The Internal Revenue Service (IRS) Inspection Service (now TIGTA) Report titled, Review of the Tax-Exempt Bond Program (Reference Number 062604, dated March 22, 1996), recommended the IRS increase the effectiveness in administering its Tax-Exempt Bond Program. It was also reported that a multi-functional approach was needed to increase the overall effectiveness of the IRS’ efforts to implement and manage a strategy for long-term success of the Program. At a minimum, this solution would require a concerted effort between the Employee Plans and Exempt Organizations, IRS Chief Counsel, Submission Processing and Information Systems functions. The audit report also noted that prior General Accounting Office recommendations concerning oversight, direction, staffing and training had not been fully resolved, due in part, to a lack of corporate commitment to the effort. As a result of these conditions, the IRS reported the lack of an automated processing system for the Tax-Exempt Bond Program as a Federal Managers’ Financial Integrity Act of 1982 (FMFIA), 31 U. S.C. §§ 1105-1106, 1113, and 3512 (1994) material weakness in 1996.

Most of the tax-exempt bond returns required to be filed with the IRS involve information reporting only. However, when investment decisions result in arbitrage, the issuers are required to report this activity to the IRS on an Arbitrage Rebate and Penalty in Lieu of Arbitrage Rebate return (Form 8038-T) and include any associated payments related to the earned interest that exceeded the arbitrage requirements. Between October 1998 and July 1999, the IRS processed approximately 1,045 of these returns in which receipts for arbitrage payments totaled $186 million.

The objectives of this follow-up audit were to review specific corrective actions taken as a result of prior audit recommendations related to the establishment of an information return processing system and oversight mechanism for the Tax-Exempt Bond Program, and to review any related corrective actions taken that may have strengthened overall controls concerning the Program.

The IRS has implemented some corrective actions from the prior audit report related to the control environment. However, further actions are needed to improve automated and manual systems for controlling Arbitrage Rebate and Penalty in Lieu of Arbitrage Rebate (Form 8038-T) bond returns, administer an effective transition of the Tax-Exempt Bond Program to its new processing site (the Ogden Service Center (OSC)), and control and track bond return examinations on the Audit Information Management System (AIMS). We believe the issue of not fully implementing an automated processing system, due to the lack of effective processing controls, continues to represent a FMFIA material weakness.

The IRS has taken some actions to improve the administration of the Tax-Exempt Bond Program. For example, the IRS has established a nationwide enforcement program, the Bond Focus Group, a detailed training curriculum on auditing techniques, and limited recording to the Masterfile system to control and process some tax-exempt bond returns. We believe these actions should result in needed improvements to the IRS’ Tax-Exempt Bond Program when fully implemented.

The IRS did not effectively implement corrective actions to ensure that all tax-exempt bond returns were properly and timely controlled. The Philadelphia Service Center (PSC) management did not adequately document the shipment of current year Form 8038-T returns (1998) to the OSC, and the OSC did not record these returns in the Return Inventory Classification System (RICS) between January and May 1999. As a result, the IRS was unable to assess the effectiveness of whether returns were controlled and information was accurately recorded on the System.

The IRS did not adequately resolve program transitional issues that resulted from the OSC taking control of the return processing operation for tax-exempt bonds. Specifically, the IRS did not always ensure that remittances attached to tax-exempt bond returns were timely deposited, and that shipment documents were properly completed for the massive transfer of bond returns from the PSC to the OSC. In addition, the IRS did not fully establish operating procedures to prevent the delayed processing of potentially late-filed bond returns. Unless these issues are promptly resolved, there is an increased risk that bond returns, including attached remittances, may be lost without detection, and that taxpayer burden will be increased as a result of delayed processing.

The IRS did not ensure that tax-exempt bond returns under examination were always controlled and tracked on the AIMS. Our analysis of 30 tax-exempt bond cases under examination indicated that 7 cases (23 percent) were not entered on the AIMS, as required. Unless bond cases are controlled and tracked on the AIMS, the IRS will not have an effective automated source to gather and analyze management information data to evaluate examination results and measure the Tax-Exempt Bond Program’s performance and accomplishments.

To ensure that the IRS effectively manages the Tax-Exempt Bond Program, we recommended that the IRS input all Forms 8038-T into the RICS, periodically monitor the various bond return information systems to promptly resolve any concerns that may impact processing, and follow all shipment procedures including the preparation of specific documentation of returns transferred to the OSC. We also recommended that the IRS revise tax-exempt bond preparation instructions to include the correct address where bond returns should be filed, record late-filed bond returns on the Masterfile and promptly address and resolve these late-filed returns with taxpayers, and process all incoming bond cases selected for audit on the AIMS before revenue agents start their audits.

Management’s Response:

IRS management agreed to the recommendations presented in the draft report. Further, management indicated that until the Masterfile is upgraded to process tax-exempt bond returns, the Tax-Exempt Bond Program will continue to be a FMFIA material weakness. Management’s complete response to the draft report is included as Appendix V.