If the information in the application meets the requirements for tax  exempt status, IRS will issue a determination letter approving tax exempt  status. EO uses a variety of sources to identify exempt organizations for possible  examination, and conducts review steps that filter out some  organizations. Referrals Identify Particular Organizations that May Be Noncompliant

Referrals are complaints of exempt organization noncompliance made by  third parties, including the public and other parts of EO and IRS. Examiners and Managers Make the Final Decision on Whether to Conduct an Examination

Dismissals. EO receives referrals from  many sources. Design and Implementation of Some Controls Was Adequate; Other Controls Should Be Strengthened to Reduce the Risk of Unfair Examination Selection

We found that the design of certain examination selection controls aligned  with the IRM or with standards for effective internal control (see sidebar  and figure 4). These control deficiencies increase the risk that  EO could fall short of TE/GE’s mission and select organizations for  examination in an unfair manner—for example, based on an  organization’s religious, educational, political, or other views. Design of Internal Controls. In alignment with IRM requirements, EO maintains well-documented  procedures for several examination selection processes. In focus groups, we found that staff who use these (and other IRM  sections) to conduct their work generally view them as valuable tools that  help them administer the tax law (see text box). If it’s a 501(c)(4), if one organization is allowed to do  something, then they all are—they are treated fairly and equally.”

		Other Controls Needed Improvement or Standards Were Not Followed

We found that while EO had established various procedures over its  examination selection processes, there were several areas where EO’s  controls were not well designed or implemented (see table 6). EO’s primary sources of guidance for compliance checks, compliance  reviews, and EOCA classification are not included in the IRM, as required  by the IRM. Reliance on procedures that are outside of the IRM creates  the risk that EO staff could deviate from procedures without executive  management approval, which could result in unfair selection of  organizations’ returns for examination. Also, an estimated 22  percent of examination returns that were dismissed in fiscal year 2014 did  not have the required management signature. As such, the current level of ongoing  monitoring of examination and database files to ensure that selection  decisions are documented and approved, to help ensure fairness, is  inadequate. Recommendations

To better ensure the Exempt Organization (EO) unit’s adherence to the  Tax Exempt and Government Entities (TE/GE) division’s mission of  “applying the tax law with integrity and fairness to all” in selecting exempt  organizations to review or examine, we recommend that the  Commissioner of Internal Revenue direct EO to take the following nine  actions:  1. Develop, document, and implement additional monitoring  procedures in order to ensure case selection controls, including  ensuring that procedures for obtaining required signatures and  documenting explanations for selection decisions, are being  followed. Appendix I: Objectives, Scope, and Methodology

This report (1) describes the processes for selecting tax-exempt  organizations for examination, and (2) assesses the adequacy of the  controls (including procedures) for selecting examination cases that the  Exempt Organizations (EO) unit uses to achieve the Tax Exempt and  Government Entities (TE/GE) division’s stated mission of “applying the  tax law with integrity and fairness to all.”
For the first objective, we reviewed Internal Revenue Service (IRS)  documents that describe the processes and criteria for selecting exempt  organization returns for examination. We asked questions on internal control related topics,  such as the clarity of EO procedures and the adequacy of training to  apply these procedures. We also selected  random probability samples of the database files to review required text,  such as justifications for selecting or not selecting a return for    Within the  examination or review. Finally, we selected random probability samples of  dismissed examination files, and closed examination files from processes  described earlier in this report.samples we reviewed. Appendix II: Effectiveness of Procedural Control Implementation for Selection Decisions and Approvals

The Exempt Organizations (EO) unit has procedures in place to  document multiple types of examination selection decisions and  approvals.
Why GAO Did This Study

IRS examines tax-exempt organizations to enforce their compliance with the tax code. Examinations can result in assessment of taxes or revocation of tax-exempt status, among other things.
GAO was asked to review IRS's criteria and processes for selecting exempt organizations for examination. This report (1) describes these processes and (2) assesses the adequacy of examination selection controls.
GAO reviewed IRS criteria, processes, and controls for selecting organizations for examination and spoke with IRS officials; assessed whether IRS controls followed Standards for Internal Control in the Federal Government ; reviewed random probability samples from two populations of examination files; and conducted tests on populations and random probability samples from three databases used in EO examination selection to determine the adequacy of EO's control implementation (for files closed in fiscal year 2014). GAO also conducted eight focus groups on internal controls topics with EO staff who conduct research or make examination selection decisions.

What GAO Found

The Exempt Organizations (EO) unit within the Tax Exempt and Government Entities (TE/GE) division at the Internal Revenue Service (IRS) reviews organizations' applications for tax-exempt status to determine whether to grant status and oversees existing exempt organizations' compliance with the tax code. To identify exempt organizations for possible examination, EO uses a variety of information sources: for example, EO receives referrals of exempt organization noncompliance from third parties, such as the public, and other parts of IRS.
EO uses various controls intended to help it select exempt organizations for examination, in an effort to adhere to TE/GE's mission of “applying the tax law with integrity and fairness to all.” For example, EO maintains well-documented procedures for several examination selection processes in the Internal Revenue Manual (IRM), IRS's primary, official source of instructions to staff; staff can deviate from procedures that are included in the IRM only with executive management approval. In focus groups, EO staff generally told GAO that these procedures were valuable tools to help them administer the tax law.
However, there are several areas where EO's controls were not well designed or implemented. The control deficiencies GAO found increase the risk that EO could select organizations for examination in an unfair manner—for example, based on an organization's religious, educational, political, or other views. Examples of internal control deficiencies GAO found include the following:
Staff could deviate from procedures for some selection processes without executive management approval. GAO found that procedures for some processes—such as applying selection criteria to organizations under consideration for review—are not included in the IRM, as required by IRS policy. As a result, staff are not required to obtain executive management approval to deviate from these procedures. This increases the risk of unfair selection of organizations' returns for examination.
EO management does not consistently monitor selection decisions. GAO found that IRS does not consistently monitor examinations and database files to ensure that selection decisions are documented and approved, to help ensure fairness. GAO's review of examination files found that approval of some selection decisions was not documented, as required by EO procedures. For example, GAO's analysis of a sample of files suggests that an estimated 12 to 34 percent of cases where staff initially selected an organization for examination, but ultimately decided not to perform the examination, were missing the indication of management approval of the final decision, as required in the IRM. Continuous monitoring is an element of internal control; EO management has not been conducting sufficient monitoring to ensure that required approvals were taking place.

What GAO Recommends

GAO is recommending that IRS take 10 actions to improve selection control design and implementation, such as ensuring that all selection procedures are included in the IRM and thus subject to executive management approval, and developing additional examination selection monitoring procedures. IRS generally agreed with the recommendations.