The Correspondence Audit Process

According to IRS, tax returns assigned to the service centers are to involve only one or two simple tax issues, such as EIC claims, that can be audited through correspondence. 1.1.) Objectives, Scope, and Methodology

In response to a request from the Chairman, Subcommittee on Oversight, House Committee on Ways and Means, this report (1) provides information on the number, results, and duration of correspondence audits as well as the characteristics of the audited returns and (2) examines the processes and requirements that IRS has had for years to govern correspondence audits. Number of Returns Audited and the Results of the Correspondence Audits

The number of correspondence audits and their results varied considerably between 1992 and 1997, with three distinct periods. This increased audit focus on EIC arose from congressional concerns about EIC noncompliance. For traditional correspondence audits closed in 1996, we found that the time between the filing of the return and the start of the audit averaged 10 months, and the time between the start of the audit and the assessment of any additional taxes took, on average, over 11 more months. In addition, the individual taxpayers subjected to traditional correspondence audits that closed in 1996 usually reported annual incomes of less than $15,000 on their audited returns. As for the reviews to measure audit quality, IRS requires each service center to review a sample of all its correspondence audits closed annually, regardless of how they closed, for adherence to IRS’ audit standards. In reviewing the correspondence audits closed in 1996, we found that an estimated 69 percent had not been classified. Further, service centers were allowed to exclude audits in which taxpayers did not respond and that lacked required documentation on the audit steps and support for recommended taxes from being measured against the audit standard on workpaper documentation. And when taxpayers did not respond, IRS had to assess the additional taxes under audit without knowing for sure if all these taxes were owed. Nevertheless, each weakness can, individually or in combination, erode the integrity of IRS’ correspondence audit processes, which are designed to help ensure that taxpayers pay the correct tax. Recommendations

GAO recommends that the IRS Commissioner improve controls to better ensure that IRS’ correspondence audit processes adhere to existing audit requirements and standards on classifying filed returns, and in particular, referring returns with complex schedules that may have potential tax changes to staff with sufficient knowledge to classify them; documenting the support for audit findings and recommendations in the ensuring consistency in the treatment of audited EIC claims by collecting and using the information required, including verification from third parties, to justify the claims; and including all types of closed audits across the 10 service centers in the samples for measuring audit quality.
Why GAO Did This Study

Pursuant to a congressional request, GAO reviewed the Internal Revenue Service's (IRS) program to audit income tax returns through correspondence, focusing on: (1) the number, results, and duration of correspondence audits as well as the characteristics of the audited returns; and (2) processes and requirements that IRS has had for years to govern correspondence audits.

What GAO Found

GAO noted that: (1) several weaknesses were found in IRS' correspondence audit processes; (2) these weaknesses, individually or in combination, can erode the integrity of the correspondence audit processes, which are designed to help ensure that taxpayers pay the correct tax amounts and are treated properly; (3) during fiscal years 1992-1997, the annual number and results of correspondence audits conducted by IRS varied considerably; (4) the number ranged annually from just over 200,000 to about 1.1 million audits; (5) the rate at which IRS auditors closed audits without recommending additional taxes ranged from 13 percent to 46 percent; (6) when they did recommend additional taxes, the average amounts ranged from $1,300 to $2,800; (7) the rate at which taxpayers did not respond to these recommended additional taxes after being requested to do so by IRS ranged from 29 percent to 63 percent; (8) these variations resulted, in part, from an increase in the number of correspondence audits of returns claiming an earned income credit (EIC); (9) for the traditional correspondence audits closed in fiscal year 1996, the time between the filing of a return and the start of the correspondence audit averaged 10 months; (10) it then took 11 more months before IRS assessed any taxes that were recommended during the audits; (11) as for the characteristics of these 1996 returns, an estimated 75 percent had reported adjusted gross incomes of less than $15,000; (12) in part, this percentage reflects the correspondence audit's focus on simple tax issues and EIC; (13) IRS had weaknesses in implementing the correspondence audit requirements for four processes; (14) not all of the traditional correspondence audits closed in 1996 were manually reviewed (or classified) to identify all issues for audit, as required by IRS; (15) support for recommended audit findings was not adequately documented in the audit workpaper files, as required, for about one-third of the audits; (16) the taxpayer documentation that was required to justify EIC claims varied from service center to service center; (17) GAO found weaknesses in the reviews that IRS did on a sample of closed audits to measure their quality; and (18) in addition to the weaknesses in implementing the requirements, IRS allowed service centers to exclude certain types of audits that did not have all required documentation from being measured against the audit standard on workpaper documentation.