A pair of reports from the Government Accountability Office found serious problems with the Internal Revenue Service’s processes for determining which individuals and businesses should be audited.

In one report, on the IRS’s Small Business/Self-Employed Division, the GAO found the IRS needs to strengthen certain internal controls for the audit. The GAO noted that the SB/SE division uses over 30 methods, called workstreams, to identify and review tax returns that may merit an audit. The returns were initially identified through seven sources which include referrals; computer programs that run filters, rules, or algorithms to identify potentially noncompliant taxpayers; and related returns that are identified in the course of another audit.

For fiscal year 2013, IRS reported that SB/SE's primary workstream for field audits identified approximately 1.6 million returns as potentially most noncompliant. About 77,500 returns (5 percent) were selected for audit, a much smaller pool of returns than was initially identified.

The GAO noted the SB/SE division has control procedures for safeguarding data and segregating duties across the overall selection process, among others, but it has not implemented other key internal controls. “The lack of strong control procedures increases the risk that the audit program's mission of fair and equitable application of the tax laws will not be achieved,” said the report.

The GAO gave some examples of internal control deficiencies, such not clearly defining the concept of “fairness.”

“Fairness is specified in SB/SE's mission statement and referenced in IRS's procedures for auditors,” said the report. “However, IRS has not defined fairness or program objectives for audit selection that would support its mission of treating taxpayers fairly. GAO heard different interpretations of fairness from focus group participants. Not having a clear definition of fairness can unintentionally lead to inconsistent treatment of taxpayers and create doubts as to how fairly IRS administers the tax law. Further, the lack of clearly articulated objectives undercuts the effectiveness of SB/SE's efforts to assess risks and measure performance toward achieving these objectives.”

In addition, the report found the IRS’s procedures for documenting and monitoring selection decisions are not consistent.

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

“In the SB/SE Examination sphere, the concept of fairness has both a collective and individual component,” wrote IRS Deputy Commissioner for Services and Enforcement John M. Dalrymple in response to the report. “The IRS takes into account the responsibilities and obligations that all taxpayers share. We pursue those individuals and businesses who fail to comply with their tax obligations to ensure fairness to those who do and to promote public confidence in our tax system, and we discharge these important responsibilities with a focus on taxpayer rights, as embodied in the Taxpayer Bill of Rights (TBOR) and formally adopted by the IRS.”

Wage and Investment Division Audits
The other GAO report issued Wednesday examined the returns selected for auditing by the IRS’s Wage and Investment Division. The report suggested the division should define its audit objectives and refine other internal controls.

Three offices in the W&I division are responsible for selecting returns for audit, according to the report. Most returns are selected via computer systems that automatically send notices to taxpayers based on certain criteria, such as the validity of dependents, according to the report. W&I program officials annually review the criteria and apply updates to the following filing season's returns. In 2014, approximately 59 percent of all W&I audits—more than 516,000—were selected with a specialized computer tool called the Dependent Database, while the remainder was selected through a combination of referrals and manual selection methods.

The report found the W&I division generally has established a positive environment for internal controls but could improve several areas in its audit selection procedures to support its mission. The GAO found several procedures that establish a positive environment for promoting internal controls, such as ethics training. In addition, the IRS has guidance to help ensure that decisions about updates to audit selection criteria are correctly implemented in its automated systems. However, the W&I division does not have established objectives for its audit selection process, and existing performance measures focus on audit results rather than audit selection. In addition, the division has not defined key terms such as “fairness and integrity,” as required by internal control standards. Documented objectives and key terms would help W&I hone the measures it uses to assess its audit selection efforts and bring a consistent understanding of “fairness and integrity” to audit selection staff.

The GAO also found that not all elements of the selection process were appropriately documented. For example, W&I does not have clear documentation about how the three offices that select the majority of returns W&I audits interact with one another. Additionally, one guidance document notes that returns with the highest audit potential should be marked, but it does not describe how audit potential is determined or any related internal controls. W&I also did not provide support showing that changes to automated audit selection processes and procedures were appropriately implemented in a timely manner. The documentation indicates the division conducts an annual—rather than continuous—review of its audit selections and results as part of an annual three-day working session.

“Strengthening controls in these areas would help provide greater assurance that W&I is fulfilling its mission to select tax returns with fairness and integrity,” said the report. “In addition, the absence of a fully documented selection process may make it difficult for W&I to defend against accusations that it is not appropriately following its processes and procedures.”

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

“We are pleased that the Government Accountability Office has recognized the positive environment for internal controls fostered within W&I,” wrote Dalrymple in response to the report. “We believe the current audit selection process, existing internal controls, and enhancement planned for implementation in 2016 provide more than reasonable assurance that audit selections are fair and are made with integrity.”

Congressional Reaction
However, two of the Republican leaders of Congress’s main tax-writing committee, the House Ways and Means Committee, expressed concern about the GAO’s findings in the two reports about the IRS’s audit selection process, suggesting that the flaws mean the IRS could continue to unfairly target American taxpayers based on their political beliefs and other First Amendment protected views.

“In December, Congress passed into law regulations to ensure that the IRS can no longer target American taxpayers for their political beliefs,” said House Ways and Means Committee chairman Kevin Brady, R-Texas, in a statement. “GAO has now exposed serious weaknesses in the IRS’s auditing process and confirmed that Americans remain at risk of political targeting. Ways and Means members will hold the IRS accountable for quickly implementing GAO’s recommendations and finally treating all American taxpayers fairly.”

House Ways and Means Subcommittee on Oversight chairman Peter Roskam, R-Ill., called on the IRS to immediately take action to address the GAO’s findings. “The American people deserve better,” he said. “We must do more to ensure the IRS treats all Americans fairly, holds employees responsible for these abuses accountable, and implements procedures to prevent this abuse from ever happening again.”
After the committee members learned that the IRS had targeted conservative groups applying for tax-exempt status, they were concerned that this could be happening in other divisions within the agency, particularly audit selection.

As a result, the committee asked the GAO to review each business unit within the IRS to determine whether there were protections in place to ensure that audits are selected fairly and without bias. Last July, the GAO released its first report on the Tax Exempt/Government Entities division and the Oversight Subcommittee held a hearing on this report. The two GAO reports released Wednesday confirmed serious problems at both the Small Business/Self Employed unit and the Wage & Investment unit, according to the lawmakers.

An IRS spokesperson emailed Accounting Today a further comment on the report. "The IRS stresses that audits of tax returns are based on the information contained on the taxpayer’s return and the underlying tax law – nothing else," said the IRS. "Politics play no factor in audit selection. There is nothing in the GAO reports that contradict that statement. GAO did not identify any instances where the selection of a case was considered inappropriate or unfair. The audit process is handled by career, non-partisan civil servants, and we have processes in place to safeguard the exam process.

"We generally agree with the recommendations in the GAO report and will take a number of steps to further improve our processes," the IRS statement continued. "The IRS has procedures in place that adhere to internal control standards, which help ensure fairness and integrity in the return selection process. No individual can control which tax returns are selected for audit. As required by law, we have a number of safeguards in place to restrict access to our systems to only authorized users. We emphasize the importance of fairness and integrity to fulfilling our responsibilities as the nation’s revenue agency."