Although these and other compliance checks  may identify potentially noncompliant tax returns that are subsequently  audited, these programs are not the subject of this report. SB/SE Uses a Multiphase Process and Many Methods to Identify and Review Returns for Potential Audit; Most Returns Are Not Selected

		SB/SE Uses a Multiphase Process to Select Tax Returns for Audit

SB/SE selects potentially noncompliant tax returns for audit using a  multiphase process intended to enable IRS to narrow the large pool of  available returns to those that most merit investment of audit resources. As shown in figure 2, in broad terms, this process generally includes (1)  identifying an initial inventory of tax returns that have audit potential (e.g.,  reporting noncompliance), (2) reviewing that audit potential to reduce the  number of returns that merit selection for audit (termed “classification”),  (3) selecting returns by assigning them to auditors based on a field  manager’s review of audit potential given available resources and needs,  and (4) auditing selected returns. Computer programs. Taxpayer-initiated. The latter generally focuses on a single compliance issue and  relies more on automated filters and rules to identify returns. Some workstreams, such  as taxpayer claims and some referrals, involve more manual processes to  identify and review returns; other workstreams involve both manual and  automated processes or are almost entirely automated. Finally, the  procedures for screening out returns vary across workstreams. In fiscal year 2014, DDb identified more than 77 percent of the  closed EITC audits. Segregation of duties. Safeguarding data/systems. Given  the different interpretations, not having a clear definition of fairness  unintentionally can lead to inconsistent treatment of taxpayers and create  doubts as to how fairly IRS administers the tax law. The procedures in IRM 1.4.2 govern  IRS’s processes for monitoring and improving internal controls, which  include the identification and mitigation of risks. SB/SE does not require  all of these decisions and rationales to be documented. Files not located. Having procedures to ensure that selection decisions and rationale are  clearly and consistently documented helps provide assurance that  management directives are consistently followed and return selection  decisions are made fairly. We also found that classification decisions are  not always required to be reviewed. SB/SE does not always  require that group manager return selection decisions (i.e., screen- out) be reviewed. Spreading responsibility for reviewing selection and screen-out decisions  can reduce the potential for error and unfairness. This complexity underscores the importance of having a robust  internal control system to support the selection process and achieve  SB/SE’s mission of administering the “tax law with integrity and fairness  to all.” SB/SE has some procedures in place that are consistent with  internal control standards. Further, IRS will not be able to  manage risk or monitor performance as well as it otherwise could. Recommendations for Executive Action

To help ensure SB/SE’s audit selection program meets its mission and  selects returns fairly, we recommend that the Commissioner of Internal  Revenue take the following actions:
Clearly define and document the key term “fairness” for return  selection activities. To help ensure that SB/SE’s audit selection objective(s) on fairness are  used and met, we recommend that the Commissioner of Internal  Revenue take the following actions:
Develop, document, and implement related performance measures  that would allow SB/SE to determine how well the selection of returns  for audit meets the new objective(s). IRS stated that it  agreed with our seven recommendations. We also recommended that IRS improve the documentation and  monitoring of selection decisions. Second, IRS’s letter stated that the seven groupings in our report  do not reflect how IRS views its workstreams for identifying  returns for potential audit selection. Appendix I: Objectives, Scope, and Methodology

This report (1) describes the processes for selecting Small Business/Self- Employed (SB/SE) returns for audit, and (2) assesses how well the  processes and controls for selecting those returns support SB/SE’s  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 SB/SE  returns for audit. We also  interviewed IRS officials responsible for overseeing audit selection. For the second objective, we reviewed SB/SE’s procedures for selecting  returns for audit and related internal controls intended to help SB/SE  achieve its stated mission of “enforcing the tax law with integrity and  fairness to all.” We then assessed whether these procedures followed  standards from Standards for Internal Control in the Federal Government  that were relevant to return selection. We also conducted eight focus groups with selected SB/SE staff who are  responsible for reviewing or selecting SB/SE returns for audit. 5. 6. 30.
Why GAO Did This Study

IRS audits small businesses and self-employed individuals to ensure compliance with tax laws. Audits can help improve reporting compliance and reduce the tax gap—the difference between taxes owed and those voluntarily paid on time, which is estimated at $385 billion annually after late payments and enforcement actions. Therefore, it is important that IRS makes informed decisions about how it selects taxpayers for audit.
GAO was asked to review IRS's processes and controls for selecting SB/SE taxpayers for audit. This report (1) describes these processes and (2) determines how well SB/SE's selection processes and controls support its mission to apply the tax law with integrity and fairness to all.
GAO reviewed IRS criteria, processes, and control procedures for selecting taxpayers for audit; assessed whether IRS control procedures followed Standards for Internal Control in the Federal Government ; and reviewed nonprobability samples of over 200 audit files. GAO also conducted eight focus groups with SB/SE staff who review or make audit selection decisions and interviewed IRS officials.

What GAO Found

The Small Business/Self-Employed (SB/SE) division of the Internal Revenue Service (IRS) uses over 30 methods, called workstreams, to identify and review tax returns that may merit an audit. These returns were initially identified through seven sources which include referrals; computer programs that run filters, rules, or algorithms to identify potentially noncompliant taxpayers; and related returns that are identified in the course of another audit.
SB/SE's workstreams follow a general, multiphase process for identifying, reviewing (classifying), and selecting returns for audit. Within this general approach, the selection process varies across workstreams. Differences include the number of review steps and manual processes, which are greater for field audits compared to correspondence audits which generally focus on a single compliance issue and are identified using automated processes. For fiscal year 2013, IRS reported that SB/SE's primary workstream for field audits identified about 1.6 million returns as potentially most noncompliant. About 77,500 returns (5 percent) were selected for audit, a much smaller pool of returns than was initially identified.
SB/SE has control procedures for safeguarding data and segregating duties across the overall selection process, among others, but it has not implemented other key internal controls. The lack of strong control procedures increases the risk that the audit program's mission of fair and equitable application of the tax laws will not be achieved. Examples of internal control deficiencies include the following:
Program objectives and key term of fairness are not clearly defined. Fairness is specified in SB/SE's mission statement and referenced in IRS's procedures for auditors. However, IRS has not defined fairness or program objectives for audit selection that would support its mission of treating taxpayers fairly. GAO heard different interpretations of fairness from focus group participants. Not having a clear definition of fairness can unintentionally lead to inconsistent treatment of taxpayers and create doubts as to how fairly IRS administers the tax law. Further, the lack of clearly articulated objectives undercuts the effectiveness of SB/SE's efforts to assess risks and measure performance toward achieving these objectives.
Procedures for documenting and monitoring selection decisions are not consistent. SB/SE does not always require selection decisions and rationales to be documented. For example, SB/SE requires that some workstreams document survey decisions (when returns are not assigned for audit), rationale, and approval using a form. Other workstreams, such as its primary workstream for field audits, require a group manager stamp but do not require the rationale to be documented. Also, SB/SE does not always require classification decisions (when returns are assessed for audit potential and compliance issues) to be reviewed. Having procedures to ensure that selection decisions and rationale are consistently documented and reviewed can reduce the potential for error and unfairness.

What GAO Recommends

GAO recommends that IRS take seven actions to help ensure that the audit selection program meets its mission, such as establishing and communicating program objectives related to audit selection and improving procedures for documenting and monitoring the selection process. In commenting on a draft of this report, IRS agreed with the recommendations.