The Internal Revenue Service needs to improve the system it uses to assess the quality of the correspondence audits it conducts with taxpayers as the IRS’s own quality review system failed to detect errors in more than half of the IRS’s penalty determinations, according to a new report.
For the report, from the Treasury Inspector General for Tax Administration, TIGTA evaluated a statistical sample of 127 of 2,913 correspondence audits that had been reviewed by the IRS’s National Quality Review System during an 18 month period and found errors with penalty determinations in 65 of the audits (in other words, 51 percent) that had not been detected and reported by NQRS quality reviewers.
The NQRS is designed to provide IRS managers at all levels with estimates of audit quality from a sample of audits to use in identifying areas in which corrective actions are needed. However, TIGTA identified areas that could be strengthened to increase the accuracy of NQRS review results, enhance the ability of managers to identify and address quality problems with correspondence audits, and ensure that the NQRS sample is selected at random.
Correspondence audits are audits that the IRS conducts through letters to taxpayers in which IRS examiners generally request additional information. They are generally seen as more cost effective and easier to carry out than in-person audits at IRS offices or the taxpayer’s location.
In the report, which TIGTA released Tuesday, TIGTA found that auditing standards and NQRS quality measures need to be better aligned. The auditing standards, including the consideration given to significant issues, contain key requirements not evaluated under the NQRS. But this can create inconsistencies in how examiners conduct audits and in how the NQRS evaluates the quality of those audits to identify errors.
TIGTA recommended that IRS executives and stakeholders should be provided with a more comprehensive snapshot of audit quality so that the necessary corrective actions can be recognized and taken in a timely manner. Only one overall measure of audit quality is currently reported on a quarterly basis by the NQRS to IRS executives and other key stakeholders even though as many as 71 items are reviewed. Finally, TIGTA pointed out that the random selection of audits for NQRS review could not be verified, and TIGTA was not able to confirm the statistical validity of the NQRS results.
TIGTA suggested that the IRS ensure that the IRS’s auditing standards align with the NQRS quality measures, and that a more complete picture of correspondence audit quality is provided to NQRS customers on a regular basis. Audits also should be selected randomly for NQRS review, TIGTA recommended.
In response to the report, IRS management agreed with the first two recommendations and said they plan to take corrective action. However, IRS management disagreed with the third recommendation, indicating that they do not have a cost-effective way to allow the randomness of the NQRS case selection process to be verified. Because the IRS’s conclusion was reached after the draft report was issued, TIGTA said the underlying details supporting the conclusion were not evaluated. But TIGTA pointed out that if the sample selection process cannot be verified, the IRS cannot be assured of the statistical validity of NQRS results.
“The audit is one of the IRS’ primary enforcement tools to address noncompliance with the tax law,” wrote Faris Fink, commissioner of the IRS’s Small Business/Self-Employed Division, in response to the report. “Over the last five years, our statistics show we conducted almost 5.7 million correspondence audits. The quality of our work is important, and we thank you for acknowledging that we have established a comprehensive system to measure the quality of correspondence audits.”
The IRS’s auditing standards outline the criteria that have been determined to produce a quality examination and are guidelines to assist examiners in the completion of their cases, Fink noted. The auditing standards are used in conjunction with applicable program procedures for evaluating case quality, but in the campus environment, due in part to the type of examination conducted and in part to the nature of the IRS’s processes, some auditing standards will be less applicable, he added. The campus examinations are generally narrowly focused and are limited to a particular schedule or issue, or they focus on stopping erroneous refunds. He said the IRS would determine if there are discrepancies between the auditing standards and the quality attribute coding and adjust the process or guidance as needed.
Fink pointed out that the IRS regularly shares more specific information about program performance with executives and all levels of IRS management who use it to monitor, evaluate and take action to improve the programs. He said the IRS would determine if providing additional quality data with more frequency would be helpful.
He explained his disagreement with TIGTA’s third recommendation about selecting audits randomly for NQRS review. “Audit cases selected for NQRS are determined based upon a statistically valid methodology designed by Statistics of Income (SOI) as described in the sample plan,” he wrote. “We ensure the randomness of a sample by selecting the Nth’ case using a skip interval based on the number of required reviews and the population of work. Upon closure of paper cases they are placed in a designated area ready for potential review. The clerk pulls the cases by applying the skip interval as determined in the sample plan. Once the sample has been selected, the unused cases are removed and the area is stocked with the next day’s cases. While the process is valid, it is not reproducible because the cases are removed daily. We have reviewed our current system to determine alternatives for creating a reproducible process. Given the volume of open cases is over 300,000, the resources necessary to implement a reproducible manual process would not be cost effective. In the alternative, a systemic report could be created, but this would take funding and years to implement. Based upon labor and cost restrictions, we are unable to implement a systemic method as per your recommendation.”
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