The Internal Revenue Service Improved Its Process for Screening Prospective Preparers and Transmitters of Electronic Returns for 1999 Electronic Filing
November 1999
Reference Number: 2000-40-011
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.
November 8, 1999
MEMORANDUM FOR COMMISSIONER ROSSOTTI
FROM: Pamela J. Gardiner /s/ Pamela J. Gardiner
Deputy Inspector General for Audit
SUBJECT: Final Audit Report – The Internal Revenue Service Improved Its Process for Screening Prospective Preparers and Transmitters of Electronic Returns for 1999 Electronic Filing
This report presents the results of our review of the Internal Revenue Service's (IRS) Electronic Return Originator (ERO) suitability screening process for processing year 1999. We conducted our review as part of our overall review of the Revenue Protection Strategy to evaluate the effectiveness of the consolidation of suitability screening to one site.
In summary, we found that the IRS improved its process for screening prospective preparers and transmitters of electronic returns for the 1999 electronic return (e-file) program. However, improvements should be made to the suitability screening computer program, and cases referred to IRS management should be reviewed.
We recommended that management correct the gap in the computer screening program and that the IRS review the cases we identified that by-passed the suitability screening process.
IRS management agreed with the recommendations in the report when they were submitted as part of an interim memorandum we issued during the review. However, as of the date of this final report, IRS management had not provided a written response to the draft report. IRS management’s response to our interim memorandum has been incorporated into the report, where appropriate, and the full text of their response to that memorandum is included as an appendix.
Copies of this report are also being sent to the IRS managers who are affected by the report recommendations. Please contact me at (202) 622-6510 if you have any questions, or your staff may call Walter E. Arrison, Associate Inspector General for Audit (Wage and Investment Income Programs), at (770) 455-2475.
Appendix I – Detailed Objective, Scope, and Methodology
Appendix II – Major Contributors to This Report
Appendix III – Report Distribution List
Appendix V – Management's Response to Memorandum #1
Reducing the filing of federal tax returns claiming abusive refunds has been identified as a national problem. In March 1994, United States House of Representatives Ways and Means Committee members expressed to the Secretary of the Treasury their concern about the Internal Revenue Service’s (IRS) tax refund fraud prevention and detection systems. In October 1994, the Chairman of the Treasury Department Task Force on Tax Refund Fraud (the Treasury Under Secretary for Enforcement) reported back to the Ways and Means Committee that up to "$5 billion in ‘problematic’ refunds [was being] paid out annually."
One of the controls the IRS has in place to reduce the risk of bulk filing of electronic tax returns claiming abusive refunds is a process for analyzing (screening) the histories of businesses and individuals desiring to participate in electronic filing as electronic return originators (EROs). This control checks, among other things, whether individuals or firms desiring to participate in federal electronic filing as EROs have filed their federal tax returns, have paid their taxes, or have a criminal history. If a prospective or previously accepted ERO fails the suitability review, the IRS formally informs the ERO which criteria they failed. They then have appeal rights.
The objective of this audit was to determine if the IRS' process for annually rechecking (screening) the histories of previously admitted preparers and transmitters of electronic returns effectively ensured that only EROs meeting publicized qualifications continued to be approved to participate in the IRS' electronic return (e-file) program. This IRS screening process is commonly referred to in IRS publications and Internet sites as determining EROs’ "suitability" to participate in electronic filing.
Results
With the exception of one computer programming problem, the IRS’ annual suitability screening of bulk preparers and transmitters of electronic returns effectively ensured that only EROs meeting publicized qualifications were approved to participate in the 1999 e-file program.
Internal Revenue Service Tax Examiner Decisions to Allow Preparers and Transmitters of Electronic Returns to Continue to Participate in 1999 Electronic Filing Were Reasonably Accurate
The IRS' annual recheck of the suitability of preparers and transmitters of electronic returns was reasonably effective in ensuring that only EROs meeting publicized standards were approved to participate in the 1999 e-file program. A Federal Managers’ Financial Integrity Act report in 1992 had cited, as a material control weakness, the problem of electronic return preparers and transmitters with problem histories successfully re-applying "from IRS district office to IRS district office" around the country, until finding an office willing to admit them as electronic return preparers or transmitters.
The Internal Revenue Service’s Preliminary Computerized Review of Electronic Return Preparers and Transmitters Was Incomplete Due to a Programming Oversight
We noted that inappropriate EROs were scheduled to participate in the IRS’ 1999 e-file program. Due to a programming flaw, the preliminary computer screening program did not check for suitability problems in the histories of 7,274 of the approximately 195,000 ERO cases subject to review. Our follow up of the 7,274 revealed that the histories of 699 prospective EROs contained such characteristics as unpaid federal tax and unfiled federal tax returns, which should have subjected them to detailed suitability review by tax examiners prior to acceptance in the 1999 program.
We notified the Assistant Commissioner (Electronic Tax Administration) of this condition in a memorandum dated November 6, 1998, in time to suspend any unsuitable EROs before the 1999 tax filing season.
Summary of Recommendations
To further improve the suitability process for e-file EROs, we recommend that the IRS correct the gap in the computer screening program to prevent its recurrence in future years, and review the 699 cases for 1999 that should have been highlighted by the screening program.
Management’s Response: The Assistant Commissioner (Electronic Tax Administration) agreed with the recommendations listed in the report when they were submitted as part of an interim memorandum we issued during the review. However, as of the date of this report, IRS management had not provided a response to the report itself. The Assistant Commissioner’s response to our interim memorandum has been incorporated into the report, where appropriate, and the full text of the response to that memorandum is included as an appendix (see Appendix V). We provided the IRS with a draft report on September 15, 1999, with a 30-calendar day comment period.
The objective of this audit was to determine if the Internal Revenue Service’s (IRS) process for annually rechecking (screening) the histories of previously admitted preparers and transmitters of electronic returns effectively ensured that only electronic return originators (EROs), meeting publicized qualifications, continued to be approved to participate in the IRS' electronic return (e-file) program. To accomplish our objective, we analyzed the overall annual suitability process, and tested it by assessing the appropriateness of suitability determinations made on:
We initiated this review as part of our overall strategy to provide coverage of the IRS’ revenue protection activities.
We performed our tests at the Andover Service Center (ANSC). The audit was conducted between September 1998 and June 1999 in accordance with Government Auditing Standards.
See Appendix I for more information on our detailed objective, scope, and methodology. Major contributors to this report are listed in Appendix II.
In March 1994, United States House of Representatives Ways and Means Committee members expressed concern to the Secretary of the Treasury about the IRS’ tax refund fraud prevention and detection systems. In October 1994, the Chairman of the Treasury Department Task Force on Tax Refund Fraud (the Treasury Under Secretary for Enforcement) testified before the Congress that up to "$5 billion in ‘problematic’ refunds [was being] paid out annually."
One IRS revenue protection control is to screen the characteristics of all organizations and individuals that participate as EROs (preparers or transmitters) in the IRS’ e-file program. This process verifies, among other things, that individuals or firms desiring to participate as EROs have filed their federal tax returns and paid their taxes. The criteria the IRS uses to disqualify EROs is published on the Internet, and is prominently described in detail in the Handbook for Electronic Filers of Individual Income Tax Returns (IRS Publication 1345), which is provided to all EROs.
The e-file preparer/transmitter suitability computer program analyzes information on each ERO for compliance with the above-cited criteria. Tax examiners research each ERO the computer program identifies as possibly not meeting the qualifying criteria before final determination of suitability. New applicants are checked prior to admission, and previously accepted EROs are rechecked once a year (in an "annual" suitability recheck) to ensure continued adherence to the suitability standards.
The IRS centralized the national screening of ERO suitability from 33 district offices to a consolidated site at the ANSC. The consolidation of suitability processing was made in response to a 1992 report of a Federal Managers’ Financial Integrity Act (FMFIA) material weakness. That report stated that EROs with questionable histories had successfully "shopped" among IRS district offices around the country until they found an IRS office which would authorize their participation as bulk preparers or transmitters of federal income tax returns for that year.
The consolidation of the suitability process was done in two phases. In the first phase, for electronic returns to be processed in 1998, the IRS consolidated the processing of applications for new preparers and transmitters of electronic returns at the ANSC. For that year, the IRS’ 33 district offices continued to recheck the "annual" suitability of previously approved EROs. In preparation for processing returns in 1999, ANSC took over from the districts the "annual" rechecks of previously accepted EROs.
The consolidated site’s computerized preliminary annual suitability process for 1999 screened over 150,000 EROs, and identified 11,804 (8 percent) for further suitability research by tax examiners.
With the exception of one computer programming problem, the IRS’ annual recheck of the suitability of preparers and transmitters of electronic returns was reasonably effective in ensuring that only electronic return originators meeting publicized standards were approved to participate in the 1999 e-file program. Our audit work showed that for the 1999 processing year:
Internal Revenue Service Tax Examiner Decisions to Allow Preparers and Transmitters of Electronic Returns to Continue to Participate in 1999 Electronic Filing Were Reasonably Accurate
IRS tax examiners had made appropriate suitability decisions in 105 of 111 (95 percent) of the cases reviewed
Inappropriate decisions were made on 6 (5 percent) of the 111 cases selected for review. These inappropriate decisions were due to incomplete research and human error.
The percentage of ERO suspensions as a result of the annual suitability process increased for the 1999 processing year
As of October 15, 1998, the consolidated site’s preliminary screening of the approximately 150,000 EROs had identified 11,804 for tax examiner research.
Analysis by consolidated site tax examiners confirmed that 32 percent (3,834) of the 11,804 computer-identified EROs did not meet the criteria to participate for 1999. In the prior two years, when the annual suitability reviews were still dispersed around the nation, the IRS had confirmed as unsuitable only 12 percent (1997) and 9 percent (1998), respectively, of the computer-identified cases.
We believe this indicates that the IRS was successful in preventing unsuitable EROs from applying at multiple offices ("shopping around") for acceptance into the e-file program, as had been cited in the past. Specifically, the 1992 FMFIA report found that IRS’ ERO clearance systems had a material weakness because questionable ERO applicants were successfully "shopping around" the country for less-stringent IRS offices which would approve their suitability.
We reviewed the suitability characteristics of 10 EROs not identified by the preliminary screening computer program as having potential suitability problems (cleared before tax examiner review). Results showed that the suitability computer program for the 1999 processing year worked as intended in 9 of the 10 cases.
Our research into the tenth case, however, showed that the computerized screening program contained a gap (see the "Preliminary Computerized Review" section which follows).
The Internal Revenue Service’s Preliminary Computerized Review of Electronic Return Preparers and Transmitters Was Incomplete Due to a Programming Oversight
Through our review of current and prior year cases, we noted that inappropriate EROs were scheduled to participate in the IRS’ 1999 e-file program. We identified 7,274 ERO TINs (of the over 195,000) which had bypassed the preliminary computerized suitability check.
This condition occurred because the suitability programming had not considered certain possible ERO inter-relationships. Unless corrected, in future years inappropriate EROs could be admitted to the e-file program, increasing the program’s vulnerability to fraud.
Using readily available information to make computerized screening more complete is a sound management practice.
For the current tax processing year, we analyzed the 7,274 cases, and identified 699 ERO TINs meeting the criteria for tax examiner review. In a memorandum dated November 6, 1998, we notified the Assistant Commissioner (Electronic Tax Administration) of this condition (see Appendix IV). We also provided the 699 cases to consolidated site personnel at the ANSC. We were informed by local management that tax examiners worked these cases promptly, with a number of EROs being suspended from 1999 electronic filing.
Recommendations
To further improve the screening and suitability process for EROs, we recommend that the Assistant Commissioner (Electronic Tax Administration):
Management’s Response: The Assistant Commissioner (Electronic Tax Administration) responded to the Office of Audit's memorandum issued November 6, 1998, that the 699 cases would be reviewed for suitability, and that procedures were initiated to implement the recommended programming change (see Appendix V). As of the date of this report, IRS management had not provided a response to this report. We provided the IRS with a draft report on September 15, 1999, with a 30-calendar day comment period.
In October 1994, the Chairman of the Treasury Department Task Force on Tax Refund Fraud (the Treasury Under Secretary for Enforcement) reported back to the Ways and Means Committee that up to "$5 billion in ‘problematic’ refunds [was being] paid out annually." One of the controls the IRS has in place to reduce the risk of bulk filing of electronic tax returns claiming abusive refunds is a process for analyzing (screening) the histories of businesses and individuals desiring to participate in electronic filing as electronic return originators.
This audit showed that the IRS improved its process for screening prospective preparers and transmitters of electronic returns for the 1999 e-file program. However, improvements should be made to the suitability screening computer program, and cases referred to IRS management should be reviewed.
Appendix I
Detailed Objective, Scope, and MethodologyThe objective of this audit was to determine if the Internal Revenue Service’s (IRS) process for annually rechecking (screening) the histories of previously admitted preparers and transmitters of electronic returns effectively ensured that only electronic return originators (EROs), meeting publicized qualifications, continued to be approved to participate in the IRS' electronic return (e-file) program.
To accomplish our objective, we analyzed the overall annual suitability process, and tested it by assessing the appropriateness of annual suitability determinations made for 1999 processing. To conduct our tests, we:
Appendix II
Major Contributors to This ReportWalter E. Arrison, Associate Inspector General for Audit (Wage and Investment Income Programs)
Kerry R. Kilpatrick, Director
Donald J. Butler, Audit Manager
Mark A. Nathan, Audit Manager
Cheryl J. Cerqua, Senior Auditor
Kenneth C. Forbes, Senior Auditor
John E. O’Rourke, Senior Auditor
Theresa M. Berube, Auditor
Edith A. Lemire, Auditor
Appendix III
Report Distribution ListDeputy Commissioner Operations C:DO
Chief Information Officer IS
Chief Operations Officer OP
Assistant Commissioner (Criminal Investigation) OP:CI
Assistant Commissioner (Electronic Tax Administration) OP:ETA
Assistant Commissioner (Program Evaluation and Risk Analysis) M:OP
Executive Officer for Service Center Operations OP:SC
Director, Andover Service Center
National Director, Electronic Program Operations OP:ETA:O
National Director for Legislative Affairs CL:LA
Office of the Chief Counsel CC
Office of Management Controls M:CFO:A:M
Appendix IV
Memorandum #1: Ensuring That All Electronic Return Originators (EROs) Are Subject to the Annual Suitability Screening Process for Processing Year 1999Memorandum has been removed due to its size. To see the complete Memorandum, please go to the Adobe PDF version of this report.
Appendix V
Management's Response to Memorandum #1
Response has been removed due to its size. To see the complete Response, please go to the Adobe PDF version of this report.