	Background

LB&I is responsible for the tax compliance of partnerships and S and C  corporations with assets of $10 million or more, as well as individuals with  high wealth or international tax implications. In 2015, IRS reported that LB&I completed audits on more than 11  percent of large corporations—those with assets in excess of $10 million. The term “selection methods” refers to all of the programs that LB&I uses  to identify and review tax returns to include in the pool of possible audits,  as well as the decisions made to audit tax returns by auditors and audit  managers in LB&I field offices. LB&I uses a variety of methods to select  returns for audit. LB&I is in the process of changing the way it addresses compliance  including how it identifies tax returns for audit and is moving toward  implementing issue-based projects it calls “campaigns.” According to  LB&I, a campaign is a compliance project focused on a specific  compliance issue, such as partnerships underreporting income, rather  than on using characteristics of the whole tax return for audit  consideration. LB&I Documentation on Audit Selection Methods We Reviewed Generally Reflected Some, but Not All, Internal Control Principles

In reviewing LB&I’s methods for identifying and selecting tax returns for  audit, we determined that LB&I’s related documentation generally  reflected 4 of the 10 internal control principles we reviewed but was  incomplete for the remaining 6 principles. Documentation Generally Reflected Internal Control Principles on Ethics, Organizational Structure, Commitment to Competence, and Implementation of Control Activities for Selection Methods Reviewed

			Internal Control Principles that LB&I Documentation Generally Reflected in Audit Selection Methods Reviewed

LB&I has documented a commitment to promoting ethical behavior  among staff, which provides some high-level assurance that the way it  selects returns for audit may contribute to its strategic goal of treating  taxpayers with integrity and fairness. For example, classifiers who identify  whether a tax return should be considered for audit and which items on  the return merit audit attention are prohibited from auditing those returns  and from assigning them to specific auditors. All LB&I  staff were certified as successfully completing the training in 2015, the  latest available data. In terms of training, LB&I’s procedures and manuals generally  documented its training to help assure the competence of staff involved in  audit selection. LB&I Does Not Have a Standard Process for Monitoring Audit Selection Decisions

LB&I does not have a process to monitor the final decisions about which  tax returns will be audited. Lacking a standard monitoring process for audit selection decisions is not  consistent with internal control standards for monitoring. LB&I Efforts to Plan and Implement New Compliance Approach to Audits Remain Incomplete

LB&I plans to conduct issue-based projects it calls “campaigns” to  address taxpayer compliance. However, gaps in  documentation related to six of the principles leave LB&I without  reasonable assurance that its selection methods are being implemented  as designed and whether tax return selection supports the division’s audit  objectives Ensuring that policies and procedures of audit selection  methods are fully documented will continue to be important for LB&I as it  implements its new campaign approach for selecting audits. LB&I’s efforts to plan and implement its new compliance approach have  partially met five key principles for effectively planning projects. Without taking the steps to fully  meet all five planning principles in implementing its new approach, LB&I  management will lack reasonable assurance that its new compliance  approach will succeed in accomplishing LB&I’s overall audit objective of  encouraging voluntary compliance and fair treatment of taxpayers. To further ensure that the new campaigns under LB&I’s new approach for  addressing tax compliance are implemented successfully, we recommend  that the Commissioner take these actions:  create a timetable with specific dates for implementing its new  compliance approach; establish metrics to help determine whether the campaign effort  overall meets LB&I’s goals;  finalize and document plans to evaluate the human resources  expended on campaign activities; document lessons learned from stakeholder input and past monitor overall performance across future campaigns, not just  individual compliance projects, and in doing so ensure that the data  used for monitoring accounts for the costs beyond the auditor’s time  can clearly be linked with specific selection methods, including the  Discriminant Analysis System (DAS) method, to the extent that the  selection methods continue to operate; develop and document criteria to use in choosing selection methods  for campaigns using audits; and  set a timetable to analyze and mitigate risks and document specific  metrics for assessing mitigation of identified risks. Appendix I: Objectives Scope and Methodology

This report (1) assesses the extent to which the Large Business and  International (LB&I) division’s documented procedures and policies on  audit selection methods generally reflect relevant internal control  principles; (2) assesses the extent to which LB&I has a standard process  to monitor audit selection decisions; (3) describes statistical information  on audit starts and closures for LB&I’s selection methods, including  LB&I’s use of audit referrals, and assesses how the Internal Revenue  Service (IRS) evaluates its audit results from its selection methods; and  (4) assesses to what extent LB&I has planned and implemented its new  approach to address compliance. The internal  control principles we used for our evaluation are noted below. Principle 7: Identify, analyze, and respond to risks to achieving the  objectives. Principle 17: Evaluate issues and remediate deficiencies. IRS agreed with  these principles during April 2016. Given the status of LB&I’s  plans, we did not assess LB&I’s decision to create the approach. LB&I said that it has developed a training strategy  for this campaign.
Why GAO Did This Study

LB&I audits large partnerships and corporations with $10 million or more in assets and high wealth individuals. These entities pose compliance challenges. For example, IRS reported that the gross underreported income tax of large corporations alone averaged an estimated $28 billion annually between 2008 and 2010, the most recent data. It is important for LB&I to have adequate controls for its audit procedures and to properly plan and implement its new approach to address noncompliance.
GAO was asked to evaluate how IRS selects returns and is implementing its new compliance approach. Among other objectives, this report (1) assesses the extent that LB&I's documented procedures and policies for its audit selection methods generally reflected relevant internal control principles, (2) assesses the extent that LB&I has a standard process to monitor audit selection decisions, and (3) assesses the extent that LB&I has planned and implemented its new approach to address compliance.
GAO reviewed LB&I procedures and policies for eight selection methods that involved the use of discretion and its plans for implementing a new compliance approach. Given the status of LB&I's plans for and implementation of its new approach, GAO did not assess LB&I's decision to create the approach. GAO held focus groups with LB&I staff responsible for selecting audits, and interviewed IRS official

What GAO Found

The Internal Revenue Service's (IRS) Large Business and International division (LB&I) uses a variety of methods, such as computer models and staff reviews of returns, to identify tax returns for audit consideration. From the returns identified, managers and auditors in LB&I field offices select the returns to be audited. For the eight methods LB&I uses for identifying and selecting tax returns for audit (selection methods) that GAO analyzed, LB&I documentation on its procedures and policies generally reflected 4 of the 10 internal control principles GAO reviewed. For example:
Related to the internal control principle of demonstrating commitment to integrity and ethical values, LB&I auditors who identify tax returns for audit consideration are prohibited from auditing those returns themselves or assigning them to specific individuals for audit. In addition, all LB&I staff completed a required training on ethics and impartiality in 2015, the latest available data.
Related to the internal control principle of demonstrating a commitment to competence, LB&I's procedures and manuals generally documented its training to help assure the competence of staff involved in audit selection. This training included courses on basic skills as well as instruction on more specific topics.
However, for the other 6 internal control principles GAO reviewed, there were gaps in documentation that limit LB&I's assurance that its selection methods are being implemented as designed and are supporting its objectives. For example:
Related to the internal control principle of identifying, analyzing, and responding to risk, LB&I documentation did not specify procedures or a process for how to respond to changing circumstances, such as a change in the law, in selecting returns for audit.
Related to the internal control principle of reporting on issues and remediating related deficiencies, LB&I documentation indicated that problems identified with selection methods were discussed in meetings, but not that corrective action was taken to address them.
GAO also found that LB&I has monitoring directives, but it does not have a standard process for monitoring field staff's audit selection decisions. Without such a process, LB&I lacks reasonable assurance that decisions are made consistently.
LB&I is in the process of implementing a new approach for addressing taxpayer compliance, including how it identifies tax returns for audit. LB&I plans to implement what officials call “campaigns,” which are projects focused on a specific compliance-related issue, such as partnerships underreporting certain income, rather than projects focused on the characteristics of whole tax returns. According to LB&I officials, campaigns could include conducting audits as well as other efforts, such as reaching out to taxpayers and tax professionals, issuing guidance, and participating in industry events. LB&I officials said certain audit selection methods that existed prior to the development of campaigns will operate while LB&I implements its campaign approach, and campaigns may subsume some of those methods.
GAO found that LB&I made some progress in implementing its new compliance approach, such as by involving stakeholders in plans and implementing the process for submitting proposals for campaigns. However, LB&I has not fully met five project planning principles set forth in prior GAO work (see table below). Until it fully meets these principles, LB&I management lacks reasonable assurance that its new compliance approach will succeed in accomplishing its overall objectives of encouraging voluntary compliance and fair treatment of taxpayers.

What GAO Recommends

GAO recommends that IRS address documentation gaps in its selection method procedures and policies related to six internal control principles, develop a standard process to monitor field staff's audit selection decisions, and take seven actions to fully address planning principles in its efforts to implement its new compliance approach. In commenting a draft of this report, IRS agreed with all of the recommendations.