Avoidable Interest Was Paid on Tentative Carryback Refunds
Requested by Corporate Taxpayers
September 2004
Reference Number: 2004-30-171
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.
September
10, 2004
MEMORANDUM FOR
COMMISSIONER, SMALL BUSINESS/SELF-EMPLOYED DIVISION
FROM: Gordon C. Milbourn III /s/ Gordon C.
Milbourn III
Acting Deputy Inspector General
for Audit
SUBJECT: Final Audit Report – Avoidable Interest
Was Paid on Tentative Carryback Refunds Requested by Corporate Taxpayers (Audit
# 200330039)
This
report presents the results of our review of refunds from Corporation
Application for Tentative Refund (Form 1139).
The overall objective was to determine whether refunds were timely
issued to avoid the payment of interest and to satisfy taxpayer rights.
Corporate
taxpayers file Forms 1139 to obtain refunds of tax by carrying back net
operating losses, net capital losses, or unused general business credits to
earlier years. The Internal Revenue Service (IRS) has 90 days to make any
refund or credit but must issue any refunds within 45 days to avoid paying
interest.
In
summary, the IRS paid corporate taxpayers an estimated $22.8 million in
interest on an estimated 3,300 late refunds issued for amounts greater than
$10,000 based on Forms 1139 processed in Calendar Year (CY) 2002. Interest was paid because the refunds were
not issued within 45 days. We determined
that the IRS could have taken actions to avoid payment of an estimated $12.6
million of this interest. We were unable
to determine how much, if any, of the remaining $10.2 million could have been
avoided, due to unavailable documents and other issues that may have
contributed to the delays.
We
recommended the Director, Customer Account Services (CAS), Small Business/Self-Employed
(SB/SE) Division, ensure interest reports are maintained to reflect the
circumstances that delayed Tentative Carryback Refunds beyond the 45-day
interest-free period and ensure corrective action is taken when the volume of
instances signifies that a problem exists.
Management’s Response: The IRS
generally agreed with our recommendation.
The Accounts Management (AM) Operation within CAS, SB/SE Division, will
request an ad hoc report from the Net Tax Refunds Report to specifically
identify Tentative Carryback Interest.
The report will enable campuses to monitor refund and interest issued
daily on Forms 1139. The AM Program Management/Process
Assurance Staff and campuses will review data collected from the ad hoc reports
through October 30, 2004, and provide recommendations, along with an assessment
of the usefulness of the report, to the Deputy Director, AM, SB/SE Division, by
November 15, 2004.
IRS management agreed with
the avoidable interest paid for CY 2002, but believed that the measurable
benefit on tax administration of $48.3 million, projected over 5 years, should
be reduced to reflect current performance.
The IRS experienced a 30 percent reduction in receipts and anticipates
this will continue. Management’s
complete response to the draft report is included as Appendix V.
Office of Audit Comment: The
computation of the measurable benefit on tax administration recognizes that
interest paid on late refunds in CY 2003 was about 30 percent less than the
amount paid in CY 2002. Our review of
actual cases was limited to those processed in CY 2002. To estimate the avoidable interest paid in CY
2003, the CY 2002 ratio of avoidable interest to total interest paid on late
refunds was applied to the total interest paid on late refunds in CY 2003. We used the lower CY 2003 estimate for each of 4 years in
addition to the CY 2002 amount to arrive at our 5-year estimate of $48.3
million of interest that could have been avoided. The computations are included in Appendix IV.
Copies of this
report are also being sent to the IRS mangers affected by the report
recommendation. Please contact me at (202)
622-6510 if you have questions or Philip Shropshire, Acting Assistant Inspector
General for Audit (Small Business and Corporate Programs), at (215) 516-2341.
The Payment
of an Estimated $12.6 Million in Interest Could Have Been Avoided
Appendix
I – Detailed Objective, Scope, and Methodology
Appendix
II – Major Contributors to This Report
Appendix
III – Report Distribution List
Appendix IV
– Outcome Measures
Appendix V –
Management’s Response to the Draft Report
Corporations are generally required to file a U.S. Corporation Income Tax Return (Form 1120) on an annual basis. In some years, corporations may have a net operating loss, net capital loss, or unused general business credit. In these situations, they may carry back these losses or credits to earlier tax years and obtain a refund of their taxes by filing a Corporation Application for Tentative Refund (Form 1139). The tax for those years is recomputed with the loss or credit, and the accounts are adjusted for the difference. The Internal Revenue Service (IRS) has 90 days from the latter of the date that the Form 1139 is filed or the last day of the month the loss year return is due (with extensions) to make any refund or credit. However, the IRS must pay interest if the refund is not issued within 45 days.
The Accounts Management Operation at the Cincinnati and Ogden Campuses processed approximately 133,000 adjustments to Form 1120 accounts, based on Forms 1139 (also known as “tentative carryback” adjustments), in Calendar Year (CY) 2002. Almost 38,000 were for amounts in excess of $10,000, and an estimated 36,400 of these resulted in refunds.
This review was performed at the IRS Cincinnati and Ogden Campuses in Customer Account Services during the period October 2003 through March 2004. The audit was conducted in accordance with Government Auditing Standards. Detailed information on our audit objective, scope, and methodology is presented in Appendix I. Major contributors to the report are listed in Appendix II.
The IRS paid corporate taxpayers an estimated $22.8 million in interest on an estimated 3,300 late refunds (9 percent of the 36,400 refunds) issued based on Forms 1139 processed in CY 2002. Interest was paid because the refunds were not issued within 45 days. We determined that by improving processes the IRS could have taken actions to avoid payment of an estimated $12.6 million of this interest on 87 percent of the estimated 3,300 late refunds. Due to unavailable documentation and other issues that may have contributed to the delays, we were unable to determine how much, if any, of the remaining $10.2 million of interest on 13 percent of the estimated 3,300 late refunds could have been avoided.
An estimated $2.5 million in interest payments could have been avoided by expediting refunds
Almost half of the late refunds were late because they were allowed to refund in the normal refund time, rather than being expedited. These refunds were issued with an estimated $2.5 million in interest that would not have been paid had the refunds been expedited when the Forms 1139 were processed.
IRS procedures require that all refunds in excess of $1 million resulting from a tentative carryback adjustment be expedited. Refunds for amounts less than $1 million, but over the tolerance based on local procedures, should be expedited when the 45-day interest-free period is in jeopardy to avoid the payment of interest. These procedures, however, were not always followed.
An estimated $10.1 million in avoidable interest was paid due to other factors
Several other factors contributed to the delay in the issuance of refunds involving an estimated $10.1 million in avoidable interest. These other factors and the percentage of avoidable interest associated with each include the following:
· Forms 1139 were received in the Accounts Management Operation in sufficient time to issue timely refunds, but there was a delay in processing the forms (45.1 percent).
· Refunds were delayed because some adjustments containing errors were not promptly corrected, and some refunds were stopped for review purposes (26.0 percent).
· Delays were caused by shipping cases from other campuses and Area Offices (16.5 percent).
· Delays at the Cincinnati Campus, of as much as 51 days, occurred between the time forms were received at the Campus and the time they were received in the Accounts Management Operation where they are processed (7.9 percent).
· Forms 1139 were erroneously sent directly to the Examination function before the accounts were adjusted and refunds issued (2.5 percent).
· Forms 1139 were processed timely, but the refunds were sometimes held to offset a portion of the overpayment to a balance due on another account (1.7 percent). The refunds were not issued until some time after the forms were processed.
· Refunds were returned as undeliverable due to errors made by IRS personnel (.2 percent).
In December 2001, the IRS consolidated the 10 campuses working these cases to 2, requiring additional employees with specialized training to handle the increased workload at these 2 campuses. In addition, the nationwide volume of these tentative carryback adjustments in CY 2002 increased 40 percent over the CY 2001 volume. Part of this increase was attributable to the Job Creation and Workers Assistance Act of 2002.
The Act, which allowed taxpayers to carry losses back 5 years instead of 2 years, became effective after some taxpayers had already filed Forms 1139 and received refunds. Therefore, the taxpayers filed amended Forms 1139, requiring tax adjustments in earlier years and, in some cases, reassessment of the previous adjustments. Resulting overpayments in 1 year had to be offset to satisfy newly created balances in other years, complicating the issuance of refunds.
An additional estimated $10.2 million in interest was
paid, some of which may have been avoidable
In 13 percent of the estimated 3,300 late refunds, we were unable to determine whether or not the payment of an estimated $10.2 million in interest could have been avoided.
In some cases, we were unable to secure the necessary documents to determine the cause for the delay in issuing refunds paid with an estimated $6.3 million in interest.
In the other cases, an additional $3.9 million was paid on late refunds, which may or may not have been avoidable. We estimate that for the cases where we could not make a determination:
· Interest was paid on refunds of taxpayers in litigation or due to insolvency issues (40.2 percent). The refunds, which must be approved before issuance, may not be approved until well after the Form 1139 has been processed. While the delay in obtaining approval could not be avoided in some cases, a case started too close to the 45-day limit would not allow sufficient time to obtain approval and issue the refund timely.
· Delays were attributed to waiting for documents, necessary for proper computations, from other areas or files (28.6 percent).
· Refunds were based on a Form 1139 that was originally disallowed or lost and based on certified receipts (16.9 percent).
· Delays were caused by necessary corrections to previous actions on the account before the refund could be issued (14.3 percent).
Significant improvements have been made in processing Form 1139 refunds
During 2002, the Ogden Campus processed almost three times
the number of tentative carryback adjustments as they processed in the previous
year.
While Forms 1139 are processed by employees in the Tentative Carryback Unit of the Taxpayer Relations Department at the Ogden Campus, Customer Service Representatives (CSR) in the Toll Free Department process most Forms 1139 at the Cincinnati Campus. The CSRs were aware that refunds were being issued late, with interest. However, they were performing a dual role: processing adjustments, and handling customer service phone calls. The phone calls took priority over processing Forms 1139.
Also, in CY 2002, Forms 1139 were distributed to any personnel with the appropriate training in the teams throughout the Accounts Management Operation at the Cincinnati Campus. Since CY 2002, distribution of Forms 1139 for processing at the Cincinnati Campus has been limited to only a few groups and control over these cases has greatly improved. A new system of sorting and identifying cases by age and amount enables any CSR to readily prioritize cases to be worked.
While the managers presently ensure that the CSRs have the necessary time for these cases, handling phone calls remains the priority. This could result in delays in processing Forms 1139 during periods of heavy receipts.
The causes of late refunds should be analyzed to reduce interest payments
Despite the improvements in procedures, an estimated $16 million in interest was paid on an estimated 3,000 late refunds based on Forms 1139 processed in CY 2003.
In the past, an interest report was prepared for management by the tax examiner in each instance when interest was paid on an expedited refund issued based on a Form 1139. The case was reviewed, and the report recorded the progress of Form 1139 since receipt and the cause for the delay. These reports have been discontinued. A simpler report recording the cause of delays in processing any Form 1139 case where the refund will be issued in excess of the 45-day limit would alert management to any recurring problems requiring attention. By using interest reports to monitor interest, management can promptly address the causes and reduce the payment of avoidable interest.
The Net Tax Refunds Report, generated from the Interim Revenue Accounting Control System, captures interest from some of these refunds, but the total interest paid on tentative carryback refunds processed by the Accounts Management Operation is not separately identified.
The Director, Customer Account Services (CAS), Small
Business/Self-Employed (SB/SE) Division, should ensure:
1. Interest reports are maintained to reflect the circumstances that delayed Tentative Carryback refunds beyond the 45-day interest-free period. These reports should be routed to a level of management with the authority to take corrective action when the volume of instances signifies that a problem exists.
The Director should determine whether it is feasible for the information captured for Corporation Income in the “Net Tax Refunds Report” to be altered to separately identify tentative carryback adjustments and whether the report could be used as a tool to monitor the interest on the normal (generated) refunds.
Management’s Response: The IRS generally agreed with our recommendation. The Accounts Management (AM) Operation within CAS, SB/SE Division will request an ad hoc report from the Net Tax Refunds Report to specifically identify Tentative Carryback Interest. The report will enable campuses to monitor refund and interest issued daily on Forms 1139. The AM Program Management/Process Assurance Staff and campuses will review data collected from the ad hoc reports through October 30, 2004, and provide recommendations, along with an assessment of the usefulness of the report to the Deputy Director, AM, SB/SE Division, by November 15, 2004.
IRS management agreed with the amount of avoidable interest
paid for CY 2002 but believed the measurable benefit on tax administration of
$48.3 million, projected over 5 years, should be reduced to reflect current
performance. The IRS experienced a 30
percent reduction in receipts and anticipates this will continue.
Office of Audit Comment: The computation of the measurable benefit on tax administration recognizes that interest paid on late refunds in CY 2003 was about 30 percent less than the amount paid in CY 2002. Our review of actual cases was limited to those processed in CY 2002. To estimate the avoidable interest paid in CY 2003, the CY 2002 ratio of avoidable interest to total interest paid on late refunds was applied to the total interest paid on late refunds in CY 2003. We used the lower CY 2003 estimate for each of 4 years in addition to the CY 2002 amount to arrive at our 5-year estimate of $48.3 million of interest that could have been avoided. The computations are included in Appendix IV.
Appendix I
Detailed
Objective, Scope, and Methodology
The objective of this audit was to determine whether refunds from Corporation Application for Tentative Refund (Form 1139) were timely issued to avoid the payment of interest and to satisfy taxpayer rights.
To accomplish our objective, we:
I.
Reviewed the U.S.
Corporation Income Tax Return (Form 1120) accounts of
the tax adjustments in our samples (details of samples to follow), and all of
the tax adjustments for amounts in excess of $1 million. We determined whether interest-free refunds
were issued within 45 days and whether any refunds were in excess of 90 days.
II.
Reviewed Internal
Revenue Manuals related to the processing of Forms 1139. We determined the correct dates to be
reflected in the adjustments and reviewed instructions for issuing manual
refunds.
III.
Reviewed the
adjustments where refunds were issued with interest and determined whether the
correct Tentative Carryback dates were used.
IV.
Determined, where possible,
the cause of the refund delays and whether the refunds could have been issued
timely.
To obtain our samples, we extracted all Transaction Codes
(TC) 295, Abatement of Prior Tax With Interest Computation Date, processed in
Calendar Year (CY) 2002 to the Business Masterfile (BMF) for an amount greater
than $10,000. We eliminated any TC 295s
processed to an account for U.S. Income Tax Return for Estates and Trusts (Form
1041) because these forms are not processed by the Small Business/Self-Employed
Division, and the 161 TC 295s processed for Exempt Organization Business Income
Tax Returns (Form 990T) and Farmers’ Cooperative Association Income Tax Returns
(Form 990C) due to the insignificant volume.
We also eliminated any TC 295s that were not processed at the
We stratified the results for each site into 3 categories
because the interest paid on refunds in excess of $1 million distorted the
dollars projected to the universe. Also,
processing differs somewhat in each of the categories.
Adjustments for amounts of $10 million or
greater
We reviewed the account of each TC 295 with amounts of $10
million or greater (
Adjustments for amounts of $1 million or
greater, but less than $10 million
We also reviewed the account of each TC 295 for an amount
of $1 million or greater, but less than $10 million (
Adjustments for amounts of $10,000 or
greater, but less than $1 million
We reviewed the accounts of a statistically valid sample of
539 randomly selected cases out of 13,434 TC 295s processed at the Cincinnati
Campus for amounts of $10,000 or greater, but less than $1 million. We also reviewed the accounts of a
statistically valid sample of 428 randomly selected cases out of 21,658 TC 295s
processed at the Ogden Campus for amounts of $10,000 or greater, but less than
$1 million.
Samples were selected using a 95 percent confidence level
and a confidence interval of 5. At the
95 percent confidence level, attribute sampling was used to project the number
of cases where interest was paid on the refund, and variable sampling was used
to project dollars of interest paid. For
the CY 2002
We also extracted a file of the TC 295s for amounts of
$10,000 or greater processed to Form 1120 accounts in CY 2003. We stratified these results for each site as
we did for CY 2002 cases. We reviewed
the account of each TC 295 for an amount of $10 million or greater (
In addition, we reviewed the account of each TC 295 for an
amount of $1 million or greater, but less than $10 million processed at the
Cincinnati Campus in CY 2003 (63), but we reviewed the accounts for only a
sample of the TC 295s in this range processed at the Ogden Campus. Specifically, we reviewed the accounts of a
statistically valid sample of 339 randomly selected cases out of 1,691 TC 295s
for amounts of $1 million or greater, but less than $10 million processed at
the
We reviewed the accounts of a statistically valid sample of
381 randomly selected cases out of 12,557 TC 295s processed at the Cincinnati
Campus in CY 2003 for amounts of $10,000 or greater, but less than $1
million. We also reviewed the accounts
of a statistically valid sample of 383 randomly selected cases out of 21,837 TC
295s processed at the Ogden Campus for amounts of $10,000 or greater, but less
than $1 million.
Samples were selected using a 95 percent confidence level
and a confidence interval of 5. At the
95 percent confidence level, attribute sampling was used to project the number
of cases where interest was paid on the refund, and variable sampling was used
to project dollars of interest paid. For
the CY 2003
Appendix II
Major Contributors to This
Report
Philip Shropshire,
Acting Assistant Inspector General for Audit (Small Business and Corporate
Programs)
Richard J. Dagliolo, Director
Kyle R. Andersen,
Acting Director
Robert
K. Irish, Audit Manager
Dolores
Castoro, Lead Auditor
Carol Gerkens, Senior
Auditor
Appendix III
Commissioner C
Office of the Commissioner – Attn: Chief of Staff C
Deputy Commissioner for Services and Enforcement SE
Deputy Commissioner, Small Business/Self-Employed Division SE:S
Director, Customer Account Services, Small Business/Self-Employed Division SE:S:CAS
Chief Counsel CC
National Taxpayer Advocate TA
Director, Office of Legislative Affairs CL:LA
Director, Office of Program Evaluation and Risk Analysis RAS:O
Office of Management Controls OS:CFO:AR:M
Audit Liaison: Commissioner, Small Business/Self-Employed Division SE:S
Appendix IV
This appendix presents detailed information on the measurable impact that our recommended corrective actions will have on tax administration. This benefit will be incorporated into our Semiannual Report to the Congress.
Type and Value of Outcome Measure:
· Funds put to better use – Potential; Estimated $48.3 million saved (see page 2).
Methodology Used to Measure the Reported Benefit:
A database of all tentative carryback adjustments, Transaction Codes (TC) 295, processed to U.S. Corporation Income Tax Return (Form 1120) accounts in Calendar Year (CY) 2002 was extracted. From this database of 135,843 transactions, less 235 for the transactions that were split into 2 due to a partial reassessment, we extracted the 56,883 processed at the Cincinnati Campus and the 76,173 processed at the Ogden Campus. For each Campus, we extracted a file of all transactions for amounts of $10,000 or greater, so that any interest paid would be significant. The resulting databases consisted of 13,732 transactions for the Cincinnati Campus and 24,145 for the Ogden Campus.
Each database was further stratified to amounts of $10,000
or greater, but less than $1 million; $1 million and greater, but less than $10
million; and $10 million or greater. The
We reviewed the account of each TC295 in these files to determine if interest was paid on the refund due to issuance in excess of 45 days. We found that the Internal Revenue Service (IRS) paid an estimated $22.8 million in interest, determined as follows:
In the
In the
We also reviewed all of the tentative carryback adjustments
for amounts of $1 million or more for
We reviewed the cases to determine why issuance of the refund was delayed and found the IRS could have taken actions to avoid the payment of an estimated $12.6 million in interest on late refunds, determined as follows:
In the
In the
We also reviewed all of the tentative carryback adjustments
for amounts of $1 million or more for
We also extracted a database of all TC 295s processed to Form 1120 accounts in CY 2003. From this database of 147,967 transactions, less 87 for the transactions that were split into 2 due to a partial reassessment, we extracted the 63,731 processed at the Cincinnati Campus and the 79,389 processed at the Ogden Campus. For each Campus, we extracted files of transactions for amounts of $10,000 or greater, so that any interest paid would be significant. The resulting databases were stratified to amounts of $10,000 or greater, but less than $1 million; $1 million and greater, but less than $10 million; and $10 million or greater. The databases included 12,642 transactions for the Cincinnati Campus and 24,009 for the Ogden Campus.
The
We reviewed the account of each TC 295 in these files to determine if interest was paid on the refund due to issuance in excess of 45 days. We found that the IRS paid an estimated $16.2 million in interest on late tentative carryback refunds processed in CY 2003, determined as follows:
In the
In the
Interest of $1,528,122 was paid on late refunds in 17 of the 63 cases where the tentative carryback adjustment processed at the Cincinnati Campus was for an amount of $1 million or greater, but less than $10 million.
In the
Interest of $4,021,282 was paid on late refunds in 3 of the 22 cases where the tentative carryback adjustment processed at the Cincinnati Campus was for an amount of $10 million or greater, and interest of $4,628,107 was paid on late refunds in 14 of the 481 cases for this amount processed at the Ogden Campus.
Projection of estimated avoidable interest for 5 years:
While CY 2002 was an exceptional year due to the consolidation from 10 campuses to 2 campuses processing Forms 1139 and increased volume of Forms 1139 due to the Job Creation and Workers Assistance Act of 2002, the payment of interest on tentative carryback refunds continued in CY 2003. We estimated the volume of avoidable interest paid in CY 2003 based on the ratio in CY 2002 of avoidable interest to interest paid, and used the CY 2003 estimated amount to project avoidable interest for an additional 3 years.
Total estimated avoidable interest for CY 2002: $12,586,644 ($2,128,656 + $2,530,345 + $3,631,206 + $4,296,437).
Estimated interest paid on late refunds in CY 2002: $22,771,136 ($2,851,694 + $4,094,654 + $7,832,751 + $7,992,037)
Estimated interest paid on Late Refunds in CY 2003: $16,161,086 ($1,517,496 + $1,650,466 + $1,528,122 + $2,815,613 + $4,021,282 + $4,628,107)
$12,586,644 / $22,771,137 = .5527
.5527 X $16,161,086 = $8,932,232
$8,932,232 X 4 years = $35,728,928 (2003 through 2006)
$12,586,644 (2002)
Estimated avoidable interest: $48,315,572
Appendix V
Management’s
Response to the Draft Report
The response was removed due to its
size. To see the response, please go to
the Adobe PDF version of the report on the TIGTA Public Web Page.