Financial Audit
IRS's Fiscal Years 2006 and 2005 Financial Statements
Gao ID: GAO-07-136 November 9, 2006
Because of the significance of Internal Revenue Service (IRS) collections to overall 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 are reliable and (2) IRS management maintained effective internal controls. GAO also tests IRS's compliance with selected provisions of significant laws and regulations and its financial systems' compliance with the Federal Financial Management Improvement Act of 1996 (FFMIA).
In GAO's opinion, IRS's fiscal years 2006 and 2005 financial statements are fairly presented in all material respects. Because of serious internal control and financial management systems deficiencies, IRS again had to rely extensively on resource-intensive compensating processes to prepare its financial statements. Because of 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. IRS made significant progress in developing its cost accounting module, which was part of the first phase of the Integrated Financial System (IFS), implemented in fiscal year 2005. IRS also improved the reliability of its property and equipment records, and we no longer consider this issue to be a reportable condition. However, because of budgetary concerns and advances in automated financial management system technologies, IRS is no longer committed to the future releases of IFS that were once intended to resolve many of its most serious financial management issues, and is currently considering alternatives. IRS has not yet committed to an alternative approach nor has funding been appropriated. Additionally, IRS has not determined how to resolve issues related to the lack of integration between IFS and its tax processing systems. Consequently, it is unclear how or when these issues will be resolved. 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. Although IRS continued to make progress in addressing weaknesses in controls over hard-copy taxpayer receipts and data, GAO concluded that remaining issues related to this activity constituted a reportable condition. In addition, IRS was not always in compliance with a law concerning the timely release of tax liens. IRS management faces serious challenges from its continued use of obsolete financial management systems that do not substantially comply with FFMIA requirements. These challenges adversely affect IRS's ability to fulfill its responsibilities as the nation's tax collector because it is unable to obtain comprehensive, timely, accurate, and useful information for day-to-day decision making. Solving IRS's financial management problems depends largely on the ultimate success of IRS's ongoing systems modernization efforts.
GAO-07-136, Financial Audit: IRS's Fiscal Years 2006 and 2005 Financial Statements
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Report to the Secretary of the Treasury:
November 2006:
Financial Audit:
IRS's Fiscal Years 2006 and 2005 Financial Statements:
GAO-07-136:
GAO Highlights:
Highlights of GAO-07-136, a report to the Secretary of the Treasury
Why GAO Did This Study:
Because of the significance of Internal Revenue Service (IRS)
collections to overall 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 are reliable and (2) IRS
management maintained effective internal controls. GAO also tests IRS‘s
compliance with selected provisions of significant laws and regulations
and its financial systems‘ compliance with the Federal Financial
Management Improvement Act of 1996 (FFMIA).
What GAO Found:
In GAO‘s opinion, IRS‘s fiscal years 2006 and 2005 financial statements
are fairly presented in all material respects. Because of serious
internal control and financial management systems deficiencies, IRS
again had to rely extensively on resource-intensive compensating
processes to prepare its financial statements. Because of 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. IRS made significant progress in
developing its cost accounting module, which was part of the first
phase of the Integrated Financial System (IFS), implemented in fiscal
year 2005. IRS also improved the reliability of its property and
equipment records, and we no longer consider this issue to be a
reportable condition. However, because of budgetary concerns and
advances in automated financial management system technologies, IRS is
no longer committed to the future releases of IFS that were once
intended to resolve many of its most serious financial management
issues, and is currently considering alternatives. IRS has not yet
committed to an alternative approach nor has funding been appropriated.
Additionally, IRS has not determined how to resolve issues related to
the lack of integration between IFS and its tax processing systems.
Consequently, it is unclear how or when these issues will be resolved.
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. Although IRS continued to make progress in
addressing weaknesses in controls over hard-copy taxpayer receipts and
data, GAO concluded that remaining issues related to this activity
constituted a reportable condition. In addition, IRS was not always in
compliance with a law concerning the timely release of tax liens.
IRS management faces serious challenges from its continued use of
obsolete financial management systems that do not substantially comply
with FFMIA requirements. These challenges adversely affect IRS‘s
ability to fulfill its responsibilities as the nation‘s tax collector
because it is unable to obtain comprehensive, timely, accurate, and
useful information for day-to-day decision making. Solving IRS‘s
financial management problems depends largely on the ultimate success
of IRS‘s ongoing systems modernization efforts.
What GAO Recommends:
In prior audits, GAO made numerous recommendations to IRS to address
issues comprising the material weaknesses and reportable condition and
compliance matters that persisted during fiscal year 2006. GAO will
continue to monitor IRS‘s progress in implementing the 72
recommendations that remain open as of the date of this report. IRS
agreed with the report's findings and that it fairly presents IRS‘s
progress and challenges. IRS said it had made significant progress in
addressing financial management issues and noted that it had a strong
management team to continue improving financial management with an
increased focus on internal controls and information security.
[Hyperlink, http://www.gao.gov/cgi-bin.getrpt?GAO-07-136].
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:
Other Accompanying Information:
Appendixes:
Appendix I: Material Weaknesses, Reportable Condition, and Compliance
Issues:
Material Weaknesses:
Reportable Condition:
Compliance Issues:
Appendix II: Details on Audit Methodology:
Appendix III: Comments from the Internal Revenue Service:
Abbreviations:
CADE: Customer Account Data Engine:
CDDB: Custodial Detailed Database:
CFO: chief financial officer:
EFDS: Electronic Fraud Detection System:
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:
IFS: Integrated Financial System:
IPIA: Improper Payments Information Act of 2002:
IRS: Internal Revenue Service:
JFMIP: Joint Financial Management Improvement Program:
OMB: Office of Management and Budget:
P&E: property and equipment:
PAR: performance and accountability report:
SGL: U.S. Government Standard General Ledger:
November 9, 2006:
The Honorable Henry M. Paulson, Jr. 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, 2006 and 2005. 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, 2006, 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 2006 and 2005 financial
statements were made possible in part 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, it is unclear when this effort will be
completed or if it will be successful. In the interim, 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
seventh consecutive year, IRS has received an unqualified opinion on
its financial statements and, for the fifth consecutive year, the audit
was completed and the report issued by November 15.
IRS has made great strides over the last several years in addressing
its financial management challenges and has resolved or substantially
mitigated several material weaknesses and other reportable conditions
in its internal controls. For example, during fiscal year 2006, IRS
improved the accuracy and reliability of its property and equipment
(P&E) accounting records by making enhancements to accounting code
definitions that make it easier for users to select the proper
accounting codes for recording a transaction, improving coordination
among units involved in processing P&E activity, and streamlining its
analysis of P&E transactions most susceptible to misclassification.
These improvements, combined with progress we reported last year,
enabled us to conclude that remaining issues related to P&E no longer
constitute a reportable condition.
During fiscal year 2006, IRS continued to expand its use of the
capabilities contained in the first phase, or release, of its
Integrated Financial System (IFS), which was implemented in fiscal year
2005. For example, IRS has populated the system's cost module with 2
years of data and made significant progress in defining how costs will
be allocated to various internal organizations, and it has successfully
used IFS to generate its statement of net cost for the first time. This
release 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, IRS cannot fully address the financial management issues
caused by the limitations of its automated systems without successful
implementation of the additional capabilities that were originally
planned to be provided by future releases of IFS, such as procurement
and workload management. Because of ongoing technological advances and
budgetary constraints, IRS is no longer committed to implementing
additional releases of IFS, but rather is considering other options
available to provide these capabilities, including utilizing a private
shared service provider or a federal center of excellence.[Footnote 1]
However, IRS has not decided what approach it will take or obtained
approval for the necessary funding. It is therefore unclear how or when
IRS will resolve the remaining related financial management systems
limitations. In formulating its strategy for dealing with these issues,
IRS will also need to address how IFS will ultimately be integrated
with the systems that support financial management of its tax
administration functions as well as addressing the limitations of those
systems if it is to fully resolve many of its long-standing financial
management challenges.
To resolve these problems, IRS is depending on its ongoing systems
modernization effort, which is intended to address the full range of
problems caused by its outdated legacy information systems. In 1995, we
designated financial management and systems modernization at IRS as
high-risk areas.[Footnote 2] We continue to consider these issues as
high risk and include them in our Business Systems Modernization high-
risk area.[Footnote 3]
Among the most serious financial management issues still remaining to
be addressed is the continued material weakness in IRS's information
security. 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. 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 10 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 4] As
we have previously reported, 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 continues to face 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 has completed a study of the rate of compliance with the
nation's tax laws by individuals and some small business taxpayers, and
has begun a study of S-corporations' compliance.[Footnote 5] However,
IRS has no approved plans to repeat its study on individual taxpayers,
or to conduct research on other significant components of the tax
gap.[Footnote 6] As we have noted before, 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; Subcommittee on Taxation and IRS Oversight,
Senate Committee on Finance; House Committee on Appropriations; House
Committee on Ways and Means; and House Committee on Government Reform.
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 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:
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 7]
this report presents the results of our audits of the financial
statements of the Internal Revenue Service (IRS) for fiscal years 2006
and 2005. The financial statements report the assets, liabilities, net
position, net costs, changes in net position, budgetary resources,
financing, 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 paid by
taxpayers, often referred to as the tax gap,[Footnote 8] nor do they
include information on tax expenditures.[Footnote 9]
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, 3
computing centers, and numerous other field offices throughout the
United States. In fiscal years 2006 and 2005, IRS collected about $2.5
trillion and $2.3 trillion, respectively, in tax payments; processed
hundreds of millions of tax and information returns; and paid about
$277 billion and $267 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, which is a primary
objective of the CFO Act. While progress continues to be made to
modernize its financial management capabilities, IRS nonetheless
confronted 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 10] though it continued to
make strides in addressing its financial management challenges. In
fiscal year 2006, for the seventh 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 fifth 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. However, until its systems are
replaced, IRS will continue to be challenged to sustain the level of
effort needed to produce reliable financial statements timely.
Throughout fiscal year 2006, IRS continued to make significant progress
in its efforts to address its weaknesses in controls over several
areas, including accountability over property and equipment (P&E),
management and reporting of unpaid assessments, reliability of
financial reporting, and security over hard-copy taxpayer receipts and
data. For example, IRS improved the accuracy and reliability of its P&E
accounting records by (1) enhancing the accounting code definitions in
its new financial management system to make it easier for users to
select the proper accounting codes for recording transactions, (2)
improving coordination among units involved in processing P&E activity,
and (3) streamlining its analysis of P&E transactions most susceptible
to misclassification. These improvements, combined with the progress
reported in our prior year audit, enabled us to conclude that remaining
issues related to P&E no longer constitute a reportable
condition.[Footnote 11]
IRS also successfully implemented the first phase of the Custodial
Detailed Database (CDDB), which is intended to ultimately serve as a
link between IRS's master files[Footnote 12] and its general ledger for
tax administration activities. The first phase contains programs to
analyze and classify for financial reporting purposes related taxpayer
accounts associated with unpaid payroll taxes.[Footnote 13] Although
IRS's use of CDDB in fiscal year 2006 improved its process for deriving
estimates of its various unpaid assessment categories, IRS continues to
lack a subsidiary ledger for unpaid assessments and must still use a
labor-intensive manual compensating process to estimate the year-end
balances of those various unpaid assessment categories for external
reporting. Full operational capability of CDDB is several years away
and depends on the successful implementation of future system releases.
Additionally, CDDB continues to rely on IRS's master files for the
information it contains.
During fiscal year 2006, IRS continued to expand processing of the less
complex individual tax returns through its Customer Account Data Engine
(CADE), the system being implemented to replace IRS's master files. In
its fiscal year 2006 Management Discussion and Analysis, IRS reported
that during the fiscal year 2006 tax filing season,[Footnote 14] CADE
processed over 7.3 million individual returns and over $3.4 billion in
refunds. This represents an increase of nearly 6 million returns and $3
billion in refunds processed by CADE compared to the same period last
year. However, IRS's detailed plans for completion of the CADE project
only extend through release 7, which is intended to replace the master
file for individual tax returns.[Footnote 15] However, these plans do
not include plans or schedules for additional CADE release(s) to
replace the master file for business tax returns, and it is unclear
when CADE will be fully implemented.
IRS also improved its financial reporting capabilities in fiscal year
2006 through expanded use of the capabilities of the Integrated
Financial System (IFS), the first release of which was implemented in
fiscal year 2005. IFS was originally intended to resolve many of the
issues discussed in this report and replace the outdated financial
management system IRS used previously to process and report
administrative transactions, such as procurement and utilization of
budgetary resources. During fiscal year 2006, IRS improved its
financial reporting capabilities by populating the cost accounting
module of IFS with another year of cost data, and by establishing a new
cost allocation methodology to take advantage of the system's cost
allocation capacity and defining how those costs will be allocated to
various IRS units. However, opportunities for further improvement in
IRS's financial reporting in the near term will be limited as IRS is
not committed to future releases of IFS and is currently reevaluating
its approach to achieving the objectives originally envisioned through
implementation of these additional releases. IRS has not decided what
approach it will take or obtained approval for the related funding
necessary to bring it to fruition. In addition, IRS has not addressed
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. It is therefore unclear how or when IRS will resolve its
remaining related financial management systems limitations.
While notable improvements were made throughout fiscal year 2006,
control deficiencies over financial reporting, management of unpaid
assessments, and collection of revenue and issuance of tax refunds
continued to represent material weaknesses.[Footnote 16] These
weaknesses are caused primarily by IRS's continued reliance on outdated
automated systems to provide the financial information that management
needs to make decisions, and similar weaknesses and problems will
continue to exist until its systems are replaced. 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. Additionally, while we continued to note significant
improvement, we still consider control deficiencies in physical
security over taxpayer receipts and data to be a reportable condition
requiring further attention by IRS management.
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,
financing, and custodial activity as of, and for the fiscal years
ended, September 30, 2006, and September 30, 2005.
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 and the
taxpayers 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's Responsibility for Internal Control.
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 2006 and 2005.
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
one reportable condition, which, although not a material weakness,
represents a significant deficiency 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. This condition
involves deficiencies in 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.
We have reported on these material weaknesses and the reportable
condition in prior audits and have provided IRS recommendations to
address these issues. Seventy-two of these recommendations were still
open as of the date of this report.[Footnote 17] 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.
As part of our fiscal year 2006 financial audit, we evaluated IRS's
implementation of OMB's revised Circular No. A-123, Management's
Responsibility for Internal Control, which became effective on October
1, 2005. Circular No. A-123 provides updated internal control standards
and new requirements for the 24 major executive branch departments and
agencies to follow in conducting management's assessment of the
effectiveness of internal control over financial reporting. Based on
this assessment, agency management is required to prepare an assurance
statement on the effectiveness of internal controls over financial
reporting to be included in the agency's performance and accountability
report (PAR). These requirements are applicable to the 24 CFO Act
agencies, including the Department of the Treasury (Treasury), of which
IRS is a significant component. The objective of our review was to
determine whether IRS appropriately planned and implemented the
requirements of OMB Circular No. A-123, and to verify that IRS
performed sufficient work to support its related assurance statement to
Treasury, upon which Treasury would rely as a basis for its own
assurance statement to be included in its fiscal year 2006 PAR. We
found that IRS's assurance statement was adequately supported by the
underlying work and appropriately reflected the state of its internal
controls. However, we did identify opportunities for improvement in the
execution and documentation of this work that we communicated to IRS
during the course of the audit and that we will be reporting on
separately.
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.[Footnote 18] 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 19]
For more details on these issues, see appendix I.
Consistency of Other Information:
IRS's Management Discussion and Analysis and required supplemental and
other accompanying 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 20]
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, 2006 and
2005. 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 its financial management progress and remaining management and
systems challenges. IRS noted its significant accomplishments in
addressing financial management issues while also successfully
implementing Appendix A of the revised OMB Circular No. A-123,
Management's Responsibility for Internal Control. IRS affirmed its
dedication to continuing to improve its financial management, and noted
significant achievements including: (1) improvements in accountability
over property and equipment that enabled us to eliminate it as a
reportable condition through implementation of a first level
procurement review, revision of material group codes, and
implementation of a materiality threshold for capital asset review, (2)
significant reductions in the numbers of matters for further
consideration related to both safeguarding of taxpayer receipts and
controls over administrative accounts, (3) acceleration of the
quarterly excise tax certifications to the Department of the Treasury
by 2 months, and (4) improvements to its cost allocation methodology
and use of Integrated Financial System to generate its statement of net
cost for fiscal year 2006.
IRS also agreed with our findings concerning information security, and
indicated that it is improving protection of sensitive information by
expanding the use of encryption, increasing employee education and
awareness, and improving IRS information security policies and
procedures to ensure protection of taxpayer, employee, and IRS
sensitive information. IRS also noted that it has established a
Security Services and Privacy Executive Steering Committee to
coordinate information security improvements and to leverage subject
matter experts from the areas of information technology security,
physical security, and privacy and identify theft. In addition, IRS
recognized that while challenges remain, it has established its ability
to consistently produce reliable financial statements, and believes it
has a solid management team in place to continue to improve financial
management.
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, 2006:
[End of section]
Management Discussion and Analysis:
Internal Revenue Service:
Management Discussion and Analysis:
For the fiscal year ended September 30, 2006:
I. Introduction
The Internal Revenue Service (IRS) administers America‘s tax laws and
collects the revenues that fund government operations and public
services. The IRS‘ Taxpayer Service and Enforcement programs generate
more than 96 percent of the total federal revenue collected for the
United States Government. In Fiscal Year (FY) 2006, the IRS collected
more than $2.5 trillion in revenue, an 11 percent increase from FY
2005.
The IRS annually processes over 220 million tax returns and over 1.3
billion information items related to tax returns, such as W-2s and
1099s. The IRS provides a wide range of taxpayer assistance through
the internet, telephone service, and Taxpayer Assistance Centers,
making it easier for taxpayers to fulfill their tax obligations. The
IRS continues to pursue opportunities to improve service to the
taxpayer by simplifying tax filing processes and expanding options for
electronic filing and payment.
Of the more than $2.5 trillion the IRS collected during FY 2006, $48.7
billion was collected through enforcement activities including
individual and small business audits, collection contacts, corporate
audits, settlement initiatives aimed at deterring the use of abusive
tax shelters, and criminal prosecutions. Over the past decade, the IRS
has steadily improved its performance by refining its workload
selection criteria, implementing streamlined and centralized work
processes, increasing managerial involvement in casework, and reducing
the time it takes from ’start to finish“ for its key examination and
collection activities.
The IRS‘ mission, to ’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,“ is best
demonstrated in the level of commitment and professionalism exhibited
by the 100,000+ employees comprising the IRS workforce. The IRS was
one of six federal agencies featured in Business Week magazine‘s ’50
Best Places to Launch a Career“ report (September 2006), and IRS
retention rates were highlighted as being among the best in the
country.
In June 2004, the IRS published its Strategic Plan for FYs 2005 through
2009. The Strategic Plan is a roadmap that reflects the priorities and
direction of the IRS, setting its course for achieving measurable
results that reduce the tax gap and balance service and enforcement.
The FY 2006 performance summary and results sections in this document
link to the Strategic Plan goals and objectives, and highlight the
quantifiable performance measures and results the IRS uses to gauge its
performance.
In FY 2006, the IRS made significant progress in achieving its three
strategic goals: improving taxpayer service; enhancing enforcement of
the tax law; and modernizing the IRS through its people, processes, and
technology. The following chart presents the portion of the IRS‘ FY
2006 budget used to fund programs that fulfill the IRS‘ three strategic
goals:
Figure: How the IRS used its resources?:
[See PDF for Image]
% may be off due to rounding.
[End of Figure]
FY 2006 brought many unanticipated and unprecedented challenges to the
IRS. The IRS responded quickly to assist the victims of the 2005
hurricanes by providing assistance and information regarding tax
responsibilities and by postponing filing and payment deadlines for all
affected taxpayers in the hardest hit areas. The IRS set up a
dedicated toll-free disaster assistance line to provide ’one-stop“ help
on tax issues and answered over one million assistance calls for
Federal Emergency Management Agency (FEMA). Also, in June 2006, severe
flooding forced closure of the IRS headquarters building in Washington,
D.C. The Commissioner and the top-level executives immediately resumed
business at alternate IRS locations, and within thirty days, over 2,200
displaced employees returned to their normal duties. There was no
impact on service to the public.
IRS‘ financial statements, including the accompanying notes, present
fairly, in all material respects, in conformity with U.S. generally
accepted accounting principles, IRS‘ 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.
With its highly-skilled workforce dedicated to balancing service and
enforcement, the IRS will continue to make progress on achieving its
goals, accomplishing its mission, and meeting the public‘s expectation.
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.
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.
The following list summarizes the guiding principles that the IRS
follows:
* Understand and solve problems from taxpayers' point of view:
* Enable IRS managers to be accountable to taxpayers:
* Use balanced measures of performance to evaluate progress in taxpayer
satisfaction, business results, and employees' satisfaction:
* Foster open, honest communications:
* Insist on total integrity:
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 focused on
unique groups of taxpayers: individual taxpayers, small business
owners, large 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.
* The organizational chart below shows these reporting relationships.
Figure: Department of the Treasury: Internal Revenue Service
Organization:
[See PDF for Image]
[End of Figure]
Commissioner of the Internal Revenue Service:
A number of functions support the IRS Commissioner. They set policies,
provide leadership and direction for the IRS, and provide support for
strategic decision-making activities needed to fulfill the IRS' mission
in administering the nation's tax laws.
² The Office of Appeals resolves tax controversies between taxpayers
and the IRS without litigation on a basis that is fair and impartial to
both. Appeals provides an independent channel for taxpayers who wish to
dispute a recommended enforcement action, enhancing voluntary
compliance and public confidence in the integrity and efficiency of the
IRS.
² Taxpayer Advocate Service (TAS) helps taxpayers with 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 have 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.
² 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.
² The Office of Chief Counsel is the chief legal advisor to the IRS
Commissioner responsible for providing correct and impartial
interpretation of the Internal Revenue laws and the highest quality
legal advice and representation for the IRS. The Chief Counsel's
principal customers are the IRS Commissioner, the operating divisions,
the functional units, 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.
² Research, Analysis, and Statistics (RAS) supports IRS senior
management, operating divisions, functional units, other research
organizations, the Department of the Treasury, and the general public
by producing studies, program evaluations, and statistical analyses of
taxpayer trends and data. RAS also provides research and reference
tools for front line IRS employees.
² 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:
The 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 eight
campuses perform tax processing services. Twenty-five sites provide
account management services. Employees at five campuses perform
compliance services, including examinations and automated underreporter
matches, which focus on dependent exemptions, credits, filing status,
and personal deductions. W&I Compliance also collects delinquent
accounts through automated collection system (ACS) call sites and
performs other collection work, including securing delinquent returns,
by corresponding with taxpayers. W&I also provides face-to- face
information, support and assistance to taxpayers in fulfilling their
tax obligations at over 400 Taxpayer Assistance Centers.
* Small Business and Self Employed Division (SB/SE) serves 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 IRS, allocating 94 percent of its resources to compliance
activities. SB/SE is aligned along functional lines of Examination,
Collection, Specialty Tax Programs, Compliance Services/Campus
Operations, and the Fraud/Bank Secrecy Act Program. This structure
provides a more focused approach to program delivery by efficient use
of existing knowledge and experience, ensuring end-to-end
accountability and specialized expertise of the workforce.
* Large and Mid-Size Business Division (LMSB) administers taxes for the
largest businesses in the United States, including corporations, sub-
chapter S-Corps and partnerships with assets greater than $10 million,
including over 6,100 publicly traded companies. LMSB taxpayers annually
file approximately 176,000 income tax returns. LMSB 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 provides taxpayers with specialized, focused support on specific
tax issues. LMSB's workforce consists largely of field-based employees,
including revenue agents, international examiners, field specialists,
technical experts and support personnel. Collectively, they deal with
tax issues ranking among the most complex addressed by any division in
the IRS.
* Tax-Exempt and Government Entities Division (TE/GE) serves a broad
array of entities with special tax status, including tax-exempt
organizations, employee retirement plans, and government entities. The
entities that comprise this customer base are subject to unique rules
and have diverse needs, ranging from small community organizations and
municipalities to major universities, pension funds, state and tribal
governments, and tax-exempt bond issuers. TE/GE administers and
enforces a complex body of law governing these entities to ensure that
they properly adhere to the statutes applicable to their status.
* Criminal Investigation (CI) investigates potential criminal
violations of the Internal Revenue Code and related financial crimes in
a manner that fosters confidence in the tax system and compliance with
the law. 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. 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. 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:
The IRS support functions are aligned into five support organizations.
Each organization provides specific services, systems, and processes
that support tax operations. Support units facilitate efficiency
improvements and implementation of best practices throughout the IRS.
The support units report to the Deputy Commissioner for Operations
Support.
* Modernization and Information Technology Services (MITS), headed by
the Chief Information Officer (CIO), delivers information technology
solutions that anticipate and meet enterprise-wide needs by delivering
customer-centered, systems, products, services, and support. The CIO
advises all heads of offices on strategic technology planning, data
administration, technology standards and privacy assurance, and
telecommunications issues.
* Agency-Wide Shared Services (AWSS) develops procedures and implements
policy for the IRS' internal real estate and facilities management,
Equal Employment Opportunity and Diversity, personnel, procurement, and
customer support activities.
* Chief Human Capital Officer (HCO) provides human capital strategies
and tools for recruiting, hiring, developing, retaining, and
transitioning a highly skilled and high performing workforce needed to
support the IRS' mission, goals, and objectives.
* Chief Financial Officer (CFO) oversees the IRS budget, 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 and Security Services (MA&SS) is responsible for
the protection of taxpayer data and information systems and the
continuing security of IRS personnel, facilities, and assuring the
security and resilience of critical agency functions and business
processes.
II. Performance Goals and Results:
The IRS uses performance measures to evaluate its effectiveness in
meeting its three strategic goals. The IRS achieved an overall success
rate of more than 68 percent for the second consecutive year, meeting
the target for 15 of its 22[Footnote 15] performance measures. Of the
seven IRS measures that did not meet targets; two related to electronic
filing where performance set records for the second consecutive year,
with individual electronic filing coming within 98 percent and business
within 89 percent of meeting the target; and two related to delivery of
tax products resulted from delayed by hurricane legislation. The fifth
missed measure dealt with determination case closures in which
inventory did not materialize. The sixth measure, examination coverage
for businesses, was missed by one percent because the IRS was prevented
from taking enforcement action on a significant number of partnership
return examinations involving a tax shelter promoter. Also, partnership
audits were not as productive as expected. As a result, the IRS has
stopped opening these audits until the examination selection
methodology is improved. The seventh measure, an efficiency measure
which dealt with contacts resolved per staff year, came within less
than one percent of being met. The performance information that follows
highlights successes and challenges during FY 2006.
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.
[End of table]
Major Results, Accomplishments, and Challenges:
The IRS serves a constituency of more than 220 million filers. Improved
service options for taxpayers and simplifying the tax process are key
strategies under the IRS strategic goal to improve taxpayer service.
The IRS allocates resources to education and outreach services to
ensure taxpayers understand their obligations and voluntarily
participate in the tax system.
Filing Season:
The IRS delivered a successful 2006 filing season in the midst of a
very challenging year. Despite natural disasters that impacted a large
number of taxpayers and required an unprecedented response, the IRS met
or exceeded 50 percent (five out of ten) of its performance goals
related to taxpayer service. The following highlights the IRS'
performance in FY 2006:
* Processed more that 134.7 million individual returns and issued more
than 100 million refunds totaling over $277 billion during the 2006
filing season (Tax Year 2005).
* Processed 46.9 million returns for partnerships, corporations,
employment taxes, and exempt organizations.
* Increased use of the IRS.gov website and "Where's My Refund?," up
more than 9.8 percent and 11.8 percent, respectively.
Despite not meeting its aggressive electronic filing targets in FY
2006, the IRS set another record for the number of returns filed
electronically. For the second year in a row, more than half (72.8
million) of all individual returns were filed electronically,
representing a 6.6 percent increase over FY 2005. The IRS' most recent
American Customer Satisfaction Index (ACSI) scores from 2005 also
reflected higher satisfaction from e-filers (77) over paper filers
(50). The 2006 ACSI scores will be available in December. The following
highlights the IRS' performance related to electronic filing:
* Home computer use to prepare and e-file tax returns increased 18.5
percent to more than 20.2 million returns.
* Tax preparation professional use of e-file increased 9.4 percent,
with 52.1 million filing electronically. In its fourth year of
operation, the Free File Alliance, the partnership between the IRS and
a consortium of tax preparation software companies, had approximately
four million taxpayers use the free service, a 22.6 percent decrease
from last year due to a change in the eligibility requirements.
* Nearly 14,000 large corporate taxpayers subject to the electronic
filing mandate successfully e-filed their returns. The largest
corporate taxpayers transmitted their returns predominately without
delay or back log. The IRS processed this volume of very complex
returns, and accepted and acknowledged receipt well within its 24-hour
turnaround standard.
* Customer use of on-line services continued to increase:
- More than 1.3 billion web pages were viewed on the IRS.gov website, a
four percent increase over FY 2005.
- More than 24.7 million taxpayers used the web application "Where's my
Refund?" to check the status of their refunds, an 11.8 percent increase
from last year.
* More than two million tax practitioners took advantage of the
electronic services provided by the IRS' e-Services project. e-Services
is a modernization project providing electronic services to promote the
goal of conducting electronic transactions between the IRS and tax
practitioners to reduce burden. In FY 2006:
- Over one million participants used a new Internet-Employer
Identification Number service,
- One million requests for transcripts were processed through the IRS'
Transcript Delivery System, and:
- More than 168,000 practitioners enrolled in the IRS e-file program.
Millions of taxpayers and tax professionals that visited IRS.gov during
the 2006 filing season benefited from many of the features the IRS
provides to simplify tax filing. Redesigned in November 2005, IRS.gov's
search and navigation tools were completely revamped to make it easier
and quicker for taxpayers to get information and answers to many of
their questions while preparing their returns. As a result, customer
satisfaction with the website increased five percentage points based on
the ACSI. In addition to improved customer satisfaction, the e-Gov
Institute awarded IRS.gov the 8TH Annual Government Solutions Center
Pioneer Award for "Innovative Use of Technology in a Government
Program." IRS.gov improvements came from listening to customers
concerns, conducting usability studies, and translating feedback into a
cohesive list of requirements.
Education & Outreach:
Helping the public to understand their tax reporting and payment
obligations remains a vital part of maintaining public confidence in
administering the tax laws. The IRS expanded its outreach by relying on
partner organizations such as state taxing authorities and a cadre of
volunteer groups to serve taxpayer needs. Through its 12,300 Volunteer
Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE)
sites, the IRS provided free tax assistance to the elderly, disabled,
and limited English proficient individuals and families. The 69,000
volunteers located at the sites prepared approximately 2.3 million
returns, a 7 percent increase over FY 2005.
In addition to conducting its own outreach and education activities,
the IRS participates in private partner education and outreach
programs. During FY 2006, the IRS provided resources and support for
over 290 Partner Coalitions, resulting in the electronic filing of 1.9
million returns. One of the larger partnerships, Connect America,
provides free tax assistance to disabled veterans and free tax
preparation and asset building strategies for low-income families. The
IRS was recognized in 2006 as the Connect America's Partner of the Year
for 2005 for its efforts to provide free tax assistance to
disadvantaged groups. The IRS is the first federal agency to receive
this award.
The IRS' nationwide marketing and education campaign, aimed at reducing
Earned Income Tax Credit (EITC) error, reached a wide audience
including taxpayers, tax practitioners, members of the media, and
partner organizations. The IRS held grassroots events in New Orleans
and Houston to focus on hurricane victims and in Denver and New York
for certain limited English proficiency communities. These events
provided information and free tax preparation to over 1,000 people and,
through the help of volunteers, nearly 300 returns were prepared. Over
1.5 million people viewed the EITC pages on IRS.gov. A million people
used the EITC Assistant, a web-based application to help taxpayers
determine eligibility, filing status, and estimate their EITC amount.
Also, the IRS provided answers to more than 160,000 EITC questions
through telephone assistance.
The IRS implemented a communication strategy to educate taxpayers and
employees about significant identity theft issues. Communication
channels included DVDs, public service announcements, and presentations
at the IRS' Tax Forums to educate tax professionals on requirements to
secure taxpayer data. The IRS also provided similar educational
services to persons with limited English proficiency.
Customer Service:
The IRS continues to improve quality, efficiency, and service delivery
through increased service coverage to taxpayers and improved business
processes. In October 2005, the IRS e-Services Project won the
Government Computer News 2005 Agency award for innovation. Winners are
chosen for their innovation, support of program or policy requirements,
and improvement of service delivery. IRS e-Services provide a set of
web-based business products for practitioners and other third parties.
IRS e-Services such as the new Internet-Employer Identification Number
(1.3 million) and Transcript Delivery Service (1.1 million),
experienced significant usage.
In December 2005, 43 state tax agency representatives, legally
authorized to receive federal tax information for state tax purposes,
were granted access to and trained on e-Services Transcript Delivery
Service. This reduced the number of transcript requests from state
agencies by 150,000. All 153 Low Income Tax Clinics were also given
access to e-Services and incentive products to better serve their
taxpayer customers.
The IRS developed processes and procedures for administering
telecommunications excise tax refunds (TETR) to more than 150 million
taxpayers. To do this, the IRS modified all individual and business tax
return forms to include TETR information; created a new form to be used
by individuals who want to request a refund but who have no other tax
filing requirement; and drafted a new form to be used by taxpayers who
choose to request refunds based on their actual payments rather than
use a standard amount set by the IRS. The IRS also launched an outreach
campaign to external stakeholder groups, programmed IRS systems to
accept form changes, developed TETR-related internal procedures (IRMs),
and trained employees who will interact with taxpayers on the phone and
at Taxpayer Assistance Centers. In addition, the IRS is developing a
methodology that can be used by businesses and non-profits to estimate
their TETR claims.
Telephone assistance calls decreased as more taxpayers opted to use
automated phone and Internet services. In FY 2006, the IRS answered
32.7 million assistor telephone calls, compared to 33.4 in FY 2005, and
completed more than 24.3 million automated calls, compared to 25.7 in
FY 2005. With the availability of improved online service options to
taxpayers, taxpayer visits to the Taxpayer Assistance Centers (TACs)
were down 10 percent from 2005, while the usage of the IRS.gov website
and the "Where's My Refund?" application were up 9.8 percent and 11.8
percent, respectively. Also, productivity improvements reduced the
resources needed to address account workload and taxpayer
correspondence cases. The IRS correctly responded to 91 percent of tax
law questions and 93 percent of account questions received via the
telephone, and achieved an 82 percent level of service answering calls
from taxpayers.
All 400 TACs remained open and services were consistent with the 2005
filing season. Additionally, wait time at the TACs was minimized with
more than 80 percent of customers being served in 30 minutes or less.
The accuracy of responses to tax law questions increased to 83 percent,
compared to 75 percent in FY 2005. Approximately 12,300 VITA and TCE
sites provided free tax assistance to the elderly, disabled, and
limited English proficient individuals and families. The 69,000
volunteers located at the sites prepared approximately 2.3 million
returns, a 7 percent increase over FY 2005.
In response to the hurricanes of 2005, emergency supplemental
appropriations were enacted that required over 230 changes to 78 tax
products. Despite passage late in the tax year, 83 percent of the
critical filing season tax products and over 61.2 percent of other tax
products were delivered to the public on time. The IRS plans to
continue its efforts to simplify its tax forms and publications making
them more user-friendly with the ultimate goal of providing all of its
published products in electronic format.
Burden Reduction:
The IRS provides help to taxpayers to file accurate and timely tax
returns in order to reduce burden. In addition, the IRS pursues tax
form simplification and an increased effort to provide forms more
suitable for a computer-based system. Taxpayer burden is measured by
the amount of time and out-of-pocket expense taxpayers incur in meeting
their tax responsibilities. The estimated FY 2006 burden was 6.7
billion hours, compared with 6.4 billion hours in FY 2005, an increase
of approximately 250 million hours. This increase reflects new forms
and changes to existing forms dictated by the ten different pieces of
legislation enacted in 2005.
The IRS also partnered with external stakeholders, including taxpayers,
practitioners, citizens and industry groups, software developers, and
state and federal agencies to receive suggestions for reducing taxpayer
burden. As a result, in FY 2006, the IRS launched a number of new forms
and procedures designed to reduce burden without compromising the tax
administration objectives. The following highlights some of these
initiatives:
* Redesigned unemployment tax returns (Form 940 and a new Form 944) to
reduce filing burden for 950,000 small business owners and governmental
entities. The new forms allow certain employment tax filers to file
annually rather than quarterly and to make a single payment with the
annual return.
* Revised Schedule K-1 for Form 1041 to provide streamlined
instructions for beneficiaries. The revised form can be scanned and
will reduce the number of transcription errors. The new Schedule K-1 is
expected to reduce 4.27 million hours of burden for 3.5 million
taxpayers.
* Launched an Alternative Minimum Tax (AMT) Calculator to assist
taxpayers in determining whether they are subject to the AMT and if
they need to complete the tax form (Form 6251). The AMT is calculated
separately, eliminates many deductions and credits, and creates a tax
liability for an individual who would otherwise pay little or no tax.
By 2010, the AMT is expected to affect nearly 32 million taxpayers.
* Simplified the process for requesting an extension of time to file an
individual return on the original Form 4868 (extension request) and now
automatically grants an additional six month extension to file. The
redesign of the extension process allowed an additional two million
taxpayers the ability to e-file/e-pay and eliminated five million
duplicate filings. Similar changes were made to the extension process
for corporate taxpayers. The automated process affected 15.5 million
submissions, reduced taxpayer burden by nine million hours, and reduced
processing costs by 50 percent.
The IRS also provided assistance to corporate taxpayers in identifying
and resolving potentially controversial disputes earlier in the
examination process through its Pre-filing Agreement (PFA) and the
Industry Issue Resolution programs. These programs reduce costs,
burden, and delays because they enable corporations and the IRS to
reach agreement on a contentious issue through a cooperative effort
before a return is filed. In FY 2006, the IRS received over 230 PFA
requests and accepted 152. Of these, 55 percent were closed with an
agreement and 20 percent were withdrawn (either by the taxpayer or the
IRS). Taxpayers reported an overall level of satisfaction with these
programs of 4.7 and 4.6, respectively (on a 5 point scale).
Disaster Assistance and Response:
The IRS provided unprecedented tax relief in the wake of the hurricanes
that occurred along the Gulf Coast in August and September of 2005.
Within days of the storms, the IRS assisted FEMA with taking
registrations on their toll-free line and provided emergency equipment
to support four FEMA call sites to handle the increased call volume.
From the end of August through October 31, 2005, the IRS responded to a
total of 948,814 FEMA calls and assigned 5,000 IRS employees to augment
staffing at FEMA call centers. In addition, the IRS provided assistance
to the Small Business Administration (SBA) and the Department of Labor
to expedite income verification for disaster loans and unemployment
benefits. The IRS processed more than 1.3 million requests for tax
information from the SBA, expediting the disaster claims process.
The IRS responded to 49 disaster declarations, providing assistance and
relief to the needs of disaster victims. Within 24 hours of the
Presidential disaster declaration in the wake of Hurricane Katrina, the
IRS formed a multi-functional policy group which worked closely with
key federal agencies and external stakeholders to develop a number of
substantive legislative proposals. The new legislative provisions
included in the emergency supplemental appropriations to address
hurricanes in the Gulf of Mexico were designed to provide broad relief
to impacted taxpayers by postponing filing and payment deadlines,
allowing penalty free withdrawals from retirement accounts, and
claiming casualty losses. The legislation required changes to 78 tax
products. Despite the passage of the statute late in the tax year, 83
percent of the critical tax products and over 61.2 percent of other tax
products were delivered to the public on time.
To help disaster victims understand the numerous tax law provisions
enacted as a result of the hurricanes, the IRS developed and
distributed 424,147 Disaster Relief Kits to individuals and businesses
and distributed more than 85,382 copies of Publication 4492. The IRS
assisted over 288,000 taxpayers on the toll-free telephone lines
providing hurricane victims with help on tax issues, provided
substantial disaster information and resources on IRS.gov, and issued
60 news releases and legal guidance documents announcing details on
relief made available to hurricane victims. The IRS secured agreements
with seven tax professional organizations to jointly provide assistance
at local disaster relief centers and secured additional agreements with
several practitioner organizations to provide free casualty loss tax
return preparation for low income taxpayers. In addition, at least 257
VITA sites remained open after April 17, 2006, to help disaster
impacted taxpayers.
In the aftermath, the IRS continued to provide assistance and education
on administrative and legislative tax relief to individual and business
taxpayers and practitioners. The IRS held more than 70 local outreach
events to assist disaster victims and has planned additional events.
IRS measures reported in the IRS' annual performance budget and
included in the Treasury Performance Reporting System are discussed
below.
Table 1 Customer Service Representative (CSR) Level of Service:
Description: The relative success rate of taxpayers that call IRS toll-
free services seeking assistance from a CSR.
CSR Level of Service;
FY 2003 Actual: 80.0%;
FY 2004 Actual: 87.0%;
FY 2005 Actual: 82.6%;
FY 2006: Plan: 82.0%;
FY2006: Actual: 82.0%.
[End of table]
FY 2006 Performance: Target Achieved. The IRS met/exceeded the FY 2006
target.
Future Plans: The IRS will continue to maintain CSR Level of Service at
82 percent in FY 2007. The IRS expects an increase in telephone demand
in FY 2007 from the Telecommunications Excise Tax Refund (TETR)
initiative, and plans to increase staffing to meet the expected demand.
Table 2: Customer Contacts Resolved per Staff Year:
Description: The number of Customer Contacts resolved in relation to
time expended based on staff usage.
Customer Contacts Resolved per Staff Year;
FY 2003 Actual: 8,318;
FY 2004 Actual: 8,015;
FY 2005 Actual; 7,585;
FY 2006: Plan: 7,477;
FY 2006: Actual: 7,414.
[End of table]
FY 2006 Performance: Target Not Achieved. Despite answering 2.7 million
more contacts than planned, the IRS did not meet this target.
Efficiencies expected from the reduction of Toll-free telephone service
operating hours (from 15 to 12 hours per day) did not occur because the
service operating hours were not reduced due to reduction in service
concerns expressed by Congress. Staffing for the 15 hours required an
additional 482 Full Time Equivalents (FTE) over plan. Overall, the IRS
came within 99 percent of the goal, answering almost 2 million
additional automated calls, 564,000 assistor calls, and completing over
750,000 additional Web Services. Completing a web service is defined as
providing a service requested by a taxpayer or tax practitioner through
self-assist internet-based applications such as Internet Refund Fact of
Filing ("Where's My Refund"), Transcript Delivery System, Preparer Tax
Identification Number, Internet-EIN, Prior Year Earned Income Option,
and Disclosure Authorizations.
Future Plans: The IRS is expecting efficiency to increase as more
taxpayers choose to use automated means to contact the IRS instead of
traditional, labor intensive methods.
Table 3: Percent of Eligible Taxpayers Who File for EITC:
Description: The number of taxpayers who claimed the Earned Income Tax
Credit (EITC) compared to the number of taxpayers who appear to be
eligible for the EITC.
Percent of Eligible Taxpayers Who File for EITC;
CY 2003 Actual: --;
CY 2004 Actual: 80.0%;
CY 2005 Actual: 80.0%;
CY 2006: Plan: 80.0%*;
CY 2006: Actual: Not yet available.
*The participation rate is an estimate based on a methodology which
includes underlying assumptions about the potential EITC eligible
population.
[End of table]
CY 2006 Performance: Data to estimate the participation rate will be
available late in 2007.
Future Plans: The methodology for estimating the EITC participation
rate is being validated using Census data in an effort to improve the
accuracy of estimates.
Table 4: Customer Accuracy -Tax Law Phones:
Description: The percentage of correct tax law answers provided by a
telephone assistor. The measure indicates how often customers receive
the correct answer to their tax law inquiry based upon all available
information and Internal Revenue Manual required actions.
Customer Accuracy - Tax Law Phones;
FY 2003 Actual: 82.0%;
FY 2004 Actual: 80.0%;
FY 2005 Actual: 89.0%;
FY 2006: Plan: 90.0%;
FY 2006: Actual: 90.9%.
[End of table]
FY 2006 Performance: Target Exceeded. The IRS met/exceeded the FY 2006
target.
Future Plans: Incremental improvement in the performance is expected in
FY 2007 and beyond from the completion of the Contact Recording
project, a program to record customer contacts for quality review to
help employees improve their skills, ease manager burden, and raise
quality for customers.
Table 5: Customer Accuracy - Accounts (Phones):
Description: The percentage of correct answers provided by a telephone
assistor. The measure indicates how often customers receive the correct
answer to their account inquiry and/or had their case resolved
correctly based upon all available information and Internal Revenue
Manual required actions.
Customer Accuracy - Accounts (Phones);
FY 2003: Actual: 88.2%;
FY 2004: Actual: 89.3%;
FY 2005: Actual: 91.5%;
FY 2006: Plan: 92.0%;
FY 2006: Actual: 93.2%.
[End of table]
FY 2006 Performance: Target Exceeded. The IRS met/exceeded the FY 2006
target.
Future Plans: Incremental improvement in performance is expected in FY
2007 and beyond from continued improvement efforts such as the
development of new online tools for assistors to research taxpayer
questions.
Table 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 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 20 (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 2006.
Timeliness of Critical Filing Season Tax Products to the Public;
FY 2003: Actual: --;
FY 2004: Actual: 76.0%;
FY 2005: Actual: 91.4%;
FY 2006: Plan: 92.0%;
FY 2006: Actual: 83.0%.
[End of table]
FY 2006 Performance: Target Not Achieved. The IRS did not meet the FY
2006 target. In:
FY 2006, the IRS shipped 166 of 200 (83 percent) Critical Filing Season
tax products timely. Shipment of the remaining products was delayed
intentionally to incorporate changes mandated in legislation enacted
late in 2005, P.L. 109-73, Katrina Emergency Tax Relief Act of 2005
(KETRA) and P.L. 109-135, Gulf Opportunity Zone Act of 2005 (GOZONE).
Future Plans: The IRS expects to resume timely delivery of all tax
products in FY 2007.
Table 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 include business, Tax Exempt and Government Entities, and
miscellaneous tax products. This measure contains two components: (1)
percentage of paper tax products that meet the scheduled ship date
within five business days of the actual date, and (2) percentage of
scheduled electronic tax products that is available on the Internet
within five business days of the scheduled print date. The intent is to
have the tax products available to the public at least 30 days before
the form is required to be filed.
Timeliness of Critical Other Tax Products to the Public;
FY 2003: Actual: --;
FY 2004: Actual: 76.0%;
FY 2005: Actual: 80.0%;
FY 2006: Plan: 85.0%;
FY 2006: Actual: 61.2%.
[End of table]
FY 2006 Performance: Target Not Achieved. The IRS did not meet the FY
2006 target. Production schedules required modification to accommodate
the delay in completion of the critical filing season tax products
(discussed in measure 6. above), necessitating changes to the scheduled
modification and ship dates for these non-critical tax products.
Monthly timeliness results during early FY 2006 reflected this shift to
the workplans. The IRS could not recover the lost production days, and
as a result, could not meet the target.
Future Plans: The IRS expects to resume timely delivery of all tax
products in FY 2007.
Table 8: Percent Individual Returns Processed Electronically:
Description: The number of electronically filed individual tax returns
divided by the total individual returns filed.
Percent Individual Returns Processed Electronically;
FY 2003: Actual: 40.0%;
FY 2004: Actual: 46.5%;
FY 2005: Actual: 51.1%;
FY 2006: Plan: 55.0%;
FY 2006: Actual: 54.1%;
[End of table]
FY 2006 Performance: Target Not Achieved. The IRS did not meet the FY
2006 target. Although the January through June performance was at 55
percent, a higher percentage of paper returns were received during July
through September causing the fiscal year percentage of electronically
filed returns to drop.
The plan number is derived from semiannual filing projections prepared
by the IRS Research organization, incorporating changes in filing
patterns, economic and demographic trends, legislative requirements,
and IRS administrative processes. The projections provide a basis for
IRS workload estimates.
Future Plans: E-file participation rates are projected to increase to
58.2 percent in 2007 based on current experience, historical growth,
increased advertising, marketing, and expanded e-file programs and do
not reflect gains from any mandates.
Table 9: Percent Business Returns Processed Electronically:
Description: The number of electronically filed business returns
divided by the total business returns filed.
Percent Business Returns Processed Electronically;
FY 2003: Actual: --;
FY 2004: Actual: 17.4%;
FY 2005: Actual: 17.8%;
FY 2006: Plan: 18.6%;
FY 2006: Actual: 16.6%.
[End of table]
FY 2006 Performance: Target Not Achieved. The IRS did not meet the FY
2006 target. The plan number is derived from semiannual filing
projections prepared by the IRS Research organization semiannually,
incorporating changes in filing patterns, economic and demographic
trends, legislative requirements, and IRS administrative processes. The
projections provide a basis for IRS workload estimates.
Future Plans: The IRS expects the percentage of business filers to
increase in the future due to increased marketing and expanded business
e-file programs, including the acceptance of new forms and schedules
attached to employer, estates and trusts, and partnership filings,
acceptance of amended returns, and acceptance of the new annualized
employment tax return. The IRS will continue to pursue additional
mandates for businesses to file electronically similar to the one
recently imposed for corporations.
Table 10: Taxpayer Self Assistance Rate:
Description: The percent of contacts that are resolved by automated
self-assistance applications.
Taxpayer Self Assistance Rate;
FY 2003: Actual: 51.0%;
FY 2004: Actual: 46.4%;
FY 2005: Actual: 42.5%;
FY 2006: Plan: 45.7%;
FY 2006: Actual:46.8%.
[End of table]
FY 2006 Performance: Target Exceeded. The IRS met/exceeded the FY 2006
target.
Future Plans: The IRS expects performance to continue to increase as
more taxpayers choose to use automated applications to resolve issues
and questions instead of more traditional methods such as contact with
the IRS by telephone and correspondence.
Table 11: Refund Timeliness - Individual (Paper):
Description: The percentage of refunds resulting from processing
Individual Master File paper returns issued within 40 days or less.
Refund Timeliness - Individual (Paper);
FY 2003: Actual: 98.8%;
FY 2004: Actual: 98.3%;
FY 2005: Actual: 99.2%;
FY 2006: Plan: 99.%;
FY 2006: Actual: 99.3%.
[End of table]
FY 2006 Performance: Target Exceeded. The IRS met/exceeded the FY 2006
target.
Future Plans: The IRS expects its performance for refund timeliness to
remain stable under the current processing system and within resource
constraints.
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:
Reducing the tax gap is at the heart of IRS' enforcement programs. The
tax gap is the difference between what taxpayers should pay and what
they actually pay due to not filing tax returns, not paying their
reported tax liability on time, or failing to report their correct tax
liability. The tax gap, about $345 billion for Tax Year (TY) 2001,
based on updated FY 2006 estimates, represents the amount of
noncompliance with the tax laws. Underreporting tax liability accounts
for 83 percent of the gap, with the remainder almost evenly divided
between non-filing (eight percent) and underpaying (nine percent). The
IRS remains committed to finding ways to increase compliance and reduce
the tax gap, while minimizing the burden on the vast majority of
taxpayers who pay their taxes accurately and on time.
The IRS uses its enforcement authority to assess and collect taxes that
are due from people who do not fulfill their tax obligations, thus
improving compliance. Noncompliance may not be deliberate and can stem
from a wide range of causes, including lack of knowledge, confusion,
poor recordkeeping, differing legal interpretations, unexpected
personal emergencies, and temporary cash flow problems. However, some
noncompliance is willful, even to the point of criminal tax evasion.
For example, certain taxpayers invest in tax shelters, trusts, and
other structured products knowing that the promised tax benefits are
not in conformity with the law. The IRS has and will continue to
enforce the law across all sectors, but is focusing on corrosive
activities of corporations, high income taxpayers, and other major
violators of the tax code. These efforts are having a positive impact
on collecting additional tax revenue. Enforcement revenue from all
sources was at a record level of $48.7 billion in FY 2006, a three
percent increase. Targeting high-risk taxpayers improves IRS
efficiency, reduces the burden on compliant taxpayers, and concentrates
enforcement presence where it is most needed.
In FY 2006, enhancing the IRS' enforcement presence remained a top
priority. At the same time, the IRS focused its efforts on improving
business processes and modernizing its information systems, both
powerful enablers of the IRS business goals. For FY 2006, ten of the
twelve enforcement performance targets were met. Focusing on more
limited scope examinations and productivity enhancements, including
improved analytics, workload identification, and selection systems that
targeted high-risk cases resulted in:
* 7 percent improvement in individual audits:
* 18 percent increase in high income audits:
* 8 percent increase in small-business audits:
* 10 percent increase in automated underreporter closures:
* 15 percent increase in collection case closures:
* 9 percent increase in revenue received from collection activities:
* 66 percent overall increase in the use of substitute for return
authority (substitute for return authority allows the IRS to file a tax
return for an individual or business when it does not file a required
return), examiners prepared and filed 665,000 returns for individuals
and 182,000 returns for businesses classified as non-filers:
The IRS also met its coverage, efficiency, and embedded quality annual
targets. Improvements in inventory management, decreases in cycle time,
and enhanced training all contributed to increase productivity.
Improved quality controls measuring critical elements of the
examination, a reinforced focus on case quality to drive improvement
efforts, and the delivery of business results, led to improved
performance for the third consecutive year. Future efforts to reduce
the tax gap will include strategies to ensure optimum balanced audit
coverage, and improve resource allocation.
In FY 2006, the IRS continued its efforts in streamlining and improving
its examination process, resulting in considerably shortened cycle time
for large corporate audits. By doing better analysis to focus on high
risk issues, and planning jointly with the taxpayers on the audit cycle
and information document requests, the cycle time was reduced
substantially. In FY 2006, the time from assigning a large corporate
return to a revenue agent until the final closing decreased more than
18 percent, from 17.5 months to 14.3 months. The improvements to the
examination process ultimately increased inventory turnover and
closures.
The IRS also implemented a new compliance assurance process where large
corporate taxpayers and IRS work together to examine transactions in
"real time" during the taxable year to: (1) reach agreement on the
taxpayer's tax liability before the tax return is filed; and (2) fast
track the appeal process by bringing the examination team and the
taxpayer to the table to expedite the settlement of remaining issues of
controversy. Under this new process, the IRS is able to determine the
tax liability within months of filing. The process is beneficial to the
taxpayer and the IRS because it reduces the taxpayers' compliance
burden while increasing currency and allows for more efficient use of
IRS resources. Tax Year (TY) 2006 was a pilot year with 34
participants; 19 new and 15 carried over from TY 2005. With full
implementation, however, the impact on compliance and the reduction in
taxpayer burden is expected to be substantial.
The IRS has developed a nationally coordinated program to combat
abusive tax schemes. The primary focus is on the identification and
investigation of the tax scheme promoters as well as those who play a
substantial or integral role in facilitating, aiding, assisting, or
furthering the abusive tax scheme (e.g., accountants, lawyers).
Secondarily, but equally important, is the investigation of investors
who participate in abusive tax schemes. The following highlights some
of the initiatives:
² The Partnership Option Portfolio Securities (POPS) initiative
challenges the tax benefits derived from manipulating portions of the
Internal Revenue Code for the purpose of generating permanent non-
economic tax losses. To date, closing agreements have been received
from 63 of the 107 partners agreeing to a settlement, totaling $556
million in tax, penalties, and interest.
² The Personal Investment Corp initiative challenged tax benefits
derived from a type of transaction related to S-Corps rules. The
transaction attempts to allocate the loss side of a foreign currency
transaction to a tax shelter investor, but not the gain. Closing
Agreements have been received from 103 of the 141 shareholders,
totaling $592 million in tax, penalties, and interest.
² Select Tax Shelter Promoters were given an opportunity to make an
election agreeing to concede 100 percent of their allocable share of
the penalty imposed for failing to register a tax shelter. In exchange,
penalties for failing to maintain investor lists were waived, and the
IRS agreed not to refer selected promoters for prosecution related to
the transactions. The settlement initiative allowed faster case
resolution, earlier receipt of investor and co-promoter information,
and ensured future compliance by taxpayers. The settlement initiative
is being offered in waves, beginning with 36 promoters in FY 2006.
In the retirement plans arena, a global settlement initiative dealt
with abusive transactions where taxpayers attempted to exclude business
income using a combination of schemes that concentrate benefits among a
small number of persons. Examinations of 182 potentially abusive plans
are in process. In FY 2006, the IRS also started examinations on 262
potentially abusive plans involving questionable life insurance
policies.
The IRS has a robust, balanced, and comprehensive plan to help reduce
improper payments that include base compliance activities and redesign
efforts. In FY 2006, the IRS conducted over 500,000 examinations,
issued over 600,000 math error notices (math or other statistical
irregularities are systemically identified during processing), and
matched 300,000 information documents (e.g. W-2s, 1099s) from employers
with information on the tax return. Collectively, these three
enforcement activities prevented nearly $2 billion from being paid out
erroneously.
The IRS redesigned portions of its examination process. Improvements
include: a process to score and select amended returns for examination;
a risk-based scoring strategy to identify and select cases for
examination that ensures the IRS works the most egregious and
productive examination cases; systemic assignment of examination cases
to campuses using new data such as capacity and risk-based scores; and
integration of a decision support tool which automates issue
identification, increases consistency in case documentation, and
eliminates duplicative data entry when the case is closed.
Focusing efforts in key areas improved the IRS' ability to address
complex strategies employed by taxpayers to avoid payment of their
taxes and contributed to meeting or exceeding all of the FY 2006
collection performance targets:
* Enhancing training to improve the skill sets needed to work complex
issues;
* Leveraging automation including securing new technology to help
streamline collection processes;
* Improving the support structures or business processes to improve
efficiency and effectiveness of collection personnel; and:
* Improving employee engagement and customer satisfaction to impact
positively on reducing the underpayment portion of the tax gap.
Enforcement of criminal statutes is an integral component of the IRS'
efforts to enhance voluntary compliance of the tax laws. In FY 2006,
abusive tax schemes and shelters remained a high investigative priority
due to egregious corporate fraud and tax avoidance of high-income
individuals. The IRS used parallel proceedings, one of its most
effective tools, to combat abusive tax schemes. This tool enables the
IRS to prevent promoters of abusive schemes from engaging in further
promotion activity while the criminal investigation is proceeding.
The IRS improved its fraud referral acceptance rate while working high
quality cases. The FY 2006 referral acceptance rate of 71.8 percent
exceeded the five-year high achieved in FY 2005 of 68.8 percent and the
total number of referrals accepted (445) also was higher than last
year. The IRS completed 4,157 criminal investigations, exceeding the
IRS' FY 2006 target of 3,945. The incarceration rate of individuals
sentenced for cases originating from a fraud referral was 81.7 percent
in FY 2006, and the significant prison sentences (on average 20 months)
handed down in cases originating from fraud referrals reflect their
overall quality. The IRS continued to increase the publicity on tax
prosecutions because of the positive effect on compliance. In FY 2006,
the publicity rate on legal source tax cases remained high at 81.3
percent with an overall publicity rate for all prosecutions of 75.6
percent.
The IRS also provides financial investigation expertise to the Federal
Bureau of Investigation's Joint Terrorism Task Forces and the U.S.
Attorney's Anti-Terrorism Advisory Council in disrupting and
dismantling terrorist financing. The IRS works closely with Treasury to
investigate and freeze accounts controlled by individuals and
"charitable" organizations suspected of raising or facilitating the
movement of funds used to support terrorism. In FY 2006, the IRS had
212 terrorism related investigations in inventory, a 31 percent
increase from last year. Fifty-two cases were recommended for
prosecution to the Department of Justice, resulting in 44 indictments.
The IRS also participated on the Joint International Tax Shelter
Information Centre (JITSIC). The JITSIC, which consists of tax
officials from the U.S., United Kingdom, Canada, and Australia, is
scrutinizing tax arbitrage by multinational corporations. The combined
detection and analytical capabilities of the JITSIC will better enable
the IRS and other participating tax agencies to take action against
those who plan, facilitate, or engage in abusive tax transactions in
other countries.
The IRS committed to strengthen its enforcement presence among those
entities with special benefits that may attract fraud and abuse. The
purpose of this scrutiny is to ensure the entity is legitimate when
established, the operation remains compliant and the entity is not
being misused by third parties for tax avoidance or other unintended
purposes. In FY 2006, the IRS focused on:
* Consumer credit counseling - Because of the changes in the way the
credit counseling industry now operates, the IRS examined 63 tax-exempt
credit counseling organizations, representing 56 percent of industry
revenues. These examinations resulted in the revocation or proposed
revocation of exempt status (under which a business can continue to
operate as a for-profit corporation), for organizations comprising 41
percent of the revenue in this industry. In addition to its vigilant
examination program, the IRS halted the growth of abusive credit
counseling organizations. Of more than 110 recently reviewed
applications, only three met the requirements for tax-exempt status.
The IRS also conducted compliance checks of the more than 700 remaining
organizations to determine whether they are operating compliant credit
counseling programs.
* Pension funding - In the wake of several prominent bankruptcies which
resulted in seriously under-funded pension plans, the IRS increased
interagency coordination with the Department of Labor (DOL) and the
Pension Benefit Guaranty Corporation (PBGC). A closing agreement in FY
2006 with an employer in bankruptcy resulted in payment of $23 million
and established a precedent for renewed assertion of claims. The IRS,
DOL, and PBGC agreed to meet weekly to coordinate administrative
actions on such plans.
* Political activity - As a result of findings from examinations
conducted during the 2004 election cycle, the IRS increased its
vigilance concerning political campaign intervention by tax exempt
501(c) (3) charitable organizations. Some level of prohibited political
activity was found in three-quarters of the cases reviewed including
violations such as distributing improper voting guides or printed
materials favoring particular candidates, endorsing or opposing
candidates from the pulpit, criticizing or supporting candidates on a
charity's website, permitting certain candidates to speak at official
functions, and making contributions to campaigns. In February 2006, the
IRS issued new procedures for the 2006 election season to ensure that
all referrals are reviewed expeditiously and consistently. The IRS also
expanded its educational effort to ensure that charities understand
what constitutes prohibited political intervention and how to stay in
compliance with the tax law.
* Down payment assistance - The IRS found that organizations claiming
to be charities are funneling down-payment assistance from sellers to
buyers through self-serving, circular financing arrangements. As a
result, in FY 2006, an active outreach effort was launched and a
vigorous audit program established to identify potential abusers. The
IRS also issued formal guidance that shows the difference between a
down-payment assistance organization operating in a manner consistent
with requirements for qualifying as a charity with seller-financed
arrangements that do not. In addition to its ongoing examination
program, the IRS denied applications for exemption from 53 seller-
financed down-payment assistance organizations. The revenue ruling and
increased enforcement activity garnered considerable media attention
and support from the Chairman of the Senate Finance Committee.
IRS measures reported in the IRS' annual performance budget and
included in the Treasury Performance Reporting System are discussed
below.
Table 12: Examination Coverage - Individual (Revised Measure):
Description: The sum of all individual returns closed by SB/SE, W&I,
and LMSB (Field Examination and Correspondence Examination) divided by
the total individual return filings for the prior calendar year.
Examination Coverage - Individual;
FY 2003: Actual: --;
FY 2004: Actual: 0.8%;
FY 2005: Actual: 0.9%;
FY 2006: Plan: 0.9%;
FY 2006: Actual: 1.0%.
Note: In FY 2005, Automated Underreported (AUR) cases were included as
part of this measure. In FY 2006, AUR is covered as a separate measure
(see measure 7. - AUR Coverage). The new methodology was applied to
prior year actual and the FY 2006 plan number.
[End of table]
FY 2006 Performance: Target Exceeded. The IRS met/exceeded the FY 2006
target.
Future Plans: The IRS will continue to balance its audit coverage to
emphasize reduction of the tax gap. Specific areas targeted for
improvement include the workload identification processes, the audit
selection criteria, and restructured examination training classes.
Table 13: Field Examination Embedded Quality (EQ) (Replaces
Examination Quality - Field):
Description: The number of EQ quality attributes that are scored as
"met" by an independent centralized review staff divided by the total
attributes measured ("mets" + "not mets") in a sample of closed Field
Examination cases. All measured attributes have the same weight when
calculating the score. Pending full implementation in FY 2007, only
like attributes corresponding to those in the prior Examination Quality
Measurement System (EQMS) (quality system preceding EQ) reviews were
used in FY 2006.
Field Examination Embedded Quality;
FY 2003: Actual: N/A;
FY 2004: Actual: N/A;
FY 2005: Actual: N/A;
FY 2006: Plan: Baseline;
FY 2006: Actual: Not yet available.
[End of table]
FY 2006 Performance: In FY 2006, a baseline year, the IRS converted to
the EQ system of measuring quality by the national independent
centralized review staff. Baseline data will be available December 1,
2006.
Future Plans: The IRS will complete the full implementation of EQ with
the addition of the front-line manager phase. This phase directly links
Critical Job Elements to the quality measurement system, improving the
relationship between individual performance and organizational
objectives. Full implementation of EQ is expected to help identify
potential problem areas in need of process improvements or focused
training, and ultimately, lead to reductions in examination cycle time.
Table 14: Office Examination Embedded Quality (EQ) (Replaces
Examination Quality - Office):
Description: A percentage representing the number of EQ quality
attributes that are scored as "met" within SBSE divided by the total
attributes measured ("mets" + "not mets") in a sample of closed Office
Examination cases. All measured attributes have the same weight when
calculating the score. Pending full implementation in FY 2007, only
like attributes corresponding to those in the prior EQMS reviews were
used in FY 2006.
Office Examination Embedded Quality;
FY 2003: Actual: N/A;
FY 2004: Actual: N/A;
FY 2005: Actual: N/A;
FY 2006: Plan: Baseline;
FY 2006: Actual: Not yet available.
[End of table]
FY 2006 Performance: In FY 2006, the baseline year, the IRS converted
to the EQ system of measuring quality at the national independent
centralized review staff within SBSE level. Baseline data will be
available December 1, 2006.
Future Plans: The IRS will complete the full implementation of EQ with
the addition of the front-line manager phase. This phase directly links
employees' Critical Job Elements to the quality measurement system,
improving the relationship between individual performance and
organizational objectives. Full implementation of EQ is expected to
help identify potential problem areas in need of process improvements
or focused training and, ultimately, lead to reductions in examination
cycle time.
Table 15: Examination Coverage - Business (Corps. >$10M):
Description: The number of Large and Mid-Size Business customer returns
with assets greater than $10 million examined and closed during the
current fiscal year, divided by filing of the same type returns from
the preceding calendar year.
Examination Coverage - Business (Corps. >$10M);
FY 2003: Actual: --;
FY 2004: Actual: 7.5%;
FY 2005: Actual: 7.8%*;
FY 2006: Plan: 7.5%;
FY 2006: Actual: 7.4%.
*Revised FY 2005 actual reflects updated case closure information from
the Automated Inventory Management System (AIMS):
[End of table]
FY 2006 Performance: Target Not Achieved. The IRS did not meet the FY
2006 target. The target was missed by .1 percentage point due to the
IRS being prevented from taking enforcement action on a significant
number of partnership return examinations involving a tax shelter
promoter. Also, partnership audits were not as productive as expected
so the IRS stopped opening these audits until improvement of the
examination selection methodology.
Future Plans: The IRS will continue to focus on the issues that pose
the greatest compliance risk and to identify enterprises that appear to
be non-compliant. The IRS' emphasis on streamlining and improving the
examination process, coupled with better risk analysis, will continue
to provide for early resolution of post-filing examination issues and
enhance large business examination coverage.
Table 16: Examination Efficiency - Individual (Revised Measure):
Description: The sum of all individual returns closed by SB/SE, W&I,
and LMSB (Field Examination and Correspondence Examination) divided by
the Total Full Time Equivalents (FTE) expended in examining those
individual returns. In FY 2005, Automated Underreporter (AUR) cases
were included as part of this measure. In FY 2006, AUR Efficiency is
covered as a separate measure (see measure 6. - AUR Efficiency). The
new methodology was applied to prior year actual and the FY 2006 plan
number.
Examination Efficiency - Individual;
FY 2003: Actual: N/A;
FY 2004: Actual: N/A;
FY 2005: Actual: 121;
FY 2006: Plan: 121;
FY 2006: Actual: 128.
[End of table]
FY 2006 Performance: Target Exceeded. The IRS met/exceeded the FY 2006
target. Record closures and stable FTE enabled the IRS to exceed its
plan.
Future Plans: The IRS will continue to provide balanced examination
coverage for those individual return categories with the highest risk
of non-compliance, focusing on both understatement of income and
overstatement of offsets to income. Newly designed training supports
this emphasis, with its focus on auditing techniques.
Table 17: Automated Underreporter (AUR) Efficiency:
Description: The total number of W&I and SB/SE contact closures (a
closure resulting from a case where the IRS made contact with the
taxpayer) divided by the total FTE.
AUR Efficiency;
FY 2003: Actual: --;
FY 2004: Actual: 1,514;
FY 2005: Actual: 1,701;
FY 2006: Plan: 1,759;
FY 2006: Actual: 1,832.
[End of table]
FY 2006 Performance: Target Exceeded. The IRS met/exceeded the FY 2006
target.
Future Plans: The IRS will leverage the process improvements
implemented in FY 2006 to improve workload selection and productivity,
and reduce the number of cases closed without taxpayer contact.
Table 18: Automated Underreporter (AUR) Coverage:
Description: Total number of W&I and SB/SE contact closures (a closure
resulting from a case where IRS made contact) divided by the total
return filings from the prior year.
AUR Coverage;
FY 2003: Actual: --;
FY 2004: Actual: 1.9%;
FY 2005: Actual: 2.2%;
FY 2006: Plan: 2.3%;
FY 2006: Actual: 2.4%.
[End of table]
FY 2006 Performance: Target Achieved. The IRS met/exceeded the FY 2006
target.
Future Plans: The IRS plans to leverage the process improvements
implemented in FY 2006 to improve workload selection and productivity,
reducing the number of cases closed without taxpayer contact.
Table 19: Examination Quality - Industry:
Description: The average of the percentage of critical quality
attributes passed on Industry cases (corporations, S-Corps (pass
through corporations), and partnerships with assets over $10 million
reviewed.
Examination Quality - Industry;
FY 2003: Actual: 74.0%;
FY 2004: Actual: 74.0%;
FY 2005: Actual: 77.0%;
FY 2006: Plan: 80.0%;
FY 2006: Actual: 85.0%.
[End of table]
FY 2006 Performance: Target Exceeded. The IRS met/exceeded the FY 2006
target.
Future Plans: The IRS plans to identify areas that warrant further
attention and improvement through its quality reviews. All examination
training courses will expand modules on the identified improvement
targets and incorporate pertinent information about the auditing
standards used to measure case quality. The IRS will also continue its
work with the Case Quality Improvement Council (CQIC) and its Industry
contacts to drive quality improvement efforts.
Table 20: Examination Quality - Coordinated Industry:
Description: The average of the percentage of critical quality
attributes passed on Coordinated Industry (the 900 largest
corporations) cases reviewed.
Examination Quality - Coordinated Industry;
FY 2003: Actual: 89.0%;
FY 2004: Actual: 87.0%;
FY 2005: Actual: 89.0%;
FY 2006: Plan: 92.0%;
FY 2006: Actual: 96.0%.
[End of table]
FY 2006 Performance: Target Exceeded. The IRS met/exceeded the FY 2006
target.
Future Plans: The IRS plans to identify areas that warrant further
attention and improvement through its quality reviews. All examination
training courses will expand modules on the identified improvement
targets and incorporate pertinent information about the auditing
standards used to measure case quality. The IRS will also continue its
work with the CQIC and its Industry contacts to drive quality
improvement efforts.
Table 21: Collection Coverage - Units (Revised Measure):
Description: The volume of collection work closed compared to the
volume of collection work available. The new methodology for FY 2006
includes balance due and delinquent return cases still in notice status
whereas, the FY 2005 methodology only considered those accounts or
investigations in delinquent status (Taxpayer Delinquent Account (TDA)
and Taxpayer Delinquent Investigation (TDI) statuses). The new
methodology was applied to recalculate the prior actual and the FY 2006
plan number.
Collection Coverage - Units;
FY 2003: Actual: --;
FY 2004: Actual: --;
FY 2005: Actual: 53.0%;
FY 2006: Plan: 52.0%;
FY 2006: Actual: 54.0%.
[End of table]
FY 2006 Performance: Target Achieved. The IRS met/exceeded the FY 2006
target.
Future Plans: The IRS plans to continue to facilitate the process for
allocating its resources and planning for program delivery through the
Collection Governance Council. This will ensure enterprise-wide
coordination of case selection and delivery decisions.
Table 22: Collection Efficiency (Revised Measure):
Description: Total work (delinquent accounts, investigations, offer- in-
compromise, automated substitution for return) divided by the total
Full Time Equivalent (FTE) realized in field collection and in campus
collection. The new methodology for FY 2006 includes balance due and
delinquent return cases still in notice status whereas, the FY 2005
methodology only considered accounts or investigations in delinquent
status (Taxpayer Delinquent Account (TDA) and Taxpayer Delinquent
Investigation (TDI) statuses). The new methodology was applied to
recalculate the prior actual and the FY 2006 plan number.
Collection Efficiency;
FY 2003: Actual: --;
FY 2004: Actual: --;
FY 2005: Actual: 1,514;
FY 2006: Plan: 1,650;
FY 2006: Actual: 1,677.
[End of table]
FY 2006 Performance: Target Exceeded: The IRS met/exceeded the FY 2006
target.
Future Plans: The IRS plans to continue its practice of allocating
resources and planning for program delivery through the Collection
Governance Council to ensure enterprise-wide coordination of case
selection and program delivery decisions.
Table 23: Field Collection Embedded Quality (EQ) - (Replaces Field
Collection Quality of Cases Handled in Person):
Description: This measure was baselined in FY 2006 and replaces the
"Field Collection Quality of Cases Handled in Person" measure. The
number of EQ quality attributes that are scored as "met" by an
independent centralized review staff divided by the total attributes
measured (mets + not mets) in a sample of closed cases. All measured
attributes have the same weight when calculating the score.
Field Collection Embedded Quality;
FY 2003: Actual: N/A;
FY 2004: Actual: N/A;
FY 2005: Actual: N/A;
FY 2006: Plan: Baseline;
FY 2006: Actual: 84.2%.
[End of table]
FY 2006 Performance: In FY 2006, the baseline year, the IRS converted
to the EQ system of measuring quality at the national independent
centralized review staff level.
Future Plans: The IRS will complete the full implementation of EQ with
the addition of the front-line manager phase. This phase directly links
employees' Critical Job Elements to the quality measurement system,
improving the relationship between individual performance and
organizational objectives. Full implementation of EQ is expected to
help identify potential problem areas in need of process improvements
or focused training and ultimately, lead to reductions in collection
cycle time.
Table 24: Automated Collection System (ACS) Accuracy:
Description: Percent of taxpayers who receive the correct answer to
their ACS question.
ACS Accuracy;
FY 2003: Actual: --;
FY 2004: Actual: 87.8%;
FY 2005: Actual: 88.5%;
FY 2006: Plan: 88.0%;
FY 2006: Actual: 91.0%.
[End of table]
FY 2006 Performance: Target Exceeded. The IRS met/exceeded the FY 2006
target.
Future Plans: The IRS will leverage the process improvements made to
its Electronic Automated Collection Service Guide, a tool designed to
further increase response accuracy. Also, the IRS will trend accuracy
statistics to better focus managerial reviews.
Table 25: Criminal Investigations Completed:
Description: The total number of subject criminal investigations
completed during the fiscal year, including those that resulted in
prosecution recommendations to the Department of Justice as well as
those discontinued due to a lack of prosecution potential.
Criminal Investigations Completed;
FY 2003: Actual: 3,766;
FY 2004: Actual: 4,387;
FY 2005: Actual: 4,104;
FY 2006: Plan: 3,945;
FY 2006: Actual: 4,157.
[End of table]
FY 2006 Performance: Target Exceeded. The IRS met/exceeded the FY 2006
target.
Future Plans: The IRS will continue to monitor Criminal Investigation's
performance and adjust program focus as necessary to ensure efforts
garner the greatest deterrent effect possible.
Table 26: TE/GE Determination Case Closures:
Description: Cases established and closed on the Employee Plans-Exempt
Organizations Determination System (EDS) includes all types of tax
exempt and employee plan application cases.
TEGE Determination Case Closures;
FY 2003: Actual: 171,812;
FY 2004: Actual: 143,877;
FY 2005: Actual: 126,481;
FY 2006: Plan: 112,400;
FY 2006: Actual: 107,761.
[End of table]
FY 2006 Performance: Target Not Achieved. The IRS did not meet the FY
2006 target. The implementation of the new staggered amendment filing
process for employee plans changed the FY 2006 inventory mix. Over 40
percent of the 25,000 receipts were prototype plans that require more
extensive review as they will subsequently be adopted by thousands of
individual employers. These cases will not close until FY 2007,
resulting in the closure of 3,600 fewer cases than originally planned.
Additionally, recent increases in user fees for employee plan
determinations resulted in a slight decrease in determination
applications and ultimately 1,500 fewer projected closures.
Future Plans: To stabilize the flow of determination receipts and
mitigate the significant swings in workload experienced prior to FY
2006, the IRS will continue its roll-out of the staggered amendment
process. The IRS also plans to test and pilot (with external partners)
a new interactive software application for preparing determination
applications designed to improve the quality of determination requests
and establish the foundation for future 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:
The IRS must strategically manage its resources, business processes,
and technology systems to effectively and efficiently support its
service and enforcement mission. "Modernization" includes technology
projects with which taxpayers are not directly involved, such as
replacement of the master file system, upgrading accounting systems,
and enhancing the modernized technological infrastructure on which
existing and all future applications will depend. Modernization also
applies to the work processes and preparing the IRS workforce to meet
the challenges of the 21st century, including replenishing a maturing
workforce, improving workforce skills, and ensuring a continual
leadership cadre for the future. The IRS strives to become a "first
choice" employer where talented people want to work and can excel in a
culture of high performance, empowerment, and a quality work
environment.
Human Capital Accomplishments:
To ensure the IRS builds a highly productive and engaged workforce, the
Human Capital Strategic Implementation Plan was introduced in FY 2006.
The plan aligns Treasury's Human Capital (HC) Strategic Goals, the IRS'
Strategic Goals, and the IRS' HC Strategic Goals, and establishes
performance monitoring against objectives, processes, and projects.
Throughout FY 2006, the IRS ensured the appropriate and necessary
investments were made in human capital, its most valuable resource. A
multi-year recruitment and marketing plan was developed to target a
diverse applicant pool. A comprehensive assessment strategy to identify
applicants with the knowledge, skills, and abilities (competencies)
necessary to support core job responsibilities positioned the IRS to
meet its current, and plan to meet its future, business needs.
Additionally, the IRS increased the use of workforce planning tools to
develop a more robust link between business plans (i.e., examination
plan) and workforce replenishment. More directly, the following areas
were targeted:
* Linking pay with performance to maximize the workforces'
contributions to the IRS core mission and goals. About 5,700 front-line
managers transitioned to a new pay band and 2,000 senior managers and
department managers transitioned to a redesigned, step-less pay band.
* Developing an IRS-wide pay for performance framework to move 90,000
employees into a performance-based pay environment.
* Delivering customized training electronically. For example,
electronic delivery of mandatory briefings (computer security,
unauthorized access) saved the IRS $1.6 million for 75,000 employees.
* Assembling a highly trained cadre of recruiters responsible for
maintaining an IRS recruiting presence at educational institutions,
particularly for the IRS' enforcement occupations. The cadre
established partnerships with over 200 colleges and universities and
attended 800 campus and commercial events across the country.
The IRS used competition as an incentive to improve IRS business
processes, reshape its workforce, and further its strategic goals. The
IRS conducted its first full and open standard competition to evaluate
work performed at three Area Distribution Centers (ADCs) and to
recommend improvements. ADCs provide warehousing, inventory, and
management services for more than 12,000 publications and process about
five million customer orders annually. The ADCs occupy 550,000 square
feet of combined leased warehouse space and employ 400 FTE positions. A
bid solicitation for the competition, developed in partnership with the
National Treasury Employees Union, resulted in seven proposals: six
from well-known private sector organizations and one from the in-house
team, called the Most Efficient Organization, which won the
competition.
The competitive sourcing competition for the Submission Processing
Files function resulted in a decision to award a contract to an
experienced vendor. The IRS reached its award decision after evaluating
all proposals including the Government's Most Efficient Organization
proposal, private vendor proposals, and public reimbursable proposals.
After careful and accurate technical and cost evaluations, the IRS
found the vendor's proposal to be the lowest-priced, technically
acceptable proposal, and awarded a five-year contract consisting of a
base period of one year and four optional years.
Business Systems Modernization:
The Business Systems Modernization (BSM) program combines best
practices and expertise in business solutions and internal management
from IRS, business, and technology sectors to develop a world-class tax
administration system that fulfills the revenue collection requirements
of the United States as well as taxpayer's needs and expectations.
The IRS executed its BSM projects with a degree of sustained success
not seen since program inception. Successful program delivery during
the past two years demonstrates that the IRS' BSM program has
established a foundation of disciplined project delivery and
accomplishment. Overall, the program delivered within the target of +/
-10 percent variance for both cost and schedule components for major
release and sub-release milestones, a significant achievement that
validates BSM program management effectiveness. This accomplishment is
especially noteworthy in that the program achieved this while
transitioning from a contractor-led program to an IRS-led program.
A key success factor has been the IRS' increased focus managing
contractor performance and leveraging IRS resources. This approach was
outlined in the Modernization Vision & Strategy (MV&S) efforts, a
comprehensive vision for IRS' future operations. The MV&S establishes a
plan that drives investment decisions, addressing the priorities for
modernizing front-line tax administration, and establishes technical
capabilities provided by infrastructure and security. The MV&S reflects
the priorities across the IRS and serves as a guide for focusing
investment by mandating development of a prioritized list of proposed
IRS modernization projects for a given year. Whenever possible, the
MV&S approach leverages existing systems, and, as necessary, the
program includes new development to optimize capacity, manage program
costs, and deliver functionality in smaller and more frequent releases.
The IRS expects this approach to deliver business value sooner and at a
lower risk.
Information technology solutions are the most effective and efficient
means of increasing the number of IRS contacts with taxpayers and
offers faster alternatives for taxpayers to meet their tax obligations.
Information technology solutions also enhance the IRS' ability to
identify non-compliance and to combat tax avoidance schemes that
contribute to the tax gap. The following highlights the IRS' efforts in
FY 2006:
* Stabilized and institutionalized program management improvements,
meeting scope expectations for implemented functional and technical
capability. The BSM program expanded its financial and schedule
management capabilities to include greater detail and controls than
previously available in past expenditure plans.
* Implemented Release 3.2 of its Modernized e-File (MeF) project, which
expanded the electronic filing of both federal and state (Forms 1120
and 1120-S) Corporate Income Tax Returns and is mandatory for certain
corporations. Corporate tax returns typically include hundreds, or even
thousands, of pages and receiving the data electronically from these
voluminous and complex returns speeds the examination process.
Electronic capture of return information allows the IRS to quickly
deliver the data to analysts and agents for compliance risk assessment
and action. MeF processed 375,000 corporate returns. The IRS plans to
expand the MeF taxpayer base to include Partnership Income tax returns
(Form 1065), eventually enabling nearly 2.7 million small business and
self-employed taxpayers to benefit from electronic filing.
* Introduced new Customer Account Data Engine (CADE) capabilities for
the 2006 filing season. CADE supported faster refunds to taxpayers,
issuing direct deposit refunds between one and seven days faster and
paper refunds four to thirteen days faster than refunds generated by
the legacy system. CADE processed over 7.3 million returns - more than
a 400 percent increase over the previous year, and issued 7 million
refunds totaling in excess of $3.4 billion. CADE improved taxpayer
service by allowing access to current information up to seven days
sooner, increasing the likelihood of single telephone call resolution
and allowed faster issue detection and more timely account settlement.
CADE is expected to process an estimated 33 million returns in 2007.
* Completed the first release of the Filing and Payment Compliance
(F&PC) strategy. F&PC functionality analyzes tax collection cases and
separates cases that require direct IRS involvement from those that can
be handled by Private Collection Agencies (PCAs). The introduction of
PCAs is expected to:
- Assist the IRS by addressing the volume of delinquent taxpayers that
exceeds the IRS' capacity to work, approximately 250,000 cases per
year.
- Eliminate backlogs in the large number of outstanding tax
liabilities, which have grown by 118 percent over the last 12 years,
increasing tax revenue and reducing the tax gap.
- Allow the IRS to close 2.4 million more collection cases each year,
improving the collection case closure rate from 53 percent (as of FY
2005) to 97 percent by 2016.
Business Process Reengineering:
The IRS continued to improve quality, efficiency, and service delivery
through a wide-range of initiatives designed to increase service
coverage to taxpayers and implemented new and improved business
processes. Processes were put in place to better integrate business and
technology strategies and manage out-of-cycle information technology
requests and budget changes. Examples of successful initiatives
include:
* Reengineered the examination function to streamline the process,
increase effectiveness and timeliness in examining returns, resolve
taxpayer issues, and reduce and redirect resources to improve
operational results.
* Reengineered collection functions to improve workload selection,
reduce cycle time, improve casework quality, and improve customer and
employee satisfaction. The focus on collection activities yielded
positive results, ensuring timely initial contacts by Revenue Officers
and reduced activity lapses in casework.
* Implemented the Desktop Integration (DI) System, replacing the old
Integrated Case Processing system. DI allows call center assistors to
determine the status of a taxpayer's account reducing the amount of
time needed for account resolution, and allows the assistor to provide
timely, quality responses to the taxpayer. The DI System was
successfully deployed to over 30,000 users.
* Developed and implemented a Phishing Web Site to provide guidance to
internal and external stakeholders. "Phishing" is the act of sending an
e-mail to a user falsely claiming to be a legitimate enterprise in an
attempt to scam the user into surrendering private information that
could be used for identity theft. The IRS phishing e-mail box at
phishing@irs.gov was established so internal and external stakeholders
could send phishing e-mails to the IRS for evidence gathering and
developing countermeasures.
* Completed the development phase of Contact Recording Release 4.0 for
use in IRS Taxpayer Assistance Centers (TACs). Contact Recording
provides functionality to record a taxpayer call for training purposes
and is expected to increase quality and accuracy of taxpayer responses
and improve productivity. Deployment added an additional 33 sites to
the existing 14 sites. By January 2007, the IRS plans to have contact
recording deployed to approximately 130 TACs representing an assortment
of small, medium, and large sites in 37 of the 50 states. Contact
Recording will be deployed to all 400 TACs by early FY 2009.
* Designed an imaging network to scan and electronically warehouse,
paper tax returns for large and mid-size businesses. This "just-in-
time" inventory of returns will reduce the examination start time from
12 -18 months from filing date, to under 90 days. The benefits of
reduced cycle times include earlier identification of emerging issues,
faster closing of returns at the completion of an audit, and reduction
of taxpayer burden.
* Launched an on-line installment agreement tool for taxpayers
(individual return filers) via the IRS.gov website. Taxpayers can now,
at their convenience, self qualify for an installment agreement and
apply for and receive notification of approval during an on-line
session. The IRS processing costs are also reduced.
* Implemented an Enterprise Queue of toll-free calls in the Automated
Collection System (ACS), Examination and Automated Underreporter call
sites. Enterprise queuing allows toll-free callers to be placed in a
central queue for an available representative anywhere in the IRS
enterprise system. Customers can now be assisted by the first available
assistor trained in their specific topic.
Security and Protection of Data:
In response to the challenge of protecting the taxpayer and employee,
the IRS took steps to improve protection of sensitive information. The
issuance of Memorandum M-06-16, Protection of Sensitive Agency
Information, issued by the Office of Management and Budget, established
requirements the IRS put in place to increase protection for networks,
laptops, and other mobile computing devices. Additional policies and
procedures are being implemented to bring the IRS in line with the
requirements of the memorandum. The IRS is deploying a three-pronged
strategy focusing on technology solutions (encryption), employee
education and awareness, and critical analysis of IRS policies and
procedures. The IRS also established a Security Services and Privacy
Executive Steering Committee to coordinate efforts and to leverage
subject matter experts from the areas of information technology
security, physical security, privacy, and identify theft.
During FY 2006, the IRS developed Information Protection Training for
employees and stakeholders. The training integrated the domains of
privacy, computer security, disclosure, and unauthorized access (UNAX).
In the future, the IRS education and awareness programs will be
expanded to focus attention on enhancing information protection
practices in daily operations.
The IRS continued progress toward the implementation of Business
Resumption Plans (BRP) at all IRS facilities. In FY 2006, the IRS
deployed business resumption plans during recovery from the Gulf Coast
hurricanes and again when operations were quickly resumed after heavy
rains late in June 2006 caused severe flooding and forced closure of
the IRS headquarters building in Washington, D.C. The Commissioner and
all of the top level executives immediately resumed business at an
alternate IRS location. Through extraordinary coordination, within
thirty days, over 2,200 displaced employees returned to their normal
duties. There was no impact on service to the public. In all of the
recent instances, BRPs were fully executed and Incident Commanders
received support from designated organizations to stand up operations
quickly and in priority order.
Safety of Employees:
During FY 2006, the IRS Continuity of Operations (COOP) Plan was
updated to maintain compliance by adding annexes that address surrender
of power to local authorities by the Federal Government, and pandemic
influenza. The IRS participated in the planning and execution of the
government-wide COOP exercise, Forward Challenge 06. During the
exercise, several scenarios, including a cyber attack on IRS tax
systems and a physical attack on a campus facility were simulated and
worked by the team. A number of lessons learned were documented that
will provide the direction for further improvement of the COOP Plan and
the IRS' overall approach to COOP preparedness. The IRS also continued
high levels of emphasis on ensuring Occupant Emergency Plans (OEP) and
Shelter in Place (SIP) Plans are current for all IRS Facilities.
IRS measures reported in the IRS' annual performance budget and
included in the Treasury Performance Reporting System are discussed
below.
Table 26: BSM Project Cost Variance by Release/Subrelease - (Replaces
the Cost portion of the Contracted Program Cost and Schedule Variance
Measure):
Description: Percent variance by release/sub-release of a BSM funded
project's initial, approved cost estimate versus current, approved cost
estimate. Cost variances less than or equal to +/-10 percent are
categorized as being within acceptable tolerance thresholds. Cost
variances greater than +/-10 percent of the variance are categorized as
being outside of acceptable thresholds.
FY 2006 BSM Project Cost Variance by Release/Subrelease.
Cost Variance for Project Segments Completed in FY 2006.
[See PDF for Table]
[End of table]
FY 2006 Performance: In FY 2006, the baseline year, the IRS used an
improved methodology for determining project cost variance by release/
subrelease. Cost variance is reported separately for each major
release/subrelease. Overall, the BSM program delivered nearly half of
project segment cost within target, and is meeting target expectations
for nearly all project segments currently in-progress. In some cases,
BSM cost targets exceeding a -10 percent threshold are attributed to
reducing project scope. Note: For a detailed variance explanation by
project segment, refer to the FY 2006/FY 2007 BSM Expenditure Plan.
Aggressively managing and monitoring contractor performance and
leveraging resources were key factors contributing to this year's
success in meeting the targets for cost variance.
Future Plans: The IRS will continue reporting on cost schedule measures
in accordance with the agreed upon performance methodology. Variance
exceeding the +/-10 percent threshold is subject to IRS change
notification process review, Executive Steering Committee approval and,
if applicable, Modernization and Information Technology Services
Enterprise Governance Committee approval. Cost variances exceeding +/-
10 percent or $1 million require Congressional notification. At each
review juncture, management ensures that proposed project changes as
reported in the BSM expenditure plan are valid and that mitigation
plans are in place when applicable.
Table 27: BSM Project Schedule Variance by Release/Subrelease -
(Replaces the Schedule portion of Contracted Program Cost and Schedule
Variance Measure):
Description: Percent variance by release/sub-release of a BSM funded
project's initial, approved schedule estimate versus current, approved
schedule estimate. Schedule variances less than or equal to +/-10
percent will be categorized as being within acceptable tolerance
thresholds. If schedule variances are greater than +/-10 percent, the
variance will be categorized as being outside of acceptable thresholds.
FY 2006 BSM Project Schedule Variance by Release/Subrelease.
Schedule Variance for Project Segments Completed in FY 2006.
Project: F&PC;
Release: R1.2;
Milestone: 3;
Planned Finish Date: 02/28/06;
Current Finish Date: 02/28/06;
Variance (days): 0;
Variance(%): 0%;
Within acceptable tolerance: yes.
Project: F&PC;
Release: R1.2;
Milestone: 4a;
Planned Finish Date: 06/30/06;
Current Finish Date: 07/10/06;
Variance (days): 5;
Variance(%): 6%;
Within acceptable tolerance: yes.
Project: MeF(FED/State project);
Release: R3.2;
Milestone: 4;
Planned Finish Date: 03/31/06;
Current Finish Date: 03/22/06;
Variance (days): -7;
Variance(%): -2%;
Within acceptable tolerance: yes.
Project: MeF;
Release: R4;
Milestone: 3;
Planned Finish Date: 06/30/05;
Current Finish Date: 12/09/05;
Variance (days): 111;
Variance(%): 59%;
Within acceptable tolerance: No.
Project: CADE;
Release: R1.3.2;
Milestone: FS06;
Planned Finish Date: 12/31/05;
Current Finish Date: 12/31/05;
Variance (days): 0;
Variance(%): 0%;
Within acceptable tolerance: yes.
Project: CADE;
Release: R2.1;
Milestone: 4;
Planned Finish Date: 08/10.06;
Current Finish Date: 08/25/06;
Variance (days): 11;
Variance(%): 7%;
Within acceptable tolerance: yes.
[End of table]
FY 2006 Performance: In FY 2006, the baseline year, the IRS used an
improved methodology for determining project schedule variance by
release/subrelease. Schedule variance is reported separately for each
major release/subrelease. The BSM program delivered most (5 out of 6)
project segments within schedule variance. (Note: For a detailed
variance explanation by project segment, refer to the FY 2006/FY 2007
BSM Expenditure Plan.)
Future Plans: The IRS will continue reporting on schedule measures in
accordance with the agreed upon performance methodology. Variance
exceeding the +/-10 percent threshold is subject to IRS change
notification process review, Executive Steering Committee approval and,
if applicable, Modernization and Information Technology Services
Enterprise Governance Committee approval. Cost variances exceeding +/-
10 percent or $1 million require Congressional notification. At each
review juncture, management ensures that proposed project changes as
reported in the BSM expenditure plan are valid and mitigation plans are
in place when applicable. Aggressively managing and monitoring
contractor performance and leveraging resources were key factors
contributing to this year's success in meeting the targets for schedule
variance.
New Measures:
The following measures are reported for the first time in the IRS' FY
2006 MD&A:
* Taxpayer Self Assistance Rate:
* Refund Timeliness - Individual (paper):
* Automated Underreporter Efficiency:
* Automated Underreporter Coverage:
Revised Measures:
The following measures were developed based on a revised methodology
and were renamed to reflect the new approach. The table below shows the
renamed measure along with its replacement.
FY 2006 Measure Name: Field Examination Embedded Quality;
FY 2005 Measure Name: Examination Quality - Field.
FY 2006 Measure Name: Office Examination Embedded Quality;
FY 2005 Measure Name: Examination Quality - Office.
FY 2006 Measure Name: Field Collection Embedded Quality;
FY 2005 Measure Name: Field Collection Quality of Cases Handled in
Person.
FY 2006 Measure Name: BSM Project Cost Variance by Release and
Subrelease;
FY 2005 Measure Name: Contracted Program Cost and Schedule Variance
(The project cost component).
FY 2006 Measure Name: BSM Project Schedule Variance by Release and
Subrelease;
FY 2005 Measure Name: Contracted Program Cost and Schedule Variance
(The project schedule component).
[End of table]
The components for calculating the following measures have changed, but
the names of the measures remain the same. The year-end actual and
projected targets reflected in Section II, Performance Goals and
Results have been adjusted accordingly.
* Examination Coverage - Individual:
* Examination Efficiency - Individual:
* Collection Coverage - Units:
* Collection Efficiency - Units:
Deleted Measure:
Contracted Requirements Stability and Contracted Requirements
Delivered:
III. Systems Controls and Legal Compliance:
Federal Managers' Financial Integrity Act (FMFIA):
During FY 2006, the IRS complied with the internal control requirements
of the FMFIA, the Federal Financial Management Improvement Act (FFMIA),
the Office of Management and Budget (OMB) Circular A-123, and the
Reports Consolidation Act of 2000. The IRS organizations are operating
in accordance with the procedures and standards prescribed by the
Comptroller General and OMB guidelines.
The systems of management control 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; and:
* financial management systems are in compliance with Federal financial
systems standards, i.e., FMFIA Section 4 and FFMIA.
The IRS has four open material weaknesses. Because the IRS has
remaining material weaknesses and its 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 2006. This assurance is
provided relative to Sections 2 and 4 of FMFIA.
The material weaknesses are:
* 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, 2006, the IRS' 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.
During FY 2006, the IRS continued to improve and enhance its Integrated
Financial System (IFS), receiving a clean financial statement audit
opinion in the first year of operations. Also, additional functionality
was implemented including budget and cost accounting user reports,
production of an automated Statement of Net Cost and incorporation of
mandated changes by oversight entities and agency management.
Also, during FY 2006, the IRS implemented Release 1 of the Custodial
Detail Data Base (CDDB) to improve custodial accounting. Release 1 is
the first step toward creating a subsidiary ledger for unpaid
assessments to the Interim Revenue Accounting Control System General
Ledger and captures cross-reference information on certain Trust Fund
Recovery Penalty (TFRP) cases, thus reducing reclassifications.
Additional milestones for Releases 2 and 3 were incorporated into the
material weakness and FFMIA remediation action plans.
Lien Release Non-Compliance Issue:
As of September 30, 2006, the IRS did not consistently comply with
section 6325 of the Internal Revenue Code regarding the timely release
of federal tax liens. The IRS developed a new action plan to address
issues identified in the April 2006 review of the filing and release of
tax liens and all issues identified by the Government Accountability
Office (GAO) and the Treasury Inspector General for Tax Administration
(TIGTA). The Financial and Management Controls Executive Steering
Committee is monitoring this plan.
Reports Consolidation Act of 2000:
In accordance with the Reports Consolidation Act of 2000, the IRS
provides assurance that its Critical Performance Measures are reliable.
Internal Revenue Manual 1.5, "Managing Statistics in a Balanced
Measurement System Handbook," provides a detailed 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:
The IRS continues to improve its enterprise-wide information technology
security program to bring the IRS in full compliance with the
requirements of the Federal Information Security Management Act
(FISMA). IRS efforts in FY 2004 and FY 2005 focused on the
accomplishment of security certification and accreditation of the
network infrastructure systems, which was achieved at the end of FY
2005. In FY 2006, the IRS updated its security plans and completed the
certification and accreditation for one-third of its systems to comply
with new process guidance issued by OMB and the National Institute of
Standards and Technology. The remaining systems will be updated in FY
2007 and FY 2008.
OMB Circular A-123, Management's Responsibility for Internal Control:
The IRS conducted the required evaluation of the effectiveness of the
internal control over financial reporting in accordance with OMB
Circular A-123 through the following activities:
* Tested internal control sets for the 45 transaction processes
identified by Treasury that are material to its Consolidated Financial
Statements. These tests included 35 administrative processes covering
material portions of the IRS' $10 billion in annual administrative
transactions, and 10 custodial tax-related processes, covering material
portions of IRS' over $2 trillion in tax revenues processed annually.
Based on IRS' testing, the internal controls were operating effectively
and no material weaknesses, other than the ones identified above in the
FFMIA part of this document, were found in the design or operation of
the internal controls.
* Reviewed controls over IRS' financial reporting, specifically
Treasury Information Executive Repository reporting, and determined
controls are in place and effective.
* Conducted a self-assessment of the internal control environment using
GAO's Abbreviated Internal Control Evaluation Checklist.
* Reviewed IRS compliance with laws and regulatory requirements
regarding financial reporting and internal control, specifically
compliance with FFMIA, FMFIA, FISMA, Improper Payments Information Act,
and the CFO Act, determining that the IRS is in compliance except for
the issues cited in this document.
* Reviewed GAO and TIGTA audit reports and findings during the test
plan development stage and at the end of the A-123 reporting period,
and determined that the IRS is making progress toward completing
corrective actions to the auditors' findings.
Based on the results of this evaluation, the IRS provided qualified
assurance that its internal control over financial reporting was
operating effectively as of June 30, 2006. The qualified assurance is
based on the condition that the IRS has four material weaknesses, as
reported by GAO in the IRS' FYs 2004 and 2005 audited financial
statements. GAO, however, acknowledged in its report that the IRS has
developed compensating procedures to produce financial statements that
are fairly stated and issued an unqualified opinion.
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 OMB, 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:
The great majority of Americans pay their fair share of taxes, but
there is still a significant tax gap created by those taxpayers who
don't pay the hundreds of billions in taxes they owe. The tax gap is
the difference between what taxpayers should pay and what they actually
pay due to:
* taxpayers not filing tax returns;
* not paying their reported tax liability on time; or:
* failing to report their correct tax liability.
The IRS' current estimate of the overall gross tax gap is about $345
billion. It is the need to address the tax gap to ensure voluntary
compliance that drives much of what the IRS does. The IRS enforcement
activities, such as examination and collection, directly target tax gap
elements, while IRS taxpayer services enhances compliance by providing
the information taxpayers need to calculate their taxes, file tax
forms, pay balances or receive refunds.
The IRS enforcement programs yield direct and indirect return on
investment. Each dollar invested yields at least four dollars for the
Federal Treasury. The link between taxpayer services and increased
federal receipts, however, isn't as measurable, but is positive. It is
important to understand that the complexity of the nation's current tax
system is a significant reason for the tax gap. It is easy for even
sophisticated taxpayers to make honest mistakes. Accordingly, helping
taxpayers understand their obligations under the tax law is a critical
part of addressing the tax gap. The IRS remains committed to assisting
taxpayers in both understanding the tax law and paying the proper
amount of tax.
Providing taxpayer service over multiple channels to align service
content, delivery, and resources with taxpayer and partner expectations
will be achieved by the implementation of the Taxpayer Assistance
Blueprint (TAB). Elements of the TAB are designed to reduce taxpayer
burden, increase voluntary compliance, and improve workforce
performance by establishing a credible taxpayer/partner baseline of
needs, preferences, and behaviors. Institutionalizing key research,
operational, and assessment activities will help the IRS manage and
improve service delivery.
The IRS has a robust, balanced, and comprehensive plan to help reduce
improper payments. The plan includes base compliance activities and
redesign efforts to identify, test, and implement new and enhanced
business processes; an outreach component to educate taxpayers and
preparers on Earned Income Tax Credit eligibility requirements; and a
research strategy that supports the IRS Strategic Plan.
The manner and means by which individuals deploy fraudulent refund
schemes is constantly evolving and is becoming more complex and
sophisticated. The Questionable Refund Program (QRP) and the Return
Preparer Program (RPP) will continue to serve an important tax
administration purpose by enabling the IRS to identify and stop the
payment of fraudulent refund claims, as well as identify and
investigate unscrupulous return preparers.
The Electronic Fraud Detection System (EFDS) is one of several tools
used by the IRS. All refund returns are scrutinized by EFDS, which
results in the identification of a substantial proportion of false
returns. The EFDS automates the review process including screening,
income verification, scheme development, and scheme inventory
management. As new schemes are identified, the computer system is
programmed to identify them to maximize the efficiencies of the
automated systems. The IRS must overcome the system failures that
prevented the use of the EFDS during the 2006 filing season to make the
legacy client/server system operational for the 2007 filing season.
Moving forward, the IRS must continue to focus on technology to ensure
it uses technological advances to optimize both taxpayer service and
enforcement programs. The IRS plans to continue the implementation of
its revised Business Systems Modernization strategy, emphasizing the
incremental release of projects to deliver business value sooner and at
a lower risk. Modernization efforts will continue to focus on three key
tax administration systems that provide additional benefits to
taxpayers and the IRS employees: Customer Account Data Engine project;
Modernized e-file; and Filing and Payment Compliance.
Recognizing the responsibility for safeguarding Americans' most
sensitive financial information, the IRS is taking aggressive steps to
improve taxpayer and employee information protection. The IRS will
continue to focus on technological solutions (encryption), employee
education and awareness, and critical analysis of IRS policies and
procedures.
Targeted training, activities to promote retention, and engagement of
employees are key elements of the IRS Strategic Plan, and necessary to
sustaining an engaged and productive workforce. To meet changing
business and technological demands, the IRS will focus efforts on
implementing retention and training programs that identify targeted
occupations, skill sets, and hard to fill positions. Features of the
program include integrating all training, recruitment, hiring, and
compensation efforts along with developing new and improved methods of
predicting future attrition through retirements. Developing activities
specifically targeted toward mitigating the impact of retirements
through training, and those necessary to attract and retain new hires
with advanced skills will be key to achieving the IRS' business goals.
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 Business Operating Divisions
is shown below.
Management Challenge or; High Risk Area; Business Operating Divisions.
[See PDF for Table]
[End of table]
The following pages summarize each Management Challenge and High-Risk
issue, FY 2006 accomplishments, and actions identified for completion
in FY 2007 and beyond:
Modernization of the Internal Revenue Service (Computerized Systems and
Business Structure) and IRS Business Systems:
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 (FY 2006):
* Continued to move the IRS towards realizing its technology
modernization strategy through the Customer Account Data Engine (CADE),
which provides key taxpayer benefits such as processing of refunds
faster, daily posting of transactions and account updates. (Ongoing):
- Delivered Release 1.3.2, which added Form 1040 and Form 1040A returns
(without schedules) to the established baseline of Form 1040EZs. (01/
2006):
- Posted 7.3 million returns for filing season 2006 resulting in the
issuance of 7 million refunds to eligible taxpayers totaling $3.4
billion. (01/2006):
- Deployed CADE Release 2.1, which added Form 1040 Schedules A, B, and
R and Form 1040A Schedules 1 and 3. (09/2006):
* Delivered full functionality for Filing & Payment Compliance (Release
1). Functionality provides for the identification of cases to be issued
to Private Collection Agencies (PCAs). The system identified and
delivered 12,500 cases with the three PCAs awarded contracts in March
2006. (09/2006):
* Implemented mandatory electronic filing for large corporations (those
with assets greater than $50 million that file at least 250 returns a
year) and certain exempt organizations. The IRS received more than
12,500 returns from required corporations. Also, for the first time,
over 10,000 exempt organizations electronically filed 990-series
returns (annual forms). (09/2006):
* Automated the Statement of Net Cost in the Integrated Financial
System. (09/2006):
Actions Planned or Underway (FY 2007 and beyond):
* Complete the Logistical Data Model and Logical Design for CADE
Release 3.0. Complete Customer Technical Review and Life Cycle State
reviews for CADE Release 3.0. (11/2006):
* Establish Modernized e-File (MeF) as primary interface for all
business filings. MeF will remedy the electronic filing limitations (e-
File) within the current legacy systems including those that prevent
partnerships with complying. (01/2007):
* Process TY 2006 U.S. Return of Partnership Income (1065 returns)
through MeF. (01/2007):
* Deploy CADE Release 2.2 to add 1040 Schedules C, E, F, (without EINs)
and/or SE, D, and update for 2006 tax law changes, including guidance
IRS established for implementing the Telephone Excise Tax Refund that
eligible taxpayers can request on their 2006 Federal income tax return.
(01/2007):
* Expand mandatory electronic filing for large corporations (those with
assets greater than $10 million that file at least 250 returns a year)
and certain other exempt organization returns. (01/2007):
* Deploy the Correspondence Examination Automation Support (CEASrev1)
application to increase efficiency and effectiveness of operations
through improved inventory, workload and resources management. (02/
2007):
* Continue operation of the computer data security web site that
provides information and guidance to assist employees in complying with
all IRS data security requirements. (Ongoing):
* Deploy the Filing and Payment Compliance Release 1.2 which will
provide automated inventory management tools with additional volumes
provided to the selected PCAs, increase caseload to 350,000 cases,
improve review queue process and information flow, and become EA
compliant. (09/2007):
The current version of IFS software will no longer be supported by the
COTS vendor effective December 2009. The IRS has provided Treasury and
OMB an initial alternatives analysis that examines several options for
a "go forward" strategy for the financial system. Further alternative
analysis is ongoing that includes evaluating cost, benefits, and risks
associated with federal Center of Excellence (COE) and private Shared
Service Provider (SSP) options. IRS has requested FY 2008 funding to
upgrade the financial system in FY 2010. The upgrade will include
increased federal functionality and vendor-supported system software.
Tax Compliance Initiatives and Enforcement of Tax Laws:
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.
Address the evolving challenge of unpaid taxes and continuing Earned
Income Tax Credit (EITC) noncompliance.
Actions Taken (FY 2006):
* Implemented the first phase of the Private Debt Collection (PDC)
initiative that allows the IRS to use Private Collection Agencies
(PCAs) to collect delinquent tax debts. (01/2006):
* Implemented major programming changes to EITC examination inventory
management and expanded abilities of the EITC Dependent Database
selection process. Expanded test of Soft Notice treatment to reach
taxpayers who are likely to self-correct behavior identified by the new
scoring models. (Ongoing):
* Developed and administered two EITC survey instruments in conjunction
with the Taxpayer Advocate and Low Income Taxpayer Clinics. The first
survey instrument identified correspondence audit barriers experienced
by EITC Taxpayers with results available at the end of the calendar
year. The second will identify EITC taxpayers' information needs and
how effectively these needs are currently being met. (09/2006):
* Updated EITC multi-year return preparer study that addresses paid
preparer non-compliance and gathers data on the effects of these
efforts on paid preparers as well as taxpayers. (Ongoing):
* Developed the withholding compliance program, an alternative
treatment to influence non-compliant taxpayers to establish an adequate
withholding behavior to promote future compliance. Developed outreach
and educational initiatives to increase withholding compliance in the
retired military population. (10/2005):
* Elevated the priority of the Federal Employee/Retiree Delinquency
Initiative by centralizing inventory in a specific site so cases can be
worked by employees with specialized training. (Ongoing):
* Began using the Return Preparer Analysis Tool to more effectively
identify egregious preparer returns for examination potential. (05/
2006):
* Upgraded the Bank Secrecy Act (BSA) workload database. Upgrades will
provide a more complete record of the affected banks tagged as
potentially non-compliant and integrate results from research projects
on the attributes that may predict non-compliance. (Ongoing):
* Continued data exchange with state taxing organizations to leverage
limited government resources: (09/2006):
- Initiated the State Revenue Agent Report project to identify non-
filers and under-reporters based on state audit reports.
- Enhanced the multifunctional non-filer strategy to provide a more
rigorous and specific data matching processing for IRS and state audit
reports and uniform record layout for more efficient data exchange.
- Piloted the State Reverse File Match Initiative which emphasizes the
identification of federal non-filers by matching against state filing
databases.
* Initiated the Attributed Tip Income Program, a tip reporting and
education program offered to small to medium size employers in the food
and beverage industry to help improve the tip income reporting of
employees with minimal burden on the employer. Benefits include
reduction in industry recordkeeping burden, simple enrollment
requirements, and improved reporting of tips on Federal income tax
returns. (07/2006):
* Secured and improved tip income reporting agreements for 90 percent
of major casinos, providing more consistent tip reporting among the
expanding number of Gaming Industry tipped employees. Planned
enhancements will increase the accuracy of casino reported year-end-
data on tips, reducing potential reporting errors, and reducing burden
for participating employee-taxpayers. (08/2006):
* Conducted simultaneous civil and criminal actions to stop abusive tax
promotions and prevent their proliferation by high income taxpayers who
frequently employ complex, multi-layered transactions. (Ongoing):
* Doubled the number of taxpayers (17 in FY 2005 to 34 in FY 2006) in
the Compliance Assurance Program (CAP), a process in which corporate
taxpayers and IRS agents work together to examine transactions in "real
time" during the taxable year to reach agreement on the taxpayer's tax
liability before the tax return is filed. (Ongoing):
* Continued the Pre-Filing Agreement program that provides corporate
taxpayers and Revenue agents with an opportunity to examine and resolve
potential issues before tax returns are filed. (Ongoing):
* Substantially completed a major effort to curb abuse by non-profit
credit counseling organizations resulting in revocation of exempt
status or termination of organizations found to be non-compliant. (05/
2006):
* Increased vigilance concerning political campaign intervention by
Section 501(c) (3) charitable organizations by issuing new procedures
for the 2006 election season to ensure that all referrals are reviewed
expeditiously and consistently. The IRS has also expanded educational
effort to ensure that charities understand what constitutes prohibited
political intervention and how to stay compliant with the tax laws.
(02/2006):
* Implemented an inventory management system to assign high-risk
examination cases using capacity and a risk-based scoring system. (01/
2006):
* Established Issue Management teams to address tax shelter and other
high risk issues and improve the IRS' ability to report on issue
trends, enhance risk analysis, and improve return selection. (09/2006):
* Implemented improvements to improve EITC participation and reduce
errors:
- Completed analysis of EITC overclaim rate ranges to identify changes
in the rate due to improved taxpayer compliance. (09/2005):
- Tested the use of a National Directory of New Hires database match in
the IRS Criminal Investigation EITC Fraud Detection Centers. (01/2006):
- Developed new strategies to prevent duplicate claims of qualifying
children. (12/2005):
- Launched second phase of EITC return preparer study to track EITC
filing volume and return math error accuracy through outreach campaigns
and volunteer tax return preparation. (12/2005):
- Developed pilot projects with New York and Massachusetts to leverage
partnership opportunities with states that offer tax credits comparable
to EITC. (06/2006):
- Designed Dependent's Database check to systemically classify and
select EITC amended returns for examination to reduce the amount of
erroneous payments by providing the same scrutiny to original returns
processing. (07/2006):
- Initiated survey of taxpayers who participated in the Qualifying
Child Certification Proof of Concept to identify specific strategies
and improvements for the EITC Program. (09/2006):
- Completed launch of over 500,000 new start examinations of EITC
returns based on enhanced scoring and selection methodology. (09/2006):
- Initiated research to assess changes in taxpayer EITC filing volume
and track EITC return math error accuracy as a result of outreach
campaigns and volunteer tax return preparation. (Ongoing):
- Developed annual enterprise research strategy in partnership with
internal and external organizations to better focus EITC compliance and
outreach activities. (Ongoing):
- Identified non-compliant EITC return preparers for due diligence
visits and case treatment using the Return Preparer Analysis Tool.
(Ongoing):
- Built a multi-dimensional database that tracks EITC claimants and
qualifying children over a period of years for use in future research
projects. (Ongoing):
- Developed and distributed materials to educate taxpayers and
practitioners on EITC eligibility rules and compliance issues.
(Ongoing):
- Completed implementation of new EITC examination business processes
and technology changes including: (12/2005):
--Enhanced examination selection criteria and scoring of amended
returns to filter cases for EITC qualifications and information about
taxpayer/ child relationship:
--Identified select returns for pre-refund v. post-refund audit and
soft notice treatment:
--Integrated expanded decision support tool for examiners to assist
with determinations and to document work papers:
-- Improved self-service web and phone applications to assist taxpayers
and tax preparers:
- Continued EITC outreach activities that included managing the
delivery of marketing and advertising campaigns, and creating EITC
specific tools for use by tax preparers using multiple
communication/media channels. (Filing Season):
Actions Planned or Underway (FY 2007 and beyond):
* Continue to expand the implementation of Issue Management teams to
address high risk tax shelter issues and improve the IRS' ability to
report on issue trends, enhance risk analysis, and enhance return
selection. (09/2007):
* Develop enhancements to the multifunctional non-filer strategy to
improve outreach and compliance efforts and develop alternative
treatments to influence non-filing taxpayers to file and remain
compliant. (Ongoing):
* Continue the Federal Employee/Retiree Delinquency Initiative to
reduce non-compliance of federal employees and retirees. (Ongoing):
* Develop recommendations for a multi-year return preparer strategy
that includes managing the delivery of marketing and advertising
campaigns, and creating specific tools for use by tax preparers, using
multiple communication/media channels. (09/2007):
* Complete the 1120-S phase of the National Research Project (NRP).
Results of the project will provide data to revise workload selection
criteria. Most NRP 1120-S audits will be complete by October 2007.
Analysis of the data will be completed during 2008. (10/2008):
² Develop initiatives to improve participation and reduce overclaims in
existing EITC Programs. (Ongoing):
- Continue to analyze changes in taxpayer EITC filing volume and track
EITC return math error accuracy through outreach campaigns and
volunteer tax return preparation. (Ongoing):
- Produce survey instruments that will identify correspondence audit
barriers experienced by EITC taxpayers, identify EITC taxpayers'
information needs, and assess how effectively these needs are currently
being met. (Ongoing):
- Complete second phase of EITC return preparer's compliance study
designed to identify and deter preparers of large numbers of erroneous
EITC claims. (02/2007):
- Continue three-year Qualifying Child test to reduce EITC overclaims.
(10/2007):
- Assess the 2007 EITC marketing/awareness campaigns that target the
EITC eligible population and refine/focus as necessary to increase
overall participation and improve compliance. (03/2007):
- Conduct Longitudinal Study that looks at specific EITC claimants over
a period of years, studying behavior patterns. (Ongoing):
- Actively research cost-effective approaches to improve EITC
participation and minimize errors. (Ongoing):
- Educate EITC taxpayers through partnerships with key stakeholders and
a public service campaign. (Ongoing):
- Evaluate the effect of an EITC certification requirement both on the
level of erroneous payments and participation by eligible taxpayers.
(Ongoing):
- Explore additional partnering options with state agencies to improve
EITC compliance and prevent erroneous payments. (Ongoing):
- Test use of requests for voluntary adjustments to returns identified
as likely to contain errors (soft notices) as an alternative to the
traditional examination process. (04/2007):
- Study characteristics of returns where more than one taxpayer claims
the same qualifying child for EITC purposes and recommend new solutions
to reduce duplicate claims. (11/2008):
* Expand Schedule M-3 corporate filing requirements to enhance ability
to identify compliance risks in book-to-tax differences. (09/2007):
* Continue the State Income Tax Levy Program process of solicitation to
participate in the program. (Ongoing):
* Continue to identify other federal payor agencies to participate in
the Federal Payment Levy Program and negotiate agreement. (09/2007):
* Validate the Taxpayer Assistance Blueprint service recommendations
through extensive research with taxpayers. (10/2006):
* Continue to conduct Fraud/Bank Secrecy Act Program Examinations
(Ongoing):
- Complete full development of workload database that provides a more
complete record of banking institutions. (09/2008):
- Integrate results from the identification of attributes to better
predict which entities have a greater probability of non-compliance.
(09/2008):
- Develop and implement BSA requirements for the insurance industry and
dealers in precious metals, gems, and jewels. (06/2007):
* Continue to emphasize collection of large dollar assessments, one of
the highest priorities in case assignment. (Ongoing):
* Continue efforts to strengthen the Fraud Referral Program to foster
voluntary compliance through the recommendation of a criminal
investigation and/or civil penalties. (Ongoing):
* Enhance methods of identifying promoters operating in tax havens.
(Ongoing):
* Continue to identify and investigate high-impact, corporate fraud.
(Ongoing):
² Continue to aggressively develop high-income, high-impact, non-filer
cases covering a broad spectrum of occupations and professions.
(Ongoing):
² Develop improved criteria for identifying unscrupulous return
preparers, especially those with high income clients and those
promoting abusive tax avoidance schemes. (Ongoing):
² Continue making improvements to the Return Preparer Analysis Tool
(analyzes characteristics of return preparers) to identify more
effective compliance treatments for return preparers including the
development of return preparer and questionable refund policies. (10/
2007):
* Assess the withholding compliance process to determine the usefulness
of letters sent to employers and employees who under withhold federal
income tax from their wages (lock-in letters). (09/2007):
² Implement toll-free phone system for Innocent Spouse operations. (01/
2007):
² Support development of the Correspondence Examination Automated
System (CEAS) system to expand electronic case assignment and
reassignment among the Campuses. (Ongoing):
² Implement the Electronic Filing of Federal Tax Liens (e-Lien),
automating the filing of Notices of Federal Tax Liens and Certification
of Release electronically, along with the electronic transmission of
recording data. (10/2009):
² Pursue access to the International Trade Data System warehouse to
enhance identification of federal excise tax on imports. Under
development by US Customs and implementation date is predicated on the
completion of the Customs project. (Ongoing):
* Continue to develop methods to detect and deter non-compliance and
overstated claims. For example, statistical information from an outside
vendor for will be used in calculating estimates of telephone expenses
for businesses and individuals. (Ongoing):
* Re-establish the Electronic Fraud Detection System legacy (client/
server) system for use during the 2007 filing season. (Ongoing):
* Implement corporate strategies to ensure optimum, balanced audit
coverage as well as improve enterprise-wide resource allocations and
the use of alternative resolution strategies. (Ongoing):
* Continue focus on registration activity under the American Jobs
Creations Act of 2004, identifying potential non-filers and inaccurate
filers through reconciliation and comparison of ExSTARS data.
(Ongoing):
Security of the Internal Revenue Service:
Issue: Strengthening the security infrastructure and the applications
that guard sensitive data.
Actions Taken (FY 2006):
² Completed mitigation of General Support Services' weaknesses
identified during certification to upgrade systems from Interim
Authority to Operate status to Full Authority to Operate. (09/2006):
² Updated the security certification and accreditation of IRS business
applications to comply with the process guidance issued by OMB and the
National Institute of Standards and Technology. Security plans and
certification and accreditation for one third of IRS systems were
updated to the standards. (09/2006):
² Completed design and first phase of development of a back-up for the
IRS incident response capability to reduce geographic vulnerability.
(09/2006):
² Continued to improve Federal Information Security Management Act of
2002 (FISMA) compliance by further increasing business owner
participation in all areas including monitoring, review, mitigation and
reporting activities. (Ongoing):
² Assumed Departmental leadership for Presidential Directive 12 (HSPD-
12), which mandates a uniform approach to employee authentication and
access government-wide. (Multi-year):
² Continued to refine both the IRS' Continuity of Operations Plan
(COOP) activities and the IRS' contribution to Department/government-
wide COOP activities. Fully participated in the planning and execution
of the government-wide COOP exercise, Forward Challenge 06. (09/2006):
* Conducted certification and accreditation update activities to meet
government-wide guidelines for information systems certified. The IRS
is 96 percent compliant, 33 percent are already certified under the
new, more stringent National Institutes of Standards and Technology
guidelines. (09/2006):
* Began an enterprise-wide strategy for IT systems disaster recovery,
including implementation of strategic testing of disaster recovery
plans. (09/2006):
² Developed a physical security technology "roadmap" for the IRS to
improve uniformity and cost effectiveness of security technologies at
IRS sites. (05/2006):
* Began an agency-wide Risk Assessment for vulnerabilities to identity
theft. Interviewed over 100 executives and performed 20 data gathering
workshops that resulted in the development of 69 remediation
strategies. (Ongoing):
* Partnered with the Treasury Inspector General for Tax Administration
to develop and implement the IRS Phishing Web Site to provide guidance
to internal and external stakeholders. Established e-mail box so
internal and external stakeholders could send phishing e-mail to IRS
for evidence gathering and developing countermeasures. (03/2006):
Actions Planned or Underway (FY 2007 and beyond):
* Complete migration of information technology security compliance
reviews to the more structured self-assessments detailed in NIST
Special Publication 800-53. (09/2007):
* Complete the implementation of the agency-wide strategy for IT
systems disaster recovery, including conducting annual exercises in
major computing environments. (09/2007):
* Complete development phases and begin implementation of a back-up for
the IRS incident response capability. (09/2007):
* Continue to improve FISMA compliance by solidifying gains in business
owner participation in all areas including monitoring, review,
mitigation and reporting activities. (Ongoing):
* Establish Disaster Recovery processes for the IRS' 25 Critical
Business Processes. Continue to implement a nationwide Disaster
Recovery Plan including all major computing facilities. (09/2007):
* Continue to advance HSPD-12 program development, including
development of IT infrastructure and deployment of Department-wide
policies and practices. (09/2007):
Using Performance and Financial Information for Program and Budget
Decisions:
Issue: The absence of accurate and complete management information
hinders the IRS' ability to produce timely, accurate and useful
information needed for day-to-day decisions.
Actions Taken (FY 2006):
* Introduced a suite of enterprise-wide long-term measures which link
directly to the IRS Strategic Plan goals. (01/2006):
* Used results from the OMB Program Assessment Rating Tool (PART) to
make the following improvements: (02/2006):
- New long-term and annual performance measures were developed for the
Criminal Investigation Program.
- Used annual performance plan to improve transparency in budget and
PART narratives and show data correlation between budget and
performance.
* Finalized an implementation plan for Budget-Performance Integration
(BPI) that identified the actions necessary to formulate and execute
fully-costed performance. (1ST and 2ND quarter 2006):
* Developed automated Statement of Net Cost from Integrated Financial
System. (08/2006):
* Implemented FMIS enhancement, Custodial Detail Database (CDDB):
- Implemented Release 1 of CDDB, the enhancement to FMIS, and is the
first step toward creating a subsidiary ledger for Unpaid Assessments
and improved reporting for Trust Fund Recovery Penalty cases. (03/
2006):
- Submitted the programming requirements to complete the CDDB design
phase, programming, and unit and integration testing to feed custodial
accounting information to the Interim Revenue Accounting Control System
(IRACS). (06/2006):
- Performed analysis and decided to use new CDDB unpaid assessment
files for the FY 2006 audit. (05/2006):
- Finalized programming requirements for CDDB Release 2B, which creates
the sub-ledger for revenue receipts and refunds. (06/2006):
* Continued to meet Treasury's Information Executive Repository (TIER)
3- day close financial reporting requirements. (Quarterly):
* Maintained clean audit opinion on FY 2005 financial statements, the
first year of the Integrated Financial System operations. (11/2005):
Actions Planned or Underway (FY 2007 and beyond):
* CDDB Planned Actions:
- Create CDDB to Interim Revenue Accounting System (IRACS) interface.
(03/2007):
- Begin test of CDDB Release 2 revenue data base. (06/2007):
- Further enhance FMIS by developing the CDDB to be compliant with
Federal Financial Management Improvement Act of 1996 requirements. The
CDDB will add revenues and refund transactions to begin the creation of
subsidiary ledgers (Releases 2 and 3). (FY 2008):
* Fully implement the use of cost accounting data for resource
allocation decisions. (FY 2008):
Complexity of the Tax Law:
Issue: Simplifying the tax process within current laws while at the
same time modernize IRS systems and processes to reduce tax complexity
for individual and business taxpayers.
Actions Taken (FY 2006):
* EITC Actions:
- Updated EITC Assistant to accommodate the Gulf Opportunity Zone Act
of 2005 to have nontaxable combat pay included in earned income
(Hurricanes Katrina, Rita and Wilma), the extension of the election for
EITC, and the Uniform Definition of Child provisions enacted in the
Working Families Relief Act of 2004 impact to EITC and filing Status.
(01/2006):
- Unified Family Credit that combines the provisions of the EITC, Child
Tax Credit, and Dependency Exemption, to reduce taxpayer compliance
burdens associated with claiming these provisions. (Ongoing):
* Continued to work with the Treasury Department on revisions to the
regulations relating to the use and disclosure of tax return
information by tax returns preparers (Internal Revenue Code §7216).
(Ongoing):
* Updated all tax law forms, processes, IRMs, and employee guidance
related to late legislation in 2005. (December 2005 through January
2006):
Actions Planned or Underway (FY 2007 and beyond):
² Release Tax Year 2006 version of EITC Assistant incorporating user
recommendations and tax law updates. (01/2007):
² Develop a compliance strategy to identify and prevent erroneous
Telecommunications Excise Tax Refunds. The goal is to design the least
burdensome procedures to enable all eligible taxpayers to claim the
right refund. (01/2007):
² Expand Modernized E-file to other forms, including flow-through
returns for partnerships and Subchapter S-Corps. (09/2008):
* Implement an option for taxpayers to be able to split refunds into as
many as three separate accounts, by updating forms, programming, IRMs,
and employee guidance. (Ongoing, implement in 01/2007):
* Begin final stages of returns processing in Philadelphia by rerouting
new work to other campuses by July 2007, and complete processing of
inventories by the end of FY 2007, thereby ceasing processing
operations in September 2007. (09/2007):
* Redesign Form 1040 and create a new Schedule O for processing year
2008; thereby, simplifying taxpayers' reporting of certain adjustments
to income, credits, taxes, and payments. (Ongoing):
* Continue to look for new ways in Accounts Management to resolve
quality and productivity issues through use of the Lean Six Sigma
process and the "Extreme Breakthrough Performance" process. (Ongoing
through 09/ 2007):
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 (FY 2006):
* Used 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. (Ongoing):
- Partnered with the U.S. Department of Health and Human Services to
sponsor workshops statewide, which connect organizations with common
goals of helping low-income families.
- Formed a partnership with the largest funder of rural activities in
the United States, and secured commitment to fund the rural strategy in
seven states in FY 2007: Louisiana, Michigan, West Virginia,
Mississippi, Arkansas, New Mexico, and Montana.
* Continued expansion of Internet Refund Fact of Filing (IRFOF)
application to reduce Toll-free telephone demand and offer customers
alternative methods of service. (09/2006):
* Incorporated multi-year Quality Improvement Process Plan (VRPP-QIP)
including web-based learning to improve quality for the VITA program.
(09/2006):
* Refined and tested "Life Cycle Products" line of publications
designed to educate taxpayers about the tax impact of significant life
events. (09/2006):
* Developed new and revised Spanish-language tax products. (09/2006):
* Conducted focus groups at the Nationwide Tax Forums to obtain
feedback from taxpayers and tax practitioners on ways to improve tax
forms, instructions and publications. (2006 forums):
* Tested all significant tax form and notice changes with taxpayers and
external stakeholders prior to implementing the changes. (Ongoing):
* Delivered the Taxpayer Assistance Blueprint (TAB) (Phase I) report to
Congress. Phase I includes options to provide taxpayer service over
multiple channels to align content, delivery, and resources with
taxpayer and partner expectations to reduce burden, improve workforce
performance, and increase voluntary compliance. TAB establishes a
credible taxpayer/partner baseline of needs, preferences, and
behaviors. (04/2006):
* Actions taken to improve service to those taxpayers filing for the
Earned Income Tax Credit included:
- Developed a service-wide integrated marketing strategy aimed at
reducing EITC error that reached 141 million contacts including
taxpayers, tax practitioners, members of the media, and partner
organizations. (06/2006):
- Assessed the overall EITC marketing/awareness campaigns that target
eligible claimants to increase overall participation and improve
compliance. (Ongoing):
- Partnered with the Ogden Usability Lab to expand the testing of EITC
notices and forms. (09/2006):
* Installed Contact Recording in 47 Taxpayer Assistance Centers (TACs).
Contact recording provides immediate performance feedback to employees
to improve the quality and completeness of responses. (07/2006):
* Completed the Phase II rollout of Queuing Management (Q-Matic), a
web- based system that captures the number and types of customer
contacts in the TACs and automates the process of tracking employee
activity. (09/ 2006):
* Developed TeleFile and Internet electronic funds withdrawal (Direct
Debit) applications for notice payments and installment agreements.
(09/2006):
* Doubled the number of taxpayers (17 in FY 2005 to 33 in FY 2006) in
the Compliance Assurance Program (CAP), a process in which large
corporations and IRS agents work together to examine transactions in
"real time" during the taxable year to reach agreement on the
taxpayer's tax liability before the tax return is filed. (01/2006):
* Continued to work with stakeholders to improve the sixteen Collection
notices with a combined annual volume of 46 million. (Ongoing):
Actions Planned or Underway (FY 2007 and beyond):
² Continue expansion of IRFOF ("Where's my refund?) to add more math
error explanations, accommodate split refund inquiries, and provide
inquiry capability for those taxpayers filing for telecommunications
excise tax refunds. (2006 filing season and beyond):
* Continue the process of conducting surveys and focus groups to obtain
feedback from taxpayers and tax practitioners about ways to improve tax
forms, instructions and publications. (Ongoing):
² Expand the web-based learning program (Link and Learn Taxes) that
provides online training in tax return preparation for Stakeholder
Partnerships, Education and Communication Partners and Volunteers. (09/
2007):
² Expand the "Life Cycle Products" line of publications designed to
educate taxpayers about the tax impact of significant life events.
(Ongoing through 09/2007):
² Install Contact Recording in 83 TACs locations in FY 2007 and in the
remaining 270 TACs in FY 2008 and FY 2009. (Ongoing):
* Expand the use of Q-Matic, the web-based system that captures the
number and types of customer contacts in the TACs and automates the
process of tracking employee activity, to the remaining TAC sites. (09/
2007):
* Complete planned actions to improve service to those taxpayers filing
for the Earned Income Tax Credit:
- Continue to educate EITC taxpayers through partnerships with key
stakeholders and a public service campaign. (Ongoing):
- Develop targeted EITC partner and compliance-oriented outreach and
assistance activities for 2007 filing season. (01/2007):
* Incorporate multi-year Volunteer Return Preparation Program-Quality
Improvement Process (VRPP-QIP) plan to promote quality assurance for
the Volunteer Income Tax Assistance program.
- Test the new quality forms by conducting volunteer return preparation
session. (09/2007):
² Continue development of Issue Management System (a streamlined and
structured process that facilitates corporate issue identification,
resolution and feedback) designed to gather data on emerging issues,
detect trends, monitor issues, and provide resolutions and
communications with greater effectiveness. (Ongoing):
² Continue to expand participation in the Compliance Assurance Process.
(09/2007):
Processing Returns and Implementing Tax Law Changes During the Filing
Season:
Issue: The filing season remains a critical IRS program that impacts
every American taxpayer. Many programs, activities and resources have
to be planned and managed effectively for the filing season to be
successful.
Actions Taken (FY 2006):
* Updated all tax law forms, processes, Internal Revenue Manuals
(IRMs), and employee guidance related to the emergency supplemental
appropriations act to address hurricanes in the Gulf of Mexico, which
was enacted late in 2005. (01/2006):
* Piloted an automated adjustment document to make a change or
correction to a taxpayer account, reducing adjustment time and
increasing the quality of required adjustments. (09/2006):
* Developed strategies to transition and consolidate the Philadelphia
Submission Processing Center. (Multi-year initiative):
* Completed deployment of Transcript Delivery System. (12/2005):
* Developed processes and procedures for administering
telecommunications excise tax refunds (TETR) to more than 150 million
taxpayers by:
- Modifying all individual and business tax return forms to include
TETR information;
- Creating a new form (1040EZ-T) to be used by individuals who want to
request a refund, but who have no other tax filing requirement;
- Drafting a second new form (8913) to be used by taxpayers who choose
to request refunds based on their actual payments rather than use a
standard amount set by the IRS;
- Developing a methodology that can be used by businesses and non-
profits to estimate their TETR claims;
- Launching an outreach campaign to external stakeholder groups;
- Programming IRS systems to accept form changes;
- Developing TETR-related procedures (IRMs); and:
- Conducting training for employees who will interact with taxpayers on
the phone and at Taxpayer Assistance Centers. (05/2006 and Ongoing
leading up to the filing season):
Actions Planned or Underway (FY 2007 and beyond):
* Administer the Telecommunications Excise Tax Refund program by
providing additional services to taxpayers claiming the credit
including answering taxpayer questions received via telephone,
correspondence and through the TACs. (01/2007):
* Assist taxpayers who use IRS Field Assistance and VITA sites to claim
the credit. (01/2007):
* Conduct a targeted compliance effort to minimize excise tax refund
over-claims. (01/2007):
* Work with community-based organizations to educate low-income
taxpayers without a filing requirement and to encourage them to request
their telecommunications excise tax refunds. (01/2007):
* Redesign Form 1040 (Individual Income Tax) and create a new Schedule
O for processing year 2008 to simplify the reporting of certain
adjustments to income, credits, taxes, and payments. (Ongoing):
* Implement an option for taxpayers to be able to split refunds. (01/
2007):
* Begin final stages of returns processing in Philadelphia, rerouting
new work to other campuses and complete processing of inventories. (09/
2007):
* Continue expansion of Modernized E-file requirements and the increase
of business electronic return processing. (Ongoing):
* Scan and image paper returns for large corporate returns that do not
meet e-file dollar or volume requirements to expedite assessments. (09/
2007):
Taxpayer Protection and Rights:
Issue: The IRS has made significant progress in complying with the
Internal Revenue Service Restructuring and Reform Act of 1998 and most
provisions pertaining to taxpayer protection and rights have been
implemented. Significant management attention is still required to
ensure that remaining issues have been addressed.
Actions Taken (FY 2006):
* Developed and implemented the Taxpayer Rights Impact Statement to
incorporate awareness and consideration of taxpayer rights into all
program planning and implementation. (Ongoing):
* Refined 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):
* Designed an education and awareness program with tax preparer
partners to: (1) educate taxpayers about the need to ensure preparers
they choose to prepare their tax returns are competent, and (2) stress
enforcement actions the IRS will take on those preparers found to be
negligent or reckless. (Ongoing):
* Continued emphasis on the Return Preparer Program and increasing
Program Action Cases (PACs) against preparers who file incorrect or
fraudulent returns by focusing on assertion and collection of penalties
and employing other enforcement options such as injunctions. Continued
discussions with Treasury, OMB, and Congress to increase maximum
penalty amounts. (Ongoing):
* Established process and procedures to minimize the effects of
questionable refunds on the taxpayer when a refund is held to resolve
issues. Included appropriate taxpayer notification procedures including
creation of notice explaining the circumstances of the refund hold or
denial. (Ongoing):
Actions Planned or Underway (FY 2007 and beyond):
* Continue systems modernization efforts to enhance the IRS' security
program to safeguard taxpayer data. (Ongoing):
* Complete the implementation of the agency-wide strategy for IT
systems disaster recovery, including conducting annual exercises in
major computing environments. (09/2007):
* Continue to study the Questionable Refund Program workflow processes
to identify areas where additional improvements can be made,
particularly in the area of refund freezes. (Ongoing):
Human Capital:
Issue: The IRS' ability to meet expectations outlined by the
President's Management Agenda in personnel management area such as
recruiting, training, and retaining employees.
Actions Taken (FY 2006):
* Completed development of the IRS Human Capital Strategic
Implementation Plan, which outlines the strategies the IRS will follow
in addressing the challenges to achieving the desired state of human
capital in the IRS. (01/2006):
* Deploy the Learning Content Management System (LCMS) to permit more
efficient development of training materials and consistency in training
across the Service to improve the skills of current employees and to
prepare them for the workforce of tomorrow. (09/2006):
* New training courses offered include enhanced computer skills,
desktop integration, purchase card and approver, and electronic
installment agreements. (FY 2006):
² Complete conversion of all Mission Critical Occupation (MCO)
application processes to the CareerConnector system (provides resume
builder functionality for applicants, and a recruitment system that
identifies well-qualified candidates for vacancies) and begin the
conversion of the non-MCO occupations. (09/2006):
* Improved CareerConnector system recruiting for front-line occupations
through expansion of category (qualified, best qualified, etc.) ratings
and use of simulations in assessing job applicants. (Ongoing):
* Resolved protest issues/ concerns and issued an award decision for
Campus Files Activity to IAP World Services, Inc.
- Implemented a well-orchestrated communications strategy that included
notification of the award decision to employees, NTEU, Congress,
Treasury, OMB, and the media. (05/2006):
* Developed an approach to identify business processes that leverage
the tools, templates, best practices, and successes of Competitive
Sourcing to create a structure that can be used as an alternative to
conducting a public-private competition and for certification of high
performing organization status. (Ongoing):
* Conducted leadership interviews to determine talent needs, and
incorporated results into the Succession Plan, which was rolled out in
FY 2006. Talent assessments and creation of a review toolkit are being
tested in the W&I and MITS organization. (09/2006):
* Conducted a study of all leadership courses (Executive Readiness
Program, Senior Manager Course/Senior Manager Readiness Program, and
Frontline Manager Course) to focus on: (09/2006):
- Delivering content in an effective and efficient manner:
- Identifying and attracting and retaining "high talent" and "high
potential" employees for leadership development.
* Designed new management training using tailored case studies,
simulations in training and work-out sessions to provide hands-on
experience, critical to enhancing employee skills. (Ongoing):
* Continued 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):
* Extended recruiting partnerships with key colleges and universities.
(Ongoing):
* Modified the employee engagement program to focus on balanced
measures at the workgroup level and to the identification of barriers
to delivery of the IRS' goals and objectives such as tools, technology
and improved processes. (01/2006):
Actions Planned or Underway (FY 2007 and beyond):
* Continue the design of management training using tailored case
studies, simulations in training and work-out sessions to provide hands-
on experience in order to develop and retain qualified managers.
(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):
* Utilize the approach developed in FY 2006 to identify business
processes that leverage the tools, templates, best practices, and
successes of Competitive Sourcing. (Ongoing):
* Continue a multi-year recruitment and marketing plan to target a
diverse applicant pool in recruitment and hiring of mission-critical
talent. Expand the number and type of colleges and universities
included in recruiting partnerships established. (Ongoing):
* Use competency models to identify the general and technical
knowledge, skills and abilities essential to current and new employee
performance in a position. (Ongoing):
* Analyze results of Succession Planning tests and continue rolling out
process to additional sites. Determine if test should be expanded to
include Management Officials. (Ongoing):
V. Financial Highlights:
Stewardship Information Analysis:
a. Overview of Revenue and Administrative Accounts:
The IRS' Fiscal Year (FY) 2006 financial statements received an
unqualified audit opinion for the seventh consecutive year.
The Balance Sheet reflects total assets of $26 billion. Of these
assets, 79.8 percent are Federal Taxes Receivable. These receivables
are the amounts expected to be collected from past due accounts. The
decrease in assets of $.7 billion is primarily attributable to
decreases in the amounts due from Treasury for tax refunds due
taxpayers and taxpayer deposits for unpaid assessments. The majority of
the liabilities, 86 percent, consist of amounts due to Treasury related
to Federal Taxes Receivable.
The Statement of Custodial Activity shows that IRS programs collected
$2.514 trillion in federal receipts. The IRS' collections constitute 96
percent of the Federal Government receipts, as shown in the chart
below.
Total Federal Receipts - (Percent):
[See PDF for Image]
% may be off due to rounding:
[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 processing tax returns and related documents,
assistance for taxpayers in filing returns and paying taxes due,
matching information with returns, and managing financial resources.
The Tax Law Enforcement appropriation provides funds for examination of
tax returns, collection of balances, the administrative and judicial
settlement of taxpayer appeals of examination findings, as well as
providing resources for strengthened enforcement 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 telecommunications support for the IRS' 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.
Budget Fiscal Year 2006 Financing Sources - (Percent):
[See PDF for Image]
% may be off due to rounding:
[End of Figure]
Besides appropriations, the IRS used other financing sources. These
included net transfers from other federal agencies, and revenue from
user fees for direct services provided to customers (for example,
installment fees, photocopy fees, and letter rulings and determinations
fees).
c. Use of Resources:
The Statement of Net Cost reflects the use of resources in conducting
the IRS' major programs.
How the IRS used its resource - Percent:
[See PDF for Image]
% may be off due to rounding:
[End of Figure]
The major programs are Pre-filing Taxpayer Assistance and Education,
Filing and Account Services, Compliance Services, and Administration of
Tax Credit Programs (EITC and HCTC). Pre-filing Taxpayer Assistance and
Education activities include taxpayer education and outreach, pre-
filing agreements, and tax publication issuance and distribution.
Filing and Account Services activities include filing tax returns,
maintaining customer accounts, and processing taxpayer information.
Compliance Services activities include document matching, examination,
collection, and criminal investigation activities. Administration of
the Tax Credit programs includes costs for EITC 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. FY 2006
revenue receipts ($2.514 trillion) increased by approximately 11
percent from FY 2005 to FY 2006. Individual income taxes increased by 9
percent and include both Federal Insurance Contributions Act (FICA) and
Self-Employment Contributions ACT (SECA) taxes. Corporate income taxes
increased by 24 percent. Collections from all other tax sources
increased 4 percent from FY 2005 to FY 2006.
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 2005 liabilities. Contributing factors
include the higher 2005 incomes, lower 2005 deductions and a higher
effective tax rate on 2005 taxable income reported in FY 2006. Net
corporate receipts increased due to the growth in gross corporate tax
receipts and the decrease in refunds.
Federal tax refund activity, which includes tax, interest, payments for
EITC and Child Care Tax Credit in excess of the tax liability, was $277
billion. In FY 2006, the IRS issued $59 million in advance payments of
the EITC. Overall refund disbursements increased by 4 percent from FY
2005 to FY 2006.
Excise Tax Trust Fund:
The Quarterly Federal Excise Tax Return, Form 720, reports liability
for excise taxes. Taxpayers make periodic deposits in advance of filing
the return. These deposits are classified as Federal Excise Tax. After
the IRS receives and processes the returns, the IRS certifies amounts
for several Trust Funds. Amounts reported on the Statement of Custodial
Activity are for fiscal year collections, i.e., October 1 through
September 30. Because Form 720 reporting requirements are completed
after receipt of most of the deposits, the certification amounts will
not match the amounts collected in the fiscal year. The table below
shows receipts certified to the Airport and Airway Trust Fund, Black
Lung Disability Trust Fund and the Highway Trust Fund for the eight
liability quarters from December 2003 through September 2005. The
Treasury Department's Financial Management Service and the Bureau of
Public Debt prepare the warrants and allocations to the various Trust
Funds.
The unpaid assessment balance includes amounts owed by taxpayers who
file returns without sufficient payment as well as amounts assessed
through the IRS enforcement programs. As reflected in the supplemental
information to the IRS' FY 2006 Financial Statements, the unpaid
assessment balance was about $245 billion as of September 30, 2006.
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' $245 Billion of Unpaid Assessments:
[See PDF for Image]
% may be off due to rounding:
[End of Figure]
Taxes receivable represent $91 billion of unpaid assessments. About $70
billion (77 percent) 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. Except for bankruptcy situations, 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 (23 percent) of taxes receivable ($91 billion) is
estimated to be collectible. The collectible balance includes
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, 2005 ($88 billion) to September 30, 2006 ($91
billion) increased by $3 billion. The percent estimated to be
collectible at September 30, 2006 (23 percent), decreased from
September 30, 2005 (24 percent).
Components of the IRS' $91 Billion of Taxes Receivable:
[See PDF for Image]
% may be off due to rounding:
[End of Figure]
Compliance assessments of $57 billion represent amounts that have not
been agreed to by either the taxpayer or a court. These assessments
result primarily from various IRS 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.
Write-off amounts of $97 billion include amounts owed by defunct
corporations with no assets and 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.
Components of the IRS' $97 Billion of Write-offs:
[See PDF for Image]
% may be off due to rounding:
[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, 2006.
About $139 billion (57 percent) of the unpaid assessment balance as of
September 30, 2006, consists of interest and penalties and is largely
uncollectible.
Unpaid Taxes and Interest and Penalty Components:
[See PDF for Image]
% may be off due to rounding:
[End of Figure]
Interest and penalties are a high percentage of the balance of unpaid
assessments because the IRS must continue to accrue them through the
ten-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 Federal Deposit Insurance Corporation and
Resolution Trust Corporation cases, and on examination assessments
where taxpayers have not agreed to the amount assessed.
[End of section]
Financial Statements:
Balance Sheets as of September 30, 2006:
[See PDF for image] - graphic text:
[End of figure] - graphic text:
Statements of Net Cost for the years ended September 30, 2006 and 2005:
[See PDF for image] - graphic text:
[End of figure] - graphic text:
Statements of Changes in Net Position for the years ended September 30,
2006 and 2005:
[See PDF for image] - graphic text:
[End of figure] - graphic text:
Statements of Budgetary Resources for the years ended September 30,
2006 and 2005:
[See PDF for image] - graphic text:
[End of figure] - graphic text:
Statements of Financing for the years ended September 30, 2006 and
2005:
[See PDF for image] - graphic text:
[End of figure] - graphic text:
Statements of Custodial Activity for the years ended September 30, 2006
and 2005:
[See PDF for image] - graphic text:
[End of figure] - graphic text:
Notes to the Financial Statements:
The accompanying notes are an integral part of these statements.
Internal Revenue Service:
Notes to the Financial Statements For the Years Ended September 30,
2006 and 2005:
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 (MITS) and Agency Wide Shared Services (AWSS)
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 generally accepted accounting
principles (GAAP) in the United States 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
2006 and FY 2005 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. Effective October 1, 2005, the Service modified its
method of allocating functional support and indirect costs in the
Statement of Net Cost. The Service transitioned from its manual
processes and utilized the cost module of the Integrated Financial
System (IFS) to systemically allocate support costs to its operational
organizations either by directly attributing costs to the organizations
or cost centers (e.g., labor) or by allocating them based on a
predetermined factor such as headcount, hours worked, units produced or
causal relationships (e.g., rent). The allocation methodology, which
goes through a formal approval process each year, enables the Service
to more accurately identify and view the operational organizations'
direct and indirect costs and to improve the overall quality and
availability of essential cost information to support the management of
Service operations and day-to-day decision making.
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:
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. The FY 2005 Statement of Budgetary Resources has
been modified to conform with the FY 2006 presentation of the
statement.
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), and child care
credits, as well as overpayments of taxes.
C. Financing Sources and Imputed Costs:
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 Appropriations and Allocation Account:
Other appropriations 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 included in the Trade Act of 2002.
In FY 2006, the Service provided services to the Department of
Transportation's Federal Highway Administration for the development,
operation, and maintenance of electronic systems for the collection of
motor fuel and other highway use taxes. The costs for these services
are reported through the use of an allocation account. The Department
of Transportation reports all activity for the Service in their
financial statements.
Imputed Costs:
The Service incurs certain costs that are paid in total or in part by
other federal entities. These are pension costs administered by the
Office of Personnel Management, legal judgments paid by the Treasury
Judgment Fund, and costs of processing payments and collections by the
Financial Management Service. These costs are recognized by the Service
on its Statement of Changes in Net Position and Statement of Financing
as imputed financing sources.
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:
Accounts Receivable:
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. 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:
Advances to government agencies primarily represent funds paid to the
Treasury Working Capital Fund (WCF) and the Department of Interior
GovWorks. Centralized services funded through the WCF consist primarily
of telecommunications services, payroll processing, and depreciation of
property and equipment owned by the WCF. Activities funded through
GovWorks consist of the acquisition of furniture.
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:
Property and equipment is recorded at historical cost. It consists of
tangible assets and software. 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 over its estimated useful life. A half year depreciation is taken
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 assets along with related
equipment: 1) mainframe computers, 2) minicomputers, 3) local area
network (LAN) servers, 4) desktop and laptop computers, and 5)
telecommunications equipment. ADP equipment includes all related
software, including commercial off-the-shelf software, except as
separately stated under Internal Use Software.
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.
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.
Internal Use Software:
Beginning in FY 2001, the Service capitalizes direct and indirect costs
of internal use software in accordance with Statement of Federal
Financial Accounting Standards No. 10, Accounting for Internal Use
Software. 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. Maintenance is excluded.
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.
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.
Disposals are recognized when software is determined to be obsolete or
nonfunctional. The IRS treats terminated projects and/or subprojects as
100% obsolete.
Leasehold Improvements:
All leasehold improvement projects are capitalized regardless of cost.
G. 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.
H. 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.
Under the Internal Revenue Code (26 USC) Section 6404, 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 carried 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.
I. 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 are 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, 2006 and 2005, consist
of the following:
Fund Balance: Appropriated funds and other;
2006: $2,066;
2005: $1,990.
Fund Balance: Fund Balance with Treasury;
2006: $2,066;
2005: $1,990.
Status of Fun Balance with Treasury: Unobligated balances: Available;
2006: $192;
2005: $252.
Status of Fun Balance with Treasury: Unobligated balances: Unavailale;
2006: 360;
2005: 236.
Status of Fun Balance with Treasury: Obligated balances not yet
disbursed;
2006: 1,520;
2005: 1,508.
Status of Fun Balance with Treasury: Other funds;
2006: (6);
2005: (6).
Status of Fun Balance with Treasury: Fund balance with Treasury;
2006: 2,066;
2005: 1,990.
[End of table]
The Business Systems Modernization (BSM) fund represents $268 million
and $297 million of the appropriated fund balance as of September 30,
2006 and 2005, 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, 2006
and 2005, consist of the following:
Imprest fund;
2006: $4;
2005: $4.
Other custodial assets;
2006: 48;
2005: 462.
Total Cash and Other Monetary Assets;
2006: $52;
2005: $466.
[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, 2006 and 2005, respectively, 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, 2006 and 2005, consist of the
following:
Advances;
2006: Intragovernmental: $187;
2006: With the public: $9;
2005: Intragovernmental: $130;
2005: With the public: $8.
Accounts receivable, net;
2006: Intragovernmental: $14;
2006: With the public: $7;
2005: Intragovernmental: $16;
2005: With the public: $7.
Federal tax lien revolving fund;
2006: Intragovernmental: [Empty];
2006: With the public: $4;
2005: Intragovernmental: [Empty];
2005: With the public: $2.
Suspense;
2006: Intragovernmental: $4;
2006: With the public: (5);
2005: Intragovernmental: $4;
2005: With the public: (5).
Total Other assets;
2006: Intragovernmental: $205;
2006: With the public: $15;
2005: Intragovernmental: $150;
2005: With the public: $12.
[End of table]
Note 5. Federal taxes Receivable, net.
Federal taxes receivable (gross) were $91 billion and $88 billion as of
September 30, 2006 and 2005, 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 as of September 30,
2006 and 2005, 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 $70 billion and $67
billion was established in FY 2006 and FY 2005, 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, 2006 and 2005, is shown in
the schedule below. The Cost column represents the historical cost of
property and equipment, net of disposals. The cost basis for FY 2006
and FY 2005 is $3,529 million and $3,502 million, respectively.
Accumulated depreciation for FY 2006 and FY 2005 is $2,249 million and
$2,080 million, respectively.
Category: ADP Assets;
Useful Life(Years): 3 to 7;
Cost: $1, 733;
Accumulated Depreciation: $(1,234);
2006 Net Book Value: $499;
2005 Net Book Value: $502.
Category: Furniture and non-ADP equipment;
Useful Life(Years): 8 to 10;
Cost: 61;
Accumulated Depreciation: (46);
2006 Net Book Value: 15;
2005 Net Book Value: 20.
Category: Investigative equipment;
Useful Life(Years): 10;
Cost: 10;
Accumulated Depreciation: (8);
2006 Net Book Value: 2;
2005 Net Book Value: 3.
Category: Vehicles;
Useful Life(Years): 5;
Cost: 76;
Accumulated Depreciation: (58);
2006 Net Book Value: 18;
2005 Net Book Value: 26.
Category: Major systems;
Useful Life(Years): 7;
Cost: 423;
Accumulated Depreciation: (391);
2006 Net Book Value: 32;
2005 Net Book Value: 89.
Category: Internal use software;
Useful Life(Years): 7;
Cost: 721;
Accumulated Depreciation: (242);
2006 Net Book Value: 479;
2005 Net Book Value: 508.
Category: Internal use software- work in progress;
Useful Life(Years): [Empty];
Cost: 41;
Accumulated Depreciation: [Empty];
2006 Net Book Value: 41;
2005 Net Book Value: 35.
Category: Leasehold improvements;
Useful Life(Years): 10;
Cost: 443;
Accumulated Depreciation: (264);
2006 Net Book Value: 179;
2005 Net Book Value: 202.
Category: Assets under capital lease;
Useful Life(Years): 4 to 10;
Cost: 21;
Accumulated Depreciation: (6);
2006 Net Book Value: 15;
2005 Net Book Value: 37.
Category: Total property and equipment;
Useful Life(Years): [Empty];
Cost: 3,529;
Accumulated Depreciation: (2,249);
2006 Net Book Value: 1,280;
2005 Net Book Value: 1,422.
[End of table]
As of September 30, 2006 and 2005, the Service has 12 internal use
software projects, including deployed and work in process. Customer
Account Data Engine (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 for tax practitioners and the public.
Modernized E-File is an electronic filing system for tax returns.
Security and Technology Infrastructure Release (STIR) is a project to
modernize and standardize the information technology security
infrastructure throughout the Service. Integrated Financial System
(IFS) is an administrative financial system. Internet Refund Fact of
Filing is a project to allow taxpayers to review the status of their
refund. Enterprise Systems Management (ESM) is a project that created a
new information technology infrastructure. Customer Communications is a
customer service telephone system. Filing & Payment Compliance is a
project to resolve payment and filing compliance issues, including
enabling private debt collection.
Deployed internal use software projects consist of the following:
[See PDF for table]
[End of table]
Until deployed, internal use software projects are carried as work in
process. Major projects in process include future releases of CADE,
Modernized E-File, and Filing & Payment Compliance.
The costs of internal use software - work in process consist of the
following:
Category: CADE;
2006: $10;
2005: $18.
Category: Modernized E-file;
2006: $16;
2005: $15.
Category: Filing and payment compliance;
2006: $15;
2005: $2.
Category: Totals;
2006: $41;
2005: $35.
[End of table]
Note 7. Other Liabilities (In Millions):
Other liabilities as of September 30, 2006 and 2005, consist of the
following:
[See PDF for Image]
[End of table]
Note 8. Leases (In Millions):
The capital lease liability as of September 30, 2006 and 2005, is $5
million and $26 million, respectively, for photocopiers, ADP Equipment
and software licenses. Future payments due on capital leases are as
follows:
Photocopiers;
Total: $1;
2007: $1;
2008: [Empty];
2009: [Empty].
ADP equipment;
Total: $5;
2007: $1;
2008: $1;
2009: $3.
Total lease obligations;
Total: $6;
2007: $2;
2008: $1;
2009: $1.
Less: imputed interest;
Total: (1);
2007: (1);
2008: [Empty];
2009: [Empty].
Present value of lease payments;
Total: $5;
2007: $1;
2008: $1;
2009: $3.
[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. Commitments and Contingencies:
The Service is subject to contingent liabilities involving litigation
of cases whose ultimate disposition is unknown. Management has
determined that it is probable that some of these proceedings and
actions will result in losses. As of September 30, 2006 and 2005, the
estimated liability for these cases was $2 million and $0,
respectively.
There are also legal actions pending for which management is unable to
determine the likelihood of losses. Adverse decisions in these cases
may, individually or in the aggregate, have a material effect on the
financial statements. As of September 30, 2006 and 2005, there were
three cases for which management is unable to determine the likelihood
or establish a range of potential losses.
As of September 30, 2006 and 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, 2006
and 2005, consist of the following:
Workers' Compensation;
2006: Intrageovernmental: $96;
2006: With the public: $487;
2005: Intragovernmental: $92;
2005: With the Public: $520.
Accrued annual leave;
2006: Intrageovernmental: [Empty];
2006: With the public: $478;
2005: Intragovernmental: [Empty];
2005: With the Public: $462.
Capitol lease liability;
2006: Intrageovernmental: [Empty];
2006: With the public: [Empty];
2005: Intragovernmental: [Empty];
2005: With the Public: $23.
Contingent liability;
2006: Intrageovernmental: [Empty];
2006: With the public: $2;
2005: Intragovernmental: [Empty];
2005: With the Public: [Empty].
[End of Table]
Workers' compensation, accrued annual leave, and contingent liabilities
are also reported in Components Requiring or Generating Resources in
Future Periods in the Statement of Financing.
Note 11: Appropriations Received:
Appropriations received reported in the Statement of Budgetary
Resources in FY 2006 and FY 2005 include $101 million and $90 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, 2006 and 2005, in the Statement
of Budgetary Resources, are as follows:
Undelivered orders -unpaid;
2006: $ (932);
2005: $ (941).
Budgetary accounts payable;
2006: (605);
2005: (587).
Budgetary accounts receivable;
2006: 15;
2005: 17.
Total obligated balances;
2006: (1,522);
2005: (1,511).
[End of table]
Note 13. Non-entity Assets (In Millions):
Non-entity 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. Non-entity assets
as of September 30, 2006 and 2005, consist of the following:
Due from Treasury;
2006: Intragovernmental: $ 1,685;
2006: With the public: $ [Empty];
2005: Intragovernmental: $1,946;
2005: With the public: $ [Empty].
Federal taxes receivable, net of allowance for doubtful accounts;
2006: Intragovernmental: [Empty];
2006: With the public: 21,000;
2005: Intragovernmental: [Empty];
2005: With the public: 21,000.
Other custodial assets;
2006: Intragovernmental: [Empty];
2006: With the public: 48;
2005: Intragovernmental: [Empty];
2005: With the public: 462.
[End of table]
Due from Treasury represents tax refunds due to taxpayers but not
disbursed as of September 30, 2006 and 2005.
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):
The Budget of the United States Government that will include FY 2006
actual budgetary execution information will not be published until
January 2007. Accordingly, the disclosure information required by
Statement of Federal Financial Accounting Standard No. 7, Accounting
for Revenue and Other Financing Sources and Concepts for Reconciling
Budgetary and Financial Accounting, is not available at the time of
publication of these financial statements.
Balances reported in the FY 2005 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.
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, 2006 and 2005, and by tax year for fiscal
year ended September 30, 2006, is as follows:
[See PDF for Image]
* Includes other collections of $492 million.
** Includes tax year 2007 corporate income tax receipts of $10 billion.
[End of Figure]
In FY 2006, Individual income, FICA/SECA, and other taxes include $71
billion in payroll taxes collected from other federal agencies. Of this
amount, $12 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,
2006 and 2005, and by tax year for fiscal year ended September 30,
2006, 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. Intragovernmental Costs and Exchange Revenue (In Millions):
Gross cost and earned revenue for the Service are categorized as
follows:
[See PDF for Image]
[End of table]
Note 18. Obligations Incurred:
In FY 2006, the Service incurred $10,634 million in obligations funded
by direct appropriations and $88 million funded by reimbursable revenue
and transfers from the Treasury Asset Forfeiture Fund. 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. Obligations incurred
are reported by the Service under Apportionment Category B which
distributes budgetary resources for the entire fiscal year. Resources
for Business Systems Modernization are distributed by projects.
Note 19. Spending Authority from Offsetting Collections (In Millions):
Spending authority from offsetting collections as of September 30, 2006
and 2005, in the Statements of Budgetary Resources and Financing, is as
follows:
Reimbursable revenue;
2006: $71;
2005: $142.
REceipts for Tax Lien Revolving Fund;
2006: 8;
2005: 5.
Refunds for Vendors;
2006: 8;
2005: [Empty].
Treasury asset Forfeiture Fund Transfers;
2006: 17;
2005: 14.
Total spending authority from offsetting collections;
2006: 104;
2005: 161.
[End of Table]
[End of section]
Supplemental Information:
Supplemental Information - Unaudited For the Years Ended September 30,
2006 and 2005:
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 2006, the total
estimated payout (including principal and interest) for claims pending
judicial review by the Federal courts is $14.8 billion and by Appeals
is $7.1 billion. In FY 2005, the total estimated payout (including
principal and interest) for claims pending judicial review by the
Federal courts was $11.9 billion and by Appeals was $11.1 billion. 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, 2006 and 2005, were as
follows:
Total unpaid assessments;
2006: $245;
2005: $230.
Less: Compliance assessments write-offs;
2006: (57);
2005: (44).
Gross federal taxes receivable;
2006: 91;
2005: 88.
Less: allowance for doubtful accounts;
2006: (70);
2005: (67).
Federal taxes receivable, net;
2006: 21;
2005: 21.
[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 $9 billion as of
September 30, 2006 and $13 billion as of September 30, 2005, 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 2006, the Service issued
$36 billion in EITC refunds. In FY 2005, the Service issued $35 billion
in EITC refunds. An additional $5.4 billion and $5.3 billion of the
EITC was applied to reduce taxpayer liability for FY 2006 and FY 2005,
respectively.
Social Security and Medicare Taxes:
The Federal Insurance Contributions Act (FICA) provides for a federal
system of old-age, survivors, disability, and hospital insurance
benefits. Payments to trust funds established for these programs are
financed by payroll taxes on employee wages and tips, employers'
matching payments, and a tax on self-employment income.
A portion of FICA benefits involve old-age, survivors, and disability
payments. These benefits are funded by the "social security tax" which
is currently 6.2% of wages and tips up to $94,200 and an employer
matching amount of 6.2% bringing the total rate to 12.4%. These
benefits are also funded by a self-employment tax of 12.4% on self
employment income up to $94,200. For FY 2005, the income ceiling for
both wages and tips and self-employment income was $90,000. Remaining
benefits under FICA pertain to hospital benefits (referred to as
"Medicare") and are funded by a separate 1.45% tax on all wages and
tips (there is no wage limit) and the employer matching contribution of
1.45% bringing the total rate to 2.9%. Self-employed individuals pay a
Medicare tax of 2.9% on all self employment income. Social Security
taxes collected by the IRS were estimated to be approximately $614
billion and $583 billion in FY 2006 and FY 2005, respectively. Medicare
taxes collected by the IRS were estimated to be approximately $178
billion and $167 billion in FY 2006 and FY 2005, respectively.
INTERNAL REVENUE SERVICE:
Supplemental Information - Unaudited For the Years Ended September 30,
2006 and 2005:
Schedule of Budgetary Resources by Major Budget Accounts (In Millions):
Fiscal Year 2006:
[See PDF for Image]
[End of table]
Supplemental Information - Unaudited For the Years Ended September 30,
2006 and 2005:
Fiscal Year 2005:
[See PDF for Image]
[End of table]
[End of section]
Other Accompanying Information:
Other Accompanying Information - Unaudited:
For the Years Ended September 30, 2006 and 2005:
Child Tax Credit:
The child tax credit provided under Internal Revenue Code (26 USC)
Section 24 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 2006, 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 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.
Tax Gap:
The tax gap is the difference between what taxpayers should pay and
what they actually pay due to not filing tax returns, not paying their
reported tax liability on time, or failing to report their correct tax
liability. The tax gap, about $345 billion based on updated FY 2006
estimates, represents the amount of noncompliance with the tax laws.
Underreporting tax liability accounts for 83 percent of the gap, with
the remainder almost evenly divided between non-filing (eight percent)
and underpaying (nine percent). The estimate is based on a study of
individual returns filed for tax year 2001. It does not include
underpayments by corporate taxpayers or taxes that should have been
paid on income from the illegal section of the economy.
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 tax gap arises from the
three types of noncompliance: not filing required tax returns on time
or at all (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. Obviously, some of the tax gap arises
from intentional (willful) noncompliance, and some of it arises from
unintentional mistakes.
The collection gap is the cumulative amount of tax, penalties, and
interest that has been assessed over many years, but has not been paid
by a certain point in time, and which 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):
Average Individual Income Tax Liability And Average Adjusted Gross
Income (AGI) Tax Year 2004:
[See PDF for Image]
[End of Figure]
Individual Income Tax Liability As A Percentage Of AGI Tax Year 2004:
Income tax as a percentage of AGI:
[See PDF for image]
[End of figure]
(All figures are estimates and based on samples provided by the
Statistics of Income (SOI) Office):
Corporation Tax Liability As A Percentage Of Taxable Income Tax Year
2003 Data:
[See PDF for Image]
[End of Figure]
[End of section]
Appendix I Material Weaknesses, Reportable Condition, and Compliance
Issues:
Material Weaknesses:
During our audits of the Internal Revenue Service's (IRS) fiscal years
2006 and 2005 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 IRS's 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 21] 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 2006, 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 2006, IRS (1) did not have an adequate general ledger
system for financial reporting purposes, (2) could not reliably report
the specific amount of revenue collected for each of several of the
federal government's largest revenue sources, and (3) was unable to
readily determine the costs of its activities and programs and did not
have cost-based performance information to assist in making or
justifying resource allocation decisions. Although labor-intensive
compensating procedures yielded financial statements that were fairly
stated as of September 30, 2006 and 2005, they do not afford real-time
data needed to assist in managing operations on a day-to-day basis and
to assist in making or justifying resource allocation decisions.
As we noted in last year's report,[Footnote 22] during fiscal year
2006, 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 23] or the requirements of the
Federal Financial Management Improvement Act of 1996 (FFMIA). Further,
IRS's use of two separate, nonintegrated 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.
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. 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. Additional key components were originally planned to be
implemented with future releases of IFS, such as property management,
procurement, and a workload management system. However, technological
improvements and budgetary constraints have led IRS to reconsider its
commitment to future releases of IFS while it reviews other available
options, such as acquiring alternate software or utilizing the services
of a shared service provider. IRS has not yet decided which course of
action to take or obtained necessary funding. It is therefore unclear
how or when IRS will attain the functionality originally planned for
future releases of IFS. 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.
In previous years, IRS had difficulty determining the specific amount
of revenue it actually collected for three of the federal government's
four largest revenue sources--Social Security, hospital insurance, and
individual income taxes. During fiscal year 2006, IRS performed an
analysis to estimate the amounts collected for Social Security and
hospital insurance. However, IRS is not yet confident of the
reliability of these amounts, and consequently reported them in its
unaudited supplemental information rather than the audited financial
statements. 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
results in the federal government depending on a complex, multistep
process to distribute excise taxes to the recipient trust funds that
continues to be susceptible to error.
IRS's inability to timely report specific amounts of excise tax revenue
to recipient trust funds is significant for these funds and their
administrators. Since fiscal year 2004, when all federal agencies were
required to begin meeting the Office of Management and Budget's (OMB)
stipulated reporting date of November 15, the annual excise tax
receipts reported by recipient trust funds 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 24] 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 3
years to determine the extent to which an acceleration of the process
would affect the amounts distributed to the trust funds. Based on IRS's
analysis of the precertifications, which has indicated no significant
variances between precertified and actual certified amounts for each
quarter for the past 3 years, the Department of the Treasury (Treasury)
Excise Tax Working Group[Footnote 25] has decided to accelerate the
actual certification to the precertification timeline, which will
accelerate the certification by approximately 2 months. The accelerated
certification will begin with the second quarter (September 30, 2006,
liability quarter) that is certified in fiscal year 2007. As a result
of the acceleration, beginning with the fiscal year 2007 reporting
year, the annual excise tax receipts reported by recipient trust funds
will include only 3 months of estimated receipts.
During fiscal year 2005, we reported that IRS implemented a cost
accounting module as part of the first release of IFS but that it
required improvements or additional components, such as a workload
management system, before its full potential would be realized. During
fiscal year 2006, IRS further improved its cost accounting capabilities
by developing and implementing a methodology for allocating its costs
of operations to its business units. This methodology utilizes the new
cost accounting module of IFS and allows IRS to accumulate the full
costs of operating each business unit and facilitates financial
reporting. For example, in fiscal year 2006 IRS was able, for the first
time, to generate its statement of net cost directly from IFS. While
these are positive steps, IRS has not yet determined what the full
range of its cost information needs are or how best to utilize the cost
module's existing capabilities to satisfy 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 at the
activity or program level. Without this detail, IRS is unable to either
readily determine the costs of activities and programs that involve
activities in multiple business units, such as the Automated
Underreporter Program, or segregate the costs for each activity in
cases where multiple activities, such as the processing of different
types of tax returns, are performed by a single business unit.
Consequently, at this time, IRS cannot rely on the system as a
significant planning and decision-making tool. It will likely require
several years and implementation of additional components, such as a
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
for attaining efficiencies and enhancing effectiveness will continue to
be hampered by a lack of meaningful underlying cost information.
Despite progress made during fiscal year 2006, the continued existence
of these financial reporting weaknesses once again compelled IRS to
expend more time and effort to maintain its accounting records and
generate financial management information than would otherwise have
been necessary. Further, despite these monumental efforts, IRS
continued to lack reliable and timely financial information to assist
in managing operations throughout fiscal year 2006. 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 2006, we continued to find serious internal control
issues that affected IRS's management of unpaid assessments.
Specifically, we continued to find that (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 26]
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. In fiscal year 2006, IRS began a
phased-in implementation of its Custodial Detailed Database (CDDB). One
of the key objectives of CDDB is to ultimately serve as a subsidiary
ledger for IRS's tax administration activities, including tax revenue
receipts, refund disbursements, and unpaid tax debt, by linking account
information in IRS's master files[Footnote 27] with its general ledger
for tax administration activities. The first phase of CDDB primarily
consisted of implementing computer programs that analyze and classify
related taxpayer accounts from IRS's master file that are associated
with unpaid payroll taxes. Although IRS successfully implemented the
first phase of CDDB during fiscal year 2006, full operational
capability of CDDB is still several years away and depends on the
successful implementation of future system releases planned through
2009. As a result, IRS continues 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 continue to apply statistical sampling and estimation
techniques to data in its master files to estimate the balances at year-
end. While the first release of CDDB refined this process by analyzing
and classifying taxpayer accounts from IRS's master files that are
associated with unpaid payroll taxes, the process continued to take
several months to complete; required adjustments totaling billions of
dollars; and produced amounts that after adjustments, were only
reliable as of the last day of the fiscal year. Consequently, the lack
of a subsidiary ledger inhibits IRS's ability to timely develop
reliable financial and management reports useful for ongoing management
decisions.
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 erroneously recorded a
taxpayer's reported tax of $1,694 as $169 million in its systems, and
sent the taxpayer two erroneous notifications to pay this amount due
plus penalties and interest of nearly $200 million. Upon receipt of
these notices, the taxpayer obtained the services of a certified public
accountant to resolve the matter with IRS; IRS ultimately corrected the
error after several months. In another example, IRS incorrectly
recorded a taxpayer's amended payroll tax return for one tax period in
a different tax period.[Footnote 28] This resulted in IRS erroneously
assessing the taxpayer over $4 million in taxes that were not owed. IRS
ultimately corrected the error several months later, after erroneously
notifying the taxpayer and requiring the taxpayer to provide additional
information.
We also identified some taxpayers that were assessed excess penalties
because of an error in IRS's computer program that calculates and
records penalty assessments. IRS increases the penalty rate assessed
against taxpayers for failing to pay taxes owed from one-half of 1
percent to 1 percent when the taxpayer fails to pay the tax debt
following repeated notification of the taxes due. If the taxpayer then
fully pays the amount owed, IRS is required to reset the penalty rate
back to one-half of 1 percent if it assesses additional taxes against
the taxpayer at a later time. However, IRS's penalty calculation
program did not recognize instances where this situation occurred and
continued to assess penalties at the higher penalty rate on subsequent
tax assessments. IRS determined that this error affected over 62,000
taxpayers with over 69,000 accounts, but IRS had not corrected these
accounts as of September 30, 2006.[Footnote 29]
On the other hand, some input errors and posting delays can cost the
government money. For example, IRS found a corporate officer liable for
not remitting federal tax withholdings from employees' salaries to IRS.
When recording the assessment on the officer's master file account for
one tax period, IRS erroneously recorded a second assessment for the
same amount. IRS attempted to correct the mistake by reversing the
duplicate transaction several weeks later. However, IRS erroneously
reversed both the original and duplicate assessments. Consequently,
there was no longer any assessment on the officer's master file account
for this tax period. IRS did not identify its error until our current
audit, and the statutory period for assessing new taxes on this
specific tax period had expired.[Footnote 30] As of September 30, 2006,
IRS had not determined whether it could still legally pursue payment of
these taxes from this officer.
As in prior years,[Footnote 31] we continued to find errors involving
IRS's failure to properly record payments to all related taxpayer
accounts associated with unpaid payroll taxes.[Footnote 32] 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 any 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, since August
2001, IRS has established procedures to more clearly link each penalty
assessment against an officer to a specific tax period 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 2006, as in
prior years, continued to find deficiencies in this process, leading to
errors in taxpayers' accounts. In our testing of 80 statistically
selected payments recorded on trust fund recovery penalty accounts
established since August 2001, we found 9 instances in which IRS did
not properly record payments received on all related taxpayer accounts.
Of these 9 payments, 4 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 11.3 percent of trust fund recovery payment
transactions posted to accounts established since August 2001 and still
outstanding during fiscal year 2006 could contain
inaccuracies.[Footnote 33]
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 2006, 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 2006 Federal Managers'
Financial Integrity Act of 1982 (FIA) assurance statement to Treasury,
in which it reported material weaknesses in earned income tax credit
(EITC) noncompliance and financial accounting of revenue. IRS's
taxpayer compliance programs identify billions of dollars of
potentially underreported taxes and erroneous EITC claims each year.
However, largely because of 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 34]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
35] 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 36]
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 37] 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. Another preventive control that IRS has relied
on in the past is the Electronic Fraud Detection System (EFDS), which
is IRS's primary source for identification of leads on fraudulently
filed tax returns. With EFDS fully operational, IRS stopped over $412
million in improper refunds during processing year[Footnote 38] 2005.
However, during processing year 2006, IRS took the original EFDS off-
line to install a new Web-based version, but encountered problems with
the Web version and stopped all related system development activities
before it became operational. As a result, IRS did not have the
services of EFDS to prevent fraudulent refunds during processing year
2006. The actual amount of improper refunds disbursed during fiscal
year 2006 as a result of EFDS being off-line is unknown. However, the
Treasury Inspector General for Tax Administration estimated that as
much as $318 million in improper refunds may have been disbursed during
processing year 2006 while EFDS was off-line.[Footnote 39]
In its guidance to heads of federal agencies issued in accordance with
the Improper Payments Information Act of 2002 (IPIA),[Footnote 40] 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 $41
billion in fiscal year 2006, of which approximately $36 billion was
refunded to taxpayers and approximately $5 billion was used to reduce
assessed taxes. 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 for fiscal year 2006. 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 2006
were improper. This error rate indicates that of the approximately $36
billion of EITC-related refunds disbursed during fiscal year 2006, at
least $8 billion, and potentially as much as $10 billion, was likely to
have been improper.
Because of 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; consequently, they do not prevent improper refunds from
being disbursed. IRS's matching program for individual tax returns
identifies billions of dollars of potentially underreported taxes each
year. IRS follows up on a portion of these cases identified to
determine how much tax is actually due and to pursue collection of
those amounts. 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 recent years, IRS has increased the
number of returns investigated and the dollar amount of the total
potential underreported taxes. For example, for tax year 2001, IRS
identified discrepancies in 15.7 million tax returns, with potential
underreported taxes totaling $17.2 billion, but only investigated 3
million (19 percent) of these tax returns, which accounted for about
$7.7 billion (45 percent) of the total potential underreported
taxes.[Footnote 41] By contrast, for tax year 2004, IRS identified
discrepancies in 15 million tax returns with potential underreported
taxes totaling $16 billion, and investigated 4.6 million (31 percent)
of these tax returns, which accounted for about $12.7 billion (78
percent) of the total potential underreported taxes.[Footnote 42]
However, as these figures also illustrate, IRS continues to pursue only
a portion of the potential underreported taxes it identifies. In
addition, 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, which could further improve IRS's net return on the
cases it does elect to pursue. 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 responsibility, IRS relies
extensively on computerized systems to support its financial and
mission-related operations. Effective information system controls are
essential to ensuring that taxpayer and financial information is
adequately protected from inadvertent or deliberate misuse, fraudulent
use, improper disclosure, or destruction. Ineffective system controls
can impair the accuracy, completeness, and timeliness of information
used by management and increase the potential for undetected material
misstatements in the agency's financial statements.
IRS has made progress in implementing information security for its
financial and tax processing systems and information by addressing many
of its previously reported security weaknesses. For example, among
other things, IRS implemented stronger password settings regarding
expiration and complexity and improved controls over data sharing among
mainframe users. IRS also improved employee training on recovering
critical systems in the event of a disaster.
Although IRS has made progress toward correcting previously identified
information security weaknesses, significant weaknesses in electronic
access and other information security controls continued to exist
during fiscal year 2006. Corrective actions had not been completed for
some of the previously identified weaknesses. For example, the security
software configurations on the mainframe system, which supports IRS's
general ledger for tax administration activities, continued to contain
numerous invalid and obsolete entries, leaving IRS with a system that
is overly complicated and difficult to secure, especially in terms of
monitoring actual access privileges. We also identified new weaknesses.
For example, we found that IRS's procurement system, which processed
about $3.9 billion in fiscal year 2006, was vulnerable to a well-known
exploit whereby database commands can be inserted into the application
through a user input screen that is available to everyone on the
agency's network. The significance of this vulnerability is compounded
by the fact that IRS had granted administrative privileges to the
database account used by the application, allowing anyone who exploits
this vulnerability to have powerful database privileges, including the
ability to change data. In addition, IRS had not fully employed
mitigating controls used to detect malicious activity, such as logging
and monitoring user activity. The agency also stored user IDs and
passwords in mainframe files that could be read by every mainframe
user. This information could provide a malicious user access to IRS's
data retrieval system, which contains taxpayer information. Weaknesses
also existed in other areas, such as physical security, configuration
management, segregation of duties, and personnel security. If IRS does
not adequately mitigate these weaknesses, unauthorized individuals
could gain access to critical systems, where they may intentionally or
inadvertently read, modify, 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, such as identity theft. Previously reported weaknesses that
have not been corrected, and the new weaknesses identified during our
fiscal year 2006 financial audit, increase the risk that data processed
by the agency's financial management and tax administration systems are
not reliable.
A key reason for the information security weaknesses in IRS's financial
and tax processing systems was that it has not yet fully implemented a
security program[Footnote 43] to ensure that controls are effectively
established and maintained. Although IRS continues to make important
progress in developing a framework for its information security
program, we identified instances in which the program had not been
fully or consistently implemented for its information systems. For
example, the system that supports IRS's general ledger for tax
administration activities did not have a documented security plan. In
addition, although IRS was periodically testing security controls on
the systems we reviewed, it did not always take remedial action to
address deficiencies identified through these tests. For example, in
March 2006, IRS identified a vulnerability in the process that manages
network connectivity to its procurement system database server; this
condition continued to exist at the time of our review 4 months later.
Further, one of the systems we reviewed did not have an alternate
backup facility in place in the event of a disaster. Until IRS takes
additional steps to fully implement key elements of its information
security program, its facilities and computing resources and the
information that is processed, stored, and transmitted on its systems
will likely remain vulnerable, and management will not have assurance
of the integrity and reliability of the information generated.
The new information security deficiencies we identified in fiscal year
2006 and the unresolved deficiencies from prior audits represent a
material weakness in IRS's internal controls over its procurement,
asset management, and tax administration accounting systems.
Collectively, these deficiencies reduce IRS's ability to secure its
financial and taxpayer information. We plan to issue a separate report
on the newly identified weaknesses and the status of previously
identified weaknesses.
Reportable Condition:
In addition to the material weaknesses discussed above, we identified a
reportable condition concerning weaknesses in IRS's internal controls
over hard-copy tax receipts and taxpayer information.
In our previous report on the results of our audit of IRS's fiscal year
2005 financial statements, we discussed the presence of a reportable
condition with respect to weaknesses in IRS's internal controls over
P&E. Over the past several years, IRS has made substantial progress in
strengthening internal controls and procedures that enhanced its
ability to account for P&E. In fiscal year 2006, IRS made further
improvements over recording P&E transactions in its accounting records.
Although IRS continues to lack an integrated property management
system, the improvements made in fiscal year 2006, combined with
progress made over the past several years, have mitigated this issue.
Thus, we no longer consider the lack of an integrated accounting and
property system to constitute a reportable condition.
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, field office taxpayer assistance centers, other field
office units,
and commercial lockbox banks.[Footnote 44] In previous audits, we have
reported that weaknesses in IRS's controls designed to safeguard
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 45] During our fiscal
year 2006 audit, we identified actions IRS has taken to address some of
these weaknesses. For example, IRS issued guidance to its large-and
midsized taxpayer assistance centers that enhanced managerial and
supervisory review requirements and provided for segregation of duties
between preparation and review activities relating to documents that
accompany shipments of taxpayer receipts and information to affiliated
IRS service center campuses for processing. Additionally, we observed
that at one service center campus, IRS had taken corrective actions to
address several physical security vulnerabilities, which, if left
uncorrected, could have resulted in unauthorized access to the
facility. Also, during fiscal year 2006, IRS and the Financial
Management Service continued implementation of a joint lockbox
performance measurement system begun in fiscal year 2005, which was
designed to address deficiencies in internal controls, such as those
identified in our prior audits, by establishing strict standards and
accountability for adherence to these standards. Because the lockbox
performance measurement system was not fully implemented during fiscal
year 2006, we could not assess the overall impact it will have on
improving the effectiveness of internal controls at the lockbox banks.
However, the system focuses on increased oversight by requiring
quarterly reviews relating to physical security and internal controls
over receipts and receipt processing, and subsequent reporting of the
reviews' results to bank management officials. In addition, a bank
receiving a cautionary rating, indicating notable deficiencies in
overall performance, may be subject to the following punitive actions
if performance does not improve: (1) ineligibility to bid on new work
or receive additional volume, (2) placement in a probationary status
for no less than 90 days, and (3) loss of existing work. This system
has the potential to significantly improve internal controls at the
lockbox bank facilities.
However, despite the improvements we found at IRS's taxpayer assistance
centers, service center campuses, and lockbox banks, IRS's controls
over receipts and related hard-copy taxpayer information did not
sufficiently limit the risk of theft, loss, or misuse of such funds and
information. 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 fiscal year 2006 audit, we observed that (1) the
external perimeter was vulnerable to external intrusions (at five
service center campuses); (2) guards did not respond timely to alarms
(at two service center campuses and one taxpayer assistance center),
and (3) security cameras did not provide for 360 degree coverage of the
building exterior or the facility's external perimeter (at two service
center campuses and three lockbox banks). These weaknesses increase the
risk that the integrity of IRS facilities and the taxpayer receipts and
information they process may be compromised.
* Weaknesses in procedural safeguards and controls designed to account
for, control, and protect taxpayer receipts and related taxpayer
information. For example, during our fiscal year 2006 audit, we found
that (1) sensitive taxpayer information in electronic form sent off-
site for storage was not encrypted to prevent potential unauthorized
access (at three lockbox banks), (2) there was no documentation that
vendors with off-site possession of actual or potential sensitive
taxpayer information had received required background investigations
(at two service center campuses and one lockbox bank), and (3) mail
potentially containing taxpayer receipts was not adequately secured to
prevent potential tampering or theft (at two service center campuses).
These weaknesses increase the risk that taxpayer receipts and
information may be compromised during processing at IRS facilities and
lockbox banks.
* 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 fiscal year 2006
audit, we found that (1) there was no evidence that IRS employees
sending packages containing taxpayer receipts and information followed
up with responsible parties at the recipient location when document
transmittal forms used to specifically identify the contents of the
packages shipped remained unacknowledged by the recipient (at one
service center campus and five Small Business/Self-Employed units); (2)
packaging and shipping procedures used by IRS employees did not
adequately secure taxpayer receipts and information to prevent
potential tampering or unauthorized access (at one service center
campus and two Small Business/Self-Employed unit); and (3) there was no
evidence documenting managerial review of transfer-related
documents[Footnote 46] (at three service center campuses, two lockbox
banks, two taxpayer assistance centers, and four Small Business/Self-
Employed units). 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. IRS's
progress in addressing these issues has been hampered by a tendency, at
times, to focus corrective actions on the issues we identify at the
specific locations where we find them, versus proactively addressing
potential weaknesses at other comparable locations to determine the
full scope of the issues across all IRS receipt processing facilities
potentially affected. For example, during our fiscal year 2005
financial audit, we identified a physical security weakness in a
perimeter fence at one service center campus, which IRS subsequently
corrected. However, IRS did not concurrently follow up to assess
whether similar issues existed at other service center campuses. During
our fiscal year 2006 audit, we found that similar vulnerabilities
existed at two additional service center campuses. The recurrence of
this issue might have been avoided if IRS had been more proactive in
its use of the information we provided in fiscal year 2005. While IRS
has made significant progress in this area, the issues identified
during our fiscal year 2006 audit indicate that more remains to be done
to effectively address these matters, which are critical to IRS's
success in meeting its customer service goals.
Compliance Issues:
Our work on 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.[Footnote 47] 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 federal tax liens 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 48]We found that this condition continued to exist in
fiscal year 2006.
In prior audits, we tested a statistical sample of tax cases with liens
in which the taxpayers' total outstanding tax liabilities were either
paid off or abated during the fiscal year under audit. In fiscal year
2006, IRS performed its own test of the effectiveness of its lien
release process as part of implementing the requirements of the revised
OMB Circular No. A-123. Consequently, we reviewed and validated IRS's
test results.
In its testing of 84 statistically selected tax cases with liens in
which the taxpayers' total outstanding tax liabilities were either paid
off or abated during fiscal year 2006, IRS found 26 instances in which
it 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 44 days to 638 days. In 4
cases, the lien still had not been released at the time of IRS's
review. Based on these results, IRS estimates that for 31 percent of
unpaid tax assessment cases in which it had filed a tax lien that were
resolved in fiscal year 2006, IRS did not release the lien within 30
days.[Footnote 49]
In 13 of the 26 cases in which liens were not released timely, the
delay in the lien release was caused by IRS's failure to timely record
information on the taxpayer's account to show that the taxpayer had
satisfied or was otherwise relieved of the tax liability. In 6 of these
cases, 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 the
initiation of the lien release process for these cases. In 5 of the
other cases, IRS did not timely update the taxpayer's account to
reflect that the taxpayer had been discharged of the taxes in
bankruptcy court. In the remaining 2 cases, IRS did not timely update
the taxpayer's account to indicate the taxpayer had satisfied all the
conditions of an offer-in-compromise. IRS's delay in timely recording
this information also prevented the initiation of the lien release
process. 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. 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 50]
Financial Management Systems' Noncompliance With FFMIA:
In fiscal year 2006, 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), 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 represented a major step forward and has
provided significant benefits, such as enhanced audit trails and a cost
module. However, as noted earlier in this report, IRS is no longer
committed to the future releases of IFS that were to include additional
features essential to IRS's ability to realize the system's full
potential, such as workload and procurement management. Since IRS does
not yet have a viable alternative planned, it is unclear how or when
IRS will obtain these capabilities. 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
2006.
IRS has established a remediation plan to address the conditions
affecting its systems' inability to comply substantially with the
requirements of FFMIA. This plan outlines the actions to be taken to
resolve these issues, but many future corrective actions are on hold
and currently unfunded. Because of 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 IRS's 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, P&E, 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 the existence and completion assertions related
to 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 IRS's 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, and OMB Circular No. A-123, Management's Responsibility
for Internal Control.
* 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, Independent Agencies, and General Government
Appropriations Act, 2005, Pub. L. No. 108-447, div. H, tit. II, 118
Stat. 2809, 3199 (Dec. 8, 2004); and Department of the Treasury
Appropriations Act, 2006, Pub. L. No. 109-115, div. A, tit. II, 119
Stat. 2396, 2432 (Nov. 30, 2005).
* 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 6, 2006:
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 comment on the draft report titled,
Financial Audit. IRS' Fiscal Years 2006 and 2005 Financial Statements.
We are pleased that the Internal Revenue Service (IRS) received an
unqualified opinion on the combined financial statements for a seventh
consecutive year. The unqualified opinion demonstrates that the IRS
accurately accounts for approximately $2.5 trillion in tax revenue
receipts, $277 billion in tax refunds, and $11 billion in IRS
appropriated funds.
The report recognizes the significant accomplishments the IRS made this
year in addressing outstanding audit issues while also implementing the
requirements of Appendix A of the Office of Management and Budget (OMB)
Circular A-123, Management's Responsibility for Internal Control. The
IRS met the new provisions of OMB A-123 and Treasury mandates, a
significant and highly visible challenge due to the complexity and need
to create an entirely new process. The IRS tested internal control sets
for 45 transaction processes and over 200 internal controls identified
by Treasury that are material to its consolidated financial statements.
We are dedicated to continuing to improve financial management at the
IRS, as evidenced by the following significant fiscal year (FY) 2006
achievements:
* Eliminated property and equipment reportable condition through
implementation of a first level procurement review, revision of
material group codes, and implementing a materiality threshold for
capital asset review:
* Reduced Matters for Further Consideration (MFCs) for the safeguarding
of taxpayer receipts by 60 percent from FY 2005:
* Reduced MFCs in administrative accounting by 40 percent from FY 2005:
* Accelerated the quarterly excise tax certifications to the Department
of the Treasury by two months and disclosed more detailed information
on Social Security tax and the three largest Excise Tax Trust Funds
revenues as supplemental information to the FY 2006 financial
statements and in the Management Discussion and Analysis:
* Improved cost allocation methodology and generated FY 2006 Statement
of Net Cost from the Integrated Financial System (IFS):
* Automated the obligation adjustment process in IFS:
* Implemented Release 1 of the Custodial Detail Data Base, creating a
subsidiary ledger for unpaid assessments that was used for audit
sampling, one year ahead of schedule:
Improving information security continues to be a priority for the IRS.
The IRS is improving protection of sensitive information by expanding
the use of encryption, increasing employee education and awareness, and
improving IRS information security policies and procedures to ensure
protection of taxpayer, employee, and IRS sensitive information. The
IRS established a Security Services and Privacy Executive Steering
Committee to coordinate information security improvements and to
leverage subject matter experts from the areas of information
technology security, physical security, and privacy and identity theft.
I want to recognize the Government Accountability Office's support
throughout the FY 2006 audit and assistance as the IRS implemented the
new requirements of OMB Circular A-123. While challenges remain, the
IRS has established its ability to consistently produce accurate and
reliable financial statements. We have a solid management team in place
to continue to improve financial management, and we continue to
increase the focus on information security and internal controls while
improving financial reporting.
Sincerely,
Signed by:
John M. Dalrymple:
[End of Section]
(196088):
FOOTNOTES
[1] A shared service provider is an organization that performs a
service, such as electronic data processing, for multiple customers
from a central location. A federal center for excellence is a federally
owned shared service provider that serves multiple federal
organizations.
[2] GAO, High-Risk Series: An Overview, GAO/HR-95-1 (Washington, D.C.:
February 1995).
[3] GAO, High-Risk Series: An Update, GAO-05-207 (Washington, D.C.:
January 2005).
[4] GAO-05-207.
[5] An S-corporation is a corporation with a limited number of
stockholders (100 or fewer) that elects not to be taxed as a regular
corporation and meets certain other requirements.
[6] The tax gap is an estimate of the amount of taxes for a given tax
year that are owed to the federal government but have not been paid by
taxpayers. IRS estimates the fiscal year 2006 tax gap to be about $345
billion.
[7] 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).
[8] IRS includes an estimate of the tax gap in its Management
Discussion and Analysis and in the other accompanying information to
the financial statements. This estimate is based on a study conducted
to measure the compliance rate of individual filers based on an
examination of a statistical sample of tax returns filed for tax year
2001.
[9] 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.
[10] GAO, Financial Audit: Examination of IRS'Fiscal Year 1992
Financial Statements, GAO/AIMD-93-2 (Washington, D.C.: June 30, 1993).
[11] 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.
[12] IRS's master files contain detailed records of taxpayer accounts.
[13] 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. See 26 U.S.C. § 6672 and implementing IRS guidance
in the Internal Revenue Manual at § 4.23.9.13, Trust Fund Recovery
Penalty (Mar. 1, 2003).
[14] The tax filing season for individuals primarily occurs from
January 1 through April 15 of each year.
[15] In addition to the 22 measures, data to estimate the Earned Income
Tax Credit measure will be available late in 2007 and five measures
were baselined in FY 2006.
[16] Department of the Treasury, Internal Revenue Service, Business
Systems Modernization Fiscal Year 2006 & 2007 Expenditure Plan (August
2006).
[17] 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.
[18] 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.
[19] Tax law requires IRS 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.
[20] Pub. L. No. 104-208, div. A, § 101(f), title VIII, 110 Stat. 3009,
3009-389 (Sept. 30, 1996).
[21] Pub. L. No. 103-62, § 4(b), 107 Stat. 285, 287 (Aug. 3, 1993)
(codified at 31 U.S.C. § 1115).
[22] GAO, Financial Audit: IRS's Fiscal Years 2005 and 2004 Financial
Statements, GAO-06-137 (Washington, D.C.: Nov. 10, 2005).
[23] GAO-06-137.
[24] Joint Financial Management Improvement Program, 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, the Department of the Treasury, the
Office of Personnel Management, and GAO, working in cooperation with
each other and with 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.
[25] 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.
[26] The Treasury Excise Tax Working Group consists of Treasury
agencies with trust fund responsibilities (IRS, Office of the Fiscal
Assistant Secretary, Bureau of the Public Debt, Financial Management
Service, and Office of Tax Analysis). The working group meets to
discuss and coordinate issues related to excise tax trust fund
distributions.
[27] 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
because of 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.
[28] 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.
[29] A "tax period" varies by tax type. For example, the tax period for
payroll and excise taxes is generally one quarter of a year. The
taxpayer is required to file quarterly returns with IRS for these types
of taxes, but payment of the taxes occurs throughout the quarter. In
contrast, for income, corporate, and unemployment taxes, a tax period
is 1 year.
[30] The balance of unpaid assessments from the affected taxpayers'
accounts totaled approximately $745 million. We were unable to
determine the exact amount by which the error overstated the account
balances but know that the amount is significantly less than the total.
Additionally, we were unable to determine whether any of the affected
taxpayers had already paid the excess penalties assessed.
[31] The statutory period for assessing new taxes is generally 3 years
from when a tax return is either filed or due, whichever is later.
I.R.C. Section 6501(a).
[32] GAO-06-137.
[33] 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. See 26 U.S.C. § 6672 and implementing IRS guidance
in the Internal Revenue Manual at § 4.23.9.13, Trust Fund Recovery
Penalty (Mar. 1, 2003).
[34] We are 95 percent confident that the error rate does not exceed
18.9 percent.
[35] IRS 1099 forms are used by third parties, such as financial
institutions, to report taxpayers' interest income, dividend
distributions, and other miscellaneous income.
[36] The tax filing season for individuals primarily occurs from
January 1 through April 15 of each year.
[37] 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).
[38] 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.
[39] A processing year is the calendar year in which tax returns and
related data are processed. During processing year 2006, IRS is
processing primarily 2005 tax returns.
[40] Treasury Inspector General for Tax Administration, The Electronic
Fraud Detection System Redesign Failure Resulted in Fraudulent Returns
and Refunds Not Being Identified, 2006-20-108 (Washington, D.C.: Aug.
9, 2006).
[41] 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.
Office of Management and Budget, Implementation Guidance for the
Improper Payments Implementation Act of 2002, P. L. 107-300, M-03-13
(Washington, D.C.: May 21, 2003).
[42] GAO, Financial Audit: IRS's Fiscal Year 2003 and 2002 Financial
Statements, GAO-04-126 (Washington, D.C.: Nov. 13, 2003).
[43] Tax year 2004 is the most recent year for which complete matching
program results are available.
[44] In December 2002, Congress enacted the Federal Information
Security Management Act of 2002 (FISMA), which requires agencies to
develop, document, and implement an information security program. FISMA
was enacted as title III of the E-Government Act of 2002, Pub. L. No.
107-347, 116 Stat. 2946 (Dec. 17, 2002). This requirement was enacted
in section 301(b)(1) of FISMA, which is now codified at 44 U.S.C. §
3544(b).
[45] IRS's receipt processing facilities include 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; commercial lockbox banks that operate under
contract with the Financial Management Service to provide tax receipt
processing and deposit services on behalf of IRS; and other business
operating divisions that provide taxpayer audit and assistance centers.
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.
[46] GAO, Internal Revenue Service: Status of Recommendations from
Financial Audits and Related Financial Management Reports, GAO-06-560
(Washington, D.C.: June 6, 2006); Management Report: Improvements
Needed in IRS's Internal Controls, GAO-06-543R (Washington, D.C.: May
12, 2006); and GAO-06-137.
[47] Transfer-related documents include courier, mail, and deposit logs
and forms 795 and 3210, which accompany taxpayer receipts and other
information shipped to other IRS locations.
[48] 26 U.S.C. §§ 6321, 6323.
[49] GAO-06-103.
[50] IRS is 97.5 percent confident that the percentage of cases in
which the lien was not released within 30 days does not exceed 41
percent.
[51] GAO, Opportunities to Improve Timeliness of IRS Lien Releases, GAO-
05-26R (Washington, D.C.: Jan. 10, 2005).
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