Audit programs in W&I cover mainly refundable credits on the  Form 1040 U.S. Individual Income Tax Return. Three Offices Have Responsibility for Audit Selection, but Automated Programs Select the Majority of Returns That W&I Audits

		Three W&I Offices Largely Determine What Returns Get Selected for Audit

W&I’s audit programs are managed out of an office called Return Integrity  and Compliance Services (RICS), which operates three other offices that  directly or indirectly review tax return data for potential audits. Automated System Led to the Most W&I Audit Selections

In fiscal year 2014, DDb selected 59 percent of W&I’s audit inventory, as  shown in figure 2. Audits that end  with no change to the reported tax assessment on the return impose  burdens on compliant taxpayers. We found several IRS procedures that demonstrated some factors of a  positive environment for promoting internal controls. W&I has not clearly defined, documented, or communicated key terms. Existing  performance measures focus on audit results rather than audit selection. For example, one workload selection template notes that returns with the  highest audit potential are marked, but it does not describe how audit  potential is determined. Additionally, the  absence of a fully documented selection process may make it difficult for  W&I to defend against accusations that it is not appropriately following its  processes and procedures, since the incomplete documentation makes it  difficult to clearly communicate about how audit selection works. However, the documentation indicates that it is an annual—rather than  continuous—review as part of W&I’s annual 3-day working session that  included evaluating the effectiveness of its criteria for selecting returns for  possible audit. Second, W&I does not have  complete documentation its audit selection procedures; doing so would  improve the assurance that W&I staff have a common understanding of  how the selection process work and their role in the process. Lastly, W&I did not provide  support that changes to audit selection processes and procedures were  appropriately monitored and implemented in a timely manner. Taking  such actions to address these areas would help provide W&I reasonable  assurance that its audit selection criteria are fair. Recommendations for Executive Action

To help ensure W&I meets its mission and selects audits fairly and with  integrity, we recommend that the Commissioner of Internal Revenue take  the following seven actions:
Clearly define and document: (1) key terms such as “fairness”; and (2)
W&I program level objectives, performance measures, and indicators  for audit selection to evaluate whether the audit selection process is  meeting its mission of applying the tax law with integrity and fairness  to all. For our recommendation on having additional procedures for monitoring  audit selection controls and corrective actions, IRS stated that it will  review the processes in place for documentation and timely  implementation of selection controls and corrective actions to further  ensure the controls and actions are implemented in a timely manner. Appendix I: Objectives, Scope, and Methodology

This report (1) describes the Wage and Investment (W&I) process for  selecting tax returns for audit; and (2) determines how well W&I’s  procedures for selecting tax returns for audit support its mission and goal  to apply the tax law with integrity and fairness to all. To determine how well W&I’s procedures for selecting tax returns for  audit support its mission, we reviewed W&I’s audit selection procedures  and related internal controls intended to help W&I achieve its stated  mission of “applying the tax law with integrity and fairness to all.” We  then assessed whether these relevant W&I procedures followed selected  internal control standards from Standards for Internal Control in the  Federal Government. To determine IRS’s definition of fairness and integrity as it applied to  W&I’s audit selection, we reviewed W&I’s mission statement and other  documentation related to how W&I selects audits for examination and  interviewed relevant IRS officials concerning their understanding of how  integrity and fairness applies to W&I audit selection activities.
Why GAO Did This Study

Audit activities help ensure taxpayers pay the right amount of tax and help address the net $385 billion tax gap—the difference between the amount of taxes paid voluntarily and on time, and the amount owed. Audit programs in W&I mainly cover refundable credits reported on the Form 1040, Individual Income Tax Return. The hundreds of thousands of taxpayers whom W&I interacts with annually during audits make it critical to apply the tax law fairly. Unfair selection would increase burden on taxpayers and reduce public confidence in IRS.
GAO was asked to review W&I's audit selection process. This report (1) describes the W&I process for selecting tax returns for audit, and (2) determines how well W&I's audit selection procedures support its mission and goal to apply the tax law with integrity and fairness to all. GAO reviewed documentation on program procedures, an audit work plan, and various Internal Revenue Manual sections; analyzed audit data from fiscal years 2013 and 2014; and interviewed relevant IRS officials.

What GAO Found

Three offices in the Internal Revenue Service's (IRS) Wage and Investment division (W&I) are responsible for selecting returns for audit. Most returns are selected via computer systems that automatically send notices to taxpayers based on certain criteria, such as the validity of dependents. W&I program officials annually review the criteria and apply updates to the following filing season's returns. In 2014, about 59 percent of all W&I audits—more than 516,000—were selected with a specialized computer tool called the Dependent Database, while the remainder was selected through a combination of referrals and manual selection methods.
W&I generally has established a positive environment for internal controls but could improve several areas in its audit selection procedures to support its mission. GAO found several procedures that establish a positive environment for promoting internal controls, such as ethics training. In addition, IRS has guidance to help ensure that decisions about updates to audit selection criteria are correctly implemented in its automated systems. However, W&I does not have established objectives for its audit selection process, and existing performance measures focus on audit results rather than audit selection. In addition, W&I has not defined key terms such as “fairness and integrity,” as required by internal control standards. Documented objectives and key terms would help W&I hone the measures it uses to assess its audit selection efforts and bring a consistent understanding of “fairness and integrity” to audit selection staff.
GAO also found that not all elements of the selection process were appropriately documented. For example, W&I does not have clear documentation about how the three offices that select the majority of returns W&I audits interact with one another. Additionally, one guidance document notes that returns with the highest audit potential should be marked, but it does not describe how audit potential is determined or any related internal controls. Further, W&I also did not provide support showing that changes to automated audit selection processes and procedures were appropriately implemented in a timely manner. Moreover, the documentation indicates that W&I conducts an annual—rather than continuous—review of its audit selections and results as part of an annual 3-day working session. Strengthening controls in these areas would help provide greater assurance that W&I is fulfilling its mission to select tax returns with fairness and integrity. Additionally, the absence of a fully documented selection process may make it difficult for W&I to defend against accusations that it is not appropriately following its processes and procedures.

What GAO Recommends

GAO recommends, among other things, that IRS establish program objectives and definitions of key terms such as “fairness” that apply to audit selection and use those definitions in assessing its selection performance; document selection processes more thoroughly; and document that changes to procedures are done in a timely manner. IRS generally agreed with all seven recommendations and provided additional comments reprinted in appendix II.