Consistent and Effective Management Involvement Is Needed in Resolving Disagreements Over Audit Results

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TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION Consistent and Effective Management Involvement Is Needed in Resolving Disagreements Over Audit Results August 7, 2009 Reference Number: 2009-30-103 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. Phone Number | 202-622-6500 Email Address | [e-mail] Web Site | http://www.tigta.gov DEPARTMENT OF THE TREASURY WASHINGTON, D.C. 20220 TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION August 7, 2009 MEMORANDUM FOR COMMISSIONER, SMALL BUSINESS/SELF-EMPLOYED DIVISION FROM: Michael R. Phillips Deputy Inspector General for Audit SUBJECT: Final Audit Report – Consistent and Effective Management Involvement Is Needed in Resolving Disagreements Over Audit Results (Audit # 200830032) This report presents the results of our review to evaluate whether reviews conducted by group managers are effective tools in managing the outcome of field audits in the Small Business/Self-Employed (SB/SE) Division. The review was part of our Fiscal Year 2008 Annual Audit Plan under the major management challenge of Human Capital. Impact on the Taxpayer Consistent and effective managerial involvement in resolving disagreements over audit results can reduce ...

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TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION 

    Consistent and Efemtnaneg eaMtcvie  Involvement Is Needed in Resolving  Disagreements Over Audit Results        August 7, 2009   Reference Number: 2009-30-103                                       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.  

Phone Number | 202-652-6200  Email Address   |   [e-mail] vog.sae Web Site   |   htp:/ vogit.g.atwww

TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION

DEPARTMENT OF THE TREASURY WASHINGTON, D.C. 20220  

 

August 7, 2009

 

    MEMORANDUM FOR   COMMISSIONER, SMALL BUSINESS/SELF-EMPLOYED DIVISION    FROM:   Michael R. Phillips   Deputy Inspector General for Audit   SUBJECT:   itsitveen tM anatn d–  ECfofnesctiR perognaimleanAe  dtu F Involvement Is Needed in Resolving Disagreements Over Audit Results (Audit # 200830032)   This report presents the results of our review to evaluate whether reviews conducted by group managers are effective tools in managing the outcome of field audits in the Small Business/Self-Employed (SB/SE) Division. The review was part of our Fiscal Year 2008 Annual Audit Plan under the major management challenge of Human Capital. Impact on the Taxpayer  Consistent and effective managerial involvement in resolving disagreements over audit results can reduce additional costs to both taxpayers and the Internal Revenue Service (IRS). At a minimum, it should result in the taxpayers or their representatives having a clear understanding of the Federal Government’s position and, thereby, promote positive customer relations.   Synopsis  Group manager involvement in casework is considered a key to enhancing service and compliance because it makes taxpayer interactions less time consuming and less expensive especially when disputes surface in audits. The policy of the IRS is to resolve disagreements over audit results at the lowest practical level, and the initial step in the resolution process is for the group manager to contact the taxpayer or his or her representative to either resolve the disagreement or understand the basis for the disagreement. Besides promoting positive customer relations, such involvement is important from a revenue perspective. Our evaluation of IRS

 

Consistent and Efctedede ni nt Is NenvolvemeegemtnI vi eaMan Resolving Disagreements Over Audit Results 

Fiscal Year 2004 audit results found agreed audit assessments are far more likely to be collected than those assessed by default and produced, on average, $642 more in collections. To determine if group managers were involved in the resolution of audits, we reviewed 38 field audits 1 in which recommended additional taxes were assessed by default after examiners could not obtain agreement to the proposed taxes owed. In 24 (63 percent) of the 38 cases, we found that the level of managerial involvement was insufficient because the group manager did not contact the taxpayer or representative, as required by the Internal Revenue Manual, in an attempt to reach agreement with the taxpayer on the results of the audit. The high number of cases in our sample without consistent and effective managerial involvement to obtain agreement is a concern because we found the guidance for group managers to be detailed and adequate. The group managers who participated in a survey we conducted considered their involvement in audits critical to the success of audit outcomes, but indicated that administrative demands on their time hamper their ability to be more involved in audits. While administrative demands and other factors cited by group managers likely contributed to the problem, another more fundamental cause may be the attitude of the group managers regarding the value of attempting to contact taxpayers to reach agreement on audit results. In several cases, we found that managers were sufficiently involved in other areas of the audit, such as reviewing and approving penalties, but not in attempting to contact taxpayers or their representatives to obtain agreement. Both within and outside the Federal Government, a considerable body of research exists that indicates employee involvement in solving problems related to their jobs can be an effective way to identify fundamental causes of problems and effective solutions. We believe that the IRS in-house assessments underway with the Workforce of Tomorrow Task Force and the SB/SE Division Management Advisory Council may be a good way to ensure that the fundamental causes of the problems discussed in this report are identified and resolved.

Recommendations  We recommended that the Director, Examination, SB/SE Division, reemphasize to group managers the importance and need to be actively involved in securing agreement to the results of audits when agreement could not be obtained by the examiners. We also recommended that the Director, Examination, SB/SE Division, share the observations made in this report with the SB/SE Division Management Advisory Council and the Workforce of Tomorrow Task Force for use in their efforts to enhance the role of managers and to address administrative burden.

                                                  1 partnerships, and corporations that occur either at the taxpayer’s place of business or throughAudits of individuals, interviews at an IRS office.   2

Consistent and Efcedeeeind  vlmenIovsIN ne t Mantiveent agem Resolving Disagreements Over Audit Results 

Response 

IRS management agreed with our recommendations. The Director, Examination Policy, SB/SE Division, will publish an article in theTechnical Digest, an internal publication, detailing the importance of group manager involvement in securing agreement to audit results when an agreement could not be obtained by the examiner. The importance of managerial involvement will be also be reemphasized during a conference call with the Area Technical Analysts. In addition, this report will be shared with the SB/SE Division Management Advisory Council and the Human Capital Office, which assumed responsibility for the action items originating from the Workforce of Tomorrow Task Force. Management’s complete response to the draft report is included as Appendix VII. Copies of this report are being sent to the IRS managers affected by the report recommendations. Please contact me at [phone] if you have questions or Margaret E. Begg, Assistant Inspector General for Audit (Compliance and Enforcement Operations), at [phone].

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Consistent and EfeedNe iedn I vnloevemtnI  sctive Management Resolving Disagreements Over Audit Results 

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

Results of Review ...............................................................................................Page 3 Involvement by First-Line Managers Is Critical to the Successful Delivery of Vital Federal Government Programs and Services....................Page 3 Group Managers Need to Be More Involved in Securing Agreement to Audit Results.............................................................................................Page 5 Recommendations 1 and 2: ................................................Page 8

Appendices Appendix I – Detailed Objective,Scope, and Methodology ........................Page 9 Appendix II – Major Contributorsto This Report ........................................Page 11 Appendix III – Report Distribution List .......................................................Page 12 Appendix IV – Survey of Group Managers ..................................................Page 13 Appendix V – National Quality Review System - Standards and   Attributes for Field Audit..............................................................................Page 21 Appendix VI – National Quality Review System - Managerial Involvement Attribute ...................................................................................Page 23 Appendix VII – Management’s Response to the Draft Report.....................Page 25  

 

   

EQRS IRS NQRS SB/SE

Consistent and Ef t en NIsdeeeind gamene tnIovvlmeective Man Resolving Disagreements Over Audit Results 

    Abbreviations    Embedded Quality Review System Internal Revenue Service National Quality Review System Small Business/Self-Employed

 

Consistent and Ef ecvetian Mgamene tnIovvlmeent Is Needed in Resolving Disagreements Over Audit Results 

    Background    Tax return audits range from reviewing tax returns and resolving questionable items by corresponding with taxpayers through the mail to conducting a detailed, field audit of a taxpayer’s financial records at his or her place of business. In contrast to the less expensive and more automated correspondence audit process, field audits are more labor intensive and conducted by examiners who are trained to deal with and focus on more complex tax returns and issues. Typically, a field audit begins with the examiner explaining to the taxpayer or his or her representative the audit process and requesting information to support items on the tax return, which the examiner has identified for audit. If the items can be resolved by the information provided, the audit is closed without any tax changes. If not, the taxpayer or the representative is requested to provide more information or be informed of a recommended tax change. At this point, the taxpayer can agree with the examiner, provide the examiner with clarifying information, participate in a discussion with the examiner’s first-line manager (called a group manager), or appeal the decision administratively to the Internal Revenue Service (IRS) Office of Appeals. If an agreement cannot be reached at the group level and the decision is not appealed administratively, the IRS will issue a Notice of Deficiency 1 and the taxpayer may petition the Tax Court to contest the proposed assessment. If a taxpayer does not petition the Tax Court, the IRS will assess the recommended tax changes by default. Group managers are responsible for ensuring audits meet quality standards and are conducted timely. This is a significant role from both a taxpayer perspective and a revenue perspective because the IRS audits more than a million tax returns each year and identifies billions of dollars in additional tax revenue. To assist IRS group managers in meeting their responsibilities, the Internal Revenue Manual recommends that they use a variety of processes, such as reviews of ongoing audits, closed audits, overall inventory, and technical time reports, as well as on-the-job visits and ongoing observations and discussions with examiners. To facilitate and document group managers’ reviews, the IRS introduced the Embedded Quality Review System (EQRS) in March 2007. The EQRS is an online system designed, in part, to align individual performance with organizational goals by linking quality attributes to examiners’ performance plans. The system can generate individual reports that group managers use to provide examiners guidance, direction, and performance feedback. The IRS views the EQRS as one way of reducing administrative burden because the system standardizes the format

                                                  1 A legal document sent to a taxpayer which explains the proposed changes and the amount of the proposed tax increase.

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Consistent and EfmeveolnvNes  IntanaM eviI tnemegecteded in  Resolving Disagreements Over Audit Results 

  for the various types of reviews and takes the guesswork out of linking the attributes with examiners’ critical job elements. Mid-level managers also use the EQRS to monitor the level and adequacy of group manager involvement in audits. They may also evaluate ongoing work in open audits during operational reviews. Operational reviews are required to be performed at least annually to ensure that work is being done in conformance with IRS policies and procedures. After an audit closes, National Quality Review System (NQRS) reviewers may evaluate the audit case file to determine whether the examiner complied with quality attributes and assess the level of managerial involvement. Besides serving as a quality control, the purpose of the NQRS is to collect information about the audit process, communicate areas of concern to top management, identify potential training needs, and improve work processes. See Appendix V for more details on the NQRS standards and associated attributes.   This review was performed in the Small Business/Self-Employed (SB/SE) Division Examination function in New Carrollton, Maryland, and in Campus 2 Compliance Services at the Memphis Campus in Memphis, Tennessee, during the period May 2008 through March 2009. Except for auditing IRS databases to validate the accuracy and reliability of the information, we conducted this performance audit in accordance with generally accepted government audit 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. Detailed information on our audit objective, scope, and methodology is presented in Appendix I. Major contributors to the report are listed in Appendix II.

                                                  2  campuses process paper and electronic submissions, correct errors, andThe data processing arm of the IRS. The forward data to the Computing Centers for analysis and posting to taxpayer accounts. Page 2  

Consistent and EfetcaManvi ent IgemevemenvoleN sI tn ni dede Resolving Disagreements Over Audit Results 

    Results of Review    Involvement by First-Line Managers Is Critical to the Successful Delivery of Vital Federal Government Programs and Services First-line managers have an extremely important role in the Federal Government because they are responsible for the day-to-day implementation of the policies, procedures, and practices that deliver vital programs and services to the public. Ensuring the successful delivery of such programs on a day-to-day basis is no easy task and is becoming even more challenging. According to a report issued by the Office of Personnel Management, first-line managers are “supervising greater numbers of employees, using broader delegations of authority, helping more employees balance work and family demands, [and] responding to increasing demands for customer service…” 3  Moreover, first-line managers throughout the Federal Government are also dealing with the demands and burdens of supervising an increasingly inexperienced workforce due to the large numbers of experienced personnel retiring. TheIRS Organization Blueprint 2000 4 for modernization helped lay the foundation to focus efforts on reducing the administrative demands on group managers so they could have more time for involvement in audits and other compliance casework. Increasing managerial involvement in casework is considered a key to enhancing service and compliance because it makes taxpayer interactions less time consuming and less expensive especially when disputes surface in audits. Since Fiscal Year 2000, the IRS continues to make progress towards better positioning its group managers to take a greater role in the audit process. A significant step was establishing four operating divisions to serve and ensure the compliance of specific taxpayer segments. By grouping taxpayers together, the IRS envisions that group managers and the examiners they supervise will have less difficulty focusing on issues and problems unique to the taxpayers they serve. Other steps taken to reduce administrative burden include the reinvigorated Management Advisory Councils, numerous pro-forma audit checklists, an online human resource system, and computer-based training packages. In addition, top IRS executives have formed, and are leading, a cross functional Workforce of Tomorrow Task Force that is charged with dealing with a host of human capital issues that range from streamlining hiring practices to enhancing the role of managers by addressing the competing demands on the group managers’ time and attention. The continuing emphasis on the importance of managerial involvement in the audit process is likely a significant contributing factor to a favorable trend NQRS reviewers are finding in their                                                   3   Report of a Special Study – Supervisors in the Federal Government: A Wake-Up Call (January 2001). 4 IRS Document 11052 (Rev 4-2000). Page 3  

Consistent and Efective ManageedNes  In  iedvnI tnemtnemevlo Resolving Disagreements Over Audit Results 

  evaluations of closed audits in the SB/SE Division. As Figure 1 illustrates, the percentage of audits where the level of group manager involvement was found to be appropriate by NQRS reviewers increased from 76.3 percent for the 12 months ending September 2007 to 81.3 percent for the 12 months ending March 31, 2009. Figure 1: Percentage of Audits in Which the Level of Group Manager Involvement Was Appropriate – September 2007 through March 2009

78.4

79.5

80.0

81.3

82.0 81.0 80.0 79.0 78.0 77.0 76.0 76.3 76.4 75.0 74.0 73.0 Sep-07 De c-07 Mar-08 Jun-08 Se p-08 De c-08 Mar-09 Ending Date of 12-M onth Pe riod

77.0

Source: Treasury Inspector General for Tax Administration analysis of IRS NQRS results for SB/SE Division Field Audits for Fiscal Years 2007, 2008, and 2009. Since managers are not expected, nor required, to be involved in every audit, it is important to recognize what the NQRS percentage in Figure 1 does and does not represent. In general, the percentage measures the portion of audits selected for quality review in which the level of managerial involvement was deemed appropriate compared with the total number of sampled cases that were reviewed. The percentage does not measure the level of group manager involvement by specific types of case closings, such as those in which taxpayers agreed or did not agree with the examiners’ findings. More details about NQRS evaluations of managerial involvement in the audit process are included in Appendix VI. While the NQRS shows that the overall level of managerial involvement in SB/SE Division audits is trending favorably, our evaluation of 38 closed field audits suggests that group managers need to be more involved in attempting to obtain agreement in audits. Group managers who participated in our survey 5 cited various factors that could have contributed to the absence of consistent and effective managerial involvement found in the cases reviewed. The                                                   5 the detailed results of our survey.See Appendix IV for

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Consistent and Efdei eeNde nveolnv Is  IntmeaM evitctnemegan Resolving Disagreements Over Audit Results 

  IRS may find our survey results and other observations made in this report useful in its continuing efforts to better position group managers to take a greater role in the audit process. Group Managers Need to Be More Involved in Securing Agreement to Audit Results The policy of the IRS is to resolve disagreement in audits at the lowest practical level, and the initial step in the resolution process is for the group manager to contact the taxpayer to either resolve the disagreement or understand the basis for the disagreement. This step is critical because managerial involvement in disagreements can result in the case being closed agreed or partially agreed, which can reduce additional costs to both the IRS and taxpayers by avoiding a protracted dispute resolution process. When a taxpayer agrees with the results of an audit, there is an additional benefit of enhancing tax revenues because agreed audit assessments are far more likely to be collected than those assessed by default. To illustrate, we evaluated statistically valid samples of Fiscal Year 2004 agreed audits and audits where the taxes were assessed by default after examiners could not obtain agreement. As summarized in Figure 2, our evaluation found that as of February 2009, most (94 percent) of the additional taxes assessed in agreed audits had been collected while only about 27 percent was collected from the taxes assessed by default. We also found that, on average, the agreed audits produced $642 more in collections than the audits where the taxes were assessed by default. Figure 2: Comparison of Audit Assessments Collected as of February 2009 Type of Returns Total Amount Collected Percent Average Amount Assessment Audited Assessments Collected Collected Agreed  94% $9,333 $585,850 $550,666 59   Default 382 $12,418,135 $3,320,008 $8,691 27%   Source: Treasury Inspector General for Tax Administration analysis of random samples of agreed and defaulted audit cases. To determine if group managers were involved in cases in which the examiner could not obtain agreement, we reviewed 38 field audits that were closed between October 2007 and March 2008 after the taxpayer failed to respond to requests from the IRS for agreement. We determined that in 24 (63 percent) of the 38 audits, the level of managerial involvement was insufficient because the group manager did not contact the taxpayer or representative, as required by the Internal Revenue Manual, in an attempt to reach agreement with the taxpayer on the results of the audit. Overall, the high number of cases in our sample without appropriate and effective managerial involvement is a concern because we found the guidance for group managers to be detailed and adequate. Given the adequacy of the guidance and feedback from the NQRS, we believe there is no easy solution to enhancing the consistency and effectiveness of managerial involvement in Page 5