considered
compliance assessments and are not considered federal taxes receivable.
Assessments considered to have no future collection potential are
called write-offs.
Components of the IRS' $230 Billion of Unpaid Assessments:
[See PDF for image]
[End of figure]
Of the $230 billion balance of unpaid assessments, $98 billion
represents write-offs. Write-offs include amounts owed by defunct
corporations with no assets and include many failed financial
institutions assisted by the Resolution Trust Corporation (RTC) and the
Federal Deposit Insurance Corporation (FDIC). The remaining amounts are
owed by taxpayers with extreme economic and/or financial hardships,
deceased taxpayers, and taxpayers who are insolvent due to bankruptcy.
Write-offs at September 30, 2005 ($98 billion) decreased about 15% from
September 30, 2004 ($115 billion) due primarily to the expiration of
the statute for collections on amounts owed by defunct corporations and
failed financial institutions. In FY2005, statutes expired for $21
billion of failed financial institution unpaid assessment accounts
assisted by the RTC and the FDIC.
Components of the IRS' $98 Billion of Write-offs:
[See PDF for image]
[End of figure]
The $44 billion of the unpaid assessments representing compliance
assessment are amounts that have not been agreed to by either the
taxpayer or a court. These assessments result primarily from various
Service enforcement programs promoting voluntary compliance. Due to the
lack of agreement, they have less potential for future collection than
the unpaid assessments considered federal taxes receivable.
The remaining $88 billion of unpaid assessments represent federal taxes
receivable. About $67 billion (76%) of this balance is estimated to be
uncollectible due primarily to the taxpayer's economic situation,
including individual taxpayers who are unemployed, are currently in
bankruptcy or have other financial problems. However, under certain
conditions, the IRS may continue collection actions for 10 years after
the assessment. Thus, these accounts may still ultimately have some
collection potential if the taxpayer's economic condition improves.
About $21 billion (24%) of federal taxes receivable is estimated to be
collectible. Components of the collectible balance include installment
agreements with estates and individuals, confirmed payment plans
through bankruptcy and some newer amounts due from individuals and
businesses with a history of compliance. The taxes receivable amount
from September 30, 2004 ($89 billion) to September 30, 2005 ($88
billion) decreased by $1 billion. The percent estimated to be
collectible at September 30, 2005 (24%), increased from September 30,
2004 (22%).
Components of the IRS' $88 Billion of Taxes Receivable:
[See PDF for image]
[End of figure]
It is important to note that the unpaid assessment balance contains
unpaid assessed tax, penalty, and interest and accrued penalty and
interest computed through September 30, 2005.
About $136 billion (59%) of the unpaid assessment balance as of
September 30, 2005, consists of interest and penalties and is largely
uncollectible.
Unpaid Taxes and Interest and Penalty Components of $230 Billion in
Unpaid Assessments:
[See PDF for image]
[End of figure]
Interest and penalties are such a high percentage of the balance of
unpaid assessments because the IRS must continue to accrue them through
the 10-year statutory collection date, regardless of whether an account
meets the criteria for financial statement recognition or has any
collection potential. For example, interest and penalties continue to
accrue on write-offs, such as FDIC and RTC cases, and on exam
assessments where taxpayers have not agreed to the amount assessed. The
overall decrease in unpaid assessments during fiscal year 2005 was
mostly attributable to expiration of the statute for collections on
amounts owed by failed financial institutions assisted by the RTC and
the FDIC.
FY 2005 Management Discussion and Analysis:
ADDENDUM: President's Management Agenda Scorecard:
The IRS made steady progress on the President's Management Agenda (PMA)
this year, earning "Green" in progress and status on Competitive
Sourcing, and "Green" in progress on Human Capital and Budget and
Performance Integration. The IRS adjusted its "getting to green plans"
to reflect the new "proud to be" criteria to achieve these goals during
2005. In FY 2005, Eliminating Improper Payments became a separate
initiative in the President's Management Agenda. Eliminating Improper
Payments is geared toward reducing erroneous payments in the Earned
Income Tax Credit (EITC) program. EITC is a refundable Federal income
tax credit for low-income working individuals and families and is the
IRS' only program impacted by the Improper Payments and Information Act
of 2002 (IPIA).
IPIA requires agencies to annually review programs and activities to
identify those susceptible to significant erroneous payments. Under
implementing OMB guidance, "Significant" means the estimated error rate
and dollar amount exceed the threshold of 2.5% of program payments and
$10 million. Once agencies identify high-risk programs, a method for
systematically reviewing them is developed using statistically valid
sampling to determine error rates. If those rates, when applied to
total program funding, result in a level of improper payments greater
than or equal to $10 million, then an action plan is developed for
resolving identified problems and reducing errors.
The table below summarizes OMB's scorecard for Treasury for FY 2005.
[See PDF for image]
[End of figure]
FY 2005 Management Discussion and Analysis:
Major Accomplishments and Future Plans:
Human Capital:
Accomplished:
* Drafted for implementation, pending the IRS Oversight Board approval,
the 2005-2009 Human Capital Strategic Plan, which will serve as primary
guidance for strategic management of human capital in the IRS.
* Continued workforce restructuring and transition initiatives to
achieve optimum mix of skills and optimum ratio of employees in Mission
Critical Occupations (MCOs) that directly support tax processing,
administration and compliance to non-MCO employees.
* Refined MCO competency models to improve ability to field a high-
performing workforce; incorporated results into recruitment marketing;
and used results to evaluate competency of MCO applicants.
* Implemented automated recruitment solution CareerConnector for
external hiring of selected MCOs enabling the IRS to meet, for certain
vacancies, OPM-recommended 45 day standard for filling vacancies.
* Improved talent pool of external MCO hires and provided management
greater flexibility to select most qualified candidates through
expanded use of category ratings and simulated job situation
assessments.
* Partnered with OPM's Go Learn initiative to implement web-based
Enterprise Learning Management System that managers, employees, and the
Learning & Education community will use to manage training and
development.
* Launched comprehensive leadership succession planning initiative-
first phase of initiative included assessment of 103 executives
Servicewide to measure and benchmark competency strengths and
weaknesses.
* Implemented human capital governance structure to address issues
resulting from large-scale human capital initiatives and to ensure fair
treatment of impacted employees.
* Executed new recruitment marketing contract, maintained active media
campaign, produced new multi-media job previews, updated the IRS
careers website and continued fostering partnering relationships with
over 200 colleges and universities.
* Used all available tools (e.g., early outs, buyouts) and developed
new tools (e.g., relocation bonuses) to support and mitigate impacts of
workforce restructuring.
* Developed, at direction of the Chief Human Capital Officer, HCO
Concept of Operations that articulates HCO's vision, mission, values,
role, responsibilities and Lines of Business.
* Executed Service Level Agreements with internal customers describing
services HCO will provide, HCO and customer commitments and measurement
of HCO performance.
Planned:
* Develop Human Capital Strategic Implementation Plan to include
significant human capital programs that will implement IRS' Human
Capital Strategic Plan over the next two years and provide
accountability for program performance.
* Continue study of leadership development training to ensure training
provides leadership with skills and knowledge needed to be effective in
today's environment, focusing on curriculum and content delivery,
attracting employees with high leadership potential, and building a
supportive learning environment.
* Deploy a Learning Content Management System that will permit more
efficient development of training materials and ensure more consistency
in training across the IRS.
* Complete the conversion of all MCO application processes to the
CareerConnector system and begin the conversion of the non-MCO
occupations.
Competitive Sourcing:
Accomplished:
* Received the 2004 President's Quality Award for Innovation in
Competitive Sourcing (CS).
* Recognized in March 2005 with the 2004 NISH organization's Government
Award for Services for Service-wide Mail and Toll Free Forms Taxpayer
virtual call center contracts issued under the Javits-Wagner-O'Day Act
providing work opportunities for disabled individuals including first
time home-based employment for people with disabilities.
* Implemented National Distribution Center (NDC) competitive sourcing
initiative enabling the IRS to cancel leases releasing approximately
395,000 square feet and reducing rent by $4.1 million.
* Launched Competitive Sourcing Internet knowledge sharing content at
www.irs.gov and Share A-76.
* Developed "Managing an Effective Competitive Sourcing Program" DVD
training sponsored by the Federal Acquisition Institute.
* Completed 2005 FAIR Act Inventory for all of Treasury on schedule.
* Implemented Microsoft Project Server enhancing project management
discipline across all support functions-HR, Procurement, Business
Divisions, etc.
* Implemented virtual team rooms using SharePoint software improving
team knowledge sharing through secure shared document creation and
version control.
* Participated in the HR Connect System walkthrough activity leading to
the use of HR Connect for FY 2006 FAIR Act inventory.
* Awarded Campus Files competition to IRS employees who were deemed
Most Efficient Organization (MEO).
* Awarded Building Designation contract to private contractor.
Planned:
* Conduct Preliminary Planning on Seat Management and Fuel Compliance.
* Continue Business Case Analysis (BCA): Real Estate and Facilities
Management.
* Announce Solicitation: Logistics.
* Develop Learning and Education Business Process Re-engineering
design.
* Implement approved Shared Services recommendations.
* Lead the development of the second Competitive Sourcing Training DVD.
* Brief the Strategy and Resource Council on proposed potential CS
projects to begin BCA planning schedules.
* Capture baseline costing in COMPARE and verify projected economic
savings.
* Continue Expert Contractor Delivery of Competitive Sourcing Training
(all phases) to IRS employees and managers.
Budget & Performance Integration:
Accomplished:
* Improved Program Assessment Rating Tool (PART) rating to "Moderately
Effective" for Submission Processing Program.
* Received PART rating of "Moderately Effective" for Criminal
Investigation and Examination Programs.
* Used IFS cost module capabilities to capture cost data for FY 2005,
enabling the IRS to analyze direct expense data (labor, supplies,
travel, etc), FTEs and on-rolls data from the lowest cost center.
* Completed allocation to distribute support costs to the operational
business units.
* Improved performance and efficiency for over half of IRS programs.
* Included programmatic long-term goals in FY 2007 budget submission.
* Developed draft set of strategic long-term goals.
Planned:
* Reach agreement with the Administration and the Appropriators on the
structure of the FY 2007 budget request.
* Link resource needs with expected performance and long term goals in
the FY 2007 Congressional Justification.
* Continue to assess and use the cost data obtained through IFS to
further develop robust cost-based performance measures for major
programs.
* Continue efforts to identify long-term goals for Regulatory
Compliance and Research.
* Introduce enterprise-wide goals linking directly to the IRS Strategic
Plan.
* Expand the pay for performance system to frontline managers linking
performance results with salary increases.
* Develop FY 2008 congressional request linking resource needs with
expected performance and long term goals.
* Submit remaining programs to OMB for an initial PART assessment.
E-Government:
Accomplished:
* Processed over five million Free File returns in 2005, representing a
43% increase over the prior year.
* Expanded support of electronic filing of business forms by completing
agreements with New York and Georgia to link state registration
applications to the federal Internet Employer Identification Number
(EIN) application for a one-stop experience.
* Expanded electronic filing of additional business forms: 1120, 990,
and 94X series.
* Actively supported other e-gov initiatives, such as Business Gateway,
grants.gov, and GovBenefits.gov.
* Implemented an eCatalog (eCat) pilot program to begin an Integrated
Acquisition Environment which will use Contract Optimization and
Strategic Contracts as tools to incur savings.
* Identified IFS alternative from Line of Business Initiative to
implement as the IFS Go Forward Strategy.
* Completed the security certification and accreditation of its network
infrastructure general support systems making substantial progress in
improving the Federal Information System Management Act (FISMA)
compliance status of all IRS information systems.
* Developed General Support Systems (GSS) and Major Applications' Plans
of Actions and Milestones (PoAMs) to manage, monitor and track
corrective actions.
Planned:
* Ensure all GSS certification and accreditations and Major
Applications conform to IRS and National Institute of Standards and
Technology (NIST) standards.
* Develop and test an Enterprise Information Technology Contingency
(Disaster Recovery) Strategy.
* Monitor GSS and Major Applications' Plans of Actions and Milestones
quarterly for identified corrective actions.
* Participate in Business Gateway Advisory and Governance Boards to
come to agreement on scope and next steps for Business Gateway
components.
* Define high level resource requirements and timeline for the IFS Go
Forward Strategy.
* Ensure that all Non Major Applications attain NIST compliant
Certification and Accreditation.
Financial Performance:
Accomplished:
* Continued to meet Treasury's TIER 3-day close financial reporting
requirements.
* Achieved full operating capability for Release 1.0 of the Integrated
Financial System (IFS).
* Developed a Computer Security material weakness plan that addresses
deficiencies in access controls, rules of behavior, contingency
planning and disaster recovery, audit trails, training and
certification and accreditation.
* Maintained clean audit opinion on FY 2004 financial statements.
* Performed a cross-walk of the Interim Revenue Accounting Control
System (IRACS) to a compliant US Standard General Ledger (US SGL)
structure for year-end financial statements.
* Identified and assigned financial information executives need to
facilitate critical decision making.
* Continued implementation of NIST compliant training program.
* Conducted IFS Cost workshop to gather operational needs and establish
process for reports development August 2005.
Planned:
* Meet administrative financial statement reporting deadlines through
IFS.
* Complete IFS Milestone 5 and implement plan to transition from PRIME
to the IRS.
* Develop and test a new data base to store Trust Fund Recovery Penalty
(TFRP) and Unpaid Assessment data which will become the foundation of
the Custodial Detailed Data Base (CDDB) and the subsidiary ledger for
all unpaid assessments.
* Put the CDDB revenue transaction database into production and test
reports.
* Maintain current parallel processes and implement changes as needed
to ensure a clean audit opinion on the Statement of Custodial Activity.
* Identity systems that enable us to link cost to performance.
* Produce the automated Statement of Net Cost in IFS.
Eliminating Improper Payments:
Accomplished:
* Developed a detailed, long-term EITC business plan, a Concept of
Operations, based on a balanced approach.
* Developed an estimate of the overall EITC error rate.
* Completed FY 2004 qualifying child certification and Filing Status
test.
* Finalized new participant selection methodology for FY 2005
qualifying child certification test.
* Completed final report to Congress on results of FY 2004 qualifying
child certification and filing status tests.
* Evaluated research initiatives and assessed prior year studies to
improve EITC outreach, compliance initiatives, program delivery and
measurement strategies.
Planned:
* Launch the final phase of the qualifying child certification test-
focus on improved selection methodology.
* Complete compliance analysis of TY 2001 returns claiming EITC
(National Research Program).
* Continue to develop and distribute materials to educate taxpayers and
practitioners on EITC eligibility rules and compliance issues.
* Report results of the National Directory of New Hires database match
test.
* Plan for TY 2006 compliance study.
* Launch integrated decision support tool for EITC examiners.
* Launch new risk-based scoring strategy and inventory management
capability to improve selection and assignment of EITC returns for
examination.
* Complete evaluation of FY 2004 certification, filing status and
income misreporting tests.
* Test new selection tools to determine more effective compliance
treatments for return preparers.
* Complete evaluation of FY 2005 certification and filing status tests.
* Launch significantly enhanced methodology to improve the selection of
EITC amended returns for examination.
* Update EITC Strategy and Program plan and identity EITC education and
outreach targets based on results from FY 2004, FY 2005 and FY 2006
tests.
[End of Management Discussion and Analysis]
Financial Statements:
Balance Sheets:
Internal Revenue Service Balance Sheet As of September 30, 2005 and
2004:
(In Millions):
[See PDF for image]
[End of table]
Statements of Net Cost:
Internal Revenue Service Statements of Net Cost As of September 30,
2005 and 2004:
[See PDF for image]
[End of table]
The accompanying notes are an integral part of these statements.
Statement of Changes in Net Position:
Internal Revenue Service Statement of Changes in Net Position For the
Years Ended September 30, 2005 and 2004:
(In Millions):
[See PDF for image]
[End of table]
The accompanying notes are an integral part of these statements.
Statement of Budgetary Resources:
Internal Revenue Service Statement of Budgetary Resources For the Years
Ended September 30, 2005 and 2004:
(In Millions):
[See PDF for image]
[End of table]
The accompanying notes are an integral part of these statements.
Statement of Financing:
Internal Revenue Service Statement of Financing For the Years Ended
September 30, 2005 and 2004:
(In Millions):
[See PDF for image]
[End of table]
The accompanying notes are an integral part of these statements.
Statements of Custodial Activity:
Internal Revenue Service Statement of Custodial Activity For the Years
Ended September 30, 2005 and 2004:
(In Billions):
[See PDF for image]
[End of table]
The accompanying notes are an integral part of these statements.
Notes to the Financial Statements:
INTERNAL REVENUE SERVICE:
Notes to the Financial Statements For the Years Ended September 30,
2005 and 2004:
Note 1. Summary of Significant Accounting Policies:
A. Reporting Entity:
The Internal Revenue Service (the Service) is a bureau of the U.S.
Department of the Treasury (Treasury). The Service originated in 1862,
when Congress established the Office of the Commissioner of the
Internal Revenue. In 1952, the Bureau was reorganized by Congress and
became the Internal Revenue Service (IRS) in 1953.
Currently, the organization consists of:
* Four operating divisions -Wage and Investment (WAGE) addresses the
needs of taxpayers with wage and investment income only. Small Business
and Self-Employed (SBSE) serves self-employed individuals and small
businesses. Tax-Exempt and Government Entities (TEGE) supports employee
plans, tax exempt organizations, and government entities. Large and Mid-
Size Business (LMSB) serves corporations, sub-chapter S corporations,
and partnerships with assets greater than $5 million.
* Functional support-Appeals, Criminal Investigation, Taxpayer Advocate
and Chief Counsel are independent of the operating divisions and other
units of the Service. Taxpayer Advocate reports directly to Congress
and Chief Counsel reports to the Secretary of the Treasury.
* National Headquarters fills the role of setting broad policy,
providing executive oversight, reviewing plans and goals of the
operating units, and developing major improvement initiatives.
* Two cross-servicing organizations - Modernization and Information
Technology Services (NITS) and Agency Wide Shared Services (AW SS)
provide central support to all areas of the Service.
The mission of the Service is to provide America's taxpayers with top-
quality service by helping them understand and meet their tax
responsibilities and by applying the tax law with integrity and
fairness to all.
B. Basis of Accounting and Presentation:
The financial statements have been prepared from the accounting records
of the Service in conformity with accounting principles generally
accepted in the United States (GAAP) and the Office of Management and
Budget (OMB) Circular A-136, Financial Reporting Requirements.
Accounting principles generally accepted for federal entities are the
standards prescribed by the Federal Accounting Standards Advisory Board
(FASAB). FASAB is recognized by the American Institute of Certified
Public Accountants as the official accounting standards-setting body of
the Federal Government.
These financial statements are provided to meet the requirements of the
Government Management Reform Act of 1994. They consist of the Balance
Sheet, the Statement of Net Cost, the Statement of Changes in Net
Position, the Statement of Budgetary Resources, the Statement of
Financing, and the Statement of Custodial Activity. The statements and
the related notes are prepared in a comparative form to present both FY
2005 and FY 2004 information.
Balance Sheet, Statement of Changes in Net Position:
These statements are presented on the accrual basis of accounting.
Under the accrual method, revenues are recognized when earned, and
expenses are recognized when costs are incurred or goods or services
are received, without regard to receipt or payment of cash.
Statement of Net Cost:
This statement is presented on the accrual basis of accounting. The
Statement of Net Cost presents the costs incurred by the Service in
performing its mission, net of related exchange revenues. These costs
include direct costs, indirect costs assigned in a manner that reflects
direct consumption of resources, and a proportionate share of other
indirect costs.
Program costs are aggregated across divisional lines into broad-based
cost centers-pre-filing, filing, compliance and administration of tax
credit programs described below.
Pre-Filing Taxpayer Assistance and Education:
Provides services to taxpayers before returns are filed to assist
taxpayers in preparing correct returns. Primary activities include
interpretations, preparing and disseminating tax publications and
information, taxpayer education programs, researching customer needs,
pre-filing agreements and determinations, and initiatives to promote
electronic tax filing. Exchange revenues include user fees from the pre-
filing agreements and determinations, letter rulings, and enrolled
agent fees.
Filing and Account Services:
Performs accounts maintenance functions of processing tax returns,
recording tax payments, issuing refunds, and maintaining taxpayer
accounts. The scope extends to all tax returns and taxpayer accounts
regardless of type and method of filing. Program activities also
include providing field assistance in preparing tax returns and
supplying tax forms to the public. Exchange revenues include user fees
from photocopy services. Exchange revenues also include reimbursable
revenues from services provided to other federal agencies.
Compliance Services:
Administers compliance activities after a return is filed in order to
identify and correct possible errors or underpayments. This program
includes field collection activities, document matching, examination of
returns, criminal investigation, and tax litigation. Exchange revenues
include installment agreement fees and offers in compromise. Exchange
revenues also include reimbursable revenues from services provided to
other federal agencies.
Administration of Tax Credit Programs:
Administers the Earned Income Tax Credit (EITC) and Health Coverage Tax
Credit (HCTC) programs. EITC includes expanded customer service, public
outreach, enforcement, and research efforts to reduce claims and
erroneous filings associated with the program. EITC comprises pre-
filing, filing and account services, and compliance activities. EITC
payments actually refunded to individuals or credited against other tax
liabilities are not included in program costs. HCTC includes activities
focused on implementing the health insurance tax credit program set out
in the Trade Act of 2002.
Statement of Budgetary Resources:
The Statement of Budgetary Resources is presented using the budgetary
basis of accounting. Budgetary accounting facilitates compliance with
legal constraints and controls over the use of federal funds. This
financial statement is in addition to the reports prepared by the
Service throughout the year pursuant to OMB directives for purposes of
monitoring and controlling the Service's obligation and expenditure of
budgetary resources.
Statement of Financing:
The Statement of Financing is presented using both an accrual and a
budgetary basis of accounting as a means to facilitate understanding of
the differences between the two accounting bases.
Statement of Custodial Activity:
The Statement of Custodial Activity is presented on the modified cash
basis of accounting. This method initially reports revenue in the
financial statements on the cash basis, which is then adjusted by the
change in net federal taxes receivable --net of the change in refunds
payable --during the current fiscal year. This adjustment effectively
converts the cash basis revenue and refunds to a full accrual amount.
The related distribution of all such collections to the Treasury is
similarly reported on the cash basis. It is then adjusted to the
accrual basis by the net change during the fiscal year in uncollected
amounts due to Treasury.
Refunds of taxes and interest are reported on the cash basis. Refunds
include payments of earned income tax credits (EITC), health coverage
tax credits (HCTC), and child care credits, as well as overpayments of
taxes.
C. Financing Sources and Exchange Revenue:
The Service receives the majority of its funding through annual, multi-
year, and no-year appropriations that are available for use within
statutory limits for operating and capital expenditures. Appropriations
are recognized as financing sources when the related expenses are
incurred. The following are the different types of operating
appropriations:
Processing, Assistance, and Management:
This appropriation provides funds for processing tax returns and
related documents, assisting taxpayers in the filing of their returns
and in paying taxes that are due, strategic planning and oversight,
finance, human resources, and agency-wide shared services.
Tax Law Enforcement:
The purpose of this appropriation is to provide funds for the
enforcement of Internal Revenue Laws, examination of tax returns,
administration of taxpayer appeals, collection of unpaid accounts, and
securing unfiled tax returns and payments. It also provides for issuing
technical rulings, monitoring employee pension plans, qualifying exempt
organizations, examining exempt tax returns, and compiling statistics
of income and compliance research.
Information Systems:
This appropriation funds costs for data processing and information and
telecommunication support for the Service's activities, including
developmental information systems and operational information systems.
The operational systems are located in a variety of sites including the
Martinsburg Computing Center, the Detroit Computing Center, the
Tennessee Computing Center, and in field offices and service centers.
Other:
These budgetary accounts consist of an aggregate of smaller multi-
functional funds that support the Service's mission to collect the
proper amount of tax and provide improved customer service to the
taxpayer. The Business Systems Modernization (BSM) appropriation is the
largest of these funds and may be obligated as Congress approves
expenditure plans. The Health Insurance Tax Credit Administration
appropriation funds necessary expenses to implement the health
insurance tax credit and was included in the Trade Act of 2002.
In addition, the Service incurs certain costs that are paid in total or
in part by other federal entities, such as pension costs administered
by the Office of Personnel Management and legal judgments paid by the
Treasury Judgment Fund. These constitute subsidized costs and are
recognized by the Service on its Statement of Changes in Net Position
and Statement of Financing as imputed financing sources equal to the
cost paid by other federal entities. Pursuant to FASAB Interpretation
Number 6 of the Statement of Federal Financial Standards Number 4, in
fiscal year 2005, the Service began recording additional imputed
financing sources for costs that are paid in total or in part by other
entities within the Department of Treasury, notably Financial
Management Services for electronic funds transfers.
D. Fund Balance with Treasury:
The fund balance with Treasury is the aggregate amount of funds in the
Service's accounts, including appropriated funds, from which the
Service is authorized to make expenditures and pay liabilities, as well
as funds in deposit, suspense, and clearing accounts.
E. Other Assets - Accounts Receivable and Advances:
Intragovernmental accounts receivable consist of amounts due from
federal agencies. Accounts receivable are recorded, and reimbursable
revenues are recognized, as the services are performed and costs are
incurred. Accounts receivable are also recorded, and transfers-in are
recognized, when notices are received from official representatives of
the Treasury Forfeiture Fund (TFF) advising IRS of the amount and
availability of planned discretionary nonreciprocal distributions of
TFF assets to IRS. The allowance for uncollectible accounts is based on
an annual review of groups of accounts by age and includes accounts
receivable balances older than one year.
Advances to government agencies primarily represent funds paid to the
Treasury Working Capital Fund (WCF). Amounts in the fund are available
for expenses of operating and maintaining common administrative
services of Treasury that can be performed more economically as a
centralized service. Centralized services funded through the WCF for
the Service consist primarily of telecommunications services, payroll
processing, and depreciation of property and equipment owned by the
WCF.
The majority of advances to the public are for investigations and
employee travel advances, which are expensed upon receipt of employees'
expense reports.
F. Property and Equipment:
The net book values of Property and Equipment as of September 30, 2005
and 2004 consist of the following components:
Property and Equipment Acquisitions:
Property and equipment is recorded at historical cost. The Service
acquires property and equipment through direct purchase, construction,
development of software and systems, and through capital lease
agreements. Property and equipment consists of tangible assets and
software that are intended for use by the Service and have an estimated
life of two years or greater. Other than limited exceptions noted
below, property and equipment is capitalized regardless of acquisition
cost. The Service depreciates property and equipment on a straight line
basis with a half year depreciated in the first and final years.
Disposals are recorded when deemed material.
The Service classifies property and equipment into the following
classes: ADP equipment, non-ADP equipment, furniture, investigative
equipment, vehicles, major systems, internal use software, and
leasehold improvements.
ADP Equipment:
ADP Equipment consists of five types of equipment: 1) mainframe
computers and related equipment, 2) minicomputers and related
equipment, 3) local area network (LAN) servers and related equipment,
4) desktop and laptop computers and related equipment, and 5)
telecommunications equipment. ADP equipment includes all related
software, including commercial off-the-shelf software, except as
separately stated under Internal Use Software discussed below.
Mainframe computers and related equipment, minicomputers and related
equipment, and telecommunications equipment have an estimated useful
life of seven years. LAN servers and equipment have an estimated useful
life of four years. Desktop and laptop computers and related equipment
have an estimated useful life of three years.
Office Equipment and Furniture, Investigative Equipment, and Vehicles:
The Service capitalizes office equipment and furniture, investigative
equipment, and vehicles, with an individual-asset acquisition cost of
$5,000 or more. The estimated useful life of office equipment and
investigative equipment is ten years. Furniture has an estimated useful
life of eight years, and vehicles have an estimated useful life of five
years.
Major Systems:
Prior to FY 2001, the Service capitalized certain costs of large-scale
computer software systems as major systems. Subsequently, such costs
are included in internal use software. Only projects exceeding $20
million were considered major systems. Major systems capitalized prior
to September 30, 2000, had an estimated useful life of seven years, and
continue to be depreciated over their remaining useful lives.
Internal Use Software:
In accordance with Statement of Federal Financial Accounting Standards
No. 10 (SFFAS No. 10), Accounting for Internal Use Software, beginning
in FY 2001, the Service capitalizes all internal use software projects
recognized and authorized by management as major development projects.
Only projects with useful lives of two years or more and recognized as
major development projects by the Modernization and Information
Technology Services Executive Governance Council are capitalized.
The Service capitalizes direct and indirect costs of internal use
software incurred in the development phase of a project as defined in
the SFFAS No. 10. Direct costs include direct salaries and benefits of
IRS employees assigned to the projects, consultant fees, and
contracting costs. Related infrastructure and project management costs
are allocated to the projects. Direct costs exclude maintenance
contracts in effect at any time during development or thereafter.
The Service applies indirect overhead to internal use software projects
using a three-year average rate of overhead costs. The overhead rate is
applied only to salaries and benefits of IRS employees directly
assigned to the internal use software projects.
In accordance with SFFAS No. 10, costs incurred for the development
phase of a project are capitalized, while costs incurred for design
(prior to the development phase) and operations (after the development
phase) are expensed. The design phase, defined by Standard No. 10,
includes conceptual formulation of alternatives, determination and
testing of alternatives, determination of existence of needed
technology, and final selection of alternatives. The development phase
includes developing the software configuration and interfaces, coding,
installation of hardware and software, and testing. The operational
phase begins upon successful completion of testing.
Internal use software's capitalized costs are accumulated in work in
process until final acceptance and testing are successfully completed.
Once completed, the costs are transferred to depreciable property.
Internal use software has an estimated useful life of seven years with
no residual value, and is depreciated using the straight-line method
with a half-year convention in the fast and final years.
In accordance with SFFAS No. 10, disposals are recognized when software
is determined to be obsolete or nonfunctional. The IRS treats
terminated projects and/or subprojects as 100% obsolete. Obsolete
projects are adjusted to reduce both the asset and accumulated
depreciation accounts, and record any losses as a result of the
disposal.
Leasehold Improvements:
All leasehold improvement projects are capitalized regardless of cost.
Leasehold improvements have an estimated useful life often years.
G. Capital Lease Liability:
Capital lease liability includes amounts for non-ADP equipment and
computer software leased under software licensing agreements. The
liability reported represents the lesser of the net present value of
future lease payments or the fair market value of the asset acquired.
The liability for non-ADP equipment acquired under a capital lease is
included in funded liabilities. The liability for software licenses is
generally included in Liabilities Not Covered by Budgetary Resources.
H. Permanent and Indefinite Funds:
The Service uses a special class of funds, designated as "permanent and
indefinite", to disburse tax refund principal and related interest.
These permanent and indefinite funds are not subject to budgetary
ceilings set by Congress during the annual appropriation process.
Because Congress permanently funds tax refunds from a budgetary
standpoint, tax refunds payable at year-end are fully funded. The asset
"Due from Treasury" designates this approved funding to pay year-end
tax refund liabilities, which are reflected in the funds used for
refund of federal taxes on the Statement of Custodial Activity along
with tax refund payments for the year.
Although funded through the appropriation process, refund activity is
reported as a custodial activity of the Service. This presentation is
appropriate because refunds are, in substance, a custodial revenue-
related activity. Federal tax revenue received from taxpayers is not
available for use in the operation of the Service and is not reported
on the Statement of Net Cost. Likewise, the resultant refunds of
overpayments are not available for use by the Service in operations.
Consequently, to present refunds as an expense of the Service on the
Statement of Net Cost with related appropriations used would be
inconsistent with the reporting of the related federal tax revenue and
would materially distort the costs incurred by the Service in meeting
its strategic objectives.
I. Tax Assessments and Abatements:
Under the Internal Revenue Code 26 USC Section 6201, the Secretary of
the Treasury is authorized and required to make inquiries,
determinations, and assessments of all taxes that have been imposed and
accruing under any internal revenue law but have not been duly paid
(including interest, additions to the tax, and assessable penalties).
The Secretary has delegated this authority to the Commissioner of the
IRS. Unpaid assessments result from taxpayers filing returns without
sufficient payments, as well as from the Service's enforcement
programs, such as examination, under-reporter, substitute for return,
and combined annual wage reporting.
The Commissioner of the IRS also has authority to abate the paid or
unpaid portion of an assessed tax, interest, and penalty. Abatements
occur for a number of reasons and are a normal part of the tax
administration process (abatements may be allowed for a qualifying
corporation that claimed a net operating loss which created a credit
that can be carved back to reduce a prior year's tax liability, amend
tax returns, and to correct an assessment from an enforcement program,
taxes discharged in bankruptcy, accepted offers in compromise, penalty
abatements for reasonable cause, contested assessments made due to
mathematical or clerical errors, and assessments contested after the
liability has been satisfied). Abatements may result in claims for
refunds or a reduction of the unpaid assessed amount.
J. Federal Taxes Receivable:
Federal taxes receivable and the corresponding liability, "Due to
Treasury", are not accrued until related tax returns are filed or
assessments made by IRS and agreed to by either the taxpayer or the
court and prepayments netted against liabilities. Accruals are made to
reflect penalties and interest on taxes receivable through the balance
sheet date.
Taxes receivable consist of unpaid assessments (taxes and associated
penalties and interest) due from taxpayers for which the Service can
support the existence of a receivable through taxpayer agreement, such
as filing of a tax return without sufficient payment, or a court ruling
in favor of the Service. Taxes receivable are shown on the balance
sheet net of an allowance for doubtful accounts. The allowance for
doubtful accounts reflects an estimate of the portion of total taxes
receivable deemed to be uncollectible.
Compliance assessments are unpaid assessments for which neither the
taxpayer nor a court has affirmed that the taxpayer owes amounts to the
Federal Government. Examples include assessments resulting from an IRS
audit or examination in which the taxpayer does not agree with the
results. These amounts are not reported on the balance sheet; however,
statutory provisions require that these accounts be maintained until
the statute for collection expires.
Write-offs consist of unpaid assessments for which the Service does not
expect further collections due to factors such as taxpayers'
bankruptcy, insolvency, or death. These amounts are also not reported
on the balance sheet; however, statutory provisions require that these
accounts be maintained until the statute for collection expires.
Note 2. Fund Balance with Treasury (In Millions):
Fund balance with Treasury as of September 30, 2005 and 2004, consist
of the following:
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[End of table]
The Business Systems Modernization (BSM) fund represents $297 million
and $340 million of the appropriated fund balance as of September 30,
2005 and 2004, respectively. BSM funds can only be obligated pursuant
to an expenditure plan approved by Congress. Other funds primarily
consist of suspense, deposit, and clearing funds.
Note 3. Cash and Other Monetary Assets (In Millions):
Cash and other monetary assets with the public as of September 30, 2005
and 2004, consist of the following:
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[End of table]
Imprest funds are maintained by Headquarters and field offices in
commercial bank accounts.
Other custodial assets primarily represent voluntary deposits received
from taxpayers, pending application of the funds to unpaid tax
assessments. This category also includes seized monies of less than $1
million as of September 30, 2005 and $1 million as of September 30,
2004, which are held pending the results of criminal investigations. As
described in Note 13, other custodial assets are classified as "Non-
entity Assets" and are offset by an equal liability in other custodial
liabilities.
Note 4. Other Assets (In Millions):
Other assets as of September 30, 2005 and 2004, consist of the
following:
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[End of table]
Note 5: Federal Taxes Receivable, Net:
Federal taxes receivable (gross) were $88 billion and $89 billion as of
September 30, 2005 and 2004, respectively, and consisted of tax
assessments, penalties, and interest that were not paid or abated, and
which were agreed to by the taxpayer and the Service, or upheld by the
courts.
Federal taxes receivable (net) equaled $21 billion and $20 billion as
of September 30, 2005 and 2004, respectively, and are the portion of
federal taxes receivable (gross) estimated to be collectible. It is
based on projections of collectibility from a statistical sample of
taxes receivable. An allowance for doubtful accounts of $67 billion and
$69 billion was established in FY 2005 and FY 2004, respectively, for
the difference between the gross federal taxes receivable and the
portion estimated to be collectible. Due to Treasury is the offsetting
liability to federal taxes receivable, representing amounts to be
transferred to Treasury when collected.
Note 6. Property and Equipment (In Millions):
Property and Equipment as of September 30, 2005 and 2004, is shown in
the schedule below. The Cost column primarily represents the actual
cost of property and equipment, net of disposals. The cost basis for FY
2005 and FY 2004 is $3,502 million and $3,422 million, respectively.
Accumulated depreciation for FY 2005 and FY 2004 is $2,080 million and
$1,647 million, respectively.
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[End of table]
Prior to FY 2001, the Service captured the costs of major systems
consulting and contractual services in the category "Major Systems".
The Service has ten systems it considers major systems as of September
30, 2005 and 2004. As of September 30, 2005, major systems consisted
largely of costs associated with re-engineering the Martinsburg and
Tennessee Computing Centers, known as the Mainframe Consolidation
project, and a system to convert paper tax documents and remittances
into electronic records, known as the Integrated Submission and
Remittance Processing System.
Major systems consist of the following:
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[End of table]
After FY 2000, the Service captured development of major systems as
Internal Use Software. As of September 30, 2005 and 2004, the Service
has 15 internal use software projects, including deployed and work in
process. Several projects are being deployed in phases (releases) as
those releases become functional and are placed into service. Deployed
projects include Customer Account Data Engine (Release 1), E-Services,
Modernized E-File (Releases 1, 2, and 3.1), Security and Technology
Infrastructure Release (STIR), Integrated Financial System (IFS),
Internet Refund Fact of Filing, Enterprise Systems Management (ESM),
and Customer Communications. CADE is a project to replace the Service's
master file for taxpayer accounts. E-Services is a project to develop
web-based products and services to communicate with the public and
expand electronic filing of returns and requests. Modernized E-File is
an electronic filing system for corporate tax returns. STIR is a
project to modernize and standardize the information technology
security infrastructure throughout the Service. IFS is an
administrative financial system that was deployed at the start of
fiscal year 2005. Internet Refund Fact of Filing is a project to allow
taxpayers to review the status of their refund. ESM is a project that
created a new information technology infrastructure, and Customer
Communications is a customer service telephone system.
Deployed internal use software projects consist of the following:
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[End of table]
Until deployed, internal use software projects are carried as work in
process. Major projects in process include Customer Account Data Engine
(Release 2) (CADE Release 2) and Modernized E-File Release 3.2. All
development work on Custodial Accounting Project (CAP), a project that
was in work in process, was stopped in fiscal year 2005 due to funding
issues. The costs accumulated in work in process for CAP were $143
million when the project ended. These costs have been recognized as a
loss on disposal in the current fiscal year.
The costs of internal use software - work in process consist of the
following:
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[End of table]
Equipment and software licenses acquired through capital leases are
included in the categories below. Disclosures concerning associated
capital lease liabilities are provided in Notes 7 and 8.
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[End of table]
Note 7. Other Liabilities (In Millions):
Other liabilities as of September 30, 2005 and 2004, consist of the
following:
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[End of table]
Other custodial liabilities (the offsetting liability to other
custodial assets) primarily consist of liabilities to taxpayers for
deposits pending application of the funds to outstanding tax
deficiencies and liability for seized monies.
Note 8. Leases (In Millions):
The capital lease liability as of September 30, 2005 and 2004, is $26
million and $52 million, respectively, for photocopiers and software
licenses. In FY 2005 and FY 2004, photocopiers were leased under Lease-
To-Ownership-Plans (LTOPs). The terms of the LTOPs provide for 48 to 60
monthly payments for photocopiers. Under each LTOP, the equipment is
owned as of the last monthly payment. Capital lease treatment is
accorded to computer software leased under software licensing
agreements. These licensing agreements provide for payments over
periods ranging from four to six years. During 2005, final payments
were made on two leases for software licenses. In FY 2005, ADP
Equipment was acquired under a 48 month capital lease, with payments in
the fast and second year of the agreement. The ADP equipment will be
returned to the vendor after the end of the 48 months. Interest rates
for capital leases range from 6 to 15 percent.
Future payments due on capital leases are as follows:
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[End of table]
The Service leases office space, vehicles and equipment under annual
operating leases. These leases are cancelable or renewable on an annual
basis at the option of the Service. They do not impose binding
commitments on the Service for future rental payments on leases with
terms longer than one year.
Note 9. Contingencies:
The Service is subject to contingent liabilities involving litigation
cases whose ultimate disposition is unknown. Based on the information
currently available, however, it is management's opinion that the
expected outcome of these matters, either individually or in the
aggregate, will not have a material effect on the financial statements.
As of September 30, 2005, the Service does not have contractual
commitments for payments on obligations related to canceled
appropriations.
Note 10. Liabilities Not Covered by Budgetary Resources (In Millions):
Liabilities not covered by budgetary resources as of September 30, 2005
and 2004, consist of the following:
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[End of table]
Note 11. Appropriations Received:
Appropriations received reported in the Statement of Budgetary
Resources in FY 2005 and FY 2004, include $90 million and $84 million,
respectively, in user fees received from the public for services
provided and retained by the agency to reduce its net cost of
operations.
Note 12. Obligated Balances (In Millions):
Obligated balances as of September 30, 2005 and 2004, in the Statement
of Budgetary Resources are as follows:
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[End of table]
Note 13. Nonentity Assets (In Millions):
Nonentity assets arise from the Service's custodial duty to collect
taxes, disburse tax refunds and maintain proper accounting for these
activities in the books and records of the Service. Nonentity assets as
of September 30, 2005 and 2004, consist of the following:
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[End of table]
Due from Treasury represents tax refunds due to taxpayers but not
disbursed as of September 30, 2005 and 2004.
Federal taxes receivable are transferred to Treasury upon receipt. An
amount equal to federal taxes receivable has been recognized as an
offsetting intragovernmental liability-Due to Treasury. Federal taxes
receivable is described in more detail in Note 5.
Other custodial assets, also discussed in Note 3, primarily relate to
seized monies and the deposits received from taxpayers, pending
application of the funds to unpaid tax assessments.
Note 14. Comparison of Statement of Budgetary Resources and the
President's Budget (In Millions):
Statement of Federal Financial Accounting Standards No. 7, Accounting
for Revenue and Other Financing Sources and Concepts for Reconciling
Budgetary and Financial Accounting, calls for explanations of material
differences between budgetary resources available, status of those
resources and outlays as presented in the Statement of Budgetary
Resources (SBR) to the related actual balances published in the Budget
of the United States Government. However, the Budget of the United
States Government that will include FY 2005 actual budgetary execution
information has not yet been published. The Budget of the United States
Government is scheduled for publication in January 2006. Accordingly,
information required for such disclosure is not available at the time
of publication of these financial statements.
Balances reported in the FY 2004 Statement of Budgetary Resources and
the related President's Budget are shown in the following table for
each of the major appropriations and the Business Systems Modernization
fund. The table does not include other minor appropriations.
[See PDF for image]
[End of table]
There are significant differences between the SBR and the President's
Budget, which are attributable to differing Treasury and OMB
requirements. The differences are primarily due to expired and
unexpired appropriations: the SBR includes both unexpired and expired
appropriations, while the President's Budget discloses only unexpired
budgetary resources that are available for new obligations. Outlays are
reported the same in both statements.
Note 15.
Collections of Federal Tax Revenue (In Billions):
The Service transfers total tax collections to the U.S. Treasury.
Collection activity, by financial statement line item for the fiscal
years ended September 30, 2005 and 2004, and by tax year for fiscal
year ended September 30, 2005, is as follows:
[See PDF for image]
* Includes other collections of $574 million.
** Includes tax year 2006 corporate income tax receipts of $9 billion.
[End of table]
In FY 2005, Individual income, FICA/SECA, and other taxes include $68
billion in payroll taxes collected from other federal agencies. Of this
amount, $11 billion represents the portion paid by the employers.
Note 16. Federal Tax Refund Activity (In Billions):
Refund activity, broken out similarly to collection activity by
financial statement line item for the fiscal years ended September 30,
2005 and 2004, and by tax year for fiscal year ended September 30,
2005, is as follows:
[See PDF for image]
[End of table]
Individual income, FICA/SECA, and other refund amounts include EITC and
child tax credit refunds.
Note 17.
Net Cost By Budget Functional Classification (In Millions):
Gross cost and earned revenue for the Service are classified under the
budget functional classification of General Government under the
President's Budget. Gross cost and earned revenue are categorized as
follows:
[See PDF for image]
[End of table]
Note 18. Obligations Incurred:
Each fiscal year, the Office of Management and Budget apportions the
Service's budgetary resources under apportionment Category B by
activities and/or projects. In FY 2005, the Service incurred:
$10,429 million in obligations funded by direct appropriations and $155
million funded by reimbursable revenue and transfers from the Treasury
Asset Forfeiture Fund. In FY 2004, the Service incurred $10,256 million
in obligations funded by direct appropriations and $165 million funded
by reimbursable revenue and transfers from the Treasury Asset
Forfeiture Fund.
Note 19. Spending Authority from Offsetting Collections (In Millions):
Spending authority from offsetting collections as of September 30, 2005
and 2004, in the Statements of Budgetary Resources and Financing is as
follows:
[See PDF for image]
[End of table]
[End of Financial Statements]
Supplemental Information:
INTERNAL REVENUE SERVICE:
Supplemental Information - Unaudited For the Years Ended September 30,
2005 and 2004:
Statement of Net Cost by Responsibility Segment (In Millions):
[See PDF for image]
[End of table]
Other Claims for Refunds:
Management has estimated amounts that may be paid out as other claims
for tax refunds. This estimate represents an amount (principal and
interest) that may be paid for claims pending judicial review by the
Federal courts or, internally, by Appeals. In FY 2005, the total
estimated payout (including principal and interest) for claims pending
judicial review by the Federal courts is $11.9 billion and by Appeals
is $11.1 billion. In FY 2004, the total estimated payout (including
principal and interest) for claims pending judicial review by the
Federal courts was $1.7 billion and by Appeals was $6.7 billion.
Although these refund claims have been deemed to be probable, they do
not meet the criteria in SFFAS No. 5 for reporting the amounts in the
balance sheet or for disclosure in the notes to the financial
statements; however, they meet the criteria in SFFAS No. 7 for
inclusion as supplemental information. To the extent judgments against
the government in these cases prompt other similarly situated taxpayers
to file similar refund claims, these amounts could become significantly
greater.
Federal Taxes Receivable, Net (In Billions):
In accordance with SFFAS No. 7, some unpaid assessments do not meet the
criteria for financial statement recognition as discussed in Note 1 to
the financial statements. Although compliance assessments and write-
offs are not considered receivables under federal accounting standards,
they represent legally enforceable claims of the IRS acting on behalf
of the federal government. There is, however, a significant difference
in the collection potential of these categories.
The components of the total unpaid assessments and derivation of net
federal taxes receivable as of September 30, 2005 and 2004, were as
follows:
[See PDF for image]
[End of table]
The Service cannot reasonably estimate the amount of allowance for
doubtful accounts pertaining to its compliance assessments, and thus
cannot determine their net realizable value or the value of the pre-
assessment work-in-process.
To eliminate double-counting, the compliance assessments reported above
exclude trust fund recovery penalties, totaling $13 billion as of both
September 30, 2005 and 2004, that were assessed against officers and
directors of businesses who were involved in the non-remittance of
federal taxes withheld from their employees. The related unpaid
assessments of those businesses are reported as taxes receivable or
write-offs, but the Service may also recover portions of those
businesses' unpaid assessments from any and all individual officers and
directors against whom a trust fund recovery penalty is assessed.
Earned Income Tax Credit:
The EITC is a special credit for employed taxpayers whose earnings fall
below the established allowance ceiling. In FY 2005, the Service issued
$35 billion in EITC refunds. In FY 2004, the Service issued $33 billion
in EITC refunds. An additional $5.3 billion and $5.2 billion of the
EITC was applied to reduce taxpayer liability for FY 2005 and FY 2004,
respectively.
Intra-Governmental Assets (In Millions):
[See PDF for image]
[End of table]
Intra-Governmental Liabilities (In Millions):
[See PDF for image]
[End of table]
Schedule of Budgetary Resources by Major Budget Accounts (In Millions):
Fiscal Year 2005:
[See PDF for image]
[End of table]
Fiscal Year 2004:
[See PDF for image]
[End of table]
Child Tax Credit:
The child tax credit was originally authorized by the Taxpayer Relief
Act of 1997 (Public Law 105-34). The child tax credit is a special
credit for taxpayers who work, whose earnings fall below the
established allowance ceiling, and who have a qualifying child. In FY
2005, the Service issued $15 billion in child tax credit refunds. An
additional $32 billion of child tax credits were applied to reduce
taxpayer liability. In FY 2004, the Service issued $9 billion in child
tax credit refunds. An additional $23 billion of child tax credits were
applied to reduce taxpayer liability.
Tax Gap:
The tax gap is the aggregate amount of tax (i.e., excluding interest
and penalties) that is imposed by the tax laws for any given tax year
but is not paid voluntarily and timely. The Service currently projects
that the annual Federal gross tax gap is somewhere between $312 billion
and $353 billion. This estimate is based on the preliminary results of
the National Research Program (NPR). The NPR was a study conducted to
measure the compliance rate of individual filers based on examination
of a statistical sample of their filed returns for tax year 2001. The
tax gap arises from three types of noncompliance: not filing timely tax
returns (the nonfiling gap), underreporting the correct amount of tax
on timely-filed returns (the underreporting gap), and not paying on
time the full amount reported on timely-filed returns (the underpayment
gap). Of these three components, only the underpayment gap is observed;
the nonfiling gap and the underreporting gap must be estimated. Each
instance of noncompliance by a taxpayer contributes to the tax gap,
whether or not the IRS detects it, and whether or not the taxpayer is
even aware of the noncompliance. Some of the tax gap arises from
intentional (willful) noncompliance, and some arises from unintentional
mistakes. The tax gap does not include underpayments by corporate
taxpayers or include taxes that should have been paid on income from
the illegal sector of the economy.
Of the three components, underreporting of income tax, employment taxes
and other taxes represents about 80 percent of the tax gap. The single
largest sub-component of the underreporting involves individuals
understating their incomes, taking improper deductions, overstating
business expenses and erroneously claiming credits. Individual
underreporting represents about half of the total tax gap. Individual
income tax also accounts for about half of all tax liabilities.
The collection gap is the cumulative amount of assessed tax, penalties,
and interest that the Service expects to remain uncollectible. In
essence, it represents the difference between the total balance of
unpaid assessments and the net taxes receivable reported on the
Service's balance sheet. The tax gap and the collection gap are related
and overlapping concepts, but they have significant differences. The
collection gap is a cumulative balance sheet concept for a particular
point in time, while the tax gap is like an income statement item for a
single year. Moreover, the tax gap estimates include all noncompliance,
while the collection gap includes only amounts that have been assessed
(a small portion of all noncompliance).
Tax Burden and Tax Expenditures:
The Internal Revenue Code provides for progressive rates of tax,
whereby higher incomes are generally subject to higher rates of tax.
The graphs that follow present the latest available information on
income tax and adjusted gross income (AGI) for individuals by AGI level
and for corporations by size of assets. For individuals, the
information illustrates, in percentage terms, the tax burden borne by
varying AGI levels. For corporations, the information illustrates, in
percentage terms, the tax burden borne by these entities by various
sizes of their total assets. The graphs are only representative of more
detailed data and analysis available from the Statistics of Income
(SOI) office.
Total tax expenditures are the foregone federal revenue resulting from
deductions and credits provided in the Internal Revenue Code. Since tax
expenditures directly affect funds available from government
operations, decisions to forego federal revenue are as important as
decisions to spend federal revenue.
(All figures are estimates and based on samples provided by the
Statistics of Income (SOI) Office):
[See PDF for image]
[End of figure]
(All figures are estimates and based on samples provided by the
Statistics of Income (SOI) Office):
[See PDF for image]
[End of figure]
[End of Supplemental Information]
[End of section]
Appendixes:
Appendix I: Material Weaknesses, Reportable Conditions, and Compliance
Issues:
Material Weaknesses:
During our audits of the Internal Revenue Service's (IRS) fiscal years
2005 and 2004 financial statements, we continued to identify four
material weaknesses in internal controls. These material weaknesses
have given rise to significant management challenges that have (1)
impaired management's ability to prepare financial statements and other
financial information without extensive compensating procedures, (2)
limited the availability of reliable information to assist management
in effectively managing operations on an ongoing basis, (3) reduced
IRS's effectiveness in enforcing the Internal Revenue Code, (4)
resulted in errors in taxpayer accounts, (5) increased taxpayer burden,
and (6) reduced assurance that data processed by its information
systems are reliable and appropriately protected. The issues that we
have identified and discuss in this report relate to IRS's controls
over (1) financial reporting, (2) unpaid assessments, (3) federal tax
revenue and refunds, and (4) information security. We reported on each
of these issues last year[Footnote 15] and in prior audits. We
highlight these issues in the following sections. Less significant
matters involving IRS's system of internal controls and its operations
will be reported to IRS separately.
Financial Reporting:
In fiscal year 2005, as in prior years, IRS did not have financial
management systems adequate to enable it to accurately and timely
generate and report the information needed to both prepare financial
statements and manage operations on an ongoing basis. To overcome these
systemic deficiencies with respect to preparation of its annual
financial statements, IRS was compelled to employ extensive
compensating procedures that were costly and labor intensive. During
fiscal year 2005, IRS (1) did not have an adequate general ledger
system for financial reporting purposes, (2) could not determine and
report on the specific amount of revenue collected for each of several
of the federal government's largest revenue sources, and (3) did not
have timely and reliable cost information related to its activities and
programs. Although labor-intensive compensating procedures yielded
financial statements that were fairly stated as of September 30, 2005
and 2004, they do not afford real-time data needed to assist in
managing operations on a day-to-day basis, such as cost-based
performance information to assist in making or justifying resource
allocation decisions.
As we noted in last year's report,[Footnote 16] during fiscal year
2005, IRS's general ledger system was not supported by adequate audit
trails or integrated with its supporting records for material balances,
including federal tax revenue, federal tax refunds, taxes receivable,
and property and equipment (P&E). Because of these deficiencies, IRS's
general ledger system does not conform to the U.S. Government Standard
General Ledger (SGL) at the transaction level as required by the Core
Financial System Requirements of the Joint Financial Management
Improvement Program (JFMIP)[Footnote 17] or the requirements of the
Federal Financial Management Improvement Act of 1996 (FFMIA). Further,
IRS's use of two separate general ledgers, one to account for its tax
administration activities and another to capture the costs of
conducting those activities, greatly complicates efforts to measure the
cost of IRS's tax administration efforts. During fiscal year 2004, we
also reported that IRS's general ledger for its tax administration
activities did not use the standard federal accounting classification
structure, which is documented in the SGL. In fiscal year 2005, IRS
implemented an SGL crosswalk for its general ledger for tax
administration activities, and this has brought this general ledger
into conformance with the SGL classification structure at the account
level.
In November 2004, IRS implemented the first release of the Integrated
Financial System (IFS), which now serves as IRS's core administrative
financial management system. IRS expects that IFS will ultimately
provide it with an integrated financial management system to account
for and control resources. However, this will be achieved only with the
implementation of all four of the planned releases of IFS and its
integration with the financial management systems that account for its
tax administration activities. The major components of this first
release of IFS are accounts payable, accounts receivable, budget
formulation, budget execution, general ledger, financial reporting, and
cost accounting. The remaining future releases of IFS are planned to
include property management, procurement, a workload management system,
software and functional upgrades, and significant cost accounting
enhancements.
If successfully implemented as originally planned, and if integrated
with IRS's tax administration activities, IFS may enable IRS to address
many of its most long-standing financial management issues, such as the
inability to perform meaningful cost benefit analysis to support
decision making. However, IRS has indefinitely deferred future releases
of IFS due to funding constraints and pending resolution of issues
related to implementation of the first phase of IFS, such as ensuring
ongoing maintenance support. IRS also experienced technical
difficulties recording some types of transactions in IFS during fiscal
year 2005. In addition, implementing such a large and complex automated
financial system entails substantial learning for personnel responsible
for using the system, and this familiarization will take time to
accomplish. Consequently, while IRS has begun to see some of the
benefits of IFS, such as more readily accessible detailed transaction
information and improved audit trails for significant balances,
obstacles remain to be overcome before the full potential of the system
can be realized. In addition, to account for and report on over $2
trillion in annual tax-related transactions, IRS continues to rely on
legacy financial management systems that do not interface with IFS or
benefit from its implementation.[Footnote 18]
In prior years, we reported that IRS did not timely record taxes
receivable and the related balances due to Treasury in its general
ledger. During fiscal year 2005, IRS began calculating taxes receivable
on a monthly basis and reported the balances on its interim financial
statements. However, these amounts are derived through statistical
projections and do not reflect the total of actual transactions
throughout the year.[Footnote 19]
During fiscal year 2005, IRS continued to be unable to determine the
specific amount of revenue it actually collects for three of the
federal government's four largest revenue sources--Social Security,
hospital insurance, and individual income taxes. In addition, IRS
continued to be unable to determine, at the time payments are received,
collections for other trust funds that receive excise tax receipts,
such as the Highway Trust Fund. This is primarily because the
accounting information needed to validate the taxpayer's liability and
record the payment to the proper trust fund is provided on the tax
return, which is received months after the payment is submitted.
Further, the information on the tax return pertains only to the amount
of the tax liability, not how to distribute the amount previously
collected among the appropriate trust funds. IRS does not require
taxpayers to submit information identifying the type of tax at the time
of payment because it has taken the position that imposing such a
requirement would create an additional burden to those particular
taxpayers. In addition, IRS's systems cannot at present routinely
capture and report the information it does receive. IRS is working on
systems improvements to accommodate this type of information. However,
IRS will continue to be unable to timely report the specific amount of
revenue it actually collects for these large revenue sources until it
has the systems capability to record, and requires taxpayers to
provide, this information. This condition also makes the federal
government reliant on a complex, multistep process to distribute excise
taxes to the recipient trust funds that continues to be susceptible to
error.
Now that all federal agencies are required by OMB to meet a reporting
date of November 15, IRS's inability to timely report specific amounts
of excise tax revenue to recipient trust funds is even more significant
for these funds and their administrators. The annual excise tax
receipts reported by recipient trust funds now include 6 months of
estimated receipts. The trust funds must report 6 months of estimated
receipts because, under its existing processes, IRS takes 5 ½ months to
complete its certification of excise tax receipts and, therefore, does
not complete the certifications for the third and fourth quarters of
the fiscal year until after November 15. To the extent that these
estimates differ from the certified amounts, inaccurate distributions
to the trust funds could result and, in the case of the Highway Trust
Fund, allocations of revenues to states could be done
incorrectly.[Footnote 20] In July 2003, we made recommendations to IRS
for accelerating its certification process. In response to our
recommendations, IRS has performed precertifications for the past 2
years to determine the extent to which an acceleration of the process
would affect the amounts distributed to the trust funds. Our comparison
of the precertification and actual certification amounts for the
Highway Trust Fund and the Airport and Airway Trust Fund, which are the
two largest trust funds receiving excise tax distributions, showed that
over the past 2 years there was little difference between
precertification amounts and actual certification amounts.[Footnote 21]
This indicates that the certification timeline could be accelerated
without significantly affecting the accuracy of excise tax
distributions to these trust funds, thereby reducing reliance on
estimates and the inherent risk that actual collections will be
materially different.
During fiscal year 2004, we reported that IRS did not have a cost
accounting system (1) capable of accurately and timely tracking and
reporting the costs of IRS's programs and projects to assist it in
managing its costs and (2) meeting the JFMIP System Requirements for
Managerial Cost Accounting.[Footnote 22] During fiscal year 2005, IRS
implemented a cost accounting module as part of the first release of
IFS. Although this module has much potential and has begun accumulating
cost information, IRS management has not yet determined what the full
range of its cost information needs are or how best to utilize the
module's existing capabilities to serve those needs. IRS has also not
yet implemented a related workload management system intended to
improve IRS's ability to effectively manage its large workforce and to
provide the cost module with detailed labor cost information. In
addition, because the cost module was implemented in fiscal year 2005,
it does not yet contain the historical cost information needed to
support meaningful future estimates and projections. Consequently, IRS
cannot yet rely on this system as a significant planning and decision-
making tool. It will likely require several years and implementation of
additional components of IFS, such as the workload management system,
as well as integration with its tax administration activities, before
the full potential of IRS's cost accounting module will be realized. In
the interim, IRS decision making will continue to be hampered by a lack
of meaningful underlying cost information.
As a result of these financial reporting weaknesses, IRS was compelled
to expend far more time and effort to maintain its accounting records
and generate financial management information than would otherwise have
been necessary, and despite these monumental efforts, IRS continued to
lack reliable and timely financial information to assist in managing
operations throughout fiscal year 2005. Addressing the financial
reporting deficiencies discussed above would enhance this process by
providing management the reliable and timely information that it needs
to support informed decision making without having to resort to costly
and time-consuming procedures to compensate for information system
deficiencies.
Unpaid Tax Assessments:
During fiscal year 2005, we continued to find serious internal control
issues that affected IRS's management of unpaid assessments.
Specifically, we continued to find (1) IRS lacked a subsidiary ledger
for unpaid assessments that would allow it to produce accurate, useful,
and timely information with which to manage and report externally and
(2) errors and delays in recording taxpayer information, payments, and
other activities. These conditions continued to hinder IRS's ability to
effectively manage its unpaid assessments.[Footnote 23]
IRS's management of unpaid assessments is hindered by a lack of
effective supporting systems. IRS continues to lack a detailed listing,
or subsidiary ledger, that tracks and accumulates unpaid assessments
and their status on an ongoing basis. As a result, IRS must continue to
rely on a costly, labor-intensive manual compensating process for
external reporting. Specifically, to report balances for taxes
receivable and other unpaid assessments in its financial statements and
supplemental information, IRS must apply statistical sampling and
estimation techniques to data in its master files[Footnote 24] to
estimate the balances at year-end. While IRS continues to refine this
process, it continued to take several months to complete, required
adjustments totaling tens of billions of dollars, and produced amounts
that, after adjustments, were only reliable as of the last day of the
fiscal year. Consequently, this information is not useful for ongoing
management decisions. In addition, the lack of a subsidiary ledger
inhibits IRS's ability to timely develop reliable financial and
management reports and promptly identify and focus collection efforts
on accounts most likely to prove collectible.
IRS's management of unpaid assessments also continued to be hindered by
inaccurate tax records. We continued to find errors and omissions in
taxpayer records resulting from IRS's failure to accurately and timely
record information. Errors in IRS records can cause frustration to
taxpayers who either do not owe the debt or owe significantly lower
amounts.
For example, during our audit we found that IRS assessed over $2
million in penalties and interest against a business for failing to
provide a required supporting schedule along with its quarterly payroll
tax return. When IRS reviewed this case as part of the fiscal year 2005
financial audit process, it determined that the required schedule was
in fact attached to the return. However, IRS had sent out a notice of
taxes due to the business and, at the time of our testing, this amount
was recorded as a valid tax assessment in IRS's records. In another
example, IRS assessed over $48 million in interest against the estate
of a deceased taxpayer for tax year 2005. When IRS reviewed the case as
part of the fiscal year 2005 financial audit process, it determined
that the interest assessment should have been about $1 million.
However, as of September 30, 2005, IRS had not corrected this error on
the taxpayer's account.
Some input errors and posting delays can cost the government money. For
example, IRS erroneously abated[Footnote 25] the entire amount of a
$26,000 penalty assessment when only $6,000 of the assessment should
have been abated. When the taxpayer made a subsequent payment of
$20,000 to satisfy the tax liability, IRS erroneously refunded the
$20,000 to the business. IRS found this error as part of the fiscal
year 2005 financial audit process and was ultimately able to recover
this amount from the taxpayer.
As in prior years,[Footnote 26] the most prevalent errors we continued
to find involved IRS's failure to properly record payments to all
related taxpayer accounts associated with unpaid payroll
taxes.[Footnote 27] IRS's current systems continued to be unable to
automatically link each of the multiple assessments made for the one
tax liability. Consequently, if the business or an officer of that
business paid some or all of the outstanding taxes, IRS's systems were
unable to automatically reflect the payment as a reduction in the
amounts owed on any related accounts. Over the past several years, IRS
has taken several steps to compensate for the lack of an automated link
between related accounts. For example, IRS manually inputs a code in
each account that cross-references it to other related accounts. In
addition, in August 2001, IRS established new procedures to more
clearly link each penalty assessment against an officer to a specific
tax period[Footnote 28] of the business account. In July 2003, IRS also
began phasing in the use of an automated trust fund recovery penalty
system that is intended to properly cross-reference payments received
and thus eliminate the opportunity for errors that plague the current
manual process.
Although IRS is making improvements in its processes for recording
trust fund recovery penalties, our work in fiscal year 2005, as in
prior years, continued to find errors. In our testing of 80
statistically selected payments recorded on trust fund recovery penalty
accounts established since August 2001, we found 6 instances in which
IRS did not properly record payments received on all related taxpayer
accounts. Of these 6 payments, 5 were not properly recorded in all
related accounts even though the accounts contained the required cross-
referencing at the time that the payments were made. Based on our
testing, we estimate that 7.5 percent of trust fund recovery payment
transactions posted to accounts established since August 2001 and still
outstanding during fiscal year 2005 could contain
inaccuracies.[Footnote 29]
Although IRS has implemented a number of compensating procedures, the
ultimate solution to many of the issues related to IRS's management of
unpaid assessments, such as the lack of a subsidiary ledger and the
lack of an automated link between related accounts, continues to be the
successful modernization of IRS's systems.
Tax Revenue and Refunds:
During fiscal year 2005, we continued to find that IRS's controls were
not fully effective in maximizing the federal government's ability to
collect what is owed and in minimizing the risk of payment of improper
refunds. IRS recognized this in its fiscal year 2005 Federal Managers'
Financial Integrity Act of 1982 (FIA) assurance statement to the
Treasury, in which it reported material weaknesses in the collection of
unpaid taxes and in earned income tax credit (EITC) noncompliance.
IRS's taxpayer compliance programs identify billions of dollars of
potentially underreported taxes and erroneous EITC claims each year.
However, due in large part to perceived resource constraints, IRS
selects only a portion of the questionable cases it identifies for
follow-up investigation and action. In addition, IRS often does not
initiate follow-up on the cases it selects until months after the
related tax returns have been filed and any related refunds disbursed,
adversely affecting its chances of collecting amounts due on these
cases. Consequently, the federal government is exposed to potentially
significant losses from reduced revenue and disbursements of improper
refunds.
The options available to IRS in its efforts to identify and pursue the
correct amount of taxes owed and to ensure that only valid refunds are
disbursed continue to be limited. For example, third-party information,
such as the data provided on IRS 1099 forms,[Footnote 30] that can
corroborate the amount of income reported by taxpayers is not required
to be filed until after the start of the tax filing season.[Footnote
31] Consequently, comparison of such information with tax return data
is problematic because IRS does not have time to prepare the third-
party data for matching prior to the receipt of individual tax returns.
Additionally, while it processes hundreds of millions of tax returns
each filing season, IRS must issue refunds within statutory time
constraints or be subject to interest charges.[Footnote 32]
As we previously reported, IRS has some preventive controls that help
to reduce the magnitude of underreported taxes owed and improper
refunds issued. For example, IRS's Examination Branch is responsible
for performing examinations on tax returns with potentially erroneous
EITC claims to determine the validity of the claims.[Footnote 33] When
performed before refunds are disbursed, these examinations are an
important control to prevent disbursement of improper refunds. However,
in some cases these examinations are performed after any related
refunds are disbursed, which negates their effectiveness as a
preventive control and instead serves only as a basis for pursuing
recovery after the fact.
In its guidance to heads of federal agencies issued in accordance with
the Improper Payments Information Act of 2002 (IPIA),[Footnote 34] OMB
identified the EITC as a program subject to IPIA and required that
Treasury accordingly report estimates of EITC-related improper payments
to the President and Congress. EITC claims totaled approximately $40.3
billion in fiscal year 2005, of which approximately $35 billion was
refunded to taxpayers and approximately $5.3 billion was used to reduce
assessed taxes. During fiscal year 2005, IRS used the preliminary
results of the National Research Program study of tax year 2001 data to
estimate the level of compliance of individual filers. Based primarily
on the results of the study, IRS estimated that from 23 percent to 28
percent of the value of EITC payments disbursed during fiscal year 2005
were improper. This error rate indicates that of the approximately $35
billion of EITC-related refunds disbursed during fiscal year 2005, at
least $8 billion, and potentially as much as $9.8 billion, was likely
to have been improper.
Due to time and other constraints noted above, IRS relies extensively
on detective controls, such as automated matching of tax returns with
third-party data such as W-2s (wage and tax statements), to identify
for collection underreported taxes and improper refunds. However, these
programs are not run until months after the returns have been filed
and, as a result, cannot be used to prevent improper refunds from being
disbursed. In addition, although IRS's matching program for individual
tax returns identifies billions of dollars of potentially underreported
taxes each year, IRS only follows up on a portion of these cases to
determine how much tax is actually due and to pursue collection of
those amounts. For example, for tax year 2003, IRS's matching program
for individuals identified 14.5 million individual tax returns, with
potential underreported taxes totaling $15 billion.[Footnote 35]
Because the volume of cases IRS can follow up on depends on resource
availability, IRS conducts an analysis that identifies case
characteristics that have historically yielded greater assessments as a
result of follow-up efforts. In deciding which or how many cases to
pursue, IRS does not consider historical collection experience or the
costs incurred to work the related cases. Based on its analysis for tax
year 2003, IRS investigated 4.1 million (28 percent) of these returns,
which accounted for about $10.1 billion (67 percent) of the total
potential underreported taxes. There are factors that affect IRS's
ability to accelerate the timing of its automated matches, such as the
limitations of its current automated systems and the timing of filing
requirements for preparers of third-party documents, some of which are
beyond IRS's control. Nonetheless, the information from IRS's automated
matching program suggests that a substantial amount of additional
revenue might be realized if additional resources, coupled with more
timely receipt of information and more effective systems to compare
such information, were devoted to follow-up efforts. At present,
billions of dollars in underreported taxes could remain uncollected and
improper refunds could be disbursed.
Information Security:
To effectively fulfill its tax processing responsibilities, IRS relies
extensively on interconnected computer systems to perform various
functions, such as collecting and storing taxpayer data, processing tax
returns, calculating interest and penalties, generating refunds, and
providing customer service. Consequently, weaknesses in controls over
its information systems could impair IRS's ability to perform these
vital functions and increase the risk of unauthorized disclosure,
modification, or destruction of taxpayer data.
Information security weaknesses--both old and new--continue to impair
the agency's ability to ensure the confidentiality, integrity, and
availability of financial and other sensitive data. During our fiscal
year 2005 audit, we identified continuing and new serious information
security weaknesses in IRS's general controls intended to protect
computing resources such as networks, computer equipment, software
programs, data, and facilities. For example, access controls did not
adequately prevent unauthorized access to taxpayer and other sensitive
data by users granted access to IRS computer systems. Further,
monitoring activities over critical computer systems were not
adequately performed to record and track security-related events. As a
result, sensitive data and computing resources are at increased risk of
unauthorized use, modification, loss, and disclosure, possibly without
detection.
A key reason for IRS's information security weaknesses was that it has
not yet fully implemented an agencywide information security program to
ensure that controls are effectively established and maintained. In
December 2002, Congress enacted the Federal Information Security
Management Act of 2002 (FISMA),[Footnote 36] which is intended to
strengthen the information security of federal information and systems
by requiring agencies to develop, document, and implement agencywide
information security programs. Some of the information security program
elements required by FISMA are:
* periodic testing and evaluation of the effectiveness of information
security policies, procedures, and practices;
* security awareness training for agency personnel, including
contractors;
* a process for planning, implementing, evaluating, and documenting
remedial action to address information security deficiencies; and:
* plans and procedures to ensure continuity of operations for
information systems that support the operations and assets of the
agency.[Footnote 37]
Although IRS had begun implementing elements required by FISMA, we
identified several shortcomings. For example, (1) certain system tests
and evaluations were insufficient, (2) security awareness training was
not consistently established across the agency, (3) remedial plans to
address information security deficiencies were lacking, and (4)
disaster recovery and business resumption plans for critical systems
were not completed. IRS has taken actions to improve information
security management; however, it still needs to take additional steps
to address all key elements of an information security program. Such a
program is critical to provide IRS with a solid foundation for
resolving existing information security problems and continuously
managing information security risks.
While IRS has corrected many previously identified information security
weaknesses, we continued to observe weaknesses identical or very
similar to those we previously identified, in addition to several new
ones. Collectively, these problems represent a material weakness in
IRS's internal controls over information systems and data.
Specifically, the continuing and newly identified weaknesses increase
the risk that data processed by IRS's computer systems are not
reliable. If IRS does not adequately mitigate these weaknesses,
unauthorized individuals could gain access to critical hardware and
software, where they may intentionally or inadvertently add, alter, or
delete sensitive data or computer programs, possibly without being
detected. These individuals could also obtain personal taxpayer
information and use it to commit financial crimes using taxpayers'
names (identity fraud), such as fraudulently establishing credit and
running up debts. Until IRS successfully manages its information
security risks, management will not have assurance of the integrity and
reliability of the information generated from the new financial
management systems. We will be issuing a separate report on issues we
identified regarding information security at IRS.
Reportable Conditions:
In addition to the material weaknesses discussed above, we identified
two reportable conditions concerning weaknesses in IRS's internal
controls over (1) hard-copy tax receipts and taxpayer information and
(2) P&E, both of which we have reported on in prior audits.
Hard-Copy Tax Receipts and Taxpayer Information:
IRS manually processes hundreds of billions of dollars of hard-copy
taxpayer receipts and related taxpayer information at its service
center campuses and field offices and at commercial lockbox banks that
operate under contract with Treasury's Financial Management Service
(FMS) to provide tax receipt processing services on behalf of IRS. In
previous audits, we reported that weaknesses in IRS's controls designed
to safeguard these taxpayer receipts and information increase the risk
that receipts in the form of checks, cash, and the like, could be
misappropriated or that the information could be compromised.[Footnote
38] IRS has continued to take actions to address these weaknesses, such
as conducting periodic security reviews of receipt processing areas and
improving its policies and procedures. For example, to enhance security
over disposal of taxpayer information at lockbox banks, IRS changed its
policy during fiscal year 2005 to require that the shredding of such
information be conducted on bank premises rather than at the premises
of an offsite contractor, as had been common practice. However, during
our testing in fiscal year 2005, we continued to find that IRS's
controls over receipts and related hard-copy taxpayer information
received from taxpayers were inadequate to sufficiently limit the risk
of theft, loss, or misuse of such funds and information. This condition
resulted primarily from inconsistencies in the establishment and
implementation of, and compliance with, policies at IRS service center
campuses, field offices, and lockbox banks.[Footnote 39] Specifically,
we found the following:
* Weaknesses in physical security controls designed to prevent
unauthorized access to IRS's receipt processing facilities. For
example, during our audit we observed (1) weaknesses in physical
safeguards intended to control access to IRS facilities (at one lockbox
bank and one service center campus) and to the facility itself (at one
lockbox bank); (2) alarms that were either not working or not working
properly (at one lockbox bank, one service center campus, and one
taxpayer assistance center); and (3) security guards who did not
respond timely to door alarms during our tests (at two service center
campuses and one lockbox bank). These weaknesses increase the risks
that the integrity of IRS facilities and the taxpayer receipts and
information they process may be compromised.
* Weaknesses in the implementation and execution of procedural
safeguards and controls designed to account for, control, and protect
taxpayer receipts and related taxpayer information while they are being
processed within IRS facilities. For example, during our audit we found
(1) inadequate segregation of duties in that the tasks of receiving
payments from taxpayers, logging them in for internal control purposes,
and preparing documents to record the payments in IRS's records were
often performed by the same person (at six of the eight taxpayer
assistance centers we visited);[Footnote 40] (2) inadequate security
over mail containing taxpayer receipts and related taxpayer information
and over the security of this information once extracted from the
envelopes (at four Small Business/Self-Employed groups, three service
center campuses, two taxpayer assistance centers, and one Tax Exempt/
Government Entities group); and (3) weaknesses in controls over access
to controlled or restricted areas in which taxpayer receipts are
received and processed (at four taxpayer assistance centers and one
service center campus). These weaknesses increase the risk that
taxpayer receipts and information may be compromised during processing
at IRS facilities.
* Weaknesses in controls designed to safeguard hard-copy taxpayer
receipts and related taxpayer information during transport between IRS
business units and to or from third parties, such as depository
institutions and post offices. For example, during our audit we found
internal control weaknesses relating to (1) couriers who physically
deliver hard-copy taxpayer receipts and related taxpayer information to
IRS from post offices and between lockbox banks and associated service
center campuses, and who deliver receipts to depository institutions
(at three lockbox banks and one service center campus); (2) compiling
and preparing taxpayer receipts and related taxpayer information for
shipment to the associated service center campuses (at three taxpayer
assistance centers); and (3) tracking hard-copy taxpayer receipts and
related taxpayer information shipped to the service centers for
processing or archiving, and verifying that they are received by the
respective service center campuses (at all eight taxpayer assistance
centers we visited, 18 Small Business/Self Employed groups, four Large
and Mid-Sized Business groups, and two Tax-Exempt/Government Entities
groups). These weaknesses increase the risk that taxpayer receipts may
be lost, misappropriated, or delayed in transit between offices and
that their loss, misappropriation, or delayed arrival may not be timely
detected.
These internal control weaknesses increase IRS's vulnerability to theft
or loss and expose taxpayers to increased risk of losses from financial
crimes committed by individuals who inappropriately gain access to
taxpayer receipts and confidential information entrusted to IRS. While
IRS has made progress in this area, our findings from our fiscal year
2005 audit indicate that much more remains to be done to effectively
address these matters, which are critical to IRS's success in meeting
its customer service goals.
During fiscal year 2005, IRS implemented two initiatives to help
address weaknesses at its lockbox banks and taxpayer assistance
centers. In conjunction with FMS, IRS developed and implemented a joint
pilot program of lockbox performance measures aimed at providing
quantitative measures of performance in, and holding bank management
more accountable for, among other areas, physical security, courier and
other personnel security, and internal controls over receipts and
receipt processing. IRS also implemented a pilot program at the field
office taxpayer assistance centers with the objective of improving
internal controls and creating, where feasible, segregation of duties
over receiving, preparing the posting documents, reviewing, and
transmitting taxpayer receipts and related taxpayer information to the
service center campuses. These initiatives, if effectively implemented,
could improve IRS's controls over hard-copy taxpayer receipts and data
at these offices in future years.
Property and Equipment:
In prior years, we identified significant internal control deficiencies
that hampered IRS's ability to have reliable and timely information on
its balance of P&E throughout the year.[Footnote 41] Over the past
several years, IRS has made substantial progress in addressing internal
control deficiencies related to its P&E. In fiscal year 2005, we noted
further improvements in IRS's controls and procedures that enhanced its
ability to account for P&E. Specifically, IRS improved the timeliness
of recording P&E activity in its accounting system. However,
fundamental deficiencies in IRS's financial management system continued
to exist, which precluded IRS from generating detailed property records
that reconcile to the financial records.
Prior to the implementation of the first release of IFS in November
2004, IRS recorded all property purchases as operating expenses and
later extracted the costs of property acquisitions from operating
expenses by recording adjustments to remove property purchases from
expenses and capitalize them as P&E. IRS performed this analysis and
updated the P&E accounting records monthly. With implementation of the
first release of IFS, IRS is now able to record the majority of P&E
activities as assets at the time of acquisition. However, because of
funding constraints, IRS deferred indefinitely implementation of a
property management module of IFS. This module was intended to generate
detailed property records that reconcile to the financial records. Due
to uncertainty over implementation of a property management module, IRS
continues to refine its compensating procedures to address the lack of
an integrated accounting and property system. However, significant and
costly efforts are required to perform these compensating procedures.
For example, IRS must still go through a labor-intensive and time-
consuming process to link the detailed property records to the
financial records. In addition, some P&E activity, such as internal use
software projects, are still initially recorded as expenses and later
extracted and capitalized as P&E because of the complexity of measuring
the full costs of the projects.[Footnote 42] An integrated accounting
and property system would provide management with the ability to
maintain control over P&E to ensure that assets are properly accounted
for and safeguarded.
Compliance Issues:
Our tests of compliance with selected provisions of laws and
regulations disclosed one area of noncompliance that is reportable
under U.S. generally accepted government auditing standards and OMB
guidance. This area relates to the release of federal tax liens against
taxpayers' property. We also found that IRS's financial management
systems do not substantially comply with the requirements of FFMIA.
Release of Federal Tax Liens:
The Internal Revenue Code grants IRS the power to file a lien against
the property of any taxpayer who neglects or refuses to pay all
assessed federal taxes. The lien becomes effective when it is filed
with a designated office, such as a courthouse in the county where the
taxpayer's property is located. The lien serves to protect the interest
of the federal government and as a public notice to current and
potential creditors of the government's interest in the taxpayer's
property. For example, federal tax liens are disclosed in credit
reports of individuals. Under section 6325 of the Internal Revenue
Code, IRS is required to release a federal tax lien within 30 days
after the date the tax liability is satisfied or has become legally
unenforceable or the Secretary of the Treasury has accepted a bond for
the assessed tax.
In each year beginning with our audit of IRS's fiscal year 1999
financial statements, we found that IRS did not always release the
applicable federal tax lien within 30 days of the tax liability being
either paid off or abated, as required by the Internal Revenue
Code.[Footnote 43] We found that this condition continued to exist in
fiscal year 2005. Specifically, in our testing of 59 statistically
selected tax cases with liens in which the taxpayers' total outstanding
tax liabilities were either paid off or abated during fiscal year 2005,
we found 13 instances in which IRS did not release the applicable
federal tax lien within the statutorily mandated 30 days. The time
between satisfaction of the liability and release of the lien ranged
from 36 days to 233 days. In 4 cases, the lien still had not been
released at the time of our review. In 1 of these cases, it had been
269 days since the taxpayer had fully satisfied the tax liability.
Based on our work, we estimate that for 22 percent of unpaid tax
assessment cases in which IRS had filed a tax lien that were resolved
in fiscal year 2005, IRS did not release the lien within 30
days.[Footnote 44]
In at least 5 of the 13 cases in which liens were not released timely,
the release was delayed because IRS did not properly credit all of the
taxpayer's outstanding accounts when the taxpayer sent in one payment
to satisfy the tax liability of multiple tax accounts. Consequently,
one or more of the taxpayer's accounts remained open even though the
taxpayer had fully satisfied the total tax liability. This, in turn,
prevented initiation of the lien release process for these cases. We
issued a report in January 2005 that discusses other issues that
contribute to IRS's failure to timely release federal tax liens, along
with our recommendations to address those issues.[Footnote 45] The
failure to promptly release tax liens could cause undue hardship and
burden to taxpayers who are attempting to sell property or apply for
commercial credit.
Financial Management Systems' Noncompliance with FFMIA:
In fiscal year 2005, we continued to find that IRS's financial
management systems did not substantially comply with the requirements
of FFMIA. Specifically, IRS's systems did not comply with Federal
Financial Management System Requirements (FFMSR), applicable federal
accounting standards (U.S. generally accepted accounting principles),
and the SGL at the transaction level. We found that IRS (1) cannot rely
solely on information from its general ledger to prepare its financial
statements; (2) lacks a subsidiary ledger for its unpaid assessments;
and (3) lacks an effective audit trail from its general ledger back to
detailed records and transaction source documents for material
balances, such as tax revenues and tax refunds. IRS's implementation of
the first release of IFS represents a major step forward. If fully
implemented as planned, it has the potential to address many of the
issues IRS has experienced in the past with its automated financial
management systems, such as the inability to provide current, reliable
information for managers' use to support decision making. However, as
noted earlier in this report, primarily because of funding constraints,
IRS has put on hold future releases of IFS that were to include
features essential to IRS's ability to realize the system's full
potential. Additionally, IRS continues to rely on obsolete legacy
systems to process tax revenues, tax refunds, and unpaid tax
assessments. These systems do not interface with IFS, which accounts
for and reports only IRS's nontax administrative activities.
This noncompliance with FFMIA ties in with our earlier discussions of
material weaknesses related to the inability of IRS's financial
management systems to produce auditable financial statements and
related disclosures that conform with U.S. generally accepted
accounting principles without substantial compensating processes and
significant adjustments. These weaknesses also indicate that IRS's
systems cannot routinely accumulate and report the full cost of its
activities. Since IRS's systems do not comply with FFMSR, U.S.
generally accepted accounting principles, and the SGL, they also do not
comply with OMB Circular No. A-127, Financial Management Systems
(revised July 23, 1993). In its FIA assurance statement to Treasury,
IRS reported that its financial management systems did not
substantially comply with the requirements of FFMIA in fiscal year
2005.
IRS has established a remediation plan to address the conditions
affecting its systems' ability to comply substantially with the
requirements of FFMIA. This plan outlines the actions to be taken to
resolve these issues, but future corrective actions are on hold and are
currently unfunded. Due to the long-term nature of IRS's systems
modernization efforts, which IRS expects will resolve many of the most
serious issues, many of the planned time frames exceed the 3-year
resolution period specified in FFMIA. However, for these instances IRS
has received a waiver from this requirement from OMB, as authorized by
FFMIA.
[End of section]
Appendix II: Details on Audit Methodology:
To fulfill our responsibilities as the auditor of the Internal Revenue
Service's (IRS) financial statements, we did the following:
* Examined, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. This included selecting
statistical samples of unpaid assessment, revenue, refund, accrued
expenses, payroll, nonpayroll, property and equipment, accounts
payable, and undelivered order transactions. These statistical samples
were selected primarily to substantiate balances and activities
reported in IRS's financial statements. Consequently, dollar errors or
amounts can and have been statistically projected to the population of
transactions from which they were selected. In testing these samples,
certain attributes were identified that indicated either significant
deficiencies in the design or operation of internal control or
compliance with provisions of laws and regulations. These attributes,
where applicable, can be and have been statistically projected to the
appropriate populations.
* Assessed the accounting principles used and significant estimates
made by management.
* Evaluated the overall presentation of the financial statements.
* Obtained an understanding of internal controls related to financial
reporting (including safeguarding assets), compliance with laws and
regulations (including the execution of transactions in accordance with
budget authority), and performance measures reported in the Management
Discussion and Analysis.
* Tested relevant internal controls over financial reporting (including
safeguarding assets) and compliance, and evaluated the design and
operating effectiveness of internal controls.
* Considered the process for evaluating and reporting on internal
controls and financial management systems under 31 U.S.C. § 3512 (c),
(d), commonly referred to as the Federal Managers' Financial Integrity
Act of 1982.
* Tested compliance with selected provisions of the following laws and
regulations: Anti-Deficiency Act, as amended (31 U.S.C. § 1341(a)(1)
and 31 U.S.C. § 1517(a)); Purpose Statute (31 U.S.C. § 1301); Release
of lien or discharge of property (26 U.S.C. § 6325); Interest on
underpayment, nonpayment, or extensions of time for payment of tax (26
U.S.C. § 6601); Interest on overpayments (26 U.S.C. § 6611);
Determination of rate of interest (26 U.S.C. § 6621); Failure to file
tax return or to pay tax (26 U.S.C. § 6651); Failure by individual to
pay estimated income tax (26 U.S.C. § 6654); Failure by corporation to
pay estimated income tax (26 U.S.C. § 6655); Prompt Payment Act (31
U.S.C. § 3902(a), (b), and (f) and 31 U.S.C. § 3904); Pay and Allowance
System for Civilian Employees (5 U.S.C. §§ 5332 and 5343, and 29 U.S.C.
§ 206); Federal Employees' Retirement System Act of 1986, as amended (5
U.S.C. §§ 8422, 8423, and 8432); Social Security Act, as amended (26
U.S.C. §§ 3101 and 3121 and 42 U.S.C. § 430); Federal Employees Health
Benefits Act of 1959, as amended (5 U.S.C. §§ 8905, 8906, and 8909);
Transportation, Treasury, and Independent Agencies Appropriations Act,
2004, Pub. L. No. 108-199, div. F, tit. II, 118 Stat. 314 (Jan. 23,
2004); and Transportation, Treasury, Independent Agencies, and General
Government Appropriations Act, 2005, Pub. L. No. 108-447, div. H, tit.
II, 118 Stat. 3235 (Dec. 8, 2004).
* Tested whether IRS's financial management systems substantially
comply with the three requirements of the Federal Financial Management
Improvement Act of 1996 (Pub. L. No. 104-208, div. A, § 101(f), title
VIII, 110 Stat. 3009, 3009-389 (Sept. 30, 1996).
[End of section]
Appendix III: Comments from the Internal Revenue Service:
DEPARTMENT OF THE TREASURY:
INTERNAL REVENUE SERVICE:
WASHINGTON, D.C. 20224:
DEPUTY COMMISSIONER:
November 7, 2005:
Mr. David M. Walker:
Comptroller General:
U.S. Government Accountability Office:
441 G Street, N.W.
Washington, D.C. 20548:
Dear Mr. Walker:
Thank you for the opportunity to review and comment on your draft
report titled, Financial Audit. IRS' Fiscal Years 2005 and 2004
Financial Statements. We agree that your report fairly presents our
financial progress and our remaining management and systems challenges.
We are pleased that your report recognizes that the IRS continues to
make great strides in addressing financial management, and our
dedication to improvement has earned the IRS an unqualified opinion on
our combined financial statements for a sixth consecutive year. This is
an extremely satisfying achievement for the IRS this year because we
accomplished this while deploying a new internal core financial
management system. Our record clearly demonstrates to our stakeholders
that the Service can consistently account for the approximately $2.3
trillion in revenue receipts, $267 billion in refunds, and $11 billion
in appropriated funds.
We appreciate your recognition of our efforts in successfully deploying
the Integrated Financial System (IFS) this year. The initial release of
IFS provides capability for general ledger management, budget
execution, budget formulation, accounts payable, accounts receivable,
cost management, and financial and tax reporting. IFS enhances the
accuracy, timeliness, and availability of data. It reduces
reconciliation and produces subsidiary ledgers with audit trails to the
transaction level. We recognize this first phase of IFS is the
cornerstone for building a fully integrated financial management system
and agree that additional enhancements will be required to meet all our
financial management objectives.
We recognize that we need to continue to address identified problems
and focus on our modernization efforts. Our commitment to enhance our
financial management is demonstrated by the numerous improvements that
we have undertaken over the years. During fiscal year (FY) 2005, we
instituted a number of financial management reforms and improvements:
Implemented a crosswalk to convert the Interim Revenue Accounting
Control System trial balance accounts into the United States Standard
General Ledger compliant account format,
* Implemented statistical projections to calculate taxes receivable on
a monthly basis, and reported these balances on our interim financial
statements,
* Developed an alternative to the Custodial Accounting Project to
remediate the custodial financial weaknesses over the next several
years,
* Centralized all Small Business/Self Employed Automated Trust Fund
Recovery work in September 2005 to two campuses to improve efficiency
and reduce TFRP assessment errors by improving the cross-referencing
and posting of the payments process,
* Increased the functionality in the Customer Account Data Engine to
post accounts on a daily basis resulting in faster refunds, and to
accept Form 1040EZ tax returns with address changes, and to detect
fraudulent returns and unpostable conditions,
* Developed Security and Internal Control Performance Measures for
physical security, courier, personal security, and internal controls
over receipts and receipt processing at Lockboxes.
We agree with the Government Accountability Office's (GAO) findings and
opinions related to information security. We have developed an action
plan to address deficiencies in access controls, rules of behavior,
contingency planning and disaster recovery, audit trails, training, and
certification and accreditation. We have also made progress in
correcting many of the issues identified during the audit. Because of
its importance, improving information security will continue to be a
priority for the IRS.
I appreciate GAO's acknowledgement of our significant improvements over
the last several years. We wish to recognize GAO's dedication and
professionalism throughout this year's audit process, especially as our
staffs and executives worked to meet the requirements of the audit
process during the first year operation of our new financial system. We
thank you for your support of our efforts, your excellent counsel, and
your willingness to work with us to promote the highest standard of
financial management in the IRS.
In closing, while challenges remain, I believe the IRS has demonstrated
its ability to consistently produce accurate and reliable financial
statements. We have a deep and continuing commitment to improving
financial management and will aggressively pursue appropriate actions
to improve processes and systems.
Sincerely,
Signed by:
John M. Dalrymple:
[End of section]
(196031):
FOOTNOTES
[1] GAO, High-Risk Series: An Overview, GAO/HR-95-1 (Washington, D.C.:
February 1995).
[2] GAO, High-Risk Series: An Update, GAO-05-207 (Washington, D.C.:
January 2005).
[3] GAO-05-207.
[4] CFO Act of 1990, Pub. L. No. 101-576, 104 Stat. 2838 (Nov. 15,
1990); Government Management Reform Act of 1994, Pub. L. No. 103-356,
108 Stat. 3410 (Oct. 13, 1994).
[5] IRS includes an estimate of the tax gap in the tax gap disclosures
contained in the other accompanying information to the financial
statements. This estimate is based on a recently completed study by IRS
on the rate of compliance with the tax laws by individuals and some
small business taxpayers. IRS is exploring approaches to developing
compliance estimates for other groups of taxpayers.
[6] Tax expenditures are revenue losses--the amount of revenue that the
government forgoes--resulting from federal tax provisions that grant
special tax relief for certain kinds of behavior by taxpayers or for
taxpayers in special circumstances. Under U.S. generally accepted
accounting principles, tax expenditure amounts are not required to be
disclosed as part of federal agencies' financial statements, but
certain information on tax expenditures can be included as other
accompanying information to the financial statements.
[7] GAO, Financial Audit: Examination of IRS' Fiscal Year 1992
Financial Statements, GAO/AIMD-93-2 (Washington, D.C.: June 30, 1993).
[8] Reportable conditions are matters coming to our attention that, in
our judgment, should be communicated because they represent significant
deficiencies in the design or operation of internal controls that could
adversely affect IRS's ability to meet the objectives described in this
report.
[9] A material weakness is a reportable condition that precludes the
entity's internal controls from providing reasonable assurance that
material misstatements in the financial statements would be prevented
or detected on a timely basis.
[10] IRS's master files contain detailed records of taxpayer accounts.
[11] A reexamination of internal control requirements for financial
reporting by federal agencies was initiated in light of the new
internal control requirements for publicly traded companies contained
in the Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745
(July 30, 2002). On December 21, 2004, OMB issued a revision of
Circular No. A-123, Management's Responsibility for Internal Control,
which will become effective in fiscal year 2006. In the interim, OMB
has instructed federal agencies to continue to follow the 1995
revision.
[12] This number does not include open recommendations related to
information security. These recommendations, because of their sensitive
nature, are contained in a series of Limited Official Use Only reports
that we have issued to IRS over the past several years.
[13] Pub. L. No. 104-208, div. A, § 101(f), title VIII, 110 Stat. 3009,
3009-389 (Sept. 30, 1996).
[14] Pub. L. No. 103-62, § 4(b), 107 Stat. 285, 287 (Aug. 3, 1993)
(codified at 31 U.S.C. § 1115).
[15] GAO, Financial Audit: IRS's Fiscal Years 2004 and 2003 Financial
Statements, GAO-05-103 (Washington, D.C.: Nov. 10, 2004).
[16] GAO-05-103.
[17] JFMIP, Core Financial System Requirements, JFMIP-SR-02-01
(Washington, D.C.: November 2001). JFMIP was originally formed under
the authority of the Budget and Accounting Procedures Act of 1950 as a
cooperative undertaking of the Office of Management and Budget (OMB),
the Department of the Treasury, the Office of Personnel Management,
GAO, and operating agencies to improve financial management practices
in the federal government. On December 1, 2004, JFMIP ceased to exist
as a separate organization, with OMB's Office of Federal Financial
Management assuming many JFMIP functions.
[18] IRS is also in the process of implementing the Customer Account
Data Engine (CADE). CADE is intended to ultimately replace the legacy
master file, which is the database of taxpayer account information.
However, during fiscal year 2005, CADE was still in the early stages of
implementation and processed less than $1 billion in refunds related to
simple individual returns. IRS does not have detailed plans or
schedules for completion of this project, and it is unclear when it
will be fully implemented.
[19] At the end of each fiscal year, IRS uses statistical sampling
techniques to estimate the portion of its total balance of unpaid
assessments that should be classified as compliance assessments, write-
offs, and taxes receivable, and to estimate the portion of the taxes
receivable balance that is likely to be collectible. Throughout the
following year, the resultant rates derived through the sampling
process are applied monthly to the total unpaid assessment balance to
update these amounts for reporting purposes.
[20] The Transportation Equity Act for the 21ST Century, Pub. L. No.
105-178, 112 Stat. 107 (June 9, 1998), enhanced the link between the
amount of funds received by states and the amount of tax receipts
credited to the Highway Trust Fund by requiring that highway program
funds be distributed to states on the basis of annual highway account
receipts.
[21] In implementing the American Jobs Creation Act of 2004, IRS issued
guidance providing a one-time filing extension of 1 month for tax
returns affecting the Highway Trust Fund and the Airport and Airway
Trust Fund for the quarter ended March 31, 2005. See I.R.S. Notice 2005-
4, § 4(i), 2005-2 I.R.B. 296-97 (Jan. 10, 2005); see also Pub. L. No.
108-357, § 853, 118 Stat. 1418, 1609 (Oct. 22, 2004). Therefore, the
quarter ended March 31, 2005, was not included in our comparison.
[22] Joint Financial Management Improvement Program, System
Requirements for Managerial Cost Accounting (Washington, D.C.: February
1998).
[23] Unpaid assessments consist of (1) federal taxes receivable, which
are taxes due from taxpayers for which IRS can support the existence of
a receivable through taxpayer agreement or a favorable court ruling;
(2) compliance assessments where neither the taxpayer nor the court has
affirmed that the amounts are owed; and (3) write-offs, which represent
unpaid assessments for which IRS does not expect further collections
due to factors such as the taxpayer's death, bankruptcy, or insolvency.
Of these three classifications of unpaid assessments, only federal
taxes receivable are reported on the principal financial statements.
[24] IRS's master files contain detailed records of taxpayer accounts.
However, the master files do not contain all the details necessary to
properly classify or estimate collectibility for unpaid assessment
accounts.
[25] Abatements are reductions to taxpayers' tax liabilities that can
either result in reducing or eliminating a taxpayer's outstanding tax
liability and, in some cases, may generate a refund to the taxpayer.
IRS is authorized to abate assessments under certain conditions. For
example, section 6404 of the Internal Revenue Code authorizes IRS to
abate erroneous assessments, which can be caused by either IRS or
taxpayer error.
[26] GAO-05-103.
[27] When a company does not pay the taxes it withholds from employees'
wages, such as Social Security or individual income tax withholdings,
IRS has the authority to assess all responsible officers individually
for the taxes withheld from employees. Although assessed to multiple
parties, the liability need only be paid once. Thus, IRS may record
assessments against each of several individuals for the employee-
withholding component of the payroll tax liability of a given business
in an effort to collect the total tax liability of the business. The
assessments made against business officers are known as trust fund
recovery penalties.
[28] A tax period is the period over which the tax liability was
created. For payroll taxes, this period is typically a calendar
quarter.
[29] We are 95 percent confident that the error rate does not exceed
14.3 percent.
[30] IRS 1099 forms are used by third parties, such as financial
institutions, to report taxpayers' interest income, dividend
distributions, and other miscellaneous income.
[31] The tax filing season for individuals primarily occurs from
January 1 through April 15 of each year.
[32] By statute, IRS must pay interest on refunds not paid within 45
days of receipt or due date, whichever is later (26 U.S.C. § 6611).
[33] Because it is a refundable tax credit, an EITC claim always
results in a reduction of the taxpayer's calculated tax liability.
However, depending on the taxpayer's amount of taxes withheld, and the
amount of tax due on the taxpayer's return before application of any
credits, it may or may not result in a refund for a particular tax
year.
[34] Pub. L. No. 107-300, 116 Stat. 2350 (Nov. 26, 2002). IPIA requires
the head of each federal agency to annually review all programs and
activities the federal agency administers to identify those that may be
susceptible to significant improper payments and to estimate the amount
of improper payments in those susceptible programs in accordance with
guidance prescribed by OMB. Agencies are required to submit these
estimates to Congress before March 31 of the following applicable year.
OMB, Implementation Guidance for the Improper Payments Implementation
Act of 2002, P. L. 107-300, M-03-13 (Washington, D.C.: May 21, 2003).
[35] Tax year 2003 is the most recent year for which complete matching
program results are available.
[36] FISMA was enacted as title III of the E-Government Act of 2002,
Pub. L. No. 107-347, 116 Stat. 2946 (Dec. 17, 2002).
[37] See 44 U.S.C. § 3544.
[38] GAO, Internal Revenue Service: Status of Recommendations from
Financial Audits and Related Financial Management Reports, GAO-05-393
(Washington, D.C.: Apr. 29, 2005); Management Report: Improvements
Needed in IRS's Internal Controls, GAO-05-247R (Washington, D.C.: Apr.
27, 2005); IRS Lockbox Banks: More Effective Oversight, Stronger
Controls, and Further Study of Costs and Benefits Are Needed, GAO-03-
299 (Washington, D.C.: Jan. 15, 2003); Financial Audit: IRS's Fiscal
Years 2002 and 2001 Financial Statements, GAO-03-243 (Washington, D.C.:
Nov. 15, 2002); and Internal Revenue Service: Progress Made, but
Further Actions Needed to Improve Financial Management, GAO-02-35
(Washington, D.C.: Oct. 19, 2001).
[39] IRS's field office structure includes service center campuses,
which process tax returns and payments submitted by taxpayers and
deposit tax payments in depository institutions; taxpayer assistance
centers, which accept payments from and provide assistance directly to
taxpayers; and other business operating divisions that provide taxpayer
audit and assistance services. These other business operating divisions
are organized along the following business lines: Large and Mid-Size
Businesses, Small-Business/Self-Employed, and Tax Exempt/Government
Entities. In addition, commercial lockbox banks operate under contract
with FMS to provide tax receipt processing services on behalf of IRS.
[40] Many taxpayer assistance centers are operated at times by only one
IRS employee, or tasks are performed by Revenue Agents or Officers
working away from the field office. In these situations, segregation of
these duties is problematic. IRS recognized these situations and is
considering potential solutions.
[41] GAO-05-103.
[42] For internal use software, capitalized costs include direct costs,
such as salaries of IRS employees assigned to the project and
contractor fees, and indirect costs, such as overhead incurred during
the development phase. The development phase includes developing the
software configuration and interfaces, coding, installing the software
to the hardware, and testing.
[43] GAO-05-103.
[44] We are 95 percent confident that the percentage of cases in which
the lien was not released within 30 days does not exceed 33 percent.
[45] GAO, Opportunities to Improve Timeliness of IRS Lien Releases, GAO-
05-26R (Washington, D.C.: Jan. 10, 2005).
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