oversight

Tax Administration: IRS Is Implementing the National Research Program as Planned

Published by the Government Accountability Office on 2003-06-16.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

             United States General Accounting Office

GAO          Report to the Committee on Finance,
             U.S. Senate



June 2003
             TAX
             ADMINISTRATION

             IRS Is Implementing
             the National Research
             Program as Planned




GAO-03-614
                                                June 2003


                                                TAX ADMINISTRATION

                                                IRS Is Implementing the National
Highlights of GAO-03-614, a report to the
Committee on Finance, U.S. Senate
                                                Research Program as Planned




The Internal Revenue Service (IRS)              IRS’s NRP is being implemented as planned and consequently is on track to
needs up-to-date information on                 meet the agency’s objectives of obtaining quality research results while
voluntary compliance in order to                minimizing the burden on the approximately 47,000 taxpayers with returns in
assess and improve its programs.                the NRP sample. IRS officials have completed the development and testing
IRS’s last detailed study of                    of NRP processes and have selected and trained staff members to carry out
voluntary compliance was done in
the late 1980s, so the compliance               the program. Additionally, as the graphic illustrates, IRS is currently nearing
information IRS is using today is               the completion of casebuilding and has made progress in classifying NRP
not current. IRS is now carrying                returns. Audits, when required, began in November 2002. As of the end of
out the National Research Program               March 2003, IRS had closed 3,651 NRP cases. In accordance with IRS’s plans
(NRP), through which IRS auditors               to minimize burden on taxpayers with returns in the NRP sample, some
are reviewing about 47,000                      cases have been closed without any taxpayer contact or with only limited
randomly selected tax year 2001                 audits. The NRP plan recognized that the initial estimates for the overall
individual tax returns. In June                 NRP sample size and the number of returns to be audited were uncertain
2002, GAO reported that NRP was                 because they were based on aging data. The overall NRP sample size will be
necessary, that its design was                  smaller and IRS officials expect to conduct more face-to-face audits than
sound, and that it appeared to meet             initially estimated.
IRS’s goals of acquiring useful
compliance data while minimizing
burden on taxpayers with returns                As IRS completes NRP casebuilding, classification, and audits, it is
in the sample.                                  implementing quality assurance steps, including efforts to ensure that key
                                                audit steps are completed on all NRP audits before they are formally closed
GAO was asked to review IRS’s                   with taxpayers. This is important since the data collected from each NRP
implementation of NRP. GAO                      audit represent information from thousands of similar taxpayers.
reviewed IRS’s method of gathering
internal and third-party data
(casebuilding) and IRS’s process of
reviewing casebuilding materials to
determine if audits are necessary
                                                NRP Work Completed and Work Remaining as of the End of March 2003
(classification) and assessed IRS’s
plans to ensure consistent data
collection while minimizing burden
on taxpayers.



GAO is not making
recommendations in this report
because IRS is following through
with its sound research plans in the
ongoing implementation of NRP.
Furthermore, when GAO identified
quality assurance steps that IRS
could add to NRP during the course
of this review, IRS agreed with the
suggestions and included the steps.
www.gao.gov/cgi-bin/getrpt?GAO-03-614.

To view the full product, including the scope
and methodology, click on the link above.
For more information, contact James White at
(202) 512-5594 or WhiteJ@GAO.gov.
Contents


Letter                                                                                                  1
             Results in Brief                                                                           2
             Background                                                                                 3
             Scope and Methodology                                                                      6
             IRS Completed NRP Process Testing                                                          7
             NRP Staff Selection and Training Is Complete                                               8
             NRP Reviews Are Under Way                                                                 10
             IRS Has Implemented NRP Quality Assurance Measures                                        12
             IRS Is Taking Steps to Minimize and Assess Taxpayer Burden                                17
             Conclusions                                                                               22
             Agency Comments                                                                           22

Appendix I   Comments from the Internal Revenue Service                                                24



Figures
             Figure 1: NRP Process for Measuring Voluntary Reporting
                      Compliance                                                                        4
             Figure 2: NRP Work Completed and Work Remaining as of the End
                      of March 2003                                                                    11
             Figure 3: NRP Implementation Progress                                                     12
             Figure 4: Estimated NRP Sample by Level of Taxpayer Contact                               20




             Abbreviations

             EQMS          Examination Quality Measurement System
             IRS           Internal Revenue Service
             NRP           National Research Program




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             Page i                            GAO-03-614 National Research Program Implementation
United States General Accounting Office
Washington, DC 20548




                                   June 16, 2003

                                   The Honorable Charles E. Grassley
                                   Chairman
                                   The Honorable Max Baucus
                                   Ranking Minority Member
                                   Committee on Finance
                                   United States Senate

                                   Understanding taxpayers’ compliance with the nation’s tax laws is critical
                                   to the ability of the Internal Revenue Service (IRS) to improve the
                                   effectiveness of its programs to enforce and promote voluntary
                                   compliance. While IRS strives to target enforcement audits to taxpayers
                                   who are not complying with tax laws, this has become increasingly
                                   difficult for IRS to do because the information it uses to identify likely
                                   noncompliant tax returns is out of date. This means that a large and
                                   growing number of IRS enforcement audits are directed at compliant
                                   taxpayers. IRS needs more current data on compliance to be able to
                                   appropriately target audits to problem returns. IRS last studied voluntary
                                   compliance with random audits of tax year 1988 tax returns. These studies
                                   included intensive, line-by-line audits and imposed a significant burden on
                                   taxpayers with returns in the sample.

                                   IRS is now carrying out a detailed study of taxpayer compliance—the
                                   National Research Program (NRP). IRS has identified a random sample of
                                   47,000 tax year 2001 returns and has begun NRP data gathering, including
                                   limited audits where necessary to verify information reported by
                                   taxpayers.

                                   NRP is intended to produce useful compliance data while minimizing the
                                   burden on the taxpayers selected for the study. IRS designed NRP to
                                   minimize taxpayer burden by gathering IRS and third-party information—a
                                   process called casebuilding—in order to limit taxpayer information
                                   requests to items that cannot be verified without such a request. Specially
                                   trained IRS agents then review the approximately 47,000 returns in the
                                   NRP sample and their supporting casebuilding files and identify lines on
                                   the returns that cannot be verified without auditing the taxpayers—a
                                   process called classification. With this approach, some taxpayers will not
                                   be contacted at all and most others will be asked to verify only some of the
                                   line items on their returns.



                                   Page 1                      GAO-03-614 National Research Program Implementation
                   In June 2002, we reported to you our assessment of IRS’s NRP plans.1 At
                   that time we determined that NRP was necessary and that its design
                   addressed both the need for up-to-date information on taxpayer
                   compliance and IRS’s goal of minimizing the burden NRP imposed on
                   taxpayers. We also reported that IRS had important casebuilding and
                   classification procedures testing to complete, as well as selection and
                   training of IRS personnel to carry out the program. You then asked us to
                   assess whether IRS is implementing NRP as planned. Accordingly, this
                   report describes and assesses (1) IRS’s completion of NRP development
                   and testing, (2) staff selection and training, (3) implementation progress of
                   the program, (4) quality assurance steps IRS is taking to ensure consistent
                   and accurate data collection, and (5) steps the agency is taking to
                   minimize burden on taxpayers with returns in the NRP sample.

                   To monitor IRS’s final development and implementation of NRP, we
                   reviewed agency documents concerning NRP design, testing, and
                   implementation. We also directly observed sessions of most aspects of
                   NRP training and two key tests of NRP procedures. We held frequent
                   discussions with the IRS personnel implementing the program and
                   conducted field office visits to several of the locations where NRP
                   classification is taking place. During our field visits, we met with managers
                   and classifiers and discussed their understanding of the program and any
                   implementation issues that came up. Our assessment of NRP
                   implementation is based on IRS’s NRP plans as described in our June 2002
                   report.


                   IRS is implementing key aspects of NRP according to the plans the agency
Results in Brief   laid out in 2002 and the program is now fully under way. IRS has
                   completed NRP process testing and development and has identified and
                   trained over 3,000 enforcement auditors to be NRP classifiers and
                   auditors. IRS has started carrying out NRP reviews. As of the end of March
                   2003, IRS had selected a sample of about 47,000 tax year 2001 returns,
                   completed casebuilding files for over 90 percent of them, and classified
                   over 70 percent of these returns. IRS had completed all NRP work on 3,651
                   NRP cases.




                   1
                    U.S. General Accounting Office, Tax Administration: New Compliance Research Effort
                   Is on Track, but Important Work Remains, GAO-02-769 (Washington, D.C.: June 27, 2002).




                   Page 2                          GAO-03-614 National Research Program Implementation
             As described in its plans, IRS has incorporated important quality
             assurance measures into NRP. IRS has made data consistency checks,
             regular communication with staff members carrying out NRP, and
             classification and audit reviews part of NRP. IRS has also adopted
             suggestions we made in the course of this study that it add additional
             quality checks to NRP in the form of classification site visits and
             centralized evaluation of classification review results.

             Also, as IRS planned, NRP casebuilding and classification processes are
             helping minimize burden on taxpayers with returns in the NRP sample by
             limiting most audits to line items that cannot be verified without directly
             contacting taxpayers. Additionally, while the NRP sample size is now
             smaller than originally projected, the number of face-to-face NRP audits
             that IRS officials expect to take place is now larger than originally
             estimated. The original NRP sample size estimates were based on now
             obsolete 1988 compliance study data, the only data available. The number
             of expected face-to-face audits, now projected to be about 39,000, is larger
             than originally estimated because the estimates were also based on the
             obsolete 1988 data and because IRS modified its classification guidelines
             to better match the training and skill level of the auditors selected to
             conduct NRP correspondence and face-to-face audits with the issues to be
             covered by those audits.

             In commenting on a draft of this report, the Commissioner of Internal
             Revenue concurred with our findings and conclusions about IRS’s
             implementation of NRP. He noted that as NRP continues, IRS will
             continue to emphasize delivering quality results and minimizing taxpayer
             burden. The commissioner’s letter is reprinted in appendix I.


             IRS designed NRP to obtain new information about taxpayers’ compliance
Background   with the tax laws. While IRS is using NRP to measure voluntary filing,
             reporting, and payment compliance, the majority of NRP efforts are
             devoted to obtaining accurate voluntary reporting compliance data. In
             measuring reporting compliance, IRS’s two primary goals are to obtain
             accurate information but minimize the burden on the approximately
             47,000 taxpayers with returns in the NRP sample. IRS plans to use NRP
             data to update return selection formulas, allow IRS to design prefiling
             programs that will help taxpayers comply with the tax law, and permit IRS




             Page 3                      GAO-03-614 National Research Program Implementation
                                       to focus its limited resources on the most significant areas of
                                       noncompliance.2

                                       NRP’s reporting compliance study consists of three major processes:
                                       (1) casebuilding—creating information files on returns selected for the
                                       NRP sample, (2) classification—using that information to classify the
                                       returns according to what, if any, items on the returns cannot be verified
                                       without additional information from the taxpayers, and (3) taxpayer audits
                                       limited to those items that cannot be independently verified. We reported
                                       in June 2002 that NRP’s design, if implemented as planned, is likely to
                                       yield the sort of detailed information that IRS needs to measure overall
                                       compliance, develop formulas to select likely noncompliant returns for
                                       audit, and identify compliance problems for the agency to address. Figure
                                       1 shows NRP’s main elements.

Figure 1: NRP Process for Measuring Voluntary Reporting Compliance




                                       2
                                         IRS uses compliance research to determine the characteristics of tax returns that are
                                       likely to be noncompliant. Screening tax returns for those characteristics is an early step in
                                       selecting returns for enforcement audits.




                                       Page 4                             GAO-03-614 National Research Program Implementation
IRS designed the casebuilding process to bring together available data to
allow the agency to establish the accuracy of information reported by
taxpayers on their returns. For each taxpayer with a return in the NRP
sample, IRS is compiling internal information, such as past years’ returns
and information reported to IRS by third parties, such as employers and
banks, and information from outside databases, such as property listings,
address listings, and stock sale price data.

Classification is where IRS uses the casebuilding information to determine
whether an NRP audit is necessary and which items need to be verified
through an audit. Classifiers place NRP returns into one of four categories:
(1) accepted as filed, (2) accepted with adjustments, (3) correspondence
audit, and (4) face-to-face audit. If the casebuilding material allows IRS to
verify all of the information that a taxpayer reported on his or her tax
return, then the taxpayer will not be contacted and the return will be
classified as accepted as filed. On returns where minor adjustments are
necessary, the adjustments will be recorded for research purposes, but the
taxpayers will not be contacted. These returns will be classified as
accepted with adjustments. NRP returns that have one or two items from a
specified list requiring examination will be classified for correspondence
audits. All other NRP returns for which the casebuilding material does not
enable IRS to independently verify the information reported on the returns
will be classified for face-to-face audits.

NRP audits will take place either through correspondence with the
taxpayers or through face-to-face audits. When classifiers determine that
an NRP return will be sent for a correspondence audit, IRS will request
that the taxpayer send documentation verifying the line items in question.
To ensure accurate and consistent data collection, NRP audits will address
all issues identified by classifiers and will not be focused only on
substantial issues or cases for which there is a reasonable likelihood of
collecting unpaid taxes, according to IRS officials. NRP auditors also may
expand the scope of the audits to cover items that were not classified
initially.

IRS plans to conduct detailed, line-by-line audits on 1,683 of the
approximately 47,000 returns in the NRP sample in order to assess the
accuracy of NRP classification and, if necessary, to adjust NRP results—a
process called calibration. One-third of the returns in the calibration
sample will be returns that were classified accepted as filed (either with or
without adjustments), one-third from those classified for correspondence
audits, and one-third from those classified for face-to-face audits. None of



Page 5                      GAO-03-614 National Research Program Implementation
              the taxpayers with returns in the calibration sample will have been audited
              or otherwise contacted by IRS prior to the start of these line-by-line audits.


              To describe IRS’s implementation of NRP, we have conducted frequent
Scope and     meetings with officials in IRS’s NRP Office and other IRS officials as they
Methodology   have implemented the program. We reviewed NRP training materials and
              observed NRP classifier, correspondence examination, and field
              examination training sessions. We also observed NRP process tests and
              conducted site visits to IRS area offices in Baltimore, Maryland; Brooklyn,
              New York; Oakland, California; Philadelphia, Pennsylvania; and St. Paul,
              Minnesota, in order to observe and review NRP classification in field
              offices.

              We considered whether NRP is being implemented in accordance with its
              design. In our report issued on June 27, 2002, we found that NRP’s design,
              if implemented as planned, is likely to provide IRS with the type of
              information it needs to ensure overall compliance, update workload
              selection formulas, and discover other compliance problems that the
              agency needs to address. For this review, we also considered whether IRS
              was maintaining a focus on meeting NRP’s objectives of obtaining quality
              research results while, at the same time, minimizing taxpayer burden. This
              assessment was also based on IRS’s NRP implementation plans.

              As of the completion of our work, IRS had a significant amount of NRP
              implementation to carry out. Our evaluation of IRS’s efforts to implement
              NRP, therefore, only provides an assessment of efforts that have taken
              place through the time of our work. Additionally, we did not attempt to
              assess IRS’s efforts to measure filing compliance and payment compliance
              through NRP. Our evaluation focuses only on IRS’s efforts to obtain
              voluntary reporting compliance information.3 A more detailed description
              of NRP can also be found in our 2002 report.




              3
               There are three types of voluntary compliance measures: filing compliance, which
              measures the percentage of taxpayers who file returns in a timely manner; payment
              compliance, which measures the percentage of tax payments that are paid in a timely
              manner; and reporting compliance, which measures the percentage of actual tax liability
              that is reported accurately on returns. Although IRS’s NRP plans include reviews of all
              three types of compliance, the majority of its efforts have been devoted to development of
              reporting compliance measurement procedures. Reporting compliance is also the only
              aspect of NRP that will include audits of taxpayers.




              Page 6                            GAO-03-614 National Research Program Implementation
                    We conducted our work from September 2002 through April 2003 in
                    accordance with generally accepted government auditing standards.


                    In addition to the two tests described in our prior report on NRP, IRS
IRS Completed NRP   conducted two more tests of NRP processes prior to implementing the
Process Testing     program. IRS tested the casebuilding and classification processes in an
                    NRP simulation in July 2002, and conducted another classification process
                    test during the initial classification training session in September 2002. IRS
                    used the preliminary results of both of these tests to estimate NRP
                    classification outcomes and to evaluate the effectiveness of NRP training.
                    As we recommended in our June 2002 report, IRS substantially completed
                    this testing prior to full NRP implementation, though final reports from the
                    tests were not completed until later.

                    In July 2002, IRS used draft NRP training materials to train 16 auditors
                    from IRS field offices in the use of NRP casebuilding materials to carry out
                    the NRP classification process. The newly trained classifiers then
                    classified 506 tax year 2000 returns. NRP staff members reviewed the
                    classifiers’ results and found that, overall, the results of this NRP
                    simulation were positive. They found that the classifiers understood the
                    NRP approach to classification but that there were instances where the
                    classifiers overlooked some of the issues indicated by the casebuilding
                    materials or made other errors.

                    In September 2002, IRS conducted another test of the NRP classification
                    process immediately following the initial training session using final
                    classification training materials. As we recommended in our June 2002
                    report, IRS had NRP classifiers classify previously audited tax returns in
                    order to compare classifiers’ results with the results of actual audits.
                    Twenty-two newly trained classifiers classified 44 previously audited
                    returns, with each return classified by 5 different classifiers. All of the
                    earlier audits resulted in some changes. NRP staff members then
                    compared the classifiers’ results with those of the other classifiers and
                    with the results of the earlier audits. NRP officials reported that the test
                    showed that about three-fourths of the time the trained NRP classifiers
                    were able to identify issues where noncompliance was found through an
                    audit.

                    IRS used preliminary results of these tests to identify and implement
                    improvements to NRP. For example, NRP staff members noticed early in
                    the course of the second test that NRP classifiers were failing to classify
                    some line items in accordance with NRP guidelines. Trainers reiterated the


                    Page 7                       GAO-03-614 National Research Program Implementation
                           importance of following the classification guidelines for these items. NRP
                           staff members also saw that the format of the form that classifiers were to
                           use to record their classification decisions made it easy to make mistakes.
                           They revised the form to make decision recording less error-prone. IRS
                           also used these tests to identify the need for more stringent classification
                           review guidelines than initially planned in order to ensure that classifiers
                           understand and follow the classification guidelines.

                           IRS did not finish analysis and documentation of the NRP simulation and
                           assessment and the classification process test until after the beginning of
                           classification in IRS area offices. NRP classification began at IRS area
                           offices during November 2002, but IRS did not finalize its report on the
                           July 2002 NRP simulation until December 2002, and the report on the
                           September 2002 NRP process test was finalized in December 2002.
                           According to NRP officials, this did not create problems because they
                           made changes to NRP processes and training materials before the reports
                           of these tests were final. Though the final reports were not completed until
                           later, these tests and the NRP modifications they generated were complete
                           before full implementation of NRP.


                           IRS identified and trained staff to complete NRP classification and audits.
NRP Staff Selection        IRS selected NRP classifiers and auditors from field offices across the
and Training Is            country to handle NRP cases along with the non-NRP enforcement cases
                           and carried out plans for special training of the staff members tasked with
Complete                   NRP responsibilities. IRS delayed the delivery of computer software
                           training to managers and clerks involved in NRP audits due to technical
                           problems with NRP software. This initially delayed the start of NRP audits,
                           but the training is now complete. The timing of NRP staff selection and
                           training fit the conclusion and recommendation in our June 2002 report
                           that IRS should make sure that these key steps are carried out in the
                           appropriate sequence and not rushed to meet an earlier, self-imposed
                           deadline.


IRS Selected Auditors to   IRS selected over 3,000 auditors to handle NRP cases. Most of these
Carry Out NRP              auditors are assigned to the Small Business/Self Employed operating
                           division.4 IRS selected 138 Small Business/Self Employed auditors to be



                           4
                            IRS has four business operating divisions: Wage and Investment, Small Business/Self
                           Employed, Large and Mid-Sized Business, and Tax Exempt and Government Entities.




                           Page 8                           GAO-03-614 National Research Program Implementation
                             NRP classifiers and about 3,500 to handle NRP face-to-face audits.
                             According to NRP staff members, IRS offices across the country now have
                             one or more auditors trained to handle the NRP cases that come to those
                             offices. IRS area office managers determined how many auditors should
                             receive NRP training based on the projected distribution of NRP returns to
                             their areas.

                             Unlike face-to-face audits, NRP correspondence audits are being handled
                             out of a single office. IRS selected two groups of correspondence
                             auditors—26 correspondence auditors—from the Wage and Investment
                             operating division’s Kansas City office to handle NRP correspondence
                             audits.

                             IRS originally planned to select a cadre of auditors to work only on NRP
                             face-to-face audits. According to NRP officials, the geographic distribution
                             of NRP returns would have made it difficult to have a cadre of auditors
                             dedicated entirely to NRP examinations because they would have had to
                             travel extensively to carry out NRP audits. IRS officials said that even
                             though they did not implement the plan for a dedicated cadre of NRP
                             auditors, the number of full-time equivalent employees needed for NRP—
                             about 1,000 in fiscal year 2003—has not changed.

NRP Classifier Training Is   In September 2002, IRS trained 138 auditors to perform NRP classification.
Complete                     The classifiers learned how to apply the guidelines for NRP classification
                             and were shown how to use NRP casebuilding materials. Instructors
                             stressed the concept of “when in doubt, classify the item” meaning that,
                             unless the casebuilding materials explicitly verify the line item in question,
                             the classifier should classify the item as needing to be verified through an
                             audit. Instructors explained that with a random sample such as in NRP,
                             every return represents many others so even small oversights on the part
                             of classifiers or auditors can have a substantial impact on data quality.

                             After the classification training, the classifiers remained at the training
                             location and began classifying NRP returns. Specially trained classification
                             reviewers reviewed most of the classified cases and provided rapid
                             feedback to the newly trained NRP classifiers. The intent of this was to
                             ensure that NRP classifiers understood and consistently applied the NRP
                             classification guidelines and received any needed retraining before
                             returning to their respective field offices and participating in future NRP
                             classification sessions.




                             Page 9                       GAO-03-614 National Research Program Implementation
NRP Auditor Training Is     IRS delivered NRP correspondence and face-to-face auditor training
Complete                    during late 2002 and early 2003. Instructors provided an overview of NRP
                            goals and objectives, reviewed the casebuilding materials that auditors
                            would have at their disposal, and explained the guidelines for NRP audits.

                            IRS trained about 3,500 auditors to conduct NRP face-to-face audits. This
                            training took place in IRS field offices across the country from October
                            2002 through February 2003. Each face-to-face NRP audit training session
                            lasted 3 days. The training consisted of an overview of NRP goals and
                            objectives, an explanation of how NRP audits differ from traditional
                            enforcement audits, and a description of how to apply NRP guidelines
                            during NRP audits. Trainers stressed that, for the purposes of consistent
                            and accurate data collection, NRP auditors should not focus solely on
                            significant issues or take into consideration the likelihood of collecting
                            unpaid taxes when conducting NRP audits, but should make sure that
                            every item identified by the classifier is carefully verified in the course of
                            the audit. Correspondence auditor training was similarly focused, and the
                            1-day training took place in September 2002. Staff members were trained
                            before they began to carry out NRP tasks.


Computer Software           IRS needed to provide training to NRP auditors and to IRS managers and
Training for Managers and   clerks with NRP responsibilities in order for staff members to understand
Clerks Was Delayed          how to use the computer program IRS developed to capture NRP
                            information. Because of some problems IRS encountered in installing the
                            NRP software in offices across the agency, IRS had to delay training some
                            clerks and managers. This led to delays in starting some NRP audits
                            because managers were unable to assign NRP cases to auditors and clerks
                            were unable to assist in loading NRP cases on NRP auditors’ laptop
                            computers. IRS resolved these problems and finished delivering the
                            majority of this training by the end of January 2003.


                            IRS is nearly finished creating NRP casebuilding files, has classified nearly
NRP Reviews Are             three-fourths of the NRP returns, and has begun conducting NRP audits.
Under Way                   As of the end of March 2003, IRS completed NRP casebuilding for about 94
                            percent of the approximately 47,000 returns in the NRP sample and about
                            73 percent of NRP returns have been classified. Also, for 3,651 NRP cases,
                            IRS completed all necessary audit work. Some of these are cases where
                            correspondence or face-to-face audits are finished, but most of the NRP
                            cases closed so far—2,709—are those that did not require audits. Cases
                            involving audits take longer to complete, so few have been closed thus far.
                            IRS made substantial progress in casebuilding and classification starting in


                            Page 10                      GAO-03-614 National Research Program Implementation
2002, and the number of cases assigned to NRP auditors has been
increasing quickly since January 2003. Figure 2 shows the progress IRS has
made in casebuilding, classifying, and closing cases.

Figure 2: NRP Work Completed and Work Remaining as of the End of March 2003




The number of completed NRP casebuilding files began to grow during the
second half of 2002, as shown in figure 3. As figure 3 also illustrates, NRP
classification began in September 2002. These were the cases classified
during sessions held immediately after classifier training. Over 9,000 NRP
returns were classified by the end of October 2002. After these sessions,
classification became an area office function, with some offices scheduling
weeklong classification sessions on a somewhat regular basis and others
classifying returns as they come into the office.




Page 11                     GAO-03-614 National Research Program Implementation
                      Figure 3: NRP Implementation Progress




                      Note: Casebuilding and classification data from July through September 2002 are estimates because
                      IRS did not keep monthly records on these processes during this period.


                      IRS began conducting some NRP audits during November 2002, though
                      these audits began in earnest during the first quarter of 2003. By the end of
                      January 2003, IRS had assigned over 4,600 NRP cases to auditors to begin
                      conducting face-to-face and correspondence audits. By the end of March
                      2003, about 18,000 taxpayers had been contacted regarding NRP audits.


                      IRS recognizes the need for accurate NRP data and, as planned, has built
IRS Has Implemented   into the program several measures to ensure the quality of NRP results.
NRP Quality           IRS designed the NRP classification process to include quality assurance
                      reviews and has added additional quality assurance measures in response
Assurance Measures    to suggestions we made in the course of this engagement. The NRP audit
                      process also includes quality assurance measures that include both in-
                      process and completed case reviews, with all NRP audits reviewed before
                      they are formally closed with the taxpayer. IRS also built accuracy checks
                      into the data capture steps that take place throughout the NRP process.



                      Page 12                             GAO-03-614 National Research Program Implementation
IRS Is Conducting           IRS designed NRP classification to include regular reviews of classifiers’
Classification Reviews on   decisions. We found that these reviews are generally taking place
a Sample of Returns         according to NRP guidelines. We also found that additional measures
                            could further improve NRP classification accuracy, and IRS implemented
                            our suggestions.

                            NRP guidelines specify that NRP classification reviewers review all cases
                            for which returns are classified as needing either no audit at all or only
                            correspondence audits to confirm their accuracy. Additionally, reviewers
                            must initially review 25 percent of the cases classified by each auditor that
                            are selected for face-to-face audits until they are satisfied with the quality
                            and consistency with NRP guidelines of the classifier’s work. After that
                            standard has been met, the guidelines specify that reviewers need only
                            review approximately 10 percent of the cases that each classifier selects
                            for face-to-face audit.

                            We conducted site visits to five IRS area offices where NRP classification
                            was taking place and found that IRS’s plans to implement the classification
                            steps of the program were generally well understood by the classifiers
                            carrying them out. Classifiers were knowledgeable about the differences
                            between the NRP classification process and the classification process
                            used in the enforcement audit environment and supported NRP goals in
                            general. However, we also found instances where NRP classifiers were not
                            consistently following NRP classification guidelines.

                            Another issue we identified involved the use of the classification review
                            sheets that reviewers fill out when they find problems with classifiers’
                            decisions. We learned that there was no provision for further review of
                            these forms. In some cases, we found that reviewers were not always
                            documenting classification errors on the forms. We discussed with NRP
                            officials the potential benefits of using NRP classification review sheets
                            for more than identifying issues at the area office level. Specifically, we
                            suggested that classification review sheets be forwarded from the area
                            offices to a central location in order to identify problems that may be
                            occurring in different locations around the country or other trends that the
                            NRP Office may need to address during the course of NRP classification.
                            The NRP Office agreed with our suggestion and added centralized review
                            of classification review sheets to its other classification quality assurance
                            measures.

                            The NRP Office adopted our suggestion that it conduct site visits to area
                            offices to identify NRP classification implementation issues. Similar to the
                            visits we conducted, NRP staff members visited area offices and met with


                            Page 13                      GAO-03-614 National Research Program Implementation
                        classifiers, reviewers, and managers to identify issues encountered in
                        carrying out NRP classification and possible areas where NRP guidelines
                        may have been misinterpreted. Among the issues they are asking about is
                        the usefulness of the various materials included in the casebuilding files,
                        information which may prove useful in the design of the casebuilding
                        portion of future iterations of NRP. NRP staff members are also
                        conducting separate reviews of completed classification cases.


NRP Audit Quality       IRS has designed NRP to include several steps to identify NRP audit
Assurance Measures      quality problems at both the individual auditor level and across the
Include a Mix of In-    program. Reviews include quality checks while cases are in progress and
                        after work is complete, and reviews by managers at different levels.
Process and Completed   Importantly, IRS’s plans call for every NRP audit to be reviewed at least
Audit Reviews           once at a point where it is still possible to return to the taxpayer and
                        complete additional audit steps, if necessary. These quality assurance
                        measures will serve to mitigate the risk of IRS including erroneous or
                        incomplete data in the NRP database.

                        NRP guidelines task group managers with reviewing one open NRP audit
                        for each auditor in the first 90 days of that auditor’s NRP activity and
                        another in the first 180 days.5 NRP officials intend for these in-process
                        reviews to be extensive and timed early enough in the program to identify
                        individual auditors’ misunderstandings of the program, correct them on
                        the audits under review, and prevent them on future NRP audits.

                        IRS has also created Quality Review Teams both to oversee individual
                        audit cases and identify problems at the area office level and systemically
                        across NRP. These teams are made up of IRS managers and are tasked
                        with checking for compliance with NRP-specific and overall IRS standards
                        on 40 open cases and 20 closed cases for each of IRS’s 15 area offices.
                        These reviews will be repeated in each area about once every 3 months
                        throughout the planned 18-month NRP audit period. The IRS standards
                        applied by the teams to the audits they review are the same standards
                        employed by IRS’s Examination Quality Measurement System (EQMS).6



                        5
                         Most auditors work in groups headed by group managers. Groups are part of territories,
                        which are part of areas. There are 15 area offices participating in NRP.
                        6
                          EQMS measures compliance with IRS standards in several areas, including audit planning,
                        timeliness, and depth and how well the auditor considered large, unusual, or questionable
                        items and income on the taxpayer’s return.




                        Page 14                          GAO-03-614 National Research Program Implementation
Similar to the visits NRP officials made to area offices to review
classification activities, NRP officials are also visiting area offices to
review NRP audit activities. NRP officials said that any systemic issues
identified through Quality Review Team reviews will then be addressed
across NRP.

Another NRP audit quality assurance element calls for all face-to-face
audits to be checked by group managers after work is completed but
before the cases are formally closed with the taxpayers. This review will
include assessing technical correctness, mathematical accuracy,
completeness, and adherence to procedural requirements. IRS officials
said that these requirements include adherence to the NRP-specific
requirement that audits include verification of all items identified through
the NRP classification process. These reviews also include assessing
adherence to IRS standards in areas such as audit depth and reviewing
large, unusual, or questionable items on the audited return. We were
initially concerned that IRS planned for these reviews to take place after
NRP audits were completely closed, precluding IRS from reopening the
cases or otherwise obtaining additional information from the taxpayers
even if the reviewers found that the original NRP audits were incomplete.7
However, senior IRS officials informed us in March 2003 that these
reviews will take place after NRP auditors consider their audit work to be
complete but before the taxpayers are notified that the audits are over.
The officials explained that these reviews of all NRP cases will be timed to
provide an important means of ensuring that complete and accurate audit
results are entered into the NRP database. They also explained that the
importance of NRP audit reviews has been stressed throughout NRP
implementation and will be the subject of ongoing communication with
managers in the field.

It is very important that IRS conduct reviews of NRP audits before they
are closed because IRS data show that auditors do not always meet
enforcement audit quality standards. In fiscal year 2002, IRS’s EQMS found
that auditors in the field did not meet the audit depth standard about 15
percent of the time on field audits; the standard for auditing taxpayer
income was not met about 25 percent of the time on field audits; and the
standard concerning audits of large, unusual, or questionable items was



7
  After IRS notifies a taxpayer that an audit is closed, IRS may only reopen the audit with
the taxpayer in order to correct errors if special circumstances, such as fraud, exist or if
reopening the case will benefit the taxpayer.




Page 15                            GAO-03-614 National Research Program Implementation
                     not met 40 percent of the time on field audits. IRS officials said that
                     accurate audit results in these areas are critical to NRP’s overall accuracy.

                     IRS officials pointed out that the error rate for NRP audits should be lower
                     than in the enforcement audit environment because NRP auditors received
                     special training and because the NRP classification process will enhance
                     NRP audit quality. For example, NRP guidelines call for classifiers to
                     identify large, unusual, or questionable items on returns (the largest EQMS
                     error category) and NRP auditors must address all classified items.
                     However, IRS did not implement its earlier plan of having a selected cadre
                     of auditors work only on NRP cases. While NRP-specific training will serve
                     to prevent many audit errors, NRP audits are now being conducted by a
                     cross section of auditors from IRS field offices across the country and
                     more typical of the auditors who generated the 2002 EQMS error rates.
                     Because every return in the NRP sample represents many returns in the
                     whole population of 1040 filers, even a small number of cases closed with
                     incomplete information could affect the accuracy of NRP data.

                     IRS officials also noted that their plan to conduct early reviews of NRP
                     cases will identify problems with auditors’ understanding of NRP and help
                     to keep them from recurring on subsequent NRP audits. At least two of
                     each NRP auditor’s early cases will have extensive manager involvement
                     while the cases are still in progress, and other managers will be looking at
                     a sample of both completed and open cases to identify problems. IRS
                     officials believe that these measures are sufficient to ensure NRP audit
                     quality.


NRP Includes Data    IRS is including a series of data consistency checks in the NRP database to
Consistency Checks   verify that the information NRP auditors record in IRS’s NRP reporting
                     system agrees with the information that IRS recorded from the tax returns
                     earlier in processing. NRP auditors must first record the results of NRP
                     audits in the report-generating software that was modified for NRP
                     purposes. Once auditors have recorded audit results, NRP coordinators
                     must use a data conversion program to transfer the data into a format that
                     the NRP database will accept. Following data conversion, IRS
                     coordinators transfer the audit data to the NRP database.

                     Once the data are transferred to the NRP database, a series of data
                     consistency checks take place to confirm that the data IRS originally
                     transcribed from the tax return are consistent, within specified tolerances,
                     with the data that NRP auditors recorded in the NRP reporting software. If
                     any of the consistency checks fail for a return in the NRP sample, the NRP


                     Page 16                     GAO-03-614 National Research Program Implementation
                         area coordinator will be notified and the mistake will need to be corrected.
                         According to IRS officials, they will impress upon NRP auditors the
                         importance of entering data into the NRP software correctly the first time
                         because it will be time-consuming to correct errors. NRP officials have
                         developed a case tracking system in order to monitor which cases still
                         need to pass all of the consistency tests and which tests they need to pass.
                         IRS officials reported that, as of early April 2003, the NRP database and
                         related programs were running and that completed NRP cases were being
                         entered into the database. They said that they were still making some
                         enhancements, but that the programs were fully functional.


                         As IRS planned, NRP casebuilding and classification processes are helping
IRS Is Taking Steps to   minimize the burden on taxpayers with returns in the NRP sample. In
Minimize and Assess      addition, the size of the NRP sample is now smaller than IRS expected it to
                         be. However, the number of taxpayers who will be subject to NRP audits
Taxpayer Burden          has increased. IRS plans to survey taxpayers who receive NRP audits to
                         assess their perceptions of the burden posed by those audits. IRS also
                         used input from tax practitioners to identify ways to improve interactions
                         with taxpayers subject to NRP audits.


NRP Processes Are        IRS is following its plans to reduce burden on taxpayers selected as part of
Helping to Reduce        the NRP sample by (1) compiling NRP casebuilding materials that allow
Taxpayer Burden          IRS to verify certain items on tax returns without requesting the
                         information from the taxpayer, (2) classifying returns according to items
                         that need to be verified through an audit, and (3) limiting most NRP audits
                         to items that cannot be verified without an audit. IRS officials also intend
                         to compare classification decisions with the results of NRP audits to
                         identify ways of improving the classification process for future rounds of
                         NRP. Moreover, IRS’s intent in carrying out NRP is to reduce the burden
                         on taxpayers in general by developing better audit selection formulas and
                         reducing the number of audits of fully compliant taxpayers.

                         The NRP casebuilding and classification processes described on page 4
                         are having their intended effect of reducing the burden NRP creates for
                         taxpayers with returns in the NRP sample. IRS has assembled IRS and
                         third-party data on most of the returns in the NRP sample and classifiers
                         have used these data to verify information on the returns, where possible,
                         without contacting taxpayers. The remaining casebuilding and
                         classification work was under way as of the end of March 2003. The
                         material in the casebuilding files has allowed IRS to fully verify about 10
                         percent of NRP returns without any audit. Classifiers were able to use the


                         Page 17                     GAO-03-614 National Research Program Implementation
                        casebuilding material to verify all but one or two items on another 5
                        percent of NRP returns, and these were sent for correspondence audits.

                        Classifiers identified line items needing verification through a face-to-face
                        audit on about 85 percent of NRP returns classified as of the end of March
                        2003. Because of the casebuilding and classification processes IRS
                        developed for NRP, these audits will generally be limited to line items that
                        cannot be verified using the information in the casebuilding files. This is a
                        substantial change from earlier compliance research efforts, in which all
                        returns were subject to audits of every line on the return. Only the 1,683
                        taxpayers with returns selected for NRP calibration audits will be subject
                        to complete audits of their returns.

                        IRS plans to use NRP results to improve future iterations of NRP. For
                        example, NRP officials plan to compare classification outcomes with NRP
                        audit results to help them to identify possible changes needed in
                        casebuilding materials and the NRP classification process. They have told
                        us that it may be possible to further reduce the number of accurately
                        reported line items that are subject to compliance research audits. On the
                        other hand, IRS may also find through NRP calibration audits that
                        classification missed many items that should have been audited, so more
                        line items should receive some form of audit in future rounds of NRP in
                        order for the research results to be useful. IRS also intends to apply
                        lessons learned in NRP classification to classification in the enforcement
                        audit environment.

                        As we noted in our prior report, NRP should also lead to reductions in
                        taxpayer burden in general. IRS plans to use NRP results to help identify
                        and reduce causes of noncompliance and to better target enforcement
                        audits to noncompliant taxpayers, reducing the number of audits of fully
                        compliant taxpayers. IRS projects that, without improved audit selection
                        formulas based on NRP results, the percentage of enforcement audits that
                        result in no tax change will be about 35 percent higher in 2005 than it was
                        in 1993, the first year that selection formulas from the 1988 compliance
                        study were available. Taxpayer burden will decrease if successful
                        execution of NRP enables IRS to reduce the number of these audits of
                        compliant taxpayers.


NRP Sample Is Smaller   The NRP sample consists of 46,860 tax returns. We reported in June 2002
Than IRS Initially      that the NRP sample would consist of 49,251 returns. The current number
Estimated               is smaller than the initial estimate because IRS originally estimated the
                        NRP sample size based on the characteristics of the filing population that


                        Page 18                      GAO-03-614 National Research Program Implementation
                             existed during the 1988 reporting compliance study. According to IRS
                             officials, when they applied the NRP sampling plan to the 2001 filing
                             population, the number of returns necessary to satisfy the requirements
                             for some of the NRP strata declined because filing rates for those strata
                             were smaller than IRS officials had projected.8 The final NRP sample
                             consists of about 2,400 fewer returns than initially planned.


IRS Estimates That NRP       IRS officials are currently finding that the NRP classification results are
Classification Will Result   different than initially planned. IRS now estimates that more face-to-face
in More Audits Than          audits will take place than initially projected because (1) as the NRP plan
                             recognized, IRS’s initial estimates were uncertain and based on aging data
Expected                     and (2) the final form of NRP classification guidelines meant more face-to-
                             face and fewer correspondence audits.

                             IRS initially estimated that out of an NRP sample of over 49,000 tax
                             returns, classification would result in about 30,000 face-to-face audits of
                             selected line items, about 9,000 correspondence audits covering no more
                             than two line items, and about 8,000 taxpayers who would not undergo
                             any audit because classifiers were able to either verify all of the items on
                             their returns or could correct some line items without contacting the
                             taxpayers.

                             The final NRP sample is 46,860 returns, and IRS now estimates that NRP
                             classification will result in face-to-face audits of about 39,000 taxpayers,
                             with approximately an additional 2,300 receiving correspondence audits
                             and 3,800 subject to no audit at all. IRS also plans to conduct 1,683 line-by-
                             line calibration audits, drawing 561 returns from each of the three
                             classification categories—these numbers have not changed. Figure 4
                             shows IRS’s current estimate of how the three NRP classification
                             categories will be distributed.




                             8
                               The NRP sample is divided into 30 categories, each of which is referred to as a stratum.
                             Each stratum contains a different type of taxpayer based on the taxpayer’s total positive
                             income and the various schedules that the taxpayer filed.




                             Page 19                           GAO-03-614 National Research Program Implementation
Figure 4: Estimated NRP Sample by Level of Taxpayer Contact




NRP officials explained that the number of face-to-face NRP audits is
higher than expected because they were relying on aging data and
preliminary classification guidelines. Our 2002 report on NRP also noted
the preliminary nature of these estimates. Initial classification breakdown
estimates were made using 14-year-old data from the 1988 Taxpayer
Compliance Measurement Program study. NRP staff members said that
changes in the tax code and in the economic makeup of the filing
population since the 1988 study make the returns from that study an
unreliable tool for predicting NRP classification results, though that was
all they had to work with.

They also said that some of the change can be attributed to changes they
made in the final form of NRP classification guidelines. NRP staff
members said that they modified the NRP classification guidelines as a
result of discussions that took place between NRP staff members and
representatives from IRS’s business operating divisions. They instituted
the changes to the classification guidelines in order to better match the
training and skills of the examiners selected to conduct NRP
correspondence and face-to-face audits with the types of issues to be
covered by those audits. One change is that discrepancies between the
casebuilding files and the tax returns for issues such as Individual
Retirement Account contributions and Social Security income were
removed from the list of issues that could be verified through a
correspondence audit. Another change is that the final guidelines call for
virtually all business returns to receive face-to-face audits—initial




Page 20                      GAO-03-614 National Research Program Implementation
                      assumptions about the classification process allowed for some business
                      returns to be accepted as filed or receive only correspondence audits.


IRS Will Survey NRP   IRS will survey taxpayers who are subject to NRP audits to assess overall
Taxpayers             customer satisfaction and their perceptions of the burden audits created
                      for them. IRS will ask taxpayers to fill out the same survey it uses to assess
                      customer satisfaction in the enforcement audit environment and compare
                      the results for the two populations.

                      The surveys include issues related to taxpayer burden in the form of
                      questions about the amount of time taxpayers spent preparing for the
                      audits and the amount of time that they spent on the audits themselves.
                      The surveys also ask whether taxpayers receiving NRP audits believe the
                      information that they were asked to provide seemed reasonable and
                      whether they feel they received fair treatment from IRS.

                      After collecting the survey results, IRS will then develop a “score” for each
                      question on the survey that relates to burden. IRS will compare the results
                      from the NRP customer satisfaction survey to the results from surveys
                      completed after enforcement audits.


IRS Consulted with    IRS consulted with outside stakeholders to enhance its efforts to minimize
Practitioners         the burden NRP created for taxpayers with returns in the sample. IRS
                      consulted with members of organizations that provide feedback to IRS on
                      matters concerning taxpayers, including the National Public Liaison, the
                      Information Reporting Program Advisory Committee, and the Internal
                      Revenue Service Advisory Council.9 According to IRS, practitioner input
                      led to wording changes on taxpayer notification letters and improvements
                      to training materials, which strengthened the emphasis on maintaining
                      good relations with NRP-selected taxpayers. Representatives of the
                      National Public Liaison also participated in the training for the staff
                      members who were selected to conduct NRP auditor training.




                      9
                       The National Public Liaison coordinates with tax practitioner organizations, other
                      government agencies, and IRS’s formal advisory groups to provide a forum for external
                      feedback. The Information Reporting Program Advisory Committee provides input to IRS
                      on reporting issues, and the Internal Revenue Service Advisory Council provides input to
                      IRS on tax administration issues.




                      Page 21                          GAO-03-614 National Research Program Implementation
                  IRS continues to be on track for meeting its NRP goal of obtaining
Conclusions       meaningful compliance data while minimizing the burden on taxpayers
                  with returns in the NRP sample. IRS has followed the key elements of the
                  plans it laid out last year and has responded to identified needs to modify
                  the program that have come from its own testing as well as from outside
                  stakeholders. Because of this, we are not making any recommendations in
                  this report.

                  We recognize that IRS efforts to gather information about NRP
                  implementation while the program is under way are very important to
                  IRS’s continued success in carrying out NRP. Classification review results,
                  audit review results, and customer satisfaction surveys all provide the
                  means for IRS to make immediate adjustments to NRP now and to
                  enhance the design of future iterations of the program. Provisions for 100
                  percent review of NRP audits before they are closed are particularly
                  important because even a small number of erroneous or incomplete cases
                  will negatively affect the quality of NRP data.


                  On May 22, 2003, we received written comments on a draft of this report
Agency Comments   from the Commissioner of Internal Revenue (see app. I). The
                  commissioner noted the importance of NRP and IRS’s continued emphasis
                  on minimizing taxpayer burden and delivering quality results. We also
                  received technical comments from NRP staff members, which we have
                  incorporated into this report where appropriate.


                  As agreed with your offices, unless you publicly announce its contents
                  earlier, we plan no further distribution of this report until 30 days after its
                  date. At that time, we will send copies of this report to the Secretary of the
                  Treasury, the Commissioner of Internal Revenue, and other interested
                  parties. This report is also available at no charge on GAO’s Web site at
                  http://www.gao.gov.




                  Page 22                      GAO-03-614 National Research Program Implementation
If you or your staffs have any questions, please contact Ralph Block at
(415) 904-2150, David Lewis at (202) 512-7176, or me at (202) 512-9110.
Thomas Gilbert was also a key contributor to this assignment.




James R. White
Director, Tax Issues
Strategic Issues Team




Page 23                     GAO-03-614 National Research Program Implementation
              Appendix I: Comments from the Internal
Appendix I: Comments from the Internal
              Revenue Service



Revenue Service




(440149)
              Page 24                        GAO-03-614 National Research Program Implementation
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