oversight

Casualty and Theft Loss Deductions Continue to Be Erroneously Processed Without a Valid Federal Emergency Management Agency Number

Published by the Office of the Treasury Inspector General for Tax Administration on 2021-07-14.

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

  TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION




                   Casualty and Theft Loss Deductions Continue
                   to Be Erroneously Processed Without a Valid
                 Federal Emergency Management Agency Number


                                                      July 14, 2021

                                         Report Number: 2021-40-045




This report has cleared the Treasury Inspector General for Tax Administration disclosure review process and information determined
                             to be restricted from public release has been redacted from this document.                1

                                  TIGTACommunications@tigta.treas.gov | www.treasury.gov/tigta
              HIGHLIGHTS: Casualty and Theft Loss Deductions Continue to Be Erroneously
               Processed Without a Valid Federal Emergency Management Agency Number
Final Audit Report issued on July 14, 2021                                      Report Number 2021-40-045

Why TIGTA Did This Audit              What TIGTA Found
This audit was initiated to follow    As a result of TIGTA’s prior report, the IRS agreed to evaluate
up on previous TIGTA                  addressing tax returns that do not contain the required FEMA
recommendations related to IRS        number in the Error Resolution function. However, because of the
processing of tax returns claiming    increased workload due to the Coronavirus Disease 2019, this has not
a deduction for a casualty and        yet been accomplished. As such, potentially erroneous casualty and
theft loss.                           theft loss deductions are still not being addressed during processing.
The Tax Cuts and Jobs Act of 2017     TIGTA’s review of Tax Year 2019 tax returns processed as of
limited the personal casualty and     September 3, 2020, identified 34,699 tax returns that claimed a
theft loss deduction to only those    casualty and theft loss deduction. TIGTA found that 12,075
claims associated with Federally      (35 percent) of the 34,699 either had a FEMA number that did not
declared disasters for Tax            match the FEMA number on the taxpayer’s tax account, had an
Years 2018 through 2025.              invalid FEMA number, or were missing the FEMA number. The
                                      deductions claimed on these returns totaled more than $309 million.
Impact on Taxpayers
                                      TIGTA estimates these individuals underpaid approximately
Casualty and theft loss deductions    $41.3 million in income tax.
are included on Form 4684,
                                      In addition, IRS management’s analysis of the 7,761 tax returns TIGTA
Casualties and Thefts, and
                                      identified in its previous review determined that 33 tax returns were
reported as a deduction on
                                      addressed through the unallowable treatment stream, and only
Form 1040, U.S. Individual Income
                                      183 tax returns would meet their Campus Exam filter selections and
Tax Return, from the Schedule A,
                                      dollar tolerance. The fact that only 2.4 percent of the identified cases
Itemized Deductions. Taxpayers
                                      will potentially be examined further supports TIGTA’s prior
are instructed to enter the Federal
                                      recommendation that these tax returns should be identified for
Emergency Management Agency
                                      review during processing rather than being examined after
(FEMA) number that qualifies as a
                                      processing.
Federally declared disaster area
on their Form 4684.                   What TIGTA Recommended
In January 2020, TIGTA reported       TIGTA made three recommendations to improve the processing of
that IRS processes did not ensure     casualty and theft loss deduction claims. The IRS should develop
that taxpayers provided the           processes and procedures to identify tax returns at the time returns
required FEMA number on               are filed for which the FEMA number is not provided or is not valid
7,761 tax returns with                and establish processes to identify returns for post compliance
disaster-related casualty and theft   review when the FEMA number on the tax return does not match the
loss deductions totaling              number on the taxpayer’s tax account. The IRS should also review
$267.9 million.                       the 12,075 tax returns TIGTA identified.
                                      IRS management agreed or partially agreed with two
                                      recommendations. IRS management revised the Form 4684,
                                      Casualties and Thefts, so the request to prompt taxpayers for the
                                      declarations labeled “DR” or “EM”, and will evaluate the effectiveness
                                      of the change after the 2021 Filing Season. IRS management also
                                      agreed to review the 12,075 returns TIGTA identified.
                                      IRS management did not agree to establish a process to consider
                                      deduction claims for post compliance review when the FEMA number
                                      on the tax return and the number in the taxpayer’s tax account do
                                      not match. IRS management stated that they already have a process
                                      in place to identify anyone who is not in a Federally declared disaster
                                      area regardless of whether the return has a different FEMA number,
                                      has an invalid FEMA number, or is missing a FEMA number.
                                         U.S. DEPARTMENT OF THE TREASURY
                                                  WASHINGTON, D.C. 20220



TREASURY INSPECTOR GENERAL
  FOR TAX ADMINISTRATION



                                              July 14, 2021


MEMORANDUM FOR: COMMISSIONER OF INTERNAL REVENUE



FROM:                        Michael E. McKenney
                             Deputy Inspector General for Audit

SUBJECT:                     Final Audit Report – Casualty and Theft Loss Deductions Continue to Be
                             Erroneously Processed Without a Valid Federal Emergency Management
                             Agency Number (Audit # 202140024)

This report presents the results of our review to follow up on previous Treasury Inspector
General for Tax Administration recommendations related to Internal Revenue Service processing
of tax returns claiming a deduction for a casualty and theft loss. This review is part of our Fiscal
Year 2021 audit coverage and addresses the major management and performance challenge of
Implementing Tax Law Changes.
Management’s complete response to the draft report is included as Appendix III.
Copies of this report are also being sent to the Internal Revenue Service managers affected by
the report recommendations. If you have any questions, please contact me or Russell P. Martin,
Assistant Inspector General for Audit (Returns Processing and Account Services).
                               Casualty and Theft Loss Deductions Continue to Be Erroneously Processed
                                   Without a Valid Federal Emergency Management Agency Number




Table of Contents
Background.....................................................................................................................................Page   1


Results of Review........................................................................................................................Page         2

            Processes Still Do Not Ensure That Valid Federal
            Emergency Management Agency Numbers Are Provided
            in Support of Casualty and Theft Loss Claims ...........................................................Page 3
                         Recommendations 1 and 2: .....................................................Page 4

                         Recommendation 3:...................................................................Page 5


Appendices
            Appendix I – Detailed Objective, Scope, and Methodology ................................Page 6
            Appendix II – Outcome Measure ...................................................................................Page 8
            Appendix III – Management’s Response to the Draft Report .............................Page 11
            Appendix IV – Glossary of Terms ...................................................................................Page 16
            Appendix V – Abbreviations.............................................................................................Page.17
                         Casualty and Theft Loss Deductions Continue to Be Erroneously Processed
                             Without a Valid Federal Emergency Management Agency Number




Background
When the President declares a Federal disaster or emergency, immediate notification is made to
the Governor of the affected State or U.S. Territory, appropriate members of Congress, and
Federal departments and agencies. The Internal Revenue Service (IRS) Disaster Assistance and
Emergency Relief Program Office prepares and distributes an internal Disaster Relief
Memorandum to the IRS that summarizes the tax relief to be provided. Individuals and
businesses in eligible counties are identified by zip code. For those individuals and businesses
affected, the IRS adds the specific Federal Emergency Management Agency (FEMA) disaster
declaration number (hereafter referred to as a FEMA number) that identifies the Federally
declared disaster to the tax account. Taxpayers who live outside the identified zip codes and are
affected by a Federally declared disaster can self-identify by calling the IRS’s disaster toll-free
telephone line. The IRS will automatically grant tax relief and manually input the FEMA number
on the taxpayer’s account.
Individuals who experience a casualty or theft loss may be eligible to claim a deduction on their
annual tax return. The Tax Cuts and Jobs Act of 2017 1 limited the personal casualty and theft
loss deduction to only those claims associated with Federally declared disasters for Tax
Years 2018 through 2025. Casualty and theft loss deductions are included on Form 4684,
Casualties and Thefts, and reported as a deduction on Form 1040, U.S. Individual Income Tax
Return, from the Schedule A, Itemized Deductions. Taxpayers are instructed to enter the FEMA
number that qualifies as a Federally declared disaster area on their Form 4684.
In July 2018, we reported that the IRS timely and accurately placed FEMA numbers on taxpayer
accounts.2 We also reported that the IRS provides a process by which affected taxpayers located
outside of a covered disaster area can self-identify for disaster relief. However, in January 2020,
we reported that IRS processes did not ensure that individuals claiming a disaster-related
casualty loss deduction provide a valid FEMA number as required. 3 Our analysis of 52,011 tax
returns processed as of May 2, 2019, that claimed casualty losses totaling more than $1.2 billion
identified 7,761 (15 percent) tax returns for which the filer did not include the required FEMA
number. These individuals reported deductions totaling $267.9 million. Figure 1 summarizes
the recommendations the Treasury Inspector General for Tax Administration (TIGTA) made and
the IRS’s response to these recommendations.




1
    Pub. L. No. 115-97, 131 Stat. 2054.
2
  Treasury Inspector General for Tax Administration (TIGTA), Report No. 2018-40-049, Actions Were Taken to Timely
Provide Disaster Relief Tax Assistance to Victims of Hurricanes Harvey, Irma, and Maria pp. 5-8 (July 2018).
3
  TIGTA, Report No. 2020-44-007, Results of the 2019 Filing Season p. 18 (Jan. 2020).
                                                                                                             Page 1
                    Casualty and Theft Loss Deductions Continue to Be Erroneously Processed
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                      Figure 1: Summary of Prior TIGTA Recommendations
                              Related to Casualty and Theft Losses

                Recommendation                                            Description

   Create a business rule to reject tax returns when   The IRS partially agreed with this recommendation
   a casualty and theft loss deduction is included     to the extent that it will reduce the volume of
   on Schedule A and Form 4684 does not include        returns processed with missing FEMA disaster
   the required FEMA disaster declaration number.      declaration numbers. IRS management does not
                                                       think the rejection of these returns is the
                                                       appropriate treatment. The absence of a FEMA
                                                       disaster declaration number on a return claiming a
                                                       casualty loss does not make an otherwise eligible
                                                       loss ineligible. The determination of eligibility for
                                                       the deduction is a question that can be answered
                                                       only through an examination, a process that must
                                                       be conducted under deficiency procedures. With
                                                       input from its compliance functions, IRS
                                                       management plans to develop processes to identify
                                                       returns missing the disaster declaration numbers
                                                       and route them to the Error Resolution function for
                                                       treatment.
   Review the 7,761 tax returns that claimed the       The IRS agreed with this recommendation. In
   casualty and theft loss deduction but did not       July 2018, IRS management implemented
   provide a sufficient FEMA disaster declaration      post-processing business rules to identify casualty
   number to determine if the taxpayers are            and theft loss deductions that did not provide a
   entitled to the deductions claimed.                 valid disaster declaration number.
                                                       Management plans to continue using its existing
                                                       post-processing business rules to identify returns
                                                       that do not provide a sufficient disaster declaration
                                                       number.
 Source: TIGTA, Report No. 2020-44-007, Results of the 2019 Filing Season pp. 21-22 (Jan. 2020).



Results of Review
We continue to find that IRS processes and procedures do not ensure that taxpayers claiming a
deduction for a disaster-related casualty and theft loss provide a valid FEMA number as
required. Our review of Tax Year 2019 tax returns processed as of September 3, 2020, identified
12,075 returns that claimed a casualty and theft loss deduction and had a potentially invalid
FEMA number.
While the IRS agreed to evaluate addressing tax returns that do not contain the required FEMA
number in the Error Resolution function, because of the increased workload due to the
Coronavirus Disease 2019, this has not yet been accomplished. As such, potentially erroneous
casualty and theft deductions are still not being addressed during processing.




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                        Casualty and Theft Loss Deductions Continue to Be Erroneously Processed
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In addition, IRS management analyzed the 7,761 tax returns we identified in our previous review
and determined that 33 tax returns were addressed through the unallowable treatment stream,4
and only 183 tax returns would meet their Campus Exam filter selections and dollar tolerance.
The IRS indicated that the 183 tax returns will be added to inventory for potential selection for
review. However, the fact that only 2.4 percent of the identified cases will potentially be
examined further supports our recommendation that these tax returns should be identified for
review during processing rather than being examined after processing.


Processes Still Do Not Ensure That Valid Federal Emergency Management
Agency Numbers Are Provided in Support of Casualty and Theft Loss Claims
Our review of Tax Year 2019 tax returns processed as of September 3, 2020, identified 34,699 tax
returns that claimed a casualty and theft loss deduction on Schedule A.5 We found that
12,075 (35 percent) of the 34,699 returns either had a FEMA number that did not match the
FEMA number on the taxpayer’s tax account, had an invalid FEMA number, or were missing the
FEMA number. The deductions claimed on these returns totaled more than $309 million. We
estimate these individuals underpaid approximately $41.3 million in income tax. These include:
       •   9,455 returns with deductions that totaled more than $228.2 million for which the FEMA
           number provided on the tax return does not match the FEMA number shown in the
           taxpayer’s tax account.6 The tax effect for these deductions is more than $32.1 million.
           The IRS took no actions to verify the legitimacy of these claims at the time the returns
           were filed. ******************************2**************************************************
           *****************2***************.
       •   1,930 returns with deductions that totaled more than $52.1 million for which the
           taxpayer did not provide a FEMA number. The tax effect for these deductions is more
           than $6.2 million.
       •   690 returns with deductions that totaled more than $29.2 million for which the taxpayer
           provided an “obviously invalid” FEMA number. The tax effect for these deductions is
           more than $2.9 million. For our review, an obviously invalid FEMA number is a number
           that does not contain a “DR” or “EM,”7 consists of the same digits, e.g., 1111, 2222, 3333,
           or is outside the range of FEMA numbers applicable for that time frame.
We provided these cases to the IRS on November 16, 2020. The IRS responded on
December 22, 2020, stating it does not have ***************************2**************************
**************************************************2*****************. IRS management also
indicated that, as of January 1, 2020, they were ************************2**************************
**************************************************2**************************************************


4
 The Unallowable program is a prerefund program that identifies items on a return for potential audit during return
processing. Returns claiming casualty or theft losses meeting specific criteria were assigned a code and sent to the
Examination function for review.
5
    These taxpayers filed Form 4684 and claimed a casualty or theft loss on Schedule A.
6
 The FEMA numbers provided on the 9,455 tax returns were numbers issued by FEMA, but they did not match the
FEMA number recorded in the taxpayer’s tax account.
7
  FEMA numbers for presidentially declared disasters will include either a DR or an EM. A DR designates disaster
recovery or disaster response and the EM designates emergency management.
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*****2******. IRS management said this decision was based on the potential for this issue to be
reviewed post processing.

The Commissioner, Wage and Investment Division, should:

Recommendation 1: As previously reported, develop processes and procedures to identify tax
returns at the time returns are filed for which there is a casualty and theft loss deduction claimed
on Schedule A and the FEMA number is not provided or is not valid to send to the Error
Resolution function to be addressed.
        Management’s Response: The IRS partially agreed with this recommendation. IRS
        management stated that the absence of the FEMA number on Form 4684 is not a
        condition the IRS could use to summarily determine whether the claim is unallowable.
        Such a determination must be made under deficiency procedures, which is beyond the
        scope of the Error Resolution function. However, Form 4684 was modified for Tax
        Year 2020 so that the request for the FEMA numbers are more explicit in that it prompts
        specifically for the declarations labeled “DR” or “EM.” IRS management plans to evaluate
        the effectiveness of this change to Form 4684 at the conclusion of the 2021 Filing Season
        to determine if the change materially decreased the volume of losses claimed without
        the declaration numbers. If the change did not have a material impact, management will
        discuss with industry partners the possibility of incorporating into their tax preparation
        software products prompts or reminders to taxpayers claiming casualty losses of the
        need to provide the FEMA numbers.
                 Office of Audit Comment: Although the actions taken may reduce reporting
                 errors, these actions will not identify and address casualty deduction claims with
                 a missing or invalid FEMA number at the time the return is filed. In addition,
                 contrary to IRS management’s assertion, the IRS can and does address tax returns
                 with similar errors (i.e., errors that require the use of deficiency procedures) in its
                 Error Resolution function.8 Finally, in December 2020, IRS management agreed to
                 develop processes and procedures that provide taxpayers with the opportunity to
                 self-correct errors, such as a missing FEMA number, on accepted electronically
                 filed returns that are suspended from processing for manual error resolution.
                 No such procedures have been developed to date.

Recommendation 2: Establish processes to identify tax returns for consideration for
post compliance review for which the FEMA number provided on the tax return is different from
the FEMA number in the taxpayer’s tax account.
        Management’s Response: The IRS disagreed with this recommendation. IRS
        management stated that they already consider the FEMA number on the taxpayer’s
        account, and their current rules identify anyone who is not in a Federally declared
        disaster area regardless of whether the return has a different FEMA number, has an
        invalid FEMA number, or is missing a FEMA number. Therefore, no material benefit
        would be achieved in performing a direct match of the FEMA number on the tax return
        to the FEMA number on the taxpayer’s account. Management also believes the match

8
  Examples include alimony deduction claims with a missing alimony recipient Taxpayer Identification Number and
returns that report supplemental profit or loss with no Schedule E, Supplement Income and Loss, attached.
                                                                                                          Page 4
                  Casualty and Theft Loss Deductions Continue to Be Erroneously Processed
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       recommended by TIGTA could unnecessarily flag compliant taxpayers for review who
       had input or transcription errors associated with the FEMA number. The proposed
       matching would waste scarce resources and unduly burden taxpayers who are already
       dealing with the aftermath of a disaster. In addition, the Small Business/Self-Employed
       Division currently has processes in place to identify ****************2*********************
       *******2*******. These systemic rules were implemented in response to the Tax Cuts and
       Jobs Act, which impacted returns reporting casualty and theft losses beginning with Tax
       Year 2018.
              Office of Audit Comment: The examination selection criteria provided during
              our review identifies claims for which ********************2************************
              ***************************************2*********************************************
              ***************************************2*********************************************
              ***************************************2*********************************************
              ****************2****************.

Recommendation 3: Review the 12,075 tax returns we identified that claimed a casualty and
theft loss deduction on Schedule A but did not provide a sufficient FEMA number to determine
if the taxpayers are entitled to the deductions claimed.
       Management’s Response: The IRS agreed with this recommendation. IRS management
       analyzed the tax returns identified and found a significant number that did not meet its
       selection tolerance. IRS management applied their existing filtering rule to the
       remaining cases to remove cases that likely qualify for the casualty loss deduction. As a
       result, management determined that nearly all the remaining cases would be eliminated
       from further compliance action and *****************2******************* of the cases
       identified by TIGTA, are above IRS selection tolerance. Under current IRS procedures,
       these cases are available for selection in accordance with existing prioritization and
       resources.




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                                                                                       Appendix I
                 Detailed Objective, Scope, and Methodology
Our overall objective was to follow up on previous TIGTA recommendations related to IRS
processing of tax returns claiming a deduction for a casualty and theft loss. To accomplish our
objective, we:
   •   Evaluated actions the IRS took to address prior recommendations related to the Tax Cuts
       and Jobs Act provision to limit personal casualty and theft loss.
   •   Determined if the FEMA number on the casualty and theft loss form does not match the
       FEMA number on the entity of the tax account.
   •   Determined if the FEMA number on the casualty and theft loss form is not valid, e.g.,
       improper format, incorrect number of digits.
   •   Determined if the FEMA number is not present on the casualty and theft loss form.
   •   Quantified the number and the amount of claims for the exceptions we identified.

Performance of This Review
This review was performed with information obtained from the Wage and Investment
Division headquarters in Atlanta, Georgia; the Wage and Investment Division Submission
Processing function offices in Cincinnati, Ohio; and the Information Technology organization in
Lanham, Maryland, during the period November 2019 through December 2020. We conducted
this performance audit in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain sufficient, appropriate
evidence to provide a reasonable basis for our findings and conclusions based on our audit
objective. We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objective.
Major contributors to the report were Russell P. Martin, Assistant Inspector General for Audit
(Returns Processing and Account Services); Deann L. Baiza, Director; Sharla J. Robinson, Audit
Manager; Sandra L. Hinton, Lead Auditor; Tracy M. Hernandez, Senior Auditor; Donald Meyer,
Information Technology Specialist; and Laura Haws, Information Technology Specialist (Applied
Research and Technology).

Validity and Reliability of Data From Computer-Based Systems
We used data extracts from the Individual Master File and the Individual Returns Transaction File
for Processing Year 2020. Prior to audit testing, we reviewed the data extracts to ensure that the
extracted data were valid and reliable and contained the information needed for audit testing.
We used judgmental samples to verify that the data contained in the extracts matched the
information found in the Employee User Portal and Integrated Data Retrieval System databases.
Audit tests were performed with the extracted data to identify Tax Year 2019 tax returns with
noncompliance of casualty and theft reporting requirements. We determined that the data were
sufficiently reliable for purposes of this report.


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Internal Controls Methodology
Internal controls relate to management’s plans, methods, and procedures used to meet their
mission, goals, and objectives. Internal controls include the processes and procedures for
planning, organizing, directing, and controlling program operations. They include the systems
for measuring, reporting, and monitoring program performance. We determined that the
following internal controls were relevant to our audit objective: the process for planning,
organizing, directing, and controlling program operations for the 2020 Filing Season. We
evaluated these controls by monitoring IRS weekly production meetings, reviewing IRS
procedures, and reviewing IRS reports.




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                                                                                               Appendix II
                                          Outcome Measure
This appendix presents detailed information on the measurable impact that our recommended
corrective actions will have on tax administration. This benefit will be incorporated into our
Semiannual Report to Congress.

Type and Value of Outcome Measure:
    •    Revenue Protection – Potential; approximately $41.3 million in additional income tax
         assessed for 11,902 Tax Year 2019 tax returns due to noncompliance with casualty and
         theft deduction reporting requirements; approximately $206 million over five years1 (see
         Recommendations 1 through 3).

Methodology Used to Measure the Reported Benefit:
We identified taxpayers who had a Tax Year 2019 tax return with a Form 4684 that claimed a
casualty loss on Schedule A. Generally, taxpayers can take a casualty and theft deduction
related to their home, household items, and vehicles on their income tax return if the loss is
caused by a Federally declared disaster. The casualty and theft deduction flows through to
Schedule A, increasing the itemized deductions on Form 1040.
Using the Processing Year 2020 Individual Returns Transaction File, we identified
36,216 Forms 4684 that claimed a deduction for casualty and theft loss for Tax Year 2019.
We limited our population to 34,699 tax returns that claimed a casualty loss on Form 4684
and claimed that loss on Schedule A. We further limited our population to 12,075 returns with a
Form 4684 that claimed a loss without a FEMA number listed on the form or forms for which the
FEMA number was either invalid or did not match the information in the taxpayer’s account.
We created three separate populations and identified the following:
    •    9,455 returns with a Form 4684 that claimed deductions totaling $228,295,498 for which
         the form listed a FEMA number that did not match the taxpayer’s account.
    •    1,930 returns with a Form 4684 that claimed deductions totaling $52,135,672 for which
         the FEMA number was not included on the form.
    •   690 returns with a Form 4684 that claimed deductions totaling $29,267,796 for which the
        FEMA number on the form was “obviously invalid,” e.g., does not contain “DR” or “EM” or
        contains consistent or consecutive numbers.
In order to calculate the difference in tax if the deduction would have been disallowed, we used
a tax simulator tool that enabled us to recalculate a tax return based on adjustments to specific
line items on a tax return. For example, for tax returns on which a casualty loss is being claimed,
we reduced the amount of the itemized deduction on the Schedule A by the casualty loss
amount. If the itemized deduction amount was less than the standard deduction amount, then


1
 The five-year forecast is based on multiplying the base year by five and assumes, among other considerations, that
economic conditions and tax laws do not change.
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the standard deduction would be applied. This allowed us to recalculate the tax returns to show
the effect of removing the casualty loss.
The tax simulator tool provides a more accurate tax effect estimate for outcome measure
purposes because it considers each tax return’s specific tax situation, including the tax rate and
credits and deductions claimed. The results more accurately represent the tax effect rather than
applying an average or estimated tax rate to the whole return population.
The tax simulator tool works in two iterations. It first attempts to recreate the original returns as
posted on the IRS’s Individual Returns Transaction File and determines whether its programming
can accurately recreate the returns. Doing this confirms whether the tax simulator program
would come up with the same tax return figures as the IRS did before considering any audit
adjustments (confirms whether the tax simulator program is a good fit for the return). Returns
that it could not accurately recreate within a certain dollar tolerance are set aside and not
adjusted (the tax simulator determined it would not have come up with the original return as
posted and would therefore not accurately calculate any audit adjustments). This first iteration
reduced our population of exceptions from 12,075 returns to 11,902 returns.
The second iteration applies audit adjustments and calculates tax effect. Audit adjustments
overwrite the original amounts on the returns and can be applied to certain line items on the
Form 1040. Once the audit adjustments are applied, the tax simulator tool then uses the new
amounts to recalculate the return. The tax simulator tool updates several summary, deduction,
and credit line items on the return. The tax simulator tool does have limitations. For example,
the tax simulator tool:
    •    Does not recalculate every line item on the tax return.
    •    Cannot account for rounding methods used by the taxpayer or IRS adjustments made by
         the IRS.
    •    Cannot account for data from underlying tax worksheets not transcribed by the IRS.
To be conservative in our outcome measure, we considered only tax returns recalculated using
the tax simulator tool. This resulted in the following populations:
    •    9,339 returns that claimed a casualty deduction for which the FEMA number on the
         return was issued by FEMA but does not match the FEMA number shown on the
         taxpayer’s account. The total tax effect for the returns is $32,137,871.
    •    1,884 returns that claimed a deduction for which the taxpayer did not list a FEMA
         number on their form. The total tax effect for the returns is $6,251,387.
    •    679 returns that claimed a deduction for which the taxpayer provided an “obviously
         invalid” FEMA number. The total tax effect for the returns is $2,964,901.
For the 11,902 (9,339 + 1,884 + 679) tax returns, we compared the Form 1040, Line 12a, tax
amount of $157,518,889 to the recalculated amount of $198,873,048 from the tax simulator tool,
resulting in a difference of $41,354,159 ($32,137,871 + $6,251,387 + $2,964,901). We forecast
that taxpayers could be assessed $206,770,795 in additional income tax over the next five years
($41,354,159 x 5) due to noncompliance with casualty and theft loss reporting requirements.2

2
 The five-year forecast is based on multiplying the base year by five and assumes, among other considerations, that
economic conditions and tax laws do not change.
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Management’s Response: IRS management disagreed with the outcome measure,
stating that their review indicates that many of the identified deductions are likely valid.
Management also stated that, for the remaining cases, TIGTA failed to consider the
opportunity cost of diverting resources from more productive work and ********2********
***********************************************2*********************************************
*****2*****.
       Office of Audit Comment: Our outcome measure represents the potential
       revenue the IRS can protect by improving its processes and procedures. The
       actual amount of revenue the IRS will protect is dependent on each taxpayer’s
       individual circumstances and the priority the IRS places on these erroneous
       claims. In addition, IRS management concluded that the 12,075 returns we
       identified are likely valid because ******2****** of the returns are under the
       selection tolerance or did not meet the existing filtering criteria. However, as
       discussed in this report, the IRS’s current criteria ****************2*****************
       ***************************************2*********************************************
       ******2******. Of the 12,075 returns we identified, **************2*****************
       ***************************************2*********************************************
       ************2************.




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                                                                  Appendix III
Management’s Response to the Draft Report




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                                                2

In addition to the steps taken in processing the returns, our post-processing
Discretionary Exam Business Rules (DEBR) identify casualty loss claims from
taxpayers ****************************2******************************, remove claims that
have additional factors indicating compliance, and address the remaining returns as
resources allow.

Additionally, we disagree with the outcome measure. Our review indicates that many of
the identified deductions are likely valid. TIGTA also fails to consider that the potentially
invalid deductions ****************************2**************************************************
********************2******************, and the opportunity costs of diverting resources from
more productive work.

Attached is our detailed response to your recommendations. If you have any questions,
please contact me or Scott Irick, Director, Examination Operations, SB/SE Division.

Attachment




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        Casualty and Theft Loss Deductions Continue to Be Erroneously Processed
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                                              2


of the FEMA number on the tax return to the FEMA number on the taxpayer’s account.
In addition, the match recommended by TIGTA could unnecessarily flag compliant
taxpayers for review who had input or transcription errors associated with the FEMA
number. The proposed matching would waste scarce resources and unduly burden
taxpayers who are already dealing with the aftermath of a disaster. In addition, SB/SE
currently has processes in place to identify taxpayers *****************2********************
****2****. These systemic rules were implemented in response to the Tax Cuts and Jobs
Act, which impacted returns reporting casualty and theft losses beginning with 2018 tax
years.

Implementation Date:
N/A

Responsible Official:
N/A

Corrective Action Monitoring Plan:
N/A


Recommendation 3:
The Commissioner, Wage and Investment Division, should review the 12,075 tax
returns we identified that claimed a casualty and theft loss deduction on Schedule A but
did not provide a sufficient FEMA number to determine if the taxpayers are entitled to
the deductions claimed.

Planned Corrective Action:
We analyzed the tax returns identified and found a significant number would not meet
our selection tolerance. We applied our existing filtering rule to the remaining cases to
remove cases that likely qualify for the casualty loss deduction. As a result, we
determined that nearly all the remaining cases would be eliminated from further
compliance action and that ***************2*************** of the cases identified by TIGTA
are above our selection tolerance. Under our current procedures, these cases are
available for selection in accordance with our existing prioritization and resources.

Implementation Date:
N/A

Responsible Official:
N/A

Corrective Action Monitoring Plan:
N/A




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                                              3


Outcome Measure 1:
Revenue Protection – Potential; approximately $41.3 million in additional income tax
assessed for 11,902 Tax Year 2019 tax returns due to noncompliance reporting for
casualty and theft deduction requirements; approximately $206 million over five years
(see Recommendations 1 through 3).

IRS Response:
We disagree with this outcome measure. As we noted in response to Recommendation
3, ***********2************ of the identified cases is below our selection tolerance. For the
remaining cases, TIGTA fails to consider the opportunity cost of diverting resources from
more productive work and *******************2**************************************************
**************************2**************************.




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                     Casualty and Theft Loss Deductions Continue to Be Erroneously Processed
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                                                                                        Appendix IV
                                        Glossary of Terms

Term                          Definition
                              The internal IRS portal that allows employees to access IRS data and
Employee User Portal          systems, such as tax administration processing systems and financial
                              information systems, in a secure, authenticated session.
                              The period from January through mid-April when most individual income
Filing Season
                              tax returns are filed.
                              The IRS database that maintains transactions or records of individual tax
Individual Master File
                              accounts.
Individual Returns            A database the IRS maintains that contains information on the individual tax
Transaction File              returns it receives.
Integrated Data Retrieval     IRS computer system capable of retrieving or updating stored information.
System                        It works in conjunction with a taxpayer’s account records.
                              The calendar year in which the tax return or document is processed by the
Processing Year
                              IRS.
                              A 12-month accounting period for keeping records on income and
Tax Year                      expenses used as the basis for calculating the annual taxes due. For most
                              individual taxpayers, the tax year is synonymous with the calendar year.




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                                                                            Appendix V
                              Abbreviations

FEMA              Federal Emergency Management Agency
IRS               Internal Revenue Service
TIGTA             Treasury Inspector General for Tax Administration




                                                                                  Page 17
             To report fraud, waste, or abuse,
                call our toll-free hotline at:
                         (800) 366-4484


                              By Web:
                      www.treasury.gov/tigta/


                             Or Write:
         Treasury Inspector General for Tax Administration
                            P.O. Box 589
                        Ben Franklin Station
                   Washington, D.C. 20044-0589




Information you provide is confidential, and you may remain anonymous.