This is the accessible text file for GAO report number GAO-03-243 
entitled 'Financial Audit: IRS's Fiscal Years 2002 and 2001 Financial 
Statements' which was released on November 15, 2002.



This text file was formatted by the U.S. General Accounting Office 

(GAO) to be accessible to users with visual impairments, as part of a 

longer term project to improve GAO products’ accessibility. Every 

attempt has been made to maintain the structural and data integrity of 

the original printed product. Accessibility features, such as text 

descriptions of tables, consecutively numbered footnotes placed at the 

end of the file, and the text of agency comment letters, are provided 

but may not exactly duplicate the presentation or format of the printed 

version. The portable document format (PDF) file is an exact electronic 

replica of the printed version. We welcome your feedback. Please E-mail 

your comments regarding the contents or accessibility features of this 

document to Webmaster@gao.gov.



Report to the Secretary of the Treasury:



November 2002:



FINANCIAL AUDIT:



IRS’s Fiscal Years 2002 and 2001 Financial Statements:



GAO-03-243:



Letter:



Auditor’s Report:



Opinion on IRS’s Financial Statements:



Opinion on Internal Controls:



Compliance with Laws and Regulations and FFMIA Requirements:



Consistency of Other Information:



Objectives, Scope, and Methodology:



Agency Comments and Our Evaluation:



Management Discussion and Analysis:



Financial Statements:



Balance Sheets:



Statement of Net Cost:



Statement of Changes in Net Position:



Statement of Budgetary Resources:



Statement of Financing:



Statement of Custodial Activity:



Notes to the Financial Statements:



Supplemental and Other Accompanying Information:



Appendixes:



Appendix I: Material Weaknesses, Reportable Conditions, and Compliance 

Issues:



Appendix II: Details on Audit Methodology:



Appendix III: Comments from the Internal Revenue Service:



Abbreviations:



EITC: Earned Income Tax Credit:



FFMIA: Federal Financial Management Improvement Act of 1996:



FFMSR: Federal Financial Management Systems Requirements:



FIA: Federal Managers’ Financial Integrity Act of 1982:



IRS: Internal Revenue Service:



JFMIP: Joint Financial Management Improvement Program:



OMB: Office of Management and Budget:



P&E: property and equipment:



SGL: U.S. Government Standard General Ledger:



TIGTA: Treasury Inspector General for Tax Administration:



Letter November 15, 2002:



The Honorable Paul H. O’Neill

The Secretary of the Treasury:



Dear Mr. Secretary:



The accompanying report presents the results of our audits of the 

financial statements of the Internal Revenue Service (IRS) as of and 

for the fiscal years ending September 30, 2002 and 2001. We performed 

our audits in accordance with the Chief Financial Officers (CFO) Act of 

1990, as expanded by the Government Management Reform Act of 1994. This 

report contains our (1) unqualified opinions on IRS’s financial 

statements, (2) opinion that IRS’s internal controls were not effective 

as of September 30, 2002, and (3) conclusion regarding IRS’s 
noncompliance 

with two provisions of laws and regulations that we tested and IRS’s 

financial management systems’ lack of substantial compliance with the 

requirements of the Federal Financial Management Improvement Act of 

1996.



Our unqualified opinions on IRS’s fiscal years 2002 and 2001 financial 

statements were made possible by the continued extraordinary efforts of 

IRS senior management and staff to compensate for serious internal 

control and financial management systems deficiencies. Meeting a 

significantly accelerated reporting date for the issuance of the 

financial statements for fiscal year 2002 was also a major 

accomplishment. The Office of Management and Budget (OMB) required that 

agencies accelerate their timeline for issuing audited financial 

statements. For fiscal year 2002, OMB requires that agencies issue 

their audited financial statements by February 1, 2003, and for fiscal 

year 2004, OMB requires that agencies issue their audited financial 

statements by November 15, 2004, or 6 weeks after the end of the fiscal 

year. The Department of the Treasury went a step further and 

established a goal of completing its fiscal year 2002 audit, including 

those of its component entities such as IRS, and issuing its 

departmentwide accountability report by November 15, 2002.



In our report on the results of our audits of IRS’s fiscal year 2001 

and 2000 financial statements,[Footnote 1] we discussed obstacles to 

IRS’s ability to achieve the department’s goal. At that time, we noted 

that if IRS was to meet this deadline and sustain an unqualified 

opinion on its financial statements, the tremendous amount of hard work 

and commitment IRS demonstrated in recent years alone would not be 

sufficient unless accompanied by systemic changes in how IRS processed 

its transactions, maintained its financial records, and reported its 

financial results. IRS took this message seriously and made great 

strides in each of these areas. For example, IRS made a significant 

investment in improving its approach to analyzing, processing, and 

recording certain transactions throughout the year; previously, such 

analyses were not performed until the end of the fiscal year, an 

approach that limited our ability to test significant transactions and 

balances at interim periods. Other business process changes, such as 

better ongoing reviews of obligation levels and activity, enabled us to 

reduce the classification of control issues related to budgetary 

activity from a material weakness to a reportable condition. IRS’s 

actions, coupled with the continued use of costly, resource-intensive 

processes to compensate for the continued serious weaknesses in systems 

and controls, enabled IRS to achieve Treasury’s goal.



Nonetheless, it will remain a challenge for IRS management and staff to 

sustain the level of effort needed to produce reliable financial 

statements until the agency is able to fully address the underlying 

systems and internal control issues that have made this process so time 

consuming and resource intensive. Presently, IRS continues to lack 

timely, accurate, and useful financial information and sound controls 

with which to make fully informed decisions and to ensure ongoing 

accountability, which is the end goal of the CFO Act. IRS has made 

significant progress in addressing its serious control and systems 

deficiencies and improving financial management during the past 5 years 

under the strong leadership of former Commissioner Charles Rossotti and 

Acting Commissioner Robert Wenzel. It is important that these financial 

management initiatives continue to receive the needed support to 

achieve comprehensive and lasting financial management reform.



The accompanying report also discusses other significant issues that we 

considered in performing our audit and in forming our conclusions that 

we believe should be brought to the attention of IRS management and 

users of IRS’s financial statements.



We are sending copies of this report to the Chairmen and Ranking 

Minority Members of the Senate Committee on Appropriations; Senate 

Committee on Finance; Senate Committee on Governmental Affairs; Senate 

Committee on the Budget; Subcommittee on Treasury, General Government, 

and Civil Service, Senate Committee on Appropriations; Subcommittee on 

Taxation and IRS Oversight, Senate Committee on Finance; Subcommittee 

on Oversight of Government Management, Restructuring, and the District 

of Columbia, Senate Committee on Governmental Affairs; House Committee 

on Appropriations; House Committee on Ways and Means; House Committee 

on Government Reform; House Committee on the Budget; Subcommittee on 

Government Efficiency, Financial Management, and Intergovernmental 

Relations, House Committee on Government Reform; and Subcommittee on 

Oversight, House Committee on Ways and Means. In addition, we are 

sending copies of this report to the Chairman and Vice-Chairman of the 

Joint Committee on Taxation, the Acting Commissioner of Internal 

Revenue, the Director of the Office of Management and Budget, the 

Chairman of the IRS Oversight Board, and other interested parties. 

Copies will be made available to others upon request. In addition, the 

report will be made available at no charge on GAO’s Web site at http:/

/www.gao.gov.



This report was prepared under the direction of Steven J. Sebastian, 

Director, Financial Management and Assurance, who can be reached at 

(202) 512-3406. If I can be of further assistance, please call me at 

(202) 512-5500.



Sincerely yours,



David M. Walker

Comptroller General of the United States:



Signed by David M. Walker



[End of Section]



Auditor’s Report To the Acting Commissioner of Internal Revenue:



In accordance with the Chief Financial Officers (CFO) Act of 1990, as 

expanded by the Government Management Reform Act of 1994, this report 

presents the results of our audits of the financial statements of the 

Internal Revenue Service (IRS) for fiscal years 2002 and 2001.[Footnote 

2] The financial statements report the assets, liabilities, net 

position, net costs, changes in net position, budgetary resources, 

reconciliation of net costs to budgetary obligations, and custodial 

activity related to IRS’s administration of its responsibilities for 

implementing federal tax legislation. The financial statements do not 

include an estimate of the amount of taxes owed the federal government 

but which have not been identified by IRS, often referred to as the tax 

gap.



In its role as the nation’s tax collector, IRS has a demanding 

responsibility in collecting taxes, processing tax returns, and 

enforcing the nation’s tax laws. The size and complexity of IRS’s 

operations present additional challenges to management. IRS is a large, 

complex organization with tens of thousands of people in 10 service 

center campuses, three computing centers, and numerous other field 

offices throughout the United States. In each of fiscal years 2002 and 

2001, IRS collected more than $2 trillion in tax payments, processed 

more than 200 million tax returns, and paid about $281 billion and $251 

billion, respectively, in refunds to taxpayers.



One of the largest obstacles facing IRS management today continues to 

be the agency’s lack of a financial management system capable of 

producing the reliable and timely information its managers need to 

assist in making day-to-day decisions. Because of this systems issue 

and other factors, IRS continues to face many of the pervasive internal 

control weaknesses that we have reported each year since we began 

auditing its financial statements in fiscal year 1992.[Footnote 3] 

Nevertheless, in fiscal year 2002, for the third consecutive year, IRS 

was able to produce financial statements covering its tax custodial and 

administrative activities that are fairly stated in all material 

respects. Moreover, IRS was able to produce these statements by 

November 15, 2002, only a month and a half after the end of the fiscal 

year.[Footnote 4]



The significant acceleration of IRS’s reporting date was a major 

accomplishment and represents a significant improvement over previous 

years. In our report on the results of our audit of IRS’s fiscal years 

2001 and 2000 financial statements, we noted that for IRS to be able to 

achieve this ambitious goal for fiscal year 2002, it would need to make 

fundamental changes in the way it processed transactions, maintained 

its records, and reported financial information. IRS made great strides 

in each of these areas in fiscal year 2002. However, these improvements 

alone were not enough to make this outcome possible. Many of IRS’s 

longstanding systems and internal control weaknesses continued to 

exist, necessitating continued reliance on costly compensating 

processes, statistical projections, external contractors, substantial 

adjustments, and monumental human efforts to prepare a set of reliable 

financial statements. These costly efforts would not have been 

necessary if IRS’s systems and controls had operated effectively.



Strong commitment, hard work, and a reassessment of certain basic 

business processes by both IRS senior leadership and staff were the key 

to IRS’s ability to meet Treasury’s goal of both receiving an 

unqualified audit opinion on its financial statements and issuing the 

statements by November 15, 2002. Part of the reason IRS was able to 

meet this accelerated reporting goal was that it made further 

refinements to its compensating procedures. Another essential element 

was IRS’s significant investment in improving its approach to 

processing and recording certain types of transactions throughout the 

year, rather than undertaking end-of-year analyses of transactions and 

activity to produce financial statement balances--a process that in 

prior years took several months to complete. During the latter half of 

fiscal year 2002, for example, IRS was able to produce quarterly 

financial information on property and equipment acquisitions within a 

few weeks after the end of each quarter. Previously, such information 

for the entire fiscal year was not available until several months after 

the fiscal year end. IRS also significantly enhanced its accountability 

over budgetary activity by increasing the frequency of its analyses of 

outstanding obligations and other budgetary accounts. As a result of 

these and other improvements, IRS management had earlier access to 

information and we were able to test financial data on an interim basis 

during the year rather than almost exclusively at year end.



IRS made notable progress in a number of areas in fiscal year 2002 and 

has laid the groundwork for sustainable improvements in several others. 

IRS’s continued progress in addressing deficiencies in its controls 

over budgetary activity, for example, allowed us to conclude that the 

remaining issues related to budgetary activity no longer constitute a 

material weakness. At the same time, despite improvements in controls 

over property and equipment, financial reporting, and computer 

security, further actions are needed, and we continue to consider these 

issues as well as management of unpaid assessments and collection of 

revenue and issuance of tax refunds to be material weaknesses.[Footnote 

5]



Producing financial statements within a month and a half after the end 

of the fiscal year while sustaining an unqualified opinion was a 

significant accomplishment for IRS. At the same time, however, the 

effort it took placed a considerable strain on IRS resources and 

required substantial contractor support. IRS has clearly made progress 

in improving its financial management, and several of the process 

changes IRS made in fiscal year 2002 represent good financial 

management practices. Nevertheless, it will be difficult for IRS 

personnel to sustain the level of effort needed to produce reliable 

financial statements timely without addressing the underlying systems 

and internal control problems that cause this process to be so 

unnecessarily time consuming and expensive. Additionally, this process 

does not produce the reliable, useful, and timely financial and 

performance information IRS needs for decision making on an ongoing 

basis, which is a goal of the CFO Act, nor can it fully address the 

underlying financial management and operational issues that adversely 

affect IRS’s ability to effectively fulfill its responsibilities as the 

nation’s tax collector.



The challenge for IRS will be to continue the improvements made in 

recent years and to develop and implement the fundamental long-term 

solutions that are needed to address the internal control weaknesses we 

have identified. As we have seen, some of these solutions can be 

addressed in the near term through the continued efforts and commitment 

of IRS senior management and staff. Others, which involve modernizing 

IRS’s financial and operational systems, will take years to fully 

achieve.



Opinion on IRS’s Financial Statements:



IRS’s financial statements, including the accompanying notes, present 

fairly, in all material respects, in conformity with U.S. generally 

accepted accounting principles, IRS’s assets, liabilities, net 

position, net costs, and custodial activity, as of and for the fiscal 

years ended September 30, 2002, and September 30, 2001, and IRS’s 

changes in net position, budgetary resources, and reconciliation of net 

costs to budgetary obligations for the fiscal year ended September 30, 

2002.



However, misstatements may nevertheless occur in other financial 

information reported by IRS as a result of the internal control 

weaknesses described in this report.



IRS’s financial statements include tax revenues collected during the 

fiscal year as well as the total unpaid taxes for which IRS, the 

taxpayer, or courts agree on the amounts owed. Cumulative unpaid tax 

assessments for which there is no future collection potential or for 

which there is no agreement on the amounts owed are not reported in the 

financial statements. Rather, they are reported as write-offs and 

compliance assessments, respectively, in supplemental information to 

IRS’s financial statements. Also, in accordance with U.S. generally 

accepted accounting principles, to the extent that taxes owed in 

accordance with the nation’s tax laws are not reported by taxpayers and 

are not identified through IRS’s various enforcement programs, they are 

not reported in the financial statements nor in supplemental 

information to the financial statements. As IRS discusses in the 

accompanying information to the financial statements, its current 

estimate of the magnitude of these unidentified and unpaid taxes--

referred to as the tax gap--is between $250 billion and $300 billion.



Opinion on Internal Controls:



Because of the material weaknesses in internal controls discussed 

below, IRS did not maintain effective internal controls over financial 

reporting (including safeguarding of assets) or compliance with laws 

and regulations, and thus did not provide reasonable assurance that 

losses, misstatements, and noncompliance with laws material in relation 

to the financial statements would be prevented or detected on a timely 

basis. Our opinion is based on criteria established under 31 U.S.C. 

3512 (c), (d), commonly referred to as the Federal Managers’ Financial 

Integrity Act of 1982 (FIA), and OMB’s Circular A-123, Management 

Accountability and Control.



Despite its material weaknesses in internal controls and its system 

deficiencies, IRS was able to prepare, primarily through compensating 

processes and approaches, financial statements that were fairly stated 

in all material respects for fiscal years 2002 and 2001. Nonetheless, 

IRS continues to face the following key issues that represent material 

weaknesses in internal controls:



* weaknesses in controls over the financial reporting process, 

resulting in IRS not (1) being able to prepare reliable financial 

statements without extensive compensating procedures or (2) having 

current and reliable ongoing information to support management decision 

making and to prepare cost-based performance measures;



* weaknesses in controls over unpaid tax assessments, resulting in 

IRS’s inability to properly manage unpaid assessments and leading to 

increased taxpayer burden;



* weaknesses in controls over the identification and collection of tax 

revenues due the federal government and over the issuance of tax 

refunds, resulting in potentially billions of dollars in improper 

payments and lost revenue to the federal government;



* weaknesses in controls over property and equipment, resulting in 

IRS’s inability to have reliable and timely information on its balance 

of property and equipment throughout the year and to reasonably ensure 

that its property and equipment are safeguarded and used only in 

accordance with management policy; and:



* weaknesses in computer security controls, resulting in increased risk 

of unauthorized individuals being allowed to access, alter, or abuse 

proprietary IRS programs and electronic data and taxpayer information.



The material weaknesses in internal controls noted above may adversely 

affect any decision by IRS’s management that is based, in whole or in 

part, on information that is inaccurate because of these weaknesses. In 

addition, unaudited financial information reported by IRS, including 

budget and performance information, may also contain misstatements 

resulting from these weaknesses.



In addition to the material weaknesses discussed above, we identified 

two reportable conditions which, although not material weaknesses, 

represent significant deficiencies in the design or operation of 

internal controls that could adversely affect IRS’s ability to meet the 

internal control objectives described in this report. These conditions 

concern deficiencies in (1) controls over budgetary activity, which 

affect IRS’s ability to routinely ensure that its budgetary resources 

are being properly accounted for, reported, and controlled and (2) 

controls over hard-copy tax receipts and taxpayer data, which increase 

the government’s and taxpayers’ risk of loss or inappropriate 
disclosure 

of taxpayer data. We reported controls over budgetary activity as a 

material weakness in our prior audits, but based on improvements we 
found 

during our fiscal year 2002 audit, we have reassessed it as a 
reportable 

condition.



We have reported on these material weaknesses and reportable conditions 

in prior audits and have provided IRS numerous recommendations to 

address these issues. More than 60 of these recommendations were still 

open as of the date of this report. IRS has made marked strides in 

resolving these matters. We will follow up in future audits to monitor 

IRS’s progress in implementing these recommendations. For more details 

on these issues, see appendix I.



Compliance with Laws and Regulations and FFMIA Requirements:



Our tests of compliance with selected provisions of laws and 

regulations disclosed two instances of noncompliance with laws and 

regulations that were reportable under U.S. generally accepted 

government auditing standards. These related to IRS’s (1) lack of 

timely release of tax liens on taxpayers’ property and (2) failure to 

ensure that installment agreements were structured to require that 

taxpayers fully satisfy their tax liability within the statutory 

collection period.[Footnote 6] Also, IRS’s financial management systems 

did not substantially comply with the requirements of the Federal 

Financial Management Improvement Act of 1996 (FFMIA): (1) Federal 

Financial Management Systems Requirements, (2) applicable federal 

accounting standards (U.S. generally accepted accounting principles), 

and (3) the U.S. Government Standard General Ledger (SGL) at the 

transaction level. IRS has readily acknowledged that its financial 

management systems do not comply with FFMIA and that it needs to 

overhaul these systems as part of its broader systems modernization 

efforts. For more details on these issues, see appendix I.



Except as noted above, our tests for compliance with laws and 

regulations disclosed no other instances of noncompliance that would be 

reportable under U.S. generally accepted government auditing standards 

or OMB audit guidance. However, the objective of our audit was not to 

provide an opinion on overall compliance with laws and regulations. 

Accordingly, we do not express such an opinion.



Consistency of Other Information:



IRS’s Management Discussion and Analysis, required supplemental 

information, and other accompanying information contain a wide range of 

data, some of which are not directly related to the financial 

statements. We did not audit and do not express an opinion on this 

information. However, we compared this information for consistency with 

the financial statements and discussed the methods of measurement and 

presentation with IRS officials. Based on this limited work, we found 

no material inconsistencies with the financial statements or 

nonconformance with OMB guidance. Under OMB guidance for the financial 

statements of federal agencies, agencies are asked to strive to develop 

and report objective measures that, to the extent possible, provide 

information about the cost-effectiveness of their programs. We found, 

however, that because of the noted internal control and systems 

limitations, IRS cannot report reliable cost-based performance measures 

relating to its various programs in accordance with the Government 

Performance and Results Act of 1993.



Objectives, Scope, and Methodology:



Management is responsible for (1) preparing the annual financial 

statements in conformity with U.S. generally accepted accounting 

principles, (2) establishing, maintaining, and assessing internal 

control to provide reasonable assurance that the broad control 

objectives of 31 U.S.C. 3512, (c), (d), FIA are met, (3) ensuring that 

IRS’s financial management systems substantially comply with the 

requirements of FFMIA, and (4) complying with applicable laws and 

regulations.



We are responsible for obtaining reasonable assurance about whether 

(1) the financial statements are presented fairly, in all material 

respects, in conformity with U.S. generally accepted accounting 

principles and (2) management maintained effective internal controls, 

the objectives of which are the following:



* Financial reporting--transactions are properly recorded, processed, 

and summarized to permit the preparation of financial statements in 

conformity with U.S. generally accepted accounting principles and 

assets are safeguarded against loss from unauthorized acquisition, use, 

and disposition.



* Compliance with laws and regulations--transactions are executed in 

accordance with laws governing the use of budget authority and with 

other laws and regulations that could have a direct and material effect 

on the financial statements and any other laws, regulations, and 

governmentwide policies identified by OMB audit guidance.



We are also responsible for (1) testing whether IRS’s financial 

management systems substantially comply with the three FFMIA 

requirements, (2) testing compliance with selected provisions of laws 

and regulations that have a direct and material effect on the financial 

statements and laws for which OMB audit guidance requires testing, and 

(3) performing limited procedures with respect to certain other 

information appearing in these annual financial statements. For more 

details on our methodology, see appendix II.



We did not evaluate all internal controls relevant to operating 

objectives as broadly defined by FIA, such as controls relevant to 

preparing statistical reports and ensuring efficient operations. We 

limited our internal control testing to testing controls over financial 

reporting and compliance with laws and regulations.



We did not test compliance with all laws and regulations applicable to 

IRS. We limited our tests of compliance to those laws and regulations 

that had a direct and material effect on the financial statements or 

that were required to be tested by OMB audit guidance that we deemed 

applicable to the financial statements for the fiscal year ended 

September 30, 2002. We caution that noncompliance may occur and not be 

detected by these tests and that such testing may not be sufficient for 

other purposes.



We performed our work in accordance with U.S. generally accepted 

government auditing standards and OMB audit guidance.



Agency Comments and Our Evaluation:



In responding to this report, IRS noted that the report fairly 

presented IRS’s progress and its remaining challenges. IRS noted that, 

in addition to maintaining its unqualified audit opinion, it also met 

the significant challenge set by the Secretary of the Treasury of 

completing the fiscal year 2002 audit by November 15, 2002, 6 weeks 

after the end of the fiscal year and 3 and a half months earlier than 

last year. IRS noted that this was accomplished by making significant 

improvements in its financial management by reassessing and 

systematically changing how it processes transactions, maintains 

financial records, and reports financial results. IRS cited a number of 

financial management reforms and improvements, which contributed to its 

ability to retain the clean opinion and to meet the accelerated 

reporting date. For example, IRS noted that it implemented procedures 

to improve the timeliness and accuracy of recording property and 

equipment transactions in its accounting records, enhanced its 

accountability over budgetary activity by increasing the frequency of 

its analyses of outstanding obligations and other budgetary accounts, 

conducted a comprehensive assessment of its strategic initiatives to 

prioritize the programs relative to its mission and available 

resources, revised its information technology security policy and 

guidance, and began conducting periodic security reviews of receipt 

processing areas. In addition, IRS noted that it took specific actions 

in fiscal year 2002 to expedite the resolution of material weaknesses 

identified under its annual FIA assessment process, revised its 

remediation plans for custodial and administrative financial management 

systems to align the remediation plans with its material weakness plans 

and business system modernization plans, and included more intermediate 

target dates to help ensure that it stays on schedule for bringing its 

systems into FFMIA compliance.



In its response, IRS recognized that it is only through implementation 

of the new integrated financial management system that IRS will be able 

to overcome many of the material weaknesses cited in the report. IRS 

noted that it would focus on ensuring that its financial management 

practices are institutionalized and that its new integrated financial 

system is implemented. IRS added that it would continue the 

improvements made in the last few years as it develops and implements 

the fundamental long-term solutions needed to address the internal 

control weaknesses cited in the report.



In its response, IRS agreed with the issues presented in the report. 

However, in commenting on the report’s discussion of IRS’s controls 

over budgetary activity, IRS disagreed with the report’s statement that 

IRS management and staff might enter into obligations that exceed the 

budgetary authority made available by Congress. IRS indicated that it 

clearly does have the capability to prevent this from happening, and, 

according to IRS, its obligations have never exceeded its budget 

authority. However, the weaknesses we identified in IRS’s controls over 

its budgetary activity, particularly with respect to delays in 

recording obligations, increase the risk that IRS could incur 

obligations in excess of its budget authority and not timely detect 

this occurrence. As discussed in our report, until the obligation of 

funds is recorded in IRS’s accounting system, obligations reflected in 

the system will understated. This understatement could lead IRS 

management to believe the agency has more funding than is actually 

available. Our intent is to point out a potential impact of the 

internal control weakness we identified.



IRS provided a number of technical comments, not included in its 

written response, which we considered in finalizing the report. The 

complete text of IRS’s response is included in appendix III.



David M. Walker

Comptroller General

of the United States:



Signed by David M. Walker



November 1, 2002:



[End of section]



Management Discussion and Analysis:



Internal Revenue Service:



Fiscal Year Ended 

September 30, 2002:



I. Introduction:



The mission of the Internal Revenue Service (IRS) is to provide 

America’s taxpayers top quality service by helping them understand and 

meet their responsibilities and by applying the tax law with integrity 

and fairness to all. The IRS is responsible for the collection of about 

$2 trillion in Federal tax payments. At the IRS, the mission statement 

serves as the central theme and guiding business philosophy for 

management actions and organizational decision making.



The IRS is executing its mission with increasing effectiveness and 

efficiency. We have identified three strategic goals and critical 

performance measures to track our progress against those goals. We use 

a balanced measures approach for each performance measure addressing 

business results, customer satisfaction, and employee satisfaction. 

Over the past year, our measures show we made great progress in a 

number of high priority areas, such as efiling, telephone and in-person 

taxpayer service, protection of taxpayer rights and burden reduction. 

We stabilized and refocused our key compliance activities and are 

identifying and attacking systematic areas of non-compliance, such as 

the promotion and use of abusive tax devices. Internal morale has 

improved, and perhaps most importantly, we are regaining the confidence 

of the public and other stakeholders.



Mission, Strategic Goals, and Guiding Principles:



The IRS mission statement accurately describes our role, as well as the 

public’s expectation as to how we should perform that role. In the 

United States, the Congress passes tax laws and requires taxpayers to 

comply with them. The taxpayer’s role is to understand and meet their 

tax obligations - and most do, since roughly 98% of the taxes collected 

are paid without active intervention by the IRS. The IRS’ role is to 

help the majority of taxpayers who are willing to comply with the tax 

law, while seeing to it that the minority who are unwilling to comply 

are not allowed to burden their fellow taxpayers. The IRS recognizes 

that it must meet the highest standards in performing this role.



The IRS has formulated three strategic goals needed to achieve our 

mission. If progress is made on all three of these goals, we can be 

confident that we are moving toward achieving our mission and meeting 

the public’s expectations. The strategic goals and a brief description 

of each follows:



*Top-quality service to each taxpayer in every interaction -Whenever 

the IRS deals with a taxpayer, we should give first-quality service and 

treatment that is helpful. We should provide better guidance to 

taxpayers, reducing the chances of error and the time and effort 

required. We should give accurate, timely and convenient assistance to 

taxpayers, and should inform them promptly and treat them 

professionally if we intervene in the form of an examination, a 

collection action, or a notification.



*Top-quality service to all taxpayers through fair and uniform 

application of the law - Our tax system depends on each person who is 

voluntarily meeting his or her tax obligations having confidence that 

his or her neighbor or competitor is also complying. Therefore, when 

taxpayers do not voluntarily meet their tax obligations, the IRS must 

use its enforcement powers to collect the taxes that are due.



*Productivity through a quality work environment-By ensuring our 

employees are satisfied, we are able to provide services more 

efficiently, getting the greatest value for every dollar we

spend. Good productivity requires employee satisfaction. This means our 

employees must have the management support, tools and equipment they 

need to provide good service to our customers, and there must be 

effective communication vertically and laterally throughout the 

organization.



Guiding principles are a link between our strategic goals and the 

actions we take to achieve them. All IRS executives, managers and 

employees are expected to manage and operate through these guiding 

principles.



The following guiding principles describe how we will operate in 

achieving our strategic goals.



*Understand and solve problems from the customer’s point of view.



*Enable managers to be accountable, with the requisite knowledge, 

responsibility, and authority to take action.



*Align measures of performance at all organizational levels. Foster 

open, honest communication.



*Insist on total integrity.



*Demonstrate effective stewardship of assets and information entrusted 

to the IRS.



Organization:



IRS’ structure closely resembles the private sector model of organizing 

around customers with similar needs. The IRS created four customer-

focused operating divisions to best serve taxpayers: Wage and 

Investment, Small Business and Self-Employed, Large and Mid-Size 

Business, and Tax Exempt and Government Entities. There are also a 

number of functional units, including Appeals, the Taxpayer Advocate 

Service, and Criminal Investigation.



Internally, the Modernization and Information Technology Services 

organization, which includes the Business Systems Modernization Office, 

and the Agency-Wide Shared Services unit provide information technology 

and administrative support, respectively, to all divisions.



[See PDF for figure]



[End of figure]



Within the four divisions, operations are structured principally along 

three program areas: prefiling, filing, and compliance. Pre-filing 

services are provided before returns are filed to assist taxpayers in 

preparing correct returns. Filing and account services are those 

provided to a taxpayer in the process of filing a return and paying 

taxes, including electronic filing and payment. Compliance services are 

provided to a taxpayer after a return is filed to identify under-

reporting, non-filing and nonpayment.



The Wage and Investment Division (W&I) serves individual and joint 

filers with wage and investment income only, almost all of which is 

reported by third parties. Most of these taxpayers deal with the IRS 

only once a year, when filing their returns, and most receive refunds. 

Compliance issues are limited, concentrated on dependent exemptions, 

credits, filing status, and deductions. Through its field organization, 

W&I provides information, support and assistance taxpayers need to 

fulfill their tax obligations. It also conducts processing, account 

management, and compliance services through eight campus locations.



The Small Business and Self-Employed Division (SB/SE) serves fully or 

partially selfemployed individuals and small businesses. Since business 

income and a range of taxes are involved, compliance issues can be 

complex. The possibility for errors in collection and compliance are 

greatest in this group and consequently, this group has considerably 

more frequent dealings with IRS compliance functions. SB/SE has a 

compliance field organization that includes both examination and 

collection. Processing, account management, compliance services, and 

education and outreach are provided at two campuses.



The Large and Mid-Size Business Division (LMSB) serves corporations 

with assets of more than $10 million. While collection issues are rare, 

many complex issues such as tax law interpretation, accounting, and 

regulation, many with international dimensions, frequently arise. LMSB 

is predominantly a field organization that is structured into five 

industry groups: Communications, Technology and Media; Financial 

Services; Heavy Manufacturing and Transportation; Natural Resources and 

Construction; and Retailers, Food, Pharmaceuticals and Healthcare.



The Tax Exempt and Government Entities Division (TE/GE) serves a wide 

range of customers including small local community organizations, 

municipalities, major universities, pension funds, state governments, 

Indian tribal governments and tax exempt bond issuers. TEGE is charged 

with administering detailed and complex provisions of law. Its efforts 

are generally not intended to raise money, but rather to ensure that 

these entities stay within the policy guidelines that enable them to 

maintain their tax-exempt status.



The Appeals organization resolves tax controversies without litigation 

on a basis that is fair and impartial to both the Government and the 

taxpayer. Appeals provides an independent channel for taxpayers who 

have a dispute over a recommended enforcement action.



The Chief Counsel’s principal customer base consists of the IRS 

Commissioner, the Operating Divisions, and the functional units of the 

IRS, as well as the General Counsel and Tax Legislative Counsel at 

Treasury. Chief Counsel provides impartial interpretation of the 

internal revenue laws and legal advice and representation for the IRS. 

The Chief Counsel has established a senior legal executive as the 

Division Counsel for each operating division to participate fully in 

the plans and activities of the operating division’s management and to 

provide legal advice and representation.



Communication and Liaison (C&L) is a functional business unit with five 

offices, each of which partners with the operating and functional 

divisions to support IRS business objectives and communications goals 

and ensures cross-divisional coordination. The offices also partner 

with their external customers to ensure that two-way communications 

exist between IRS, its employees and various stakeholder groups. C&L 

manages relationships with the media, Congress, state and local 

governments, and other external stakeholders.



The Criminal Investigation (CI) unit enforces the criminal provisions 

of the Internal Revenue Code. CI operates through a structure of 35 

field offices under the supervision of Special Agents in Charge (SACs). 

The SACs report to Headquarters through six Directors of Field 

Operations located in key cities across the country. CI supports the 

strategies of the four operating divisions to enhance tax 

administration and foster voluntary compliance.



National Headquarters (NHQ) includes the Office of the Commissioner, 

Deputy Commissioner, Assistant Deputy Commissioner, Chief Financial 

Officer, Senior Counselor to the Commissioner, Competitive Sourcing 

Program, National Headquarters Management and Finance, Servicewide EEO/

Diversity, Office of Tax Administration Coordination, Commissioner’s 

Complaint Processing & Analysis Group, Strategic Human Resources, and 

Research, Analysis and Statistics of Income. NHQ focuses on strategic 

direction, capital allocations, and building partnerships with key 

stakeholders, e.g., Congress, Office of Management and Budget.



The Taxpayer Advocate Service (TAS) exists to help taxpayers resolve 

problems that have not been resolved through normal IRS channels. TAS 

is an independent program headed by the National Taxpayer Advocate. 

Each state and IRS Service Center has at least one local Taxpayer 

Advocate who is independent of the local IRS office and reports 

directly to the National Taxpayer Advocate. Operating Division Taxpayer 

Advocates work directly with operating divisions to identify and 

recommend solutions to systemic problems.



The Modernization, Information Technology and Security Services (MITS) 

organization provides information technology solutions that anticipate 

and meet enterprise-wide needs.



The Agency-Wide Shared Services organization (AWSS) provides efficient 

and standardized common services to all organizational components of 

the IRS, such as, personnel, security, and facilities management.



INTERNAL REVENUE SERVICE 





II: Performance Goals and Results:



When all things are considered, the IRS performed well in 2002. This 

was in the face of unanticipated funding dilemmas (e.g., unfunded 

increased pay raise and postage), changing program priorities (e.g., 

greater focus on more complicated and time consuming high-risk cases) 

and the impact of 9/11 (e.g., suspension of notices in targeted 

geographic areas). In addition, any discussion or review of IRS 

performance must consider the context in which performance goals are 

set. FY 2002 marks the second year in which the IRS has set corporate 

goals for its balanced measures under the agency’s new program and 

organizational structure. Thus,



FY 2002 goals were set with one year’s experience in the new IRS. The 

learning process for goal development continues. To drive the agency to 

high levels of performance, the IRS set aggressive goals with the 

knowledge that it is best to push for greater performance than settle 

for marginal progress.



The IRS uses performance measures to determine its effectiveness in 

meeting the three IRS strategic goals. The FY 2002 performance 

information that follows is organized by the main objectives within 

each strategic goal.



Strategic Goal 1: Top-quality service to each taxpayer in every 

interaction.



Main Objectives:



*Make filing easier:



*Provide top-quality service to taxpayers needing help with their 

returns or accounts:



*Provide prompt, professional, helpful treatment to taxpayers in cases 

where additional taxes may be due:



Whenever the IRS deals with a taxpayer, we strive to give quality 

service. The measures of our success in this goal are whether or not 

taxpayers believe we are meeting their expectations and how well we 

help them understand and meet their tax obligations.



Major Results and Accomplishments:



Make Filing Easier:



a. Results Summary:



Increased the number of e-filed individual returns by 17% over FY 2001 

resulting in 36% of all returns being filed electronically.



Increased number of Federal Tax Payment Transactions Paid 

Electronically by 3% over FY 2001.



Introduced a newly designed and more accessible web site. Increased the 

number of web site hits to 3.4 billion and downloaded files to 436 

million projected through the end of FY 2002. This represents increases 

of 31 % and 38% respectively over FY 2001.



The number of taxpayers e-filing from their home computers is up 38% 

over last year. Increased the number of private letter rulings 

completed by 19% over FY 2001.



b. Improved Electronic Filing:



Added 29 electronic forms and schedules for individual and business 

filers.



INTERNAL REVENUE SERVICE 





Opened up e-file eligibility to over 99% of all individual taxpayers, 

adding 38 million potential new e-filers.



Virtually all 1040 forms and schedules could be filed electronically 

this year and no paper signature document was required.



c. Reducing Burden:



Expanded the check-the-box initiative to allow taxpayers to designate a 

friend, family member or tax professional to talk to the IRS to correct 

errors during processing of returns. For tax years beginning with 2002, 

will exempt 2.6 million corporations from filing Schedules L, M1 and M2 

at a burden reduction of 61 million hours.



Allowing more businesses to use the cash method of accounting.



Indefinitely suspended the requirement for taxpayers filing Schedule F 

of Form 5500. Simplified forms, such as the Schedule D for reporting 

capital gains.



Rewrote and simplified procedures, such as those for distributions from 

qualified retirement plans.



Created the Office of Taxpayer Burden Reduction.



Working to develop a methodology for calculating the number of taxpayer 

hours that will be saved through burden reduction efforts.



d. Simplifying Forms and Notices:



Reduced lines on forms, such as the Schedule D to report capital gains.



Eliminated 11 lines on Form 6251 for the Alternative Minimum Tax and 

working with a contractor to redesign Form 941, Employers Quarterly 

Federal Tax Return. Simplified determination letters for the nearly one 

million employee plans.



Began sending out six redesigned notices, including those dealing with 

math errors, balance due, overpayments and offsets.



Redesigning 24 additional notices; released eleven and remaining 13 

will be released in January 2003.:



Provide top-quality service to taxpayers needing help with their 

returns or accounts.



a. Results Summary:



On the American Customer Satisfaction Index (ACSI) Survey, taxpayers 

gave the IRS an overall score of 62, an 11 % increase in satisfaction 

among individual tax filers over 2000, and a 22% increase over 1999. 

This was the largest favorable gain of the 30 federal agencies surveyed 

by the ACSI.



The 2002 annual rating for IRS in the Roper Starch customer 

satisfaction survey was 44% - a 12 point increase over our result of 

32% in 1998. It does, however, reflect a small decrease from the 2001 

score of 46%.



By the end of the 2002 filing season, taxpayers were receiving correct 

responses to 84% of their telephone tax law questions and 90% of their 

telephone account questions compared to the overall rates for FY 2001 

of 79% and 88% respectively.



Access to telephone service and time spent waiting, while still below 

private sector standards, improved substantially. Average wait time is 

down 26% from last year. Assistor access rose from 56% only two years 

ago to nearly 70% this year.



b. Improvements in Telephone Service:



Increased toll-free phone assistance with regard to: level of service, 

quality of tax law responses, and quality of responses to account 

inquiries.



Organized telephone Customer Service Representatives by specialization 

on a division-wide basis to utilize call routing more effectively. 

Trained assistors in one or more technical and account topics, enabling 

them to be more proficient in assisting customers quickly and 

accurately.



Implemented toll-free script changes to better address the needs of 

Business Master File (BMF) callers and to address the significant 

number of inquiries regarding the tax rebate. Implemented an automated 

voice recognition service to provide taxpayers the amount of the 

advanced credit, reducing burden on the telephone system.



Increased staffing for Spanish language Customer Service 

Representatives.



c. Expanded Face-to-Face Services:



Offered walk-in service during the filing season at more than 400 

locations nationwide for face-to-face meetings to resolve account or 

case problems.



At many sites, walk-in service was offered on 12 Saturdays between 

January 27 and April 14.



d. Special Assistance in Response to 9/11:



Issued guidance to resolve tax-related issues, including setting up 

appropriate tax relief and postponement of certain filing deadlines.



Established a dedicated toll-free line for impacted victims and 

families in response to the September 11 tragedy.



Provide prompt professional helpful treatment to taxpayers in cases 

where additional taxes may_ be due:



a. Results Summary:



Field Collection customer satisfaction and quality stayed at FY 2001 

levels. Field Exam customer satisfaction and quality increased slightly 

above FY 2001. Service Center Exam customer satisfaction declined 

slightly and quality stayed the same. Automated Collection System level 

of service and customer satisfaction declined below FY 2001 as volume 

was greater than expected from new levy programs.



b. Enhanced Customer Service:



Throughout the year, and at a variety of locations, held Problem 

Solving Days at 46 Taxpayer Assistance Centers to resolve long-standing 

taxpayer issues for those who cannot take advantage of weekday problem 

solving services.



Created the Tax Resolution Representative position. These IRS employees 

will receive the training and authority to provide “one-stop-service” 

for a broad range of issues.



c. Special Assistance in Response to 9/11:



Developed computer programs to suppress assessments of penalties and 

interest, allowing individuals impacted by the September 11 tragedy 

additional time to meet their federal tax obligations.



Froze the accounts of taxpayers who lived in the Federal Disaster and 

Emergency Areas of New York, New Jersey, Virginia, and 11 other 

counties in Connecticut and New York. The freeze indicator alerted IRS 

employees of a taxpayer’s disaster status.



Advised affected taxpayers who lived outside of the federal disaster 

and emergency areas to contact the IRS to obtain tax relief.



Balanced Measures:



A. Employee Plans and Exempt Organization (EP/EO) Determination 

Letters:



Description: Cases established and closed on the Tax Exempt/Government 

Entities Determination System. This measure is an indication of the 

volume of activity in Employee Plans and Exempt Organizations. 

Determinations are taxpayer-initiated requests for specific rulings or 

approvals with respect to an Employee Plan or Exempt Organization 

issue.



FY 2002 Performance: Exempt Organizations (EO) closures were at the 

planned level, but Employee Plans (EP) determinations were 

substantially below plan. With the closure of the remedial plan 

amendment period scheduled for December 2001, EP expected to receive 

120,000 determination requests in FY2002. However, due to a two-month 

extension of the deadline (granted in response to 9/11) and overall 

consolidation in the pension plan market, IRS received slightly more 

than half that number of applications. As a result, EP issued fewer 

than half of the planned 106,000 determination letters. There was a 

positive trend among the receipts toward more pre-approved plans. 

Reduced determination workload freed up resources to support other 

critical program goals such as the examination program.



[See PDF for image]



[End of Table]



Future Plans: IRS plans to stabilize resources and improve performance 

in Exempt Organization determinations. Dedicated groups reporting to 

Determination Management will improve consistency and efficiency to 

keep up with steadily increasing customer demand. To further improve 

productivity, IRS began a pilot of a new method of reviewing 

applications in FY2002 and is designing a new form for determination 

applicants to use beginning in FY2004. Not only should customers find 

this new form easier to use, but it should also reduce the resources 

necessary to review each application.



The existing system for processing determination letter requests has 

severe shortcomings. The redesign and replacement of this system with 

the new Tax Exempt Determination System (TEDS) will provide critical 

business capabilities required by customers, while improving overall 

system performance and reliability. Release 1 will be piloted in FY 

2003.



B. Private Letter Rulings Completed:



Description: Total number of Private Letter Rulings (PLRs) completed by 

the Office of the Chief Counsel. PLRs are written statements that 

address specific, tax-related issues pertaining to the taxpayer and the 

IRS about the tax treatment of particular matters before a taxpayer’s 

return is filed. These techniques reduce taxpayer burden, eliminate 

controversy, and enhance voluntary compliance, even before the taxpayer 

is involved.



FY 2002 Performance: Private Letter Rulings have been a very popular 

and high growth program for Chief Counsel because of their positive 

impact on the taxpayer of reducing burden and resolving questions about 

tax code interpretation up front.



[See PDF for image]



[End of Table]



Future Plans: IRS’ Chief Counsel Division will move toward greater use 

of Revenue Rulings, a key Published Guidance product, and reduce use of 

Private Letter Rulings, an Advance Case Resolution product, as a means 

of providing guidance to taxpayers. Consistent with its major strategy 

and operational plans, Chief Counsel Division will work with IRS 

Operating Divisions and Treasury to identify and address emerging 

issues through Published Guidance, and integrate efforts directed to 

the Published Guidance program with the IRS Operating Divisions.



C. Taxpayer’ Advocacy Projects:



Description: An Advocacy Project is an Operating Division Taxpayer 

Advocate project to address an identified operational issue that 

adversely affects a group of taxpayers.



FY 2002 Performance: Taxpayer Advocate Services (TAS) originally 

planned to open 88 projects in FY 2002. However, TAS only opened 67 

because they focused on the quality and impact of their projects 

instead of the raw number opened.



[See PDF for image]



[End of Table]



Future Plans: This measure is slated for deletion from the Critical 

Measures list for FY 2003.



D: Percent Individual Returns Filed Electronically:



Description: The number of electronically filed individual tax returns 

divided by the total number of individual returns filed. Includes all 

returns where electronic filing is permitted (Practitioner e-file, 

TeleFile, VITA [Volunteer Income Tax Assistance], On - Line Filing, 

Federal/State returns, etc.):



FY 2002 Performance: The IRS can provide the customer service taxpayers 

deserve only with the efficiencies of modernization, especially 

electronic filing and processing. Each year, Electronic Tax 

Administration (ETA) works with Modernization, Information Technology 

and Security Services (MITS) to allow more submissions to be filed 

electronically. As a result, in FY 2002 over 46 million individual 

returns were filed electronically. Focused advertising and marketing as 

well as expansion of electronic signature and payment options 

contributed to success in this area in FY 2002. Continued growth is 

expected as we increase the number of forms and schedules available for 

use in electronic filing.



[See PDF for image]



[End of Table]



Future Plans: To continue a solid e-file marketing campaign, IRS will 

use its research strategies to identify and educate targeted EROS 

(Electronic Return Originators), self-preparers and filers who use 

paper instead of electronic media. IRS will focus on those non-EROs who 

currently file a significant volume of paper returns and current EROS 

who file high volumes of computer prepared returns as paper tax 

returns.



In addition, IRS will continue to develop key messages to display on 

the IRS Digital Daily web site, the Servicewide Electronic Research 

Program web site, and QuickAlerts to encourage e-filing by tax 

professionals and taxpayers. IRS territory offices will expand 

distribution of the e-file marketing toolkit and related publications 

through local outreach efforts and promote e-filing through partnering 

opportunities which may include seminars, training, presentations at 

Nationwide Tax Forums, advertising, public service announcements and 

coordination with Stakeholder Partnership, Education and 

Communications (SPEC). If we are successful in this marketing, IRS may 

more rapidly approach the 80% Congressional mandate for e-filing and 

concurrently reduce return error rates.



E. Electronic Federal Tax Payments System:



Description: All individual and business tax type payments made 

directly through the Electronic Federal Tax Payment System (EFTPS), 

through IRS e-file, directly through payroll service providers, or 

through credit card processors.



FY 2002 Performance: Fiscal years 2000 and 2001 saw a 2% increase over 

the prior year. Based on the IRS’ marketing and anticipated growth, an 

expected 5% increase established the original planned target of 67.4 

million. The actual performance, however, stayed at the 2% growth level 

in line with historical growth rates.



Offering convenient, easy to use electronic payment options, such as 

credit card payments, encourages taxpayer compliance, reduces internal 

paper processing burdens, and promotes the use of electronic commerce 

when transacting with the Service. Taxpayers may now use any of the 

four major credit cards - VISA, Mastercard, American Express or 

Discover - for federal tax payments. The current year Form 1040 balance 

due, Form 1040ES and Form 4868 payments can be made with a credit card. 

Taxpayers can also charge installment agreement payments for tax year 

1998 or later. The acceptance of installment agreement payments by way 
of 

credit card furthers the Service’s goals of expanding electronic 
payment 

options. The acceptance of credit cards reduces the number of 
misapplied 

payments, minimizes insufficient funds conditions, and reduces lockbox 

volumes and related fees.



In 2002, the IRS extended PIN authority to selected tax practitioners. 

As a result, nearly 15 million PIN’s were used, saving the IRS about $4 

million in direct labor costs alone.



[See PDF for image]



[End of Table]



Future Plans: IRS continues to improve and expand the use of Personal 

Identification Number (PIN) programs to allow taxpayers nationwide to 

file electronically using a selfselected PIN and a “shared secret” 

known only to the taxpayer and the IRS. This will reduce the need for 

the paper signature jurat and produce savings.



F. Toll-Free Customer Satisfaction:



Description: Represents the customers’ overall level of satisfaction 

with the services provided by the IRS Toll-Free program. Survey 

recipients are asked to rate IRS performance on a four-point scale, 

where 1 indicates Very Dissatisfied and 4 indicates Very Satisfied. 

Limitations on the survey data not affecting the statistical validity 

include: only customers calling one of the IRS toll-free telephone 

numbers are included in the sample. Calls are selected based on a 

sampling pattern that includes variables for the hour of day, day of 

week, and time of year. Customers calling when IRS monitors are not 

available (Saturday, Sunday and some evening hours) are excluded from 

the survey.



FY 2002 Performance: The IRS barely missed meeting the plan because of 

customer dissatisfaction with getting connected to the appropriate live 

assistor or automated application to address their issue. While we 

missed the plan, 55% of customers did rate service as a 4 out of 4 and 

only 2% rated service as a 1.



[See PDF for image]



[End of Table]



Future Plans: The two areas for top-priority improvement efforts are 

the automated answering system and ease of getting through by phone. To 

reduce the demand for phone access, IRS implemented Internet Refund/

Fact of Filing to provide on-line ability to check refund status 

through the IRS.gov web site.



To increase accessibility to assistors, IRS is making changes in the 

routing of calls and scripting of telephone systems. IRS will implement 

recommendations from the Customer Contact Engineering Study group’s 

plan to optimize the use of outward facing Toll-Free numbers by 

configuring these numbers to relate directly to taxpayers’ inquiries. 

Rather than using one or two general numbers for all inquiries, 

customers will call a telephone number relative to the inquiry at hand. 

This plan will enable taxpayers to reach assistors with fewer levels of 

prompting and will decrease the number of customers who hang up due to 

the complexity of the menu system.



Telephone numbers on notices, letters, and bills will direct customers 

to prompts related to their circumstance, and not to tax lawrelated 

prompts. A team is being formed to identify and implement the technical 

aspects of the changes. IRS expects these changes to have a positive 

impact on customer satisfaction, which should be reflected in survey 

data available in 2003.



INTERNAL REVENUE SERVICE 





G. Toll-Free Customer Service Representative (CSR) Level of Service:



Description: Reported as the percentage of taxpayers that call IRS 

toll-free services and want to talk to an assistor, and get to speak to 

one. Factors used to arrive at the level of service provided by 

assistors and taken into consideration in the calculation are callers 

selecting an automated application, receiving a busy signal or 

abandoning while in queue waiting for an assistor.



FY 2002 Performance: Assistor level of service shows the percentage of 

taxpayers who want to talk to an assistor who actually reach an 

assistor. Level of service was negatively impacted by problems with the 

call routing system and several weeks with higher than anticipated call 

demand made up of residual rebate issues.



[See PDF for image]



[End of Table]



Future Plans: IRS will implement recommendations from the Customer 

Contact Center Optimization study, including a call router to build a 

pyramid of specialization that will enable us to route each customer to 

an employee having the appropriate skill level to successfully address 

the customer’s issue. Once implemented, we will also utilize CSR call 

recording technology for purposes of quality review, training and 

evaluation. This will optimize employee commitment to quality customer 

service, enhance performance feedback systems and improve the value of 

training modules.



IRS will make modifications to the scripting, routing and handling of 

taxpayer calls in order to improve access levels and customer 

satisfaction. We plan to test a skill-based routing concept, which 

involves rules-based routing to agent groups of similarly skilled 

employees, as opposed to the current system of routing to applications, 

based upon menu selection chosen. This will allow us to more easily use 

one group of employees to staff 2 or 3 similar applications. This 

concept will be tested early FY 2003, and if successful, we will fully 

deploy skill-based routing at the end of the FY 2003 filing season.



H. Toll-Free Tax Law Quality:



Description: The percentage of customers receiving accurate responses 

to their tax law inquiries. This evaluates the customer (external), 

administrative (internal) and regulatory accuracy of this service.



FY 2002 Performance: The FY2002 goal was met because of a strong 

accuracy score for responses to taxpayer questions. Continued focus on 

the individual factors that contribute to the overall score including 

the standards associated with case documentation was also a contributor 

to improvement.



[See PDF for image]



[End of Table]



Future Plans: IRS plans to implement the Embedded Quality Review 

System. The new quality attributes place more focus on the customer 

experience and will provide us with a better indication of our 

accuracy, professionalism and timeliness. Evaluating quality within our 

product lines focusing on the customer’s experience will build 

commitment and capability among employees and managers, thus providing 

opportunities to improve our performance in all areas of our balanced 

measures. Improved accuracy will increase customer satisfaction and 

reduce repeat calls, aiding achievement of the level of service plan.



I. Toll-Free Account Quality:



Description: The percentage of customers receiving accurate responses 

to their account inquiries. This evaluates the customer (external), 

administrative (internal) and regulatory accuracy of this service.



FY 2002 Performance: The FY2002 goal was met because of a very high 

accuracy score for responses to taxpayer inquiries about their 

accounts. Increased management attention and focused training to 

improve knowledge of the Customer Service Representatives contributed 

to the increase in this area. The significant improvement in the scores 

in FY 2001 continued into FY 2002 with additional progress made in 

focusing on both quality and quantity on account cases.



[See PDF for image]



[End of Table]



Future Plans: The IRS will continue to align toll-free sites according 

to specialty areas. We will enable front-line employees to access 

accurate, up-to-date information about taxpayers’ accounts and to 

adjust accounts immediately. We will continue to increase taxpayer 

access and customer satisfaction through the intelligent call routing 

system by routing calls to sites dedicated to specific types of work. 

Intelligent call routing will also be used to route calls to Customer 

Service Representatives (CSRs) who will specialize in specific areas of 

expertise.



Customer Satisfaction Walk-in:



Description: Represents the customers’ overall level of satisfaction 

with the services provided by the IRS at its Taxpayer Assistance 

Centers. The scores represent the average overall level of customer 

satisfaction (“Keystone” question) from the Customer Satisfaction 

transactional surveys. Survey recipients are asked to rate IRS 

performance on a seven-point scale, where 1 indicates Very Dissatisfied 

and 7 indicates Very Satisfied. A Limitation that may affect the 

validity of the data is the method in which the survey is conducted. 

This is a “comment card” hand out survey. The taxpayer receives a 

survey card after being served. A very small number of cards are 

returned. This “non-response” bias leads to a small sample size that 

may not represent the whole population.



FY 2002 Performance: Based on our analysis of the data, IRS did not 

meet the plan because even those customers who were satisfied overall 

were still not completely satisfied with our promptness of service, and 

dissatisfied customers were not satisfied with our resolution of their 

question or issue. While the target was missed, 86% of customers rated 

service performance as a 4 or 5 on a five-point scale, and only 8% of 

customers rated service performance at a 1 or 2.



[See PDF for image]



[End of Table]



Future Plans: Field Assistance will continue to concentrate on 

identifying ways to address customer expectations and perceptions of 

the “promptness of service” including explaining the automated 

numbering system at sites and advising taxpayers of the approximate 

wait time.



K. EP/EO’ Customer Satisfaction:



Description: Customers’ overall level of satisfaction with the way 

their cases were handled by the IRS Employee Plans and Exempt 

Organizations Examination programs. Scores represent the average 

overall level of customer satisfaction (“Keystone” Question) from the 

Customer Satisfaction Transactional Surveys. Survey recipients are 

asked to rate IRS performance on a seven-point scale, where 1 indicates 

Very Dissatisfied and 7 indicates Very Satisfied.



FY 2002 Performance: Customer satisfaction has improved as Area 

managers promote effective case management practices to reduce cycle 

time and address the highest improvement opportunity, Time Spent on 
Audit. 

In addition, employee and stakeholder input has been solicited to 
identify 

actions to further improve service to the EP/EO customers.



[See PDF for image]



[End of Table]



Future Plans: The IRS Tax-Exempt and Government Entities Division (TE/

GE) is expanding customer satisfaction measurement efforts.



L. Employee Plans (EP) / Exempt Organizations (EO) Examination Quality:



Description: Level of quality in the EP & EO examination program is 

measured by the Tax Exempt Quality Measurement System.



FY 2002 Performance: IRS established aggressive goals to improve the 

quality of examinations over FY2001 results. Though still short of its 

goal, EP made significant improvements in quality through site visits 

by Quality Review staff to address quality concerns and distribution of 

Frequently Asked Questions to all employees. EO, on the other hand, 

continued to have problems with targeted elements of Examination 

Planning, Examination Scope and Workpapers, despite actions to share 

best practices and incorporate quality goals into Area managers’ 

performance plans.



[See PDF for image]



[End of Table]



Future Plans: For FY2003, IRS has formed a task team to review the 

quality standards to ensure that measurement reflects actual technical 

and procedural quality. Removing determination work from the 

responsibilities of both Examination agents and managers will promote 

efficiency, consistency and quality in Examination.



M. Telephone Customer Satisfaction - Automated Collection System (ACS):



Description: Represents the customer’s perception of IRS service 

received through contact with employees in the Automated Collection 

System call centers. Limitations on survey respondents not affecting 

the statistical validity are as follows: ACS outgoing calls are not 

included in the survey due to technological limitations, and customers 

calling when IRS monitors are not available (Saturday, Sunday and some 

evening hours) are excluded from the survey. Customer satisfaction is 

measured on a 4-point scale. 1 indicates Unsatisfied and 4 indicates 

Very Satisfied.



FY 2002 Performance: Telephone Customer Satisfaction was impacted 

significantly in the factor, “difficulty in getting through to 

representatives by phone” because of higher than planned incoming call 

demand, which also negatively affected ACS Level of Service (LOS). 

Customers report high degrees of satisfaction in the areas of courtesy, 

attitude and professionalism.



[See PDF for image]



[End of Table]



Future Plans: In FY2003, IRS will better align workload to staffing to 

improve the ease of reaching a representative. IRS will identify and 

implement process and infrastructure requirements to move the Automated 

Collection System (ACS) from 9 stand-alone sites to an enterprise-

operating environment that better balances telephone operations with 

management of notice issuances and case closures. By the end of FY 

2003, ACS will complete consolidation of inventory.



N. Automated Collection System - Telephone Level of Service:



Description: The percentage of calls attempted by taxpayers compared to 

the number of calls answered (calls which abandon after having been 

answered but while in queue for the next available assistor are not 

included in the count of calls answered) in the Automated Collection 

System (ACS).



FY 2002 Performance: The start-up of the State Income Tax Levy Program 

and the Federal Payment Levy Program increased call demand, 

significantly affecting the workplan. Although resources were 

redirected, IRS was unable to meet the incoming volume. IRS is 

assessing the increased volume of calls and evaluating the methods used 

to forecast calls to better align workload to staffing. The reduced 

level of service also negatively impacted Customer Satisfaction.



[See PDF for image]



[End of Table]



Future Plans: In addition to consolidating ACS inventory, IRS has 

developed call recording capability for use in training ACS assistors. 

Implementation is contingent upon funding.



O. Customer Satisfaction-Collection Field:



Description: Customers’ overall level of satisfaction with the way 

their cases were handled by the IRS Field Collection program. The 

following limitations are placed on the Collection sample: only those 

customers who owe money to the IRS and have been referred to Collection 

are sampled. Samples drawn from the Collection Quality Measurement 

System (CAMS) database only include three types of closures; Currently 

Not Collectible/Hardship, Installment Agreements, and Full Pays. The 

sample does not include: cases with no case history, cases for 

customers the IRS cannot locate, cases where the statute has expired, 

bankruptcy cases, deceased taxpayers, and defunct or insolvent 

corporations. For cases involving an Offer in Compromise, only those 

offers that are accepted by the IRS are currently included. Customer 

satisfaction is measured on a 7-point scale. 1 indicates Very 

Unsatisfied and 7 indicates Very Satisfied.



FY 2002 Performance: Field Collection’s FY2002 actual was only 3 

hundredths below their FY2002 plan. While they missed the goal, this 

difference is not statistically significant. They are in the process of 

analyzing their results to continue the drive for improvement in 
FY2003. 

In FY2002, satisfaction was highest among taxpayers who had a case time 

of 120 days or less, were self represented, or were in a delinquency 

investigation. Targeted training, procedural improvements, a 
reexamination 

of the documentation standards were all factors examined by the re-
engineering 

team put in place as a result of the FY 2001 results.



[See PDF for image]



[End of Table]



Future Plans: IRS will continue reengineering initiatives in Collection 

operations. The Collection Quality Measurement System will also be 

reengineered, as we incorporate features from the joint Small Business 

and Self-Employed and Wage and Investment Divisions embedded quality 

effort. IRS will examine and refine data gathering and reporting 

systems, making available quality review information to improve 

training and training management for front-line employees.



P. Field Collection Quality:



Description: Score awarded to a reviewed Collection case by a third-

party reviewer using the Collection Quality Measurement System 

standards. Each standard if met, has a value. Values are totaled to 

arrive at the score with deductions in the overall composite score for 

failure to meet a standard designated as critical.



FY 2002 Performance: The score was slightly below the plan target of 

85%. Defects occurred primarily in Clear Action Dates and Case 

Documentation.



[See PDF for image]



[End of Table]



Future Plans: IRS will continue to incorporate features of the embedded 

quality effort to Collection operations. Among these features will be 

an assessment indicating whether or not we are measuring the right 

program aspects as well as where we stand in assigning top to bottom 

accountability for case quality.



Q. Automated Underreporter Quality:



Description: Quality of all Automated Underreporter (AUR) account 

actions as a result of taxpayer inquiries or internal requests. Quality 

of casework in the underreporter area is measured on paper closed cases 

only.



FY 2002 Performance: While still 94%, quality defects have increased in 

comparison to the prior year. Defects are primarily attributable to 

Inventory Management/Case Controls, Transaction Code (Account Action), 

and Correspondence (IRS Procedure). The AUR sites have implemented 

various steps to decrease errors associated with the defects. Flyers/

alerts and Job Aids addressing the errors were issued, and weekly 

meetings at which top errors were discussed were held with managers.



[See PDF for image]



[End of Table]



Future Plans: IRS expects the AUR paper quality score to drop slightly 

from FY 2002 levels due to the increase in complexity of work resulting 

from more Schedule K-1 s. Using analyses of error trends arising from 

this more complex work, IRS will ensure training efforts and new job 

aides target problem areas.IRS will also develop business requirements 

to record phone calls to improve case quality, managerial oversight, 

and employee accountability.



R. Service Center Exam-Customer Satisfaction:



Description: Customer’s overall level of satisfaction with the IRS 

Service Center Examination process. The following limitations are 

placed on the service center examination sample: sole proprietors and 

self-employed individuals and farmers, as well as individual 

shareholders and partners examined as a result of a corporate audit are 

included in the sample; the sample excludes businesses that file 

corporate and partnership returns, individuals who did not respond to 

correspondence and audit appointment letters, individuals IRS cannot 

locate and individuals with an international address. Customer 

satisfaction is measured on a 7-point scale. 1 indicates Very 

Unsatisfied and 7 indicates Very Satisfied.



FY 2002 Performance: The target was missed because of low scores on 

discussing length of process, explanation of adjustments, perception of 

fairness of treatment and listening to concerns. Aspects of attitude, 

professionalism and staff courtesy rank the highest. Significant 

increases have been noted in aspects of explanation of rights, 

explanation of process and records required.



[See PDF for image]



[End of Table]



Future Plans:



IRS will embed quality into our Service Center Compliance programs, 

providing a higher-quality experience for taxpayers and engaging 

managers in the delivery of our services. Identifying customer service 

trends and issues earlier will allow us to react to our customer needs 

more rapidly, increasing customer satisfaction.



S. Service Center Examination Quality:



Description: Quality of actions taken while working service center 

examination cases. Each site’s quality reviewer reviews a sample of 

cases and writes a review record for each case.



FY 2002 Performance: The target was missed in FY2002 because of the 

large number of overage cases that were closed. Long cycle times 

negatively impacted the quality score. Since the overage cases were 

closed in FY2002, average cycle time should drop in FY2003 and the 

quality score rise accordingly.



[See PDF for image]



[End of Table]



Future Plans: IRS will continue efforts to embed quality into Service 

Center Compliance operations. Compliance will process cases more 

efficiently with less systemic work disruptions by implementing the 

Correspondence Examination Automation Support system as a replacement 

to Report Generation System Batch Processing. The Inventory Management 

Tool, which predicts the receipt of taxpayer correspondence and phone 

calls, will be used to ensure started cases can be handled timely. 

Audit issues initiated through improved system processes will produce 

resource savings.



T. Examination -Customer Satisfaction:



Description: Represents the level of satisfaction customers receive 

from interactions with IRS Field Examination employees. Scores 

represent the average overall level of customer satisfaction 

(“Keystone” Question) from the Customer Satisfaction Transactional 

Surveys. Survey recipients are asked to rate IRS performance on a 

seven-point scale, where 1 indicates Very Dissatisfied and 7 indicates 

Very Satisfied. A limitation on survey data not affecting the 

statistical validity in the survey population is based solely on the 

audit closures of individual taxpayers. Audit closures involving 

estate, corporate, excise and gift tax returns are not included in the 

survey population. The results also do not include contacts the 

Examination division had with individuals that did not result in an 

audit closure.



FY 2002 Performance: The highest satisfaction was by taxpayers whose 

cases were handled by a tax professional and/or whose examinations had 
a 

relatively short cycle time. Further reducing cycle time offers the 
largest 

improvement opportunity. The hiring of additional resources in FY 2001 
and 

resultant productivity gains, particularly in working through the case 
backlog 

(reducing overall cycle time), was a significant contribution to the 

improvement in the score over the FY 2001 level and achievement of the 
FY 

2002 target.



[See PDF for image]



[End of Table]



Future Plans: IRS will continue to fulfill the vision of the 

Examination Re-engineering project, to make the Examination process 

easier and faster for taxpayers, minimizing the accrual of interest on 

additional assessments, while ensuring consistency and fairness.



U. Examination-Case Quality Score:



Description: The score awarded to a reviewed Field Examination case by 

a Quality Reviewer using the Examination Quality Measurement System 

quality standards.



FY 2002 Performance: Continued focus on targeted improvement areas 

coupled with the reduction in cycle time (a quality standard) were 

major contributions to continued achievement of the target.



[See PDF for image]



[End of Table]



Future Plans: We will improve the Examination process by combining 

database systems to provide faster results. We will enhance our 

examination inventory selection processes by incorporating more data 

from additional sources. We will also improve our ability to identify 

noncompliance electronically and automate routine examination 

processes to optimize our resources.



[See PDF for image]



[End of Table]



V. Taxpayer Advocate Casework Quality Index:



Description: Measure of effectiveness in meeting customer expectations 

based on a random sample of cases reviewed and scored against customer 

service standards of timeliness, accuracy, and communication.



Taxpayer Advocate Casework Quality Index:



[See PDF for image]



[End of Table]



FY 2002 Performance: Taxpayer Advocate Service met this goal and 

greatly exceeded FY2001 performance by having each office set a goal 

and make an improvement plan around the three standards listed above to 

achieve that goal.



Future Plans: Taxpayer Advocate Service field offices will continue to 

focus on improving case quality through locally developed action plans. 

IRS will study those offices making the greatest improvement to see 

what “best practices” may be applicable elsewhere.



Strategic Goal 2: Top-quality service to all taxpayers through fair and 

uniform application of the law.



Main Objectives:



*Increase overall compliance:



*Increase fairness of compliance:



Our tax system depends on each person who is voluntarily meeting his or 

her tax obligations having confidence that his or her neighbor or 

competitor is also complying. We cannot allow those taxpayers who do 

not comply to place a burden on those who do.



Major Results and Accomplishments:



Increase overall compliance:



a. Results Summary:



Field Collection Taxpayer Delinquent Account closures decreased 4% and 

Taxpayer Delinquent Investigation closures increased 18% over FY 2001.



Automated Underreporter case closures are up 16% over FY 2001.



Increased the number of examinations for Coordinated Industry Cases by 

27% over FY 2001.



Automated Collection System Closures declined noticeably below FY 2001 

levels because of the suppression of notices as a result of the 9/11 

crisis, which delayed the issuance of liens and levies on ACS 

inventories. Also, the need to address increased incoming call volume 

pulled resources from the time available to close assigned cases.



b. Improved Communications and Service:



Placed significant media attention on Abusive Tax Schemes in order to 

alert Taxpayers to the schemes and prevent potential tax problems.



Piloted an accelerated determination processing program to ascertain 

types of applications suitable for accelerated processing and to track 

time savings and trends in issues developed.



As part of a national strategy to combat abusive schemes, placed 

emphasis on crossfunctional training and multi-function coordination in 

the identification of fraudulent trust promotions and the use of civil 

and criminal enforcement actions. Engaged in outreach activities to 

educate people to recognize and avoid fraudulent trust promotions.



c. New Initiatives and Program Improvements:



Identified five serious compliance problem areas: promoters of tax 

schemes; misuse of devices such as trusts and passthroughs to hide or 

improperly reduce income; use of complex and abusive corporate tax 

shelters to reduce taxes improperly; failure to file and pay large 

accumulations of employment taxes; and erroneous refund claims.



Revamped compliance programs to refocus resources and to use a full 

scope of tools and techniques ranging from educating the public to 

systematically identifying promoters and participants, to 

reinvigorating enforcement actions such as summons enforcement, 

injunctions and criminal investigation of promoters.



Began matching information reported on Schedule K-1 with income and 

losses reported on Form 1040 and other schedules.



Reinvigorated the use of long dormant enforcement tools that deal with 

serious cases of non-compliance and tax schemes, e.g., aggressively 

identifying promoters and schemes through summonses of records, 

including John Doe summonses on credit card accounts in offshore tax 

havens and vendor summonses to refine that data.



Initiated 43 contacts of promoters to uncover lists of taxpayers 

participating in shelters. Launched a tax shelter disclosure 

initiative. As of August 2002, processed 1,664 disclosures from 1,206 

taxpayers who came forward. These disclosures cover 2,264 tax returns 

and involved more than $30 billion in claimed losses or deductions.



Commenced a test to gauge the effectiveness of the Automated Substitute 

for Return Program (ASFR).



Initiated summons procedures on all major credit card companies and 

commenced initial examinations from credit card leads (off shore credit 

card data & charges).



Intercepted Slavery Reparation scheme credit cases and stopped 

erroneous payments from approximately 17,000 erroneous claims this 

fiscal year.



Published the Tax Shelter Disclosure Initiative, providing taxpayers 

with a 120-day opportunity period to voluntarily disclose their 

participation in tax shelters and other questionable items that may 

have resulted in an underpayment of tax. For taxpayers who voluntarily 

disclosed, the IRS promised to waive certain accuracy-related 

penalties.



Announced a voluntary compliance program to help Section 527 political 

organizations comply with their new reporting requirements. Sent 

letters to organizations that appeared to have some confusion with 

their reporting requirements.



d. Special Assistance in Response to 9/11:



Established a special program to expedite processing of applications 

from organizations created to assist in relief efforts.



Provided compliance guidance and a single point of contact to new 

disaster relief organizations.



Posted a draft publication, Disaster Relief: Providing Assistance 

through Charitable Organizations, to the IRS website within days of the 

September 11 attacks (subsequently revised and published as Publication 

3833).



Provided extensions and other relief in response to the attacks.



Increase fairness of compliance:



a. Results Summary:



Increased number of examinations for individual returns greater than 

$100,000 by 20% over FY 2001. Decreased number of examinations for 

individual returns less than $100,000 by 4% over FY 2001. These data 

reflect success in shifting focus to high-income taxpayers.



b. Reengineering:



Revisiting the examination workload model and planning processes to 

include more data on other return types and to incorporate non-filer 

and non-payment data.



Placed all innocent spouse claim processing at the Cincinnati 

Centralized Innocent Spouse Operation and provided increased and 

specialized skills for examiners working claims.



Implemented an automated decision-making tool to lead examiners through 

the complex decision-making process and to assist them in making timely 

and accurate decisions.



c. Focus on Higher Risk Areas:



Improving the methodology of examination workload planning for higher 

income individuals. Implementing new systematic way to identify returns 

with a high probability of omitting income. Previously, these returns 

were only identified by indirect examination techniques. Shifting audit 

and enforcement forces to focus more resources on tracking down 

highincome taxpayers who fail to report income or hide it offshore.



Reorienting agents so that most of their activities are focused toward 

the highest-risk areas. Increased focus on promoters of abusive tax 

schemes by: identifying flow-through entities used to mask questionable 

structured transactions; addressing abusive schemes through 

enforcement; implementing the Schedule K-1 matching program; directing 

research efforts to profile promoters and build our understanding of 

trust filing reporting issues; developing skilled employees; and 

targeting educational products and outreach to influence tax compliance 

behaviors.



d. Improved Communications:



Improved service to taxpayers by reducing the time it takes to notify 

them of innocent spouse claim decisions.



Provided innocent spouse literature to Low Income Tax Clinics and 

Volunteer Income Tax Assistance tax return preparation sites.



Balanced Measures:



A. Automated Collection System Closures -Taxpayer Delinquent Accounts 

(TDA):



Description: Number of entity delinquent account closures produced in 

the Automated Collection System. Entities closed using codes related to 

systemic reduction of inventory are not included in the actual count.



FY 2002 Performance: TDA closures were impacted by 1) the suppression 

of notices as a result of the 9/11 crisis which delayed the issuance of 

liens and levies on ACS inventories, 2) holiday moratorium on notices 

was instituted a week earlier this year compared to last year, and 3) 

increase in incoming calls and time spent on calls detracted from the 

time available to close assigned cases.



[See PDF for image]



[End of Table]



Future Plans: IRS will shift the mix of cases for Automated Collection 

System work in FY 2003. TDA entities are traditionally high priority 

inventory and the emphasis on high priority cases will increase the 

number of TDA closures. Additional factors that will contribute to 

increased TDA dispositions include: an overall refocus on ACS mission 

of collecting delinquent accounts and securing delinquent returns, ACS 

employees hired in FY 2002 should become more productive in FY 2003 as 

they continue to gain experience, and the percent of direct time to 

total time should increase due to reduced training.



B. Automated Collection System Closures - Taxpayer Delinquent 

Investigations (TDI):



Description: Number of entity delinquent investigation closures 

produced in the Automated Collection System. Entities closed using 

codes related to systemic reduction of inventory are not included in 

the actual count.



[See PDF for image]



[End of Table]



FY 2002 Performance: The number of TDI closures did not meet the FY 

2002 plan because of a management decision in February 2002 to shift 

inventory priorities that resulted in a change in the mix of closures 

of TDAs and TDIs.



Future Plans: To better identify TDI cases, certain TDI select codes 

will be worked thoroughly, and the results used to improve TDI case 

creation. Additionally, productivity is planned to recover to FY 2001 

levels.



C. Field Collection - Number of Cases Closed Taxpayer Delinquent 

Account (TDA):



Description: A count of the number of actual TDA dispositions completed 

by Revenue Officers. A TDA disposition occurs on the Integrated Data 

Retrieval System (IDRS) when the status of an account changes from an 

open status to any closed status as defined in Section 8 (Document 6209 

- Automated Data Processing (ADP)/IDRS Information.) Data is reported 

as modules.



FY 2002 Performance: TDA closures were adversely impacted by a variety 

of factors including the suppression of notices and enforcement actions 

due to September 11 th attacks; concentration on working higher risk 

cases; computer reprogramming to segment cases between Area and 
Territory 

Offices; and Service Center Workload Realignment.



[See PDF for image]



[End of Table]



Future Plans: The shift toward higherpriority TDA entities will 

increase the number of cases closed. IRS will continue re-engineering 

initiatives to increase productivity.



D. Field Collection - Number of Cases Closed Taxpayer Delinquent 

Investigation (TDI):



Description: Count of the number of actual TDI dispositions completed 

by Revenue Officers. A TDI disposition occurs on Integrated Data 

Retrieval System (IDRS) when the status of an investigation changes 

from an open status to a closed status as defined in Section 8 of 

Document 6209 (Automated Data Processing (ADP)/IDRS Information.) Data 

is reported as entities.



FY 2002 Performance: The target was exceeded as a result of efforts to 

re-balance inventories and increasing the percentage of time applied to 

TDI cases.



[See PDF for image]



[End of Table]



Future Plans: Re-engineering initiatives will increase productivity. 

However, due to an emphasis on priority TDA work, we expect a decrease 

in the number of TDI closures. Process improvements will reduce the 

amount of direct time spent resolving a TDI.



E. Automated Underreporter Closures:



Description: Total number of closures of Automated Underreporter Cases.



FY 2002 Performance: We surpassed our plan through the implementation 

of improved workload selection systems and management practices 

resulting from partnering efforts between Headquarters and Field 

Management on the use of Management Information Systems data.



[See PDF for image]



[End of Table]



Future Plans: IRS will refine selection criteria in our Automated 

Underreporter (AUR) unit to coincide with our strategic priorities. As 

a result, we anticipate closing more leads in the AUR unit. IRS will 

develop, test and implement a centralized AUR workload selection model. 

IRS will implement a research study of each AUR income category to 

gather data for analysis of screen-outs, seldom worked categories, 

minimally productive categories, and categories with potential for 

productive Correspondence Examination cases. Differences across 

categories and subcategories, operating divisions, and campuses will 

also be analyzed in order to maximize workload selection.



F. Individual Return Examinations Greater Than $100K:



Description: Number of Individual (Form 1040) returns closed by Field 

Examination with a total positive income or total gross receipts 

greater than $100,000.



[See PDF for image]



[End of Table]



FY 2002 Performance: The goal was exceeded because productivity was 

higher than planned in some case categories, and there were 

improvements in direct examination time (DET) applied. The hiring of 

additional resources in FY 2001 (565 Revenue Agents and 108 Tax 

Compliance Officers) and completion of their initial training 

significantly improved the productivity, closing the gap created in 

past years. More management attention paid to case management and 

maintaining optimal inventory levels were also primary contributors to 

improvement in this area.



Future Plans: IRS will develop and implement a strategy for high income 

taxpayers. Research of higher income taxpayers has revealed potential 

pockets of non-compliance in income strata of $1 million Total Positive 

Income (TPI) and above. We will use new national Unreported Income 

Discriminate Index Function (UI DIF) formulas in conjunction with the 

new TPI strata to surface potential non-compliant returns for audit. 

Our most experienced field revenue agents will work these cases. We 

will redirect our traditional audit program to include taxpayers with 

incomes over $100,000. Since many higher income taxpayers invest in 

various flowthrough entities to defer or hide potential taxable income, 

we will continue to build our understanding of the filing, reporting 

and payment attributes of Partnerships and Trusts.



IRS will assess examination coverage across 1040 non-EITC filers and 

develop a strategy for addressing compliance issues in this area. 

Workload identification business rules will be designed and tested to 

identify non-compliant returns. Focus will be on expanded coverage of 

the higher income Wage and Investment population.



G. Individual Return’ Examinations Less Than $100K:



Description: Number of Individual (Form 1040) returns closed by Field 

Examination with a total positive income or total gross receipts less 

than $100,000.



[See PDF for image]



[End of Table]



FY 2002 Performance: See measure F. above.



Future Plans: See measure F. above.



H, Total Returns Examined:



Description: Combined count of the Number of Individual (Form 1040) 

returns closed by Field Examination. This measure is the sum of 

measures F and G.



[See PDF for image]



[End of Table]



FY 2002 Performance: See measure F. above.



Future Plans: See measure F. above.



I. Number of Business Returns Examined:



Description: Includes all Large and MidSized Business returns closed 

outside of coordinated industry, and Small Business/Self Employed 

corporation and schedule C and F examinations.



FY 2002 Performance: Fiscal year to date closures are somewhat under 

plan, but starts and inventories are in line to accomplish full year 

targets. Accomplishments are also expected to increase with the 

realignment of $5 million to $10 million cases from the Large and Mid 

Size Business Division to Small Business/Self Employed.



[See PDF for image]



[End of Table]



Future Plans: IRS will increase emphasis on shelters, establish a 

strategy to address high-risk passthrough entities related to high 

wealth individuals, continue the Compliance Initiative Project on 

passthrough entities, and continue reduction in staff years applied to 

Coordinated Industry Cases through the use of issue management 

strategies.



J. Number of Cases Examined - Large Case:



Description: Number of regular Coordinated Industry cases (CIC) closed 

during the period (“R1” cases; i.e., not including claim cases, cases 

returned from Appeals, or non-examined closures). A Coordinated 

Industry case consists of one or more tax years of the primary taxpayer 

(usually a large corporate return) plus all related returns examined in 

conjunction with the primary taxpayer.



FY 2002 Performance: The FY 2002 Performance was 528 Cases or 93% of 

the 566 planned. There is no single barrier to explain this 

performance, although the increased focus upon abusive shelters 

frequently increases cycle time. While short of the target, this level 

of performance demonstrates a significant improvement from the Large & 

Mid-Size Business Division Stand-up year (FY 2000) when 328 were 

closed, and FY 2001 when 417 were closed. In fact, FY 2002 performance 

for CIC closures reflects a 43% increase from FY 2000 and the number of 

CIC closures for FY 2002 exceeds the performance in each of the last 5 

years.



[See PDF for image]



[End of Table]



Future Plans: IRS’ highest priority for resources will be to address 

abusive shelters, especially at the promoter level. For non-shelter 

coordinated industry workload, we will use an issue driven approach, 

based on risk analysis results, and smartly employ issue management 

strategies to reduce examination time and to determine scope. We will 

apply resources to pre-filing activities with the goal of reducing the 

issues that are resolved in a post-filing, contentious environment. We 

will develop procedures and policies to engage all employees in the use 

of productivity improvement tools such as prefiling products, risk 

analysis, improved planning, and other issue management strategies. 

These activities should directly improve cycle time, currency, and 

quality.



K. Number of Returns Closed - Large Case:



Description: Coordinated Industry Corporate returns (F1120 and 

associated Partnership and Employment Tax forms) closed with designated 

activity codes.



[See PDF for image]



[End of Table]



FY 2002 Performance: IRS surpassed the plan because of a greater than 

expected number of Employment Tax Returns associated with Coordinated 

Industry Cases.



Future Plans: CIC returns are a function of a work product (CIC Cases) 

rather than a planned output. In contrast to Industry returns, where 

goals and targets are established, these returns are a result of 

examination of a key taxpayer. For Coordinated Industry we plan an 

examination for a key taxpayer case, but the related returns (e.g., 

Partnership, Excise Tax, Employment Tax, etc.) are more a byproduct 

than an intended outcome.



L. Employee Plans /Exempt Organizations Examinations Closed:



Description: Number of Employee Plans and Exempt Organizations return 

examinations closed in all categories.



FY 2002 Performance: The FY 2002 goal was based on an assumption about 

the number of determination letter receipts that would come in and how 

many Full-Time Equivalents (FTEs) would need to be diverted from 

examination casework to cover that workload. Since determinations were 

lower than forecast, Examination FTEs were moved back to doing 

examinations and the additional FTEs enabled surpassing the goal.



[See PDF for image]



[End of Table]



Future Plans: By removing determination work from the responsibilities 

of both Examination agents and managers, realignment of resources will 

promote efficiency, consistency and quality in Examination. To improve 

productivity in the face of declining resources in FY2003, IRS is 

aggressively pursuing the use of limitedscope and correspondence 

audits. Limitedscope audits were initiated in FY2002, and more are 

planned in FY2003 and FY2004. Beginning in FY2003, IRS will also 

implement recommendations from a study of time-per-case and related 

returns now underway, as well as any findings regarding the 

effectiveness of the limited-scope approach.



M. Criminal investigations Completed:



Description: Cumulative count of the number of all subject criminal 

investigations completed by Criminal Investigation during the fiscal 

year. This includes investigations that resulted in a criminal 

prosecution recommendation to the Department of Justice as well as 

investigations that were discontinued due to a lack of evidence or to a 

finding that the original allegation was false.



FY 2002 Performance: IRS achieved approximately 98 percent of its year-

end plan for total investigations completed, a significant 

accomplishment in light of redirection of resources to the war on 

terrorism. IRS also shifted criminal investigation inventory mix, 

reducing the time spent on narcotics related investigations, and 

increasing the resources dedicated to income tax related 
investigations.



[See PDF for image]



[End of Table]



Future Plans: IRS will increase emphasis on promoters of abusive 

foreign and domestic trusts, and schemes based on frivolous legal 

arguments. The Criminal Investigation Division will partner with the 

Small Business and Self-Employed and Large and Mid-Size Business 

Divisions in their efforts to identify abusive tax schemes, promoters, 

and abusive tax shelter activities.



N. Appeals. Cases Closed:



Description: Total Cases Closed equals the total number of cases closed 

in Appeals, including both non-docketed and docketed cases. (A docketed 

case is one in which a taxpayer has filed a petition in the Tax Court.) 

This measure is currently reported in workunits. A workunit represents 

a single case or group of related cases, which are being considered by 

Appeals as one unit for settlement of decision purposes.



FY 2002 Performance: Appeals exceeded its FY2002 plan by closing 68,015 

cases. Improved resource allocations, case development practices, 

better management and communications resulted in more efficiency and 

greater productivity during FY 2002 making it possible for Appeals to 

achieve its target.



[See PDF for image]



[End of Table]



Future Plans: One of our top priorities is to reduce the length of time 

it takes for a case to go through Appeals (cycle time). We are taking a 

multifaceted approach to achieve this goal. IRS plans to balance 

inventory among teams, within areas, across Appeals Operating Units and 

nationally. IRS will pursue workload prioritization to ensure 

appropriate resources are spent on the right cases, and process cases 

more efficiently based on particular characteristics of certain case 

segments. IRS also plans to test the use of Fast Track Mediation for 

new types of casework and permanently implement and actively promote 

the Fast Track Settlement program.



0. Taxpayer Advocate Service (TAS) Closed Cases:



Description: Number of cases worked in TAS and closed on the Taxpayer 

Advocate Management Information System.



FY 2002 Performance: The closure target was missed because receipts 

were significantly lower than forecast. The original plan number was 

based on the assumption that case receipts would decrease approximately 

1.5% from the prior year, however, TAS receipts decreased at a much 

higher rate.



[See PDF for image]



[End of Table]



Future Plans: Additional training, crosstraining and experience by 

Taxpayer Advocate Service case advocates, along with National Customer 

Service Agreements with IRS Operating Divisions, should continue the 

Advocate’s efficiency in closing cases. Since receipts, and 

consequently closures, are decreasing, TAS is changing this measure to 

focus on the efficiency of processing cases instead of just the raw 

number. In FY2003, TAS is replacing this critical measure with the Case 

Closure to Receipt Ratio.



Strategic Goal 3: Productivity Through a Quality Work Environment:



Main Objectives:



*Increase employee job satisfaction:



*Increase productivity and staffing to levels necessary to adequately 

close the tax gap and manage workload growth and expansion in scope:



Employee satisfaction is one measure of management effectiveness and, 

as such, is viewed as an early indicator of the ability to succeed in 

meeting the mission and providing quality products and services to the 

public. By ensuring our employees are satisfied, we are able to provide 

services more efficiently, getting the greatest value for every dollar 

we spend. Good productivity requires employee satisfaction. This means 

our employees must have the management support, tools and equipment 

they need to provide good service to our customers, and there must be 

effective communication vertically and laterally throughout the 

organization.



Major Results and Accomplishments:



a. Major Results:



The overall level of IRS employee satisfaction reached 55% in FY 2002, 

exceeding FY 2001 by 4% and the FY 2002 target by 1 %.



This year a record 82,027 (69%) employees responded to our annual 

census survey.



In an effort to reduce errors inherent in a paper survey and to provide 

workgroup reports much quicker, IRS piloted a totally paperless survey 

in two of its campus locations. Moving to a paperless process in the 

campuses will provide employees with the same flexible survey 

application available in locations other than the campuses.



Improvement in the area of training and career development continued to 

increase as evidenced by higher employee satisfaction scores in these 

areas.



Began greater focus on Employee Health and Safety and established 

related measures. The addition of the employee scholarship program 

targeted at key staffing needs reinforced our commitment to employee 

development.



The Human Resources Investment Fund, established in response to earlier 

employee feedback about training needs, continued as a complement to 

the scholarship program.



An electronic data base of Employee Satisfaction meetings, issues 

arising from these meetings and actions taken as a result of the 

meetings will expand our ability to identify cross-cutting issues and 

best practices. The database will also facilitate our ability to hold 

managers accountable for actions taken in response to Employee 

Satisfaction data.



IRS has addressed employee health and safety by replacing old desks and 

chairs with ergonomically correct models.



Balanced Measures:



A. Agency Wide Employee Satisfaction:



Description: Measure of employee’s satisfaction with their job at the 

IRS. At the Service-wide level the results of Survey Item CO 1 

(Considering everything, how satisfied are you with your job?) are used 

as the sole determining factor in the externally reported results. 

Additionally, survey questions regarding the employees perception of 

management practices, organizational barriers, and overall work 

environment that impacts an employees’ efforts to do a good job are 

used in the internally reported results.



FY 2002 Performance: Improvement was most notable in the areas of 

overall job satisfaction, recent recognition or praise for doing a good 

job, and increased feelings of job importance. IRS’ strongest 

performance was in the areas of ensuring employees know what is 

expected of them, creating a caring environment, and engendering a 

commitment to quality work. IRS provided results of SURVEY2002 to 

employees for discussions in workgroups this summer, with subsequent 

action plans developed to ensure continued improved working conditions.



In an effort to reduce errors inherent in a paper survey and provide 

workgroup reports much quicker, IRS piloted a totally paperless survey 

in two campus locations. Moving to a paperless process in the campuses 

will provide employees with the same flexible survey application 

available in locations other than the campuses.



Responses to questions about training and development continue to 

improve. The addition of the employee scholarship program targeted at 

key staffing needs will reinforce our commitment to employee 

development. The Human Resources Investment Fund, established in 

response to earlier employee feedback about training needs, is 
continuing 

as a complement to the scholarship program.



[See PDF for image]



[End of Table]



Future Plans: IRS has conducted an analysis of the top and bottom 10% 

of workgroups to determine what drives scores. Survey questions that 

deal with employee recognition, development, opinions and progress have 

the greatest impact for groups falling in this category. In FY 2003, 

IRS will more actively involve the second line manager in evaluation of 

those work groups most in need of improvement and development of plans 

to improve both manager skills and workgroup scores.



IRS also plans to improve readability of the survey and will expand the 

use of electronic (telephone and web-based) survey tools to make it 

easier for employees to participate.



Several current activities will be continued in the future to sustain 

progress in this area. An electronic database of Employee Satisfaction 

meetings, issues arising from these meetings, and actions taken as a 

result of the meetings, will expand our ability to identify cross-

cutting issues and best practices, and will facilitate our ability to 

hold managers accountable for actions taken in response to Employee 

Satisfaction data. Operating Divisions are providing managers with new 

tools to improve their ability to take action in response to survey 

results and workgroup meetings. For example, SBSE has a managers guide 

to employee satisfaction on-line and W & I has a “Managers’ Tool for 

Engaging the Workforce,” on-line and has developed a training course 

for managers on Employee Engagement.



B. Lost Work Day Case Rate:



Description: The Lost Work Day Case Rate is the number of Federal 

Employee Compensation Act claim cases with lost time filed in the 

current fiscal year per 100 full-time equivalent employees. Each 

division is analyzing their specific data to determine the drivers of 

new claim cases and will prepare action plans addressing them once 

their analysis is complete.



FY 2002 Performance: IRS formed a new team this year to define the 

national strategy for the Safety and Health Program. The team began 

work toward developing the Concept of Operations that will result in a 

Strategic Plan for the Safety and Health Program.



[See PDF for image]



[End of Table]



Future Plans: IRS will integrate the Safety and Health Program into our 

Strategic Planning Process for the next cycle (FY 2005).



III. System Controls and Legal Compliance:



Federal Managers’ Financial Integrity Act (FMFIA):



In accordance with the requirements of the Federal Managers’ Financial 

Integrity Act, the Service evaluated its systems of internal controls 

for the fiscal year ending:



September 30, 2002. The Service provides qualified assurance that the 

objectives of the FMFIA are being achieved with regard to Section 2 

(procedures and records of the organization) and Section 4 (systems 

that carry out financial management functions and accounting systems 

that carry out unique programs). This qualified assurance is based on 

our identification of material weaknesses and reportable conditions, 

all of which are being addressed by corrective action plans.



This summer we thoroughly reassessed our material weaknesses. As 

discussed below, we are proposing to close, downgrade or consolidate 

several, reducing the number remaining open from 14 to 9. Top 

executives reviewed each remaining material weakness to identify the 

key issues and determine what types of actions could be taken to more 

expeditiously resolve them. We identified procedural modifications that 

could be implemented quickly wherever possible, instead of waiting for 

the longer-term systemic solutions. All of these actions enabled us to 

move up the planned closing dates of the following material weaknesses:



“Demonstrate Capability to Manage Replacement of Tax Processing and 

Business Systems” (from FY 2010 to several years earlier, specific date 

to be determined):



“Financial Accounting of Revenue - Custodial” (from FY 2009 to FY 2006) 

“Financial Statements - Administrative” (from FY 2005 to FY 2003):



Three other material weaknesses will close in the same fiscal years as 

previously planned and one other had its planned closing date extended 

by one year.



Federal Financial Management Improvement Act (FFMIA):



As of September 30, 2002, the Service’s financial management systems 

did not substantially comply with the FFMIA. Plans are in place to 

resolve the material weaknesses causing this condition. The estimated 

dates for bringing our financial management systems into substantial 

compliance are 2006 for the custodial and 2004 for the administration 

functions. The initiatives associated with these plans are in the IRS 

Modernization Blueprint. Due to changes in the Business Systems 

Modernization plan, the 2006 date for custodial accounting is under 

evaluation.



Laws and Regulations:



As of September 30, 2002, the IRS did not always comply with section 

6325 of the Internal Revenue Code regarding the release of federal tax 

liens nor with section 6159 of the code regarding the structuring of 

installment agreements.



Performance Measures:



The Service provides assurance that the IRS Critical Performance 

Measures are reliable. During the year, IRS has enhanced the level of 

detail required for its critical measures to ensure reliability and 

validation and verification of data. Data owners are now required to 

provide information on management controls in place for data submitted 

and used in reports.



Continuity of Operations:



IRS is addressing continuity of operations planning in critical areas 

and the planning is sufficient to reduce risk to reasonable levels.



Improper Payments:



Within current law and resources available, IRS will continue to focus 

on assuring that controls are adequate to minimize erroneous EITC 

payments. The most significant actions for program improvement include 

implementation of the joint IRS-Treasury Task Force recommendations.



Reports Consolidation Act of 2000:



The IRS FY 2002 Performance and Accountability Report was prepared to 

comply with the Reports Consolidation Act of 2000. This act authorizes 

the consolidation of Federal financial and performance management 

reports while also satisfying the requirements of the Government 

Performance and Results Act.



Limitations of the Financial Statements:



The principal financial statements have been prepared to report the 

financial position and results of operations of the entity, pursuant to 

the requirements of 31 U.S.C. 3515(b). While the statements have been 

prepared from the books and records of the entity in accordance with 

generally accepted accounting principles (GAAP) for Federal entities 

and the format prescribed by OMB, the statements are in addition to the 

financial reports used to monitor and control budgetary resources which 

are prepared from the same books and records. The statements should be 

read with the realization that they are for a component of the U.S. 

Government, a sovereign entity.



IV. Future Challenges:



This report discusses many of the IRS’ major accomplishments in FY 

2002. The improvements in service and widespread redirection of 

compliance programs toward higher priorities reflect the benefits of a 

more customer-focused and accountable organization. We remain committed 

to reach even higher levels of performance in the coming years, but we 

also must acknowledge the many challenges ahead.



Our strategic planning process is the major vehicle through which we 

identify and assess challenges to our continuing success. We use this 

systematic approach to inform our decision making as we allocate 

resources and direct our management focus to achieve IRS goals. We are 

also guided by the General Accounting Office (GAO) and the Treasury 

Inspector General for Tax Administration (TIGTA) who have identified 

Management Challenges and High-Risk Areas facing the IRS over the last 

several years (discussed in the next sub-section). Together, these 

sources of information reveal four key areas upon which we must focus 

in the next few years - Modernizing Systems and Business Processes; 

Compliance and Enforcement; Customer Service; and Employee 

Satisfaction.



Modernizing Systems and Business Processes - The modernization of the 

IRS’ tax administration and internal management systems and processes 

is the greatest long-term challenge we face. Successful implementation 

of new systems and processes will increase: (1) customer satisfaction 

through more timely and accurate handling of taxpayer returns, refunds 

and accounts management; (2) employee satisfaction through a more 

productive workforce that will, for example, reduce rework caused by 

errors inherent in the current manual processes; and (3) business 

results as greater accuracy will increase quality and greater 

efficiencies will increase quantity. Systems modernization will take 

approximately ten years to accomplish. In FY 2003, our plans project 

the following accomplishments: (1) implementation of a new Integrated 

Financial System, (2) an Enterprise Systems Management strategy to 

provide network and systems management to improve information 

technology infrastructure availability and performance, (3) the 

deployment of Customer Account Data Engine Release 1, authoritative 

computations and data stores for individual taxpayer account and return 

data, (4) the deployment of Enterprise Data Warehouse / Custodial 

Accounting Project Release 1, integrated, reliable tax operations and 

internal management information, (5) the implementation of Security and 

Technology Infrastructure Release, a technical infrastructure for 

secure phone and electronic communication, and (6) the deployment of HR 

Connect, which allows employees to manage their human resources 

information online.



Compliance and Enforcement-The most current projection of our nation’s 

gross tax gap (i.e., Federal taxes owed but not paid voluntarily and 

timely) is somewhere between $250 billion and $300 billion. Some of the 

most serious and current compliance problem areas include: promoters of 

tax schemes of all varieties; the misuse of devices such as trusts and 

offshore accounts to hide or improperly reduce income; abusive 

corporate tax shelters; underreporting of tax by higher-income 

individuals; and the failure to file and pay large amounts of 

employment taxes by some employers. Efforts in FY 2003 and beyond will 

address these compliance areas through better education of the public; 

systematically identifying promoters and participants; improving the 

efficiency of exam and collection efforts through reengineering; and 

reinvigorating enforcement actions such as summons enforcement, 

injunctions and criminal investigation of promoters. We must continue 

to make significant progress in collecting better compliance and 

noncompliance data, as well as in quantifying our corporate level 

strategic compliance measures. These two goals will be achieved in 
large 

part through our new National Research Program (NRP). The first 
available 

data on payment compliance and return filing compliance recently became 

available. Initial data on reporting compliance will be available in 

October 2003.



Customer Service - Over the past several years, the IRS has achieved an 

increase in public perception scores on both American Customer 

Satisfaction Index and the Roper Starch surveys. The most recent data 

from Roper Starch, however, shows a slight decrease in 2002 below 2001. 

Although the Roper Starch score remains above the levels recorded in 

1998 through 1999, the drop must be taken seriously.



Employee Satisfaction - Results from our 2002 survey of all employees 

showed an increase in employee satisfaction. This followed a drop in 

2001 that we believe was attributable to the uncertainty and change 

that naturally comes from a reorganization of significant magnitude. 

Even though overall scores increased in 2002, the survey indicated 

areas for improvement. For 2003 we must continue to increase engagement 

of front-line managers so that they are full partners in the new IRS. 

Our management team must also work to more actively engage our front-

line employees, so those employees know they are valued and 

appreciated.



Management Challenges and High Risk Areas:



IRS has undertaken specific actions to address each of the Management 

Challenges and HighRisk Areas identified by GAO and TIGTA. Measures 

within our program activities show progress in addressing them. The 

first twelve Management Challenges and High Risk Areas listed below are 

those identified and prioritized by TIGTA in January 2002. The last two 

areas discussed, Collect Unpaid Taxes and Revamp Business Practices to 

Meet Taxpayer Needs are additional carry over items from GAO’s list 

published in January 2001.



Security of the IRS - Employees and Facilities -:



Recent terrorist activity in the United States demonstrated very 

graphically that the physical security of IRS employees, equipment, and 

structures should be of utmost concern to IRS management. Immediately 

after the terrorist attacks, Facilities Management Officers were 

directed to assess all IRS offices and take actions necessary to 

safeguard personnel and assets in concert with the General Services 

Administration (GSA) and local law enforcement.



In FY 2002, IRS addressed this challenge through the following 

accomplishments:



Developed National Physical Standards that establish security 

enhancements for areas such as guard services, blast mitigation, and 

IRS infrastructure.



Conducted an assessment of all IRS buildings and facilities based upon 

current and proposed security standards.



Developed contingency plans for all ten IRS campuses to address 

hazardous materials threats for the upcoming filing season.



Purchased and distributed protective equipment, such as gloves, masks, 

and lab coats, as a result of the anthrax threats.



Consolidated all mail-opening activities throughout IRS.



Participated in government-wide programs that plan for and minimize the 

risk of catastrophic events on mission achievement.



Developed posters, tri-fold brochures, and a Director’s briefing 

package to provide information and instruction to managers and 

employees regarding anthrax and other hazardous materials threats.



Developed a plan to upgrade communications systems such as public 

address and closed circuit television for all ten IRS campuses.



Developed an action plan to address deficiencies in offices that do not 

meet the National Physical Security Standards.



Completed Phase 1 and 2 initiatives to contain Service Center Automated 

Mail Processing System and mail extraction units in all campuses to 

isolate these areas from other units.



In FY 2003, IRS will continue to respond to this challenge through the 

following planned actions:



Continue to work with GSA and law enforcement agencies to safeguard 

personnel and assets.



Closely monitor procedures regarding the inspection of incoming mail 

and packages. Continue implementation of security enhancements.



Continue to participate in government-wide programs that plan for 

disaster response. Take actions to improve and institutionalize changes 

for campus mail operations. Complete security risk assessments of all 

level 1, 2, and 3 buildings and implement all necessary corrective 

measures and/or upgrades identified.



Security of the IRS - Information Systems:



Although computer security has measurably improved, computer security 

control weaknesses continue to place automated systems and taxpayer 

data at serious risks to both internal and external threats. As the 

primary revenue collector for the United States, IRS is a target for 

both terrorists and hackers. This threat has increased over the last 

few years with more interconnectivity of systems. Until stronger 

security controls are in place over its information systems, tax-

processing operations remain vulnerable to disruption. Furthermore, the 

sensitive taxpayer data maintained by IRS is at risk of being disclosed 

to unauthorized individuals, modified and improperly used, or 

destroyed, thereby unnecessarily exposing taxpayers to financial crimes 

such as identity fraud.



In FY 2002, IRS addressed this challenge through the following 

accomplishments:



Established Security Services organization to create corporate security 

solutions.



Focused on evaluating and improving IRS security programs and 

processes, and identifying how to implement security capabilities that 

are balanced with operational requirements. Conducted reviews of IRS 

facilities and programs to evaluate and test security controls, and 

assisted IRS organizations to set up internal security review 

processes.



Monitored IRS networks to prevent cyber attacks.



In FY 2003, IRS will continue to respond to this challenge through the 

following planned actions:



Conduct reviews to evaluate security performance in key business areas, 

such as remittance processing, and work with IRS business units to 

mitigate these weaknesses. Improve the adequacy of physical, logical, 

communications, and personnel security, operating practices, software 

quality assurance activities and business resumption plans to mitigate 

the IRS’ computer security material weaknesses.



Use a model facilities approach to improve the consistency of security 

controls across IRS facilities.



Continue to improve the ability to prevent, identify and resolve cyber 

attacks by completing build-out and improving operational readiness of 

the Computer Security Incident Response Center.



Conduct regular assessments of the overall state of security in IRS; 

use the security assessment framework as a guide to improve and better 

measure IRS security capabilities.



Systems Modernization of the IRS:



The ability to balance the goals of helping taxpayers meet their tax 

responsibility and improving overall compliance with tax laws depends 

on the successful completion of the modernization effort. Modernization 

of technology is crucial to implementing the new business vision of 

providing world-class service to taxpayers. While the development of 

new technology evolves, existing operations must continue, and 

improvements must be made to meet the needs of tax administration and 

demonstrate IRS’ commitment to improved service to taxpayers.



In FY 2002, IRS addressed this challenge through the following 

accomplishments:



Implemented repeatable management processes.



Ensured ongoing projects are aligned with the Enterprise Architecture 

(EA) in accordance with the compliance certification process.



Fully implemented a risk management program.



Established a centralized Configuration Management repository.



Fully defined and institutionalized standard configuration management 

procedures. Identified configuration items for current production 

environment impacted by near-term modernization project releases.



In FY 2003, IRS will continue to respond to this challenge through the 

following planned actions:



Identify and implement efforts to slow projects to match management 

capacity. Focus on better cost and schedule estimating and on building 

reserves in plans. Continue strong governance and rigid adherence to 

Enterprise Life Cycle.



Identify and address all potential funding problems by scaling back or 

deferring some projects, improving estimates and releasing funds 

annually to reduce administrative burden. Identify and correct 

inconsistencies in implementing key systems, focusing on 14 key 

management processes.



Provide special executive focus in acquisition and contracting areas.



Develop a detailed plan for maturing all management processes presented 

to GAO/TIGTA and implement a monthly progress reporting process.



Integrating Performance and Financial Management - Performance 

Management/ GPRA:



Balanced measures are being aligned with the employee performance 

evaluation system to clearly link the work of individual managers and 

employees to the mission and goals. Additionally, the effectiveness of 

compliance improvement initiatives and current compliance levels can 

not be accurately determined until a measure of taxpayers voluntary 

compliance is developed.



In FY2002, IRS completed the following actions:



Almost all functions have approved balanced measures composed of 

business results quantity and quality, customer satisfaction and 

employee satisfaction.



Divisions used balanced measures to report to the Commissioner on 

executing their workplans, and also as the cornerstones for building 

their strategic plans.



Divisions are in the process of deploying and setting targets for their 

balanced measures down to the Area office (or equivalent) level.



Began implementing Embedded Quality (EQ), which revamps the way quality 

is measured, calculated, and reported in the sites. EQ will create 

accountability by connecting employee evaluations directly to the 

corporate balanced measures in a fair and meaningful way.



IRS replaced the manual process to collect, collate and report 

performance data by automating these steps through the Data Mart and 

Business Performance Management System (BPMS) for most of the IRS 

critical measures.



IRS continues to develop its strategic measures, and included seven 

strategic measures in the FY2004 OMB Budget Submission - four related 

to tax administration and three on worker safety. Three of the tax 

administration strategic measures in the budget had historical data: 

Payment Compliance, Filing Compliance and Potentially Collectible 

Inventory (PCI). Data for the fourth, Reporting Compliance, will be 

available by December 31,2002. Expanded participation in American 

Customer Satisfaction Index.



In FY2003, IRS will continue to respond to this challenge through the 

following actions:



Continue to automate data collection and reporting through Data Mart 

and BPMS.



Beginning with linking collection workplans to reducing PCI, divisions 

are in the process of linking their operational critical measures to 

relevant strategic measures to better align resource decisions to 

achieving strategic outcomes.



Major operating divisions are developing their own strategic measures.



Integrating Performance and Financial Management - Financial 

Management:



IRS’ current financial systems alone cannot produce reliable 

information necessary to prepare financial statements in accordance 

with federal accounting standards. The data produced from the current 

financial system has to be reconciled with other subsidiary systems to 

produce reliable financial statements. Further, IRS does not fully 

comply with the requirements of the Federal Financial Management 

Improvement Act (FFMIA). IRS’ remediation plans do not identify 

resource commitments for all remedial actions, independent 

verifications were not performed for all implemented remedial actions, 

and sufficient explanations were not provided for the necessity of 

revised remedial action intermediate target dates. In addition, the

financial systems cannot provide reliable cost accounting information.



To improve overall financial management, IRS is implementing two major 

systems: the Custodial Accounting Project (CAP) and the Integrated 

Financial System (IFS).



In FY2002, IRS completed the following actions:



*IRS has completed the Architecture Phase of the CAP.



In FY2003, IRS will continue to respond to this challenge through the 

following actions:



The Systems Development Phase of the CAP is scheduled for completion in 

December 2002.



Deployment of Build 1 of Taxpayer Accounts Sub Ledger (TASL) is 

scheduled for March 2003.



The first release of IFS is scheduled for deployment on October 1, 2003 

and will include the Core Financial System as defined by the Joint 

Financial Management Improvement Program (General Ledger, Accounts 

Payable, Accounts Receivable, Funds and Cost Management, and Financial 

Reporting), as well as Budget Formulation.



Processing Returns & Implementing Tax Law Changes during the Filing 

Season:



The filing season impacts every American taxpayer and is therefore 

always a highly critical concern. Many programs, activities and 

resources have to be planned and managed effectively for the filing 

season to be successful. Critical programming changes for the filing 

season must receive priority over other programming requests. This is 

further complicated by the modernization efforts that are updating and 

replacing the very core tax processing systems needed to deliver a 

successful filing season. In addition, IRS must ensure systems capacity 

and telecommunications will accommodate the new electronic filing 

requirements and the accuracy and utility of information received and 

processed.



In FY 2002, IRS completed the following actions:



Implemented a secure transaction-based web site.



Incorporated new procedures required by the Economic Growth and Tax 

Relief Reconciliation Act of 2001.



Completed centralization of all employment tax processing, including 

information returns, by consolidating operations in two Submission 

Processing sites.



In FY 2003, IRS will continue to respond to this challenge through the 

following planned actions:



Continue to use workload forecasting to ensure the required number of 

employees is available for each telephone product line and ensure tools 

are updated and available timely. Continue to identify training needs 

and develop training plans to improve performance. Conduct CPE training 

to ensure assistors are knowledgeable of tax law changes.



Ensure the Corporate Filing Season Readiness Process is operational and 

covers all aspects of the filing season, including the Annual Readiness 

Certification.



Conduct pilot and roll out the Remittance Transaction Research (RTR) 

system.



Implement registered user access to enable authorized third parties and 

practitioners to request and receive transcripts electronically, submit 

account inquiries, powers of attorney and disclosure authorizations 

electronically.



Implement taxpayer identification number (TIN) matching with payers. 

Expand e-filing options by adding and converting additional forms.



Complexity of the Tax-Law:



According to the FY 2000 Taxpayer Advocate’s Annual Report to the 

Congress, the highestranked problem individual and business taxpayers 

had with IRS was tax law complexity. The problems that exist because of 

this complexity range from individual to corporate and international 

tax issues. Stakeholders from divergent constituencies have informed 

decision-makers about the problems and recommended solutions. It is 

unlikely that the Internal Revenue Code will be simplified at one time. 

Therefore, IRS has the challenge to remove as much complexity as 

possible as a service to taxpayers. The effect of tax law complexity is 

compounded as IRS modernizes. Since complexity can be a major factor in 

the cost of operations, IRS must devote resources to simplifying taxes 

while at the same time modernizing its systems and processes.



In FY 2002, IRS completed the following actions:



Integrated Probe and Response methodology into IRS publications and 

made their use the standard tool for Field Assistance technical 

employees.



Trained Customer Service Representatives in one or more technical and 

account topics, enabling them to be more proficient in assisting 

customers quickly and accurately.



In FY 2003, IRS will continue to respond to this challenge through the 

following actions:



The National Taxpayer Advocate’s FY2001 Annual Report contains 28 

legislative proposals, 19 of which are described in detail as key 

recommendations. The legislative recommendations taken as a whole 

represent proposals the NTA believes will reduce complexity of the 

Code, reduce taxpayer burden in complying with requirements, and reduce 

IRS’ burden in administering the tax system.



The NTA has also identified potential legislative issues to be 

developed for the 2002 Annual Report to Congress and continues to work 

with members of Congress and their staffs to increase understanding and 

support of the key legislative recommendations contained in the 2001 

report. The NTA has addressed complex issues such as family status, 

alternative minimum tax, installment agreements for less than full 

payment, joint and several liability, penalty and interest, and 

collection procedures.



Tax Compliance Initiatives:



The most current analysis estimates that our nation’s gross tax gap 

(i.e., Federal taxes and related payments owed but not paid) is 

somewhere between $250 billion and $300 billion. Some of the most 

serious and current compliance problem areas include: promoters of tax 

schemes of all varieties; the misuse of devices such as trusts and 

offshore accounts to hide or improperly reduce income; abusive 

corporate tax shelters; underreporting of tax by higherincome 

individuals; and the failure to file and pay large amounts of 

employment taxes by some employers. Efforts in FY 2003 and beyond will 

address these compliance areas through better education of the public; 

systematically identifying promoters and participants; improving the 

efficiency of exam and collection efforts through reengineering; and 

reinvigorating enforcement actions such as summons enforcement, 

injunctions and criminal investigation of promoters. We must continue 

to make significant progress in collecting better compliance and non-

compliance data as well as quantifying our corporate level strategic 

compliance measures. These two goals will be achieved in large part 

through our new National Research Program (NRP). The first available 

NRP data on payment compliance recently became available. Initial data 

on reporting compliance will be available in October 2003.



In FY 2002, IRS completed the following actions:



* Analyzed Correspondence Examination programs to determine areas of 

non-compliance that can be addressed through the use of soft notice and 

math error treatments.



Developed improvement strategies to address escalating and aged Offers 

in Compromise (OIC) inventory and to reduce open OIC inventory within 

six to twelve months.



Enhanced and realigned the current Examination legacy systems to help 

identify the most productive returns to examine. Information will be 

made available to examiners to conduct more effective examinations.



Expanded the range of information documents and returns that may be 

filed electronically for Corporate Taxpayers.



In FY 2003, IRS will continue to respond to this challenge through the 

following planned actions:



Deploy a range of initiatives using education and outreach to improve 

the overall rate of voluntary compliance.



Increase efficiency and effectiveness by updating and re-engineering 

work processes to make better use of resources.



Advance the use of Voluntary Compliance Agreements, reducing the need 

for traditional enforcement actions.



Fully implement K-1 matching program and target enforcement efforts 

towards promoters and participants of abusive tax schemes.



Implement improved processes to move to an issue-driven compliance 

process that will result in productivity savings and redirect these 

savings to the highest compliance work. Compliance, with the assistance 

of SB/SE Research, is in the process of analyzing the Potentially 

Collectible Inventory reports to identify the causes of growth and 

develop a course of action to impact continued growth.



Explore the use of limited scope examination processes to improve case 

resolution.



Apply alternative dispute resolution procedures and other issue 

resolution programs to resolve tax shelter issues in timely and 

consistent manner.



Providing Quality Customer Service Operations:



Providing top quality service to every taxpayer in every transaction is 

an integral part of IRS’ modernization plans. IRS provides customer 

service in many ways, including toll-free telephone service, electronic 

customer service, written communications to taxpayers, walk-in service, 

and accurate and timely tax refunds. Each of these services affects 

taxpayers’ ability and desire to voluntarily comply with the tax laws.



In FY 2002, IRS completed the following actions:



Created a bar-coding system for adjustment notices and refund checks so 

they can be mailed in the same envelope.



Developed a formal training plan and schedule to improve employee 

knowledge of tax law, marketing, communication, and relationship 

management skills.



Targeted and built quality relationships with internal and external 

partners and intermediaries to educate and support taxpayer and 

practitioner programs.



Provided employers with access to on-line employment tax and wage 

information through the Simplified Tax and Wage Reporting System.



Reconfigured the Practitioner Hotline into a centralized system.



Trained Customer Service Representatives in one or more technical and 

account topics, enabling them to be more proficient in assisting 

customers quickly and accurately.



*Analyzed and trained the volunteer workforce to create subject matter 

experts both internally and externally.



In FY 2003, IRS will continue to respond to this challenge through the 

following planned actions:



Add 7 new forms that can be electronically filed in 2003.



Implement and improve availability of on-line services such as Internet 

Employer Identification Number (EIN), Centralized Authorization File 

and Practitioner Priority Services. Improve e-services for 

practitioners.



Enhance electronic interactions (such as e-filing and e-paying), 

augment communication with taxpayers through the development of e-

government operations, and provide employers with access to on-line 

employment tax and wage information.



Implement recommendations developed as part of the Service’s 

Multilingual Initiative. Review computer-generated notices and 

correspondence to improve quality and clarity. Configure outward facing 

Toll-Free numbers to relate directly to taxpayers’ inquiries. Provide 

new and expanded services through Internet Refund/Fact of Filing 

(IRFOF) to reduce toll-free demand and offer customers alternative 

methods of service.



Provide taxpayers a way to resolve tax problems every day at Taxpayer 

Assistance Centers. Address issues associated with Globalization by 

using Tax Attaches stationed overseas.



Erroneous-Payments; Noncompliance with EITC:



The President and the Congress have expressed concerns with the large 

amount of erroneous payments made by Federal agencies each year. The 

risk of improper payments increases in programs with complex criteria 

for computing payments, a significant volume of transactions, or 

emphasis on expediting payments. Although many IRS programs are 

susceptible to erroneous payments, the Earned Income Tax Credit (EITC) 

Program is particularly vulnerable. Subsequent to studies showing 

billions of dollars of EITC noncompliance, Congress provided additional 

funding and enforcement tools to improve compliance. In 1998, a five-

year compliance initiative directed at major sources of EITC 

noncompliance was initiated. In addition, IRS received from Congress 

and implemented additional statutory authority to deny questionable 

claims during initial processing (math error processing).



Despite its compliance initiative, which has saved the Government over 

$5 billion, the most recent compliance study, Compliance Estimates For 

Earned Income Tax Credit Claimed on 1999 Returns, released in February 

2002, estimates a 31-36% error rate and a 27-32% unrecovered overclaim 

rate. EITC non-compliance results from three major error sources: (1) 

taxpayers claiming EITC amounts based on children with whom they do not 

have the required relationship and/or with whom they did not reside for 

at least six months of the tax year; (2) taxpayers claiming EITC 

amounts based on erroneously reporting their filing status and (3) 

income misreporting. To address the systemic flaws in the current EITC 

program, and to address the complexity of the EITC law, which was 

highlighted in a then-recent Taxpayer Advocate Report to Congress, 

Secretary O’Neill convened an EITC task force. This mission of this 

joint Treasury-IRS task force was to achieve the objectives of the EITC 

program while reducing taxpayer confusion and increasing the accuracy 

of the administration of benefits. The task force was convened in March 

2002 and presented final recommendations in July 2002. In August 2002, 

Secretary O’Neill approved the recommendations and also approved the 

formation of an IRS implementation team charged with development of an 

implementation plan. This team began a study of the cost and business 

process changes necessary for implementation, and is on-going at this 

time.



In FY 2002, IRS completed the following actions:



Convened a Task Force to thoroughly examine complexity and compliance 

issues of EITC and recommend fundamental program changes to reduce 

complexity and improve compliance.



Expanded use of the Dependent Database (DDb) as an external data source 

to identify noncompliant taxpayers.



Expanded examinations of the Duplicate TIN repeater population.



Began study of data supplied to DDb by the Federal Case Registry of 

Child Support Orders. Created the EITC Executive Advisory Council.



Realigned EITC Project Office to enhance strategic program development 

and execution. Participated in a government-wide task force on 

erroneous payments.



In FY 2003, IRS will continue to respond to this challenge through the 

following planned actions:



Assess overall EITC compliance, identify knowledge gaps and plan 

additional research. Assess marketing/awareness campaigns that target 

eligible EITC non-claimant population. Analyze processing year 2002 

audit results to refine existing DDb business rules. Identify, 

investigate, and prosecute promoters of EITC-related refund schemes.



Finalize EITC preparer cases being actively investigated and prepared 

for prosecution. Assess Federal Case Registry of Child Support Orders 

study data to determine if using expanded math error authority to deny 

EITC will improve compliance efforts.



Continue to address the EITC Task Force recommendations.



Continue our participation in a government-wide task force on erroneous 

payments. Better integrate EITC Program Office into the IRS’ 

established strategic planning process. Continue to expand and refine 

tools used by campus examiners in EITC examinations.



Taxpayer Protection and Rights:



The legislative changes required by the Restructuring and Reform Act of 

1998 (RRA 98) continue to have a profound impact. RRA 98 included 

fundamental changes to tax law procedures, and required IRS to change 

its organizational structure from one that was geographically 

structured to one that was set up to serve particular groups of 

taxpayers with similar needs. Most RRA 98 provisions, including massive 

training programs for thousands of employees, have been modified or 

implemented. Significant management attention will be required to 

evaluate the effectiveness of the reforms. Additionally, IRS’ 

reorganization focus on taxpayer groups presents both a risk of 

treating groups of taxpayers differently and an opportunity to use 

specialized knowledge to promote compliance among all taxpayers 

equitably. IRS is committed to treat all taxpayers equitably, and 

strategic plans indicate equitable treatment of taxpayers is included 

in efforts to promote compliance among business taxpayers.



In FY 2002, IRS completed the following actions:



Implemented a secure transaction-based web site.



Ensured alternative signature initiatives comply with IRS 

authentication policy.



Implemented the next phase of the Checkbox initiative to allow 

taxpayers to designate an individual preparer to serve as their 

designee to discuss tax matters and notices with IRS.



Combined the Centralized Authorization Files into a central repository 

to eliminate the need for taxpayers to submit multiple third party 

authorization requests for numerous issues. Evaluated performance by 

deploying balanced measures to the appropriate levels.



Linked Critical Job Elements and performance expectations to 

organizational quality goals. Redesigned examination work processes and 

assessed legal requirements.



Redesigned internal Collection processes, policies and procedures, and 

updated workload selection and inventory delivery systems.



In FY 2003, IRS will continue to respond to this challenge through the 

following planned actions:



Continue to administer the credit card contract to ensure protection of 

taxpayer data and credit card numbers.



Reduce the volume of paper jurats, expand alternative methods of 

signature. Evaluate computer security to ensure protection of taxpayer 

information. Review and assess implementation of Title VI of the Civil 

Rights Act of 1964 to certify that all tax preparation sites provide 

equal access and non-discriminatory services.



Ensure documentation does not include specific labeling of taxpayers 

raising frivolous tax arguments.



Reinforce the requirements to provide a statement to taxpayers at 

initial meetings that advises them of the Taxpayer Advocate’s 

independence.



Develop a standard practice for IRC Section 7803 (c)(4)(iv), which 

states that local taxpayer advocates may choose not to disclose contact 

with or information provided by a taxpayer.



Human Capital:



GAO considers strategic human capital management as a high-risk area 

for the government, and the President’s FY 2001 budget has added human 

capital to its list of Priority Management Objectives. Inadequate 

attention to strategic human capital management has created a 

government-wide risk of eroding the capacity of some agencies to 

perform their missions. Like many other government agencies, IRS faces 

a range of serious personnel management issues, ranging from 

recruiting, training, and retaining employees to problems associated 

with IRS’ recent reorganization and modernization efforts. During FY 

2001, IRS struggled with a continuing need to properly staff, train, 

and provide adequate tools for employees.



In FY 2002, IRS completed the following actions:



Used the Senior Manager Pay Band system to more effectively allocate 

salary resources to promote and encourage individual and organizational 

excellence.



Expanded the pay band system to all front-line and mid-level managers.



Continued to offer an extensive array of web-and computer-based 

training for employees via the Internet, Intranet, and by CD-ROM 

covering subjects such as communications, customer service, project 

management, finance, accounting, and leadership.



Continued to provide an extensive array of executive development 

training activities that prepare our participants for top-level 

leadership positions.



Continued to encourage executives to establish relationships with their 

alma mater or with schools in their local areas.



Continued partnerships with employee organizations to help recruiters 

establish relationships with community-based organizations.



Continued the state-of-the-art advertising campaign that was 

established to promote IRS as an employer of choice.



IRS has established a strategic human capital strategy that consists of 

four principal elements: Renewal, Training and Development, 

Performance, and Transition.



In FY 2003, IRS will continue to respond to this challenge through the 

following planned actions:



Sustain recruitment efforts over the long term with continued entry-

level intake in key frontline occupations remaining a high priority.



Maintain a continued labor market presence through electronic and print 

advertising. Continue to streamline and automate the hiring process.



Emphasize a management development pipeline. Implement a mid-career 

recruiting strategy. Implement an IRS-wide learning strategy, including 

additional investment in e-learning. Continue expansion of pay-for-

performance system to all remaining front-line managers. Increase bonus 

and staffing flexibility to strengthen the linkage between executive 

performance and compensation.



Capitalize future transition efforts on past experience; coordinate 

efforts such as workload realignment to maximize placement of employees 

while addressing business needs.



Collect Unpaid Taxes:



Reliable and timely financial, operational, and compliance data is not 

available to help target efforts to collect billions of dollars in 

unpaid taxes. As a result, the Federal government is exposed to 

significant losses of tax revenue while compliant taxpayers bear an 

undue burden of financing the government’s activities. Certain key 

collection actions, such as levies and seizures, have declined since 

1997 during IRS modernization efforts and because of the IRS 

Restructuring and Reform Act of 1998 (RRA98) impacts. These declines 

may increase the incentives for taxpayers to either not report or 

underreport their tax obligations. Attempts to identify taxpayers that 

have not paid the taxes they owe are made through various enforcement 

programs. IRS inability to fully pursue such cases is attributable to a 

decrease in staff, reassignment of collection employees to support 

customer service activities, and additional staff time needed to 

implement certain taxpayer protections that were included in RRA98. 

Additionally, inadequate financial and operational information has 

hindered development of cost-based performance information for tax 

collection and enforcement programs.



In FY 2002, IRS completed the following actions:



Developed a risk-based compliance strategy to use knowledge regarding 

taxpayer behavior, history, and needs in the collection decision 

process to ensure that the highest priority cases get worked first and 

reduce the number of accounts closed as currently not collectible. 

Centralized the processing of Offers in Compromise.



Used non-Compliance resources during the filing season to minimize 

impact on Compliance casework.



Redesigned internal processes, policies, and procedures, and updated 

the antiquated system of workload selection and inventory delivery.



In FY 2003, IRS will continue to respond to this challenge through the 

following planned actions:



Provide credit card payment option for delinquent taxes (individuals), 

installment agreement payments and extension-related payments and 

expand credit card options to BMF returns. Develop and implement a 

comprehensive nonfiler strategy.



Identify and target noncompliance with employment tax deposit and 

payment requirements. Continue efforts to gain full participation in 

the State Income Tax Levy Program.



Align Collection legacy systems. Implement a modernized collection 

system. Tailor treatment streams and route cases to appropriate 

functions and employees.



Develop educational products and a marketing plan to address abusive 

flow-throughs, tax shelters, trust filers and their practitioners.



Develop and implement a strategy for High-Income Taxpayers.



Fully implement the K-1 matching program, reconciling partnership 

income reporting documents to the beneficiaries of this income on 

federal income tax returns.



Revamp Business Practices to Meet Taxpayer Needs:



The ability to balance the goals of improving customer service and 

improving overall compliance depends in part on successful 

modernization of business practices.



In FY 2002, IRS completed the following actions:



Completed centralization of all employment tax processing to two 

Submission Processing sites.



Tested feasibility of correspondence imaging to allow immediate on-line 

access to customer correspondence. Improved and enhanced employee 

manuals and tools. Provided new tools and information such as the 

Remittance Transaction System (RTR), Notice Viewing, and Correspondence 

Imaging to employees.



Improved training to Toll-free/Adjustments workforce by determining 

skill gaps.



Integrated business systems such as Automated Offer in Compromise, 

Automated Lien System, Inventory Delivery System and Automated Trust 

Fund Recovery System onto a single platform.



Provided a single-point for electronic filing and test prototype 

solutions for the combined electronic transmission of federal and state 

employer quarterly tax and wage reports. Prototyped an application to 

provide employers a quicker method to securely access, apply for, and 

receive a Federal EIN on-line.



Reconfigured the Practitioner Hotline to a centralized system. 

Centralized the processing of Offers in Compromise (OIC).



Continued efforts to ensure that work is allocated to the proper 

operating division by implementing standardized criteria to reassign 

compliance cases.



Responded to taxpayer demand and implemented pre-filing agreement 

program.



Customer Service Representatives:



In FY 2003, IRS will continue to respond to this challenge through the 

following planned actions:



Establish customer liaisons for media and publications.



Continue to work with industry to enable online tax return entry and 

submission at no cost. Expand electronic tax products for business.



Enhance customer experience by routing calls to appropriate assistors. 

Improve and enhance employee manuals and tools.



Continue to deploy the Integrated Case Processing system.



Redesign business processes to provide service around an industry 

rather than geographically to provide better service for each taxpayer.



Move to an issue-driven examination process for large and midsize 

businesses. Re-engineer the Published Guidance process.



V.Financial Highlights:



Stewardship Information Analysis:



a. Overview of Revenue and Administrative Accounts:



The IRS’ financial statements and footnotes received an unqualified 

audit opinion for the third consecutive year for administrative 

accounts and the sixth consecutive year for revenue accounts. 

Administrative accounts reflect resources used and expenses incurred in 

administering the tax laws. Revenue accounts reflect net taxes 

receivable and taxes collected to support the federal government.



The Balance Sheet reflects total assets of $24.71 billion. Of these 

assets, almost 81 percent are Federal Taxes Receivable. These 

receivables are the amounts expected to be collected from past due 

accounts. The decrease in assets of $0.53 billion is mainly 

attributable to a decrease in the IRS’ fund balance with Treasury. The 

majority of the liabilities, a little over 86 percent, consist of 

Federal Taxes Receivable due to Treasury.



The Statement of Custodial Activity shows that IRS programs resulted in 

$2.016 trillion in Federal receipts. IRS collections constitute 95 

percent of the Federal Government receipts, as shown in the following 

chart.



Total Federal Receipts:



[See PDF for image]



[End of figure]



b. Financing Sources:



The IRS receives the majority of its funding through annual, multiyear, 

no-year and trust fund appropriations which are available for use 

within certain specified statutory limits. There are three major and 

several minor operating appropriations. The Processing, Assistance and 

Management appropriation funds the processing of tax returns and 

related documents, assistance for taxpayers in the filing of their 

returns and paying taxes due,



[See PDF for image]



[End of figure]



matching information with returns, conducting internal audit reviews 

and security investigations, and managing financial resources. The Tax 

Law Enforcement appropriation provides funds for the examination of tax 

returns and the administrative and judicial settlement of taxpayer 

appeals of examination findings. The Information Services appropriation 

funds costs for data processing and information and telecommunications 

support for the Service’s activities. The Business Systems 

Modernization Account and the Earned Income Tax Credit appropriations 

are the most significant of the minor operating appropriations. The 

former funds capital asset acquisitions of information technology 

systems. The latter provides resources for expanded customer service 

and outreach, strengthened enforcement, and enhanced research to reduce 

claims and erroneous filings associated with the Earned Income Tax 

Credit.



Besides appropriations, the Service utilizes other financing sources. 

These include net transfers from other federal agencies, and imputed 

financing (subsidies from other federal funds that cover specific 

expenses such as retirement benefits).



c. Use of Resources:



The Statement of Net Cost reflects the use of resources in carrying out 

the agency’s major programs. The major programs are:



Pre-filing, Filing and Account Services, Compliance, and Administration 

of the Earned Income Tax Credit (EITC). Pre-filing activities include 

taxpayer education and outreach, pre-filing agreements, and tax 

publication issuance and distribution. Filing and account services 

activities include the filing of tax returns, current account status, 

and processing of taxpayer information.Compliance activities include 

document matching, audits, and criminal investigation activities. 

Administration of the EITC activities includes pre-filing, filing and 

account services, and compliance activities.



[See PDF for image]



[End of figure]



Revenue and Refund Trend Information:



Federal tax revenues are collected through six major classifications: 

individual income, corporate income, excise taxes, estate and gift 

taxes, railroad retirement, and Federal unemployment taxes. Overall 

revenue receipts (approximately $2.016 trillion) for FY 2002 decreased 

by approximately 5 percent. Individual income taxes, which include both 

FICA and SECA taxes, decreased by 7 percent. Corporate income taxes 

increased by 13 percent. Collections from all other tax sources were 

relatively stable from 2001 to 2002.



The decline in receipts is predominately due to the 2001 recession, the 

decline in the stock market, and the September 11, 2001 terrorist 

attacks. These occurrences resulted in reductions in relatively highly-

taxed forms of income, especially wages and salaries, and indicates 

that much of the decline in these forms of income is attributable to 

the recession. At the same time, the decline in the stock market 

reduced capital gain receipts and further reduced taxes on wage and 

salary income. The entire amount of Federal revenue received in 2002 

was distributed to Treasury.



[See PDF for image]



[End of figure]



Federal tax refund activity, which includes tax, interest, the special 

tax rebate authorization, payments for Earned Income Tax Credits, and 

Child Tax Credits in excess of the tax liability was $281 billion. This 

increase from FY 2001 activity is attributable to the Job Creation and 

Worker Assistance Act (the Economic Stimulus Bill) that affects both 

individuals and corporations by reducing the tax rate for individuals, 

extending the corporation carry-back period for net operating losses 

from two to five years, and temporarily extending a number of tax 

reductions that had expired December 31, 2001.



Overall refund disbursements increased by 12 percent. The table below 

shows that the largest dollar volume tax classes, Individual, FICA/

SECA, and the other refunds appear to remain relatively consistent; 

however, in FY 2001 approximately $36 billion was disbursed for the 

special tax rebate, which means the remaining disbursements were 

approximately $175 billion. When FY 2001 and 2002 are normalized to 

exclude the special tax rebate refunds for these same tax classes in FY 

2002 ($212 billion) increased by approximately 21 percent. Corporate 

Income refunds increased by 76 percent, which offset increased 

corporate tax receipts. Other tax class refunds remained relatively 

consistent.



[See PDF for image]



[End of figure]



Analysis of Unpaid Assessments:



Figure 1: Components of IRS’ $249 Billion of Unpaid Assessments as of 

September 30, 2002:



[See PDF for image]



[End of figure]



As reflected in the supplemental information to IRS’ fiscal year 2002 

Financial Statements, the unpaid assessment balance was about $249 

billion as of September 30, 2002. This unpaid assessment balance 

represents assessments resulting from taxpayers filing returns without 

sufficient payment; as well as from the Service’s enforcement programs 

such as Examination, Underreporter, Substitute for Return, and Combined 

Annual Wage Reporting. The majority of this balance is not considered a 

receivable. In addition, a substantial portion of the amounts 

considered receivables is largelyuncollectible.



Under federal accounting standards, unpaid assessments require taxpayer 

or court agreement to be considered federal taxes receivable. 

Assessments not agreed to by taxpayers or the courts are considered 

compliance assessments and are not considered federal receivable. 

Assessments with little or no future collection potential are called 

write-offs.



[See PDF for image]



[End of figure]



Of the $249 billion balance of unpaid assessments, $137 billion 

represents writeoffs. Write-offs principally consist of amounts owed by 

defunct corporations and include many failed financial institutions 

resolved by the Federal Deposit Insurance Corporation (FDIC) and the 

former Resolution Trust Corporation (RTC). Taxpayers with extreme 

economic and/or financial hardships, deceased taxpayers, and taxpayers 

who are insolvent due to bankruptcy owe the remaining amounts.



In addition, $25 billion of unpaid assessments represent amounts that 

have not been agreed to by either the taxpayer or a court. These 

assessments result primarily from various Service enforcement programs 

to promote voluntary compliance. Due to the lack of agreement, these 

compliance assessments have less potential for future collection than 

the unpaid assessments that are considered federal taxes receivable.



[See PDF for image]



[End of figure]



The remaining $87 Billion of unpaid assessments represent federal taxes

receivable. About $67 billion (77%) of this balance is estimated to be 

uncollectible due primarily to the taxpayer’s economic situation, 
including 

individual taxpayers who are unemployed, are currently in bankruptcy, 
or 

have other financial problems. However, under certain conditions, IRS 
may 

continue collection action for 10 years after the assessment. Thus, 

these accounts may still ultimately have some collection potential if 

the taxpayer’s economic condition improves.



About $20 billion, or about 23%, of federal taxes receivable is 

estimated to be collectible. Components of the collectible balance 

include installment agreements with estates and individuals; confirmed 

payment plans through bankruptcy; and some newer amounts due from 

individuals and businesses with a history of compliance. The taxes 

receivable amount from September 30, 2001, to September 30, 2002, 

increased $7 billion from $80 billion to $87 billion. The percent 

estimated to be collectible at September 30, 2002 (23%), decreased from 

September 30, 2001 (25%).



Figure 4: Unpaid Taxes and Interest and Penalty Components of $249 

Billion in Unpaid Assessments as of September 30, 2002:



[See PDF for image]



[End of figure]



It is also important to note that the unpaid assessment balance 

contains unpaid assessed tax, penalty, and interest; and accrued 

penalty and interest computed through September 30, 2002. About $160 

billion (64%) of the unpaid assessment balance as of September 30, 

2002, contains interest and penalties, as depicted in Figure 4, and are 

largely uncollectible.



Interest and penalties are such a high percentage of the balance 

because IRS must continue to accrue them through the 10-year statutory 

collection date, regardless of whether an account meets the criteria 

for financial statement recognition or has any collection potential. 

For example, interest and penalties continue to accrue on write-offs, 

such as FDIC and RTC cases, and on exam assessments where taxpayers 

have not agreed to the amount assessed. The overall growth in unpaid 

assessments during fiscal year 2002 was mostly attributable to the 

accrual of interest and penalties.



ADDENDUM: President’s Management Agenda:



The IRS made steady progress on the President’s Management Agenda this 

year and we still have room for improvement. The table below summarizes 

the status and progress ratings for IRS in the second, third and fourth 

quarters of FY 2002. In “Progress” ratings, the area where we can have 

the most short-term impact, we received two greens and three yellows. 

In “Status” ratings, we received one green, two yellows and two reds. 

The IRS was not rated in the first quarter for any agenda item, and 

received ratings in the area of Budget & Performance Integration in the 

third and fourth quarters only.



IRS Overall Ratings as of; September 30, 2002.



[See PDF for image]



[End of table]



Green = meets OMB Scorecard criteria for factor being rated Yellow = 

partially meets scorecard criteria:



Red = does not meet criteria:



Major Accomplishments and Future Plans:



IRS has developed a rigorous, quantitatively-driven succession planning 

and management system that assesses current and projected candidate 

supply/demand at each management level of the organization.



IRS implemented a pay-for-performance system for its executives and 

managers that links salary adjustments directly to performance 

evaluations.



IRS was awarded two prestigious Creative Excellence Awards, sponsored 

by the Society for Human Resources Management, for its interactive 

professional recruitment efforts.



Competitive Sourcing.



*Established a program for FY 2002 and FY 2003 to review approximately 

4500 FTE for competitive sourcing.



*Completed feasibility studies in five additional functional areas.



*A-76 Project Development - Began Performance Work Statements (PWS) for 

500 FTE; began streamlined competition for 30 FTE; convened most 

efficient organization team for 500 FTE; and convened PWS teams for 560 

FTE.



*Completed direct conversion of 93 FTE.



Budget & Performance’ Integration:



Developed and used for first time ever, data on program performance 

gaps to develop strategic plans and prioritize budget initiatives.



Developed integrated financial and performance plans that tie budget to 

performance for each program. Plans were certified by Division 

Commissioners to assure accountability. Enhanced the use of performance 

data and program evaluations in the budget decisionmaking process to 

create stronger linkage between current performance and future-year 

performance goals.



Will continue development and reporting of corporate strategic measures 

and will use data to begin discussion and development of servicewide 

outcome goals.



Will realign IRS budget structure to help link costs to program 

results.



Will develop the Integrated Financial System and deploy a cost module 

that is interfaced with program area data systems to provide both 

direct and indirect cost data to support budget requests and execution.



E-Government:



Increased the number of e-filed individual returns by 17% over FY 2001 

resulting in 36% of all returns being filed electronically.



The number of taxpayers e-filing from their home computers is up 38% 

over last year. Implemented electronic payment via the internet for the 

2002 filing season.



Increased the number of Federal Tax Payment Transactions Paid 

Electronically by 3°% over FY:



Implemented internet based taxpayer access to answers for their 

inquiries regarding refunds and fact of filing.



Introduced a newly designed and more accessible web site. Increased the 

number of web site hits to 3.4 billion and downloaded files to 436 

million projected through the end of FY 2002. This represents increases 

of 31 % and 38% respectively over FY 2001.



Will continue efforts with industry partners to develop the free 

internet filing web page, to be hosted on IRS.gov.



Will continue initiatives on EZ Tax Filing and Expanding Electronic Tax 

Products for Businesses.



Financial Performance:



Achieved clean audit opinion by November 15 through significant 

improvements in the timing and accuracy of financial data throughout 

the fiscal year.



Administrative and Revenue Accounting Divisions achieved the Treasury 

June target for 3day close for both timeliness and quality.



Revising the Remediation Plan to reflect a comprehensive set of actions 

to improve IRS’ financial management systems and ensure they meet 

federal requirements and standards. Addressed components of material 

weaknesses in internal controls, e.g., controls over material balances 

in the general ledger and recording of transactions; quarterly 

reporting of capital items; timely recording of adjustments; and 

consistent implementation of existing computer security policies and 

procedures.



Formed an implementation team to develop procedures, processes, and 

costs associated with recommendations of joint Treasury and IRS task 

force to address erroneous payments.



Actions are on schedule for long-term solutions to address six material 

weaknesses in internal controls.



Integrated Financial System is on schedule for implementation on 10/1/

03.



Custodial Accounting Project (CAP) Build 1 will be deployed November 

2003. All future dates and builds of CAP/EDW (Enterprise Data 

Warehouse) are under review due to changes in the Business Systems 

Modernization Plans (dependent on Modernized Data Access Projects).



Financial Statements:



[See PDF for image]



[End of table]



Balance Sheets:



[See PDF for image]



[End of table]



Statement of Net Cost:



[See PDF for image]



[End of table]



Statement of Changes in Net Position:



[See PDF for image]



[End of table]



Statement of Budgetary Resources:



[See PDF for image]



[End of table]



Statement of Financing:



[See PDF for image]



[End of table]



Statement of Custodial Activity:



[See PDF for image]



[End of table]



Notes to the Financial Statements:



[See PDF for image]



[End of section]



Supplemental and Other Accompanying Information:



[See PDF for image]



[End of figure]



[End of section]



Appendixes:



[End of section]



Appendix I: Material Weaknesses, Reportable Conditions, and Compliance 

Issues:



Material Weaknesses:



During our audits of the Internal Revenue Service’s (IRS) fiscal year 

2002 and 2001 financial statements, we identified five material 

weaknesses in internal controls. These material weaknesses have given 

rise to significant management challenges that have (1) impaired 

management’s ability to prepare financial statements and other 

financial information without extensive compensating procedures, (2) 

limited the availability of reliable information to assist management 

in effectively managing operations on an ongoing basis, (3) reduced 

IRS’s effectiveness in enforcing the Internal Revenue Code, (4) 

resulted in errors in taxpayer accounts, and (5) increased taxpayer 

burden. The issues that we have identified and discuss in this report 

relate to IRS’s controls over (1) financial reporting, (2) unpaid 
assessments, 

(3) federal tax revenue and refunds, (4) property and equipment, and 
(5) 

computer security. We reported on each of these issues last 
year.[Footnote 7] 

We also reported a material weakness in controls over IRS’s budgetary 

activity in prior years. However, as a result of improvements in IRS’s 

controls over its budgetary transactions, we have reassessed this as a 

reportable condition. We highlight these issues in the following 
sections. 

Less significant matters involving IRS’s system of internal controls 
and 

its operations will be reported to IRS separately.



Financial Reporting:



In fiscal year 2002, as in prior years, IRS did not have financial 

management systems adequate to enable it to timely, routinely, and 

reliably generate and report the information needed to prepare 

financial statements and manage operations on an ongoing basis. To 

overcome these systemic deficiencies, IRS was compelled to rely on 

extensive compensating procedures that were costly, labor intensive, 

and not always effective. During fiscal year 2002, IRS (1) did not have 

an adequate general ledger system for financial reporting and 

management purposes, (2) did not always timely recognize material 

transactions in its general ledger system, (3) could not determine and 

report on the specific amount of revenue collected for each of several 

of the federal government’s largest revenue sources, and (4) did not 

have a cost accounting system capable of providing timely and reliable 

cost information related to IRS’s activities and programs. In fiscal 

year 2002, IRS enhanced its procedures to more timely record certain 

types of transactions and thereby improved the ongoing reliability of 

its financial information. However, primarily because it continues to 

rely on the same inadequate financial management systems as in prior 

years, material financial reporting control weaknesses remain. To 

compensate for these weaknesses, IRS continued to depend extensively on 

labor-intensive compensating procedures to enable it to generate 

reliable information for the annual financial statements. Although this 

approach culminated in financial statements that were fairly stated as 

of September 30, 2002 and 2001, it has not produced the current data 

needed to assist in managing operations on an ongoing basis, such as 

cost-based performance information to assist in making resource 

allocation decisions.



As in previous years,[Footnote 8] during fiscal year 2002, IRS’s 

general ledger system (1) comprised two independent general ledgers 

that were not integrated with each other or with their supporting 

records for material balances, and (2) was not supported by adequate 

audit trails for federal tax revenue, federal tax refunds, taxes 

receivable, or property and equipment. IRS’s use of two separate 

general ledgers to account for its tax collection activities and the 

costs of conducting those activities, respectively, greatly complicates 

efforts to measure the cost of IRS’s tax collection efforts. In 

addition, IRS’s general ledger for its custodial activities does not 

use the standard federal accounting classification structure. Because 

of these deficiencies, IRS’s general ledger system does not conform to 

the U.S. Government Standard General Ledger (SGL) as required by the 

Core Financial System Requirements of the Joint Financial Management 

Improvement Program (JFMIP)[Footnote 9] or the requirements of the 

Federal Financial Management Improvement Act of 1996 (FFMIA). In its 

Management Discussion and Analysis, IRS discusses its plans to 

implement a single, integrated general ledger that will be fully 

compliant with FFMIA.[Footnote 10] However, it is unclear when this 

will be accomplished, and thus when IRS will have a functional general 

ledger that is fully compliant with FFMIA, including being supported by 

detailed subsidiary records for its administrative and custodial 

accounts.



Also, during fiscal year 2002, IRS did not always timely record 

material transactions in its general ledger. As a result, affected 

balances were not always current and accurate on an ongoing basis. In 

fiscal year 2002, IRS implemented procedures to more timely record 

material activity, such as quarterly recording of property and 

equipment acquisitions and related depreciation and monthly recognition 

of imputed financing costs, which have significantly improved the 

reliability of related balances during the year. However, IRS did not 

record accruals to recognize nonpayroll-related expenses, such as rent 

and utilities, during the year. As a result, transactions totaling more 

than $156 million and more than $95 million remained in IRS’s suspense 

account as of March 31 and June 30, respectively.[Footnote 11] Thus, 

affected accounts in IRS’s general ledger continued to be materially 

misstated during the year. At interim periods, these problems also 

resulted in the understatement of the cost of IRS’s operations and 

outlays in the Statements of Net Cost and Budgetary Resources, 

respectively. Additionally, as discussed in the material weakness over 

unpaid assessments, IRS requires months of effort and compensating 

procedures to produce a balance for taxes receivable, the single 

largest item on its balance sheet. This number is only derived on an 

annual basis.



During fiscal year 2002, IRS continued to be unable to determine the 

specific amount of revenue it actually collects for three of the 

federal government’s four largest revenue sources--Social Security, 

hospital insurance, and individual income taxes. In addition, IRS 

continued to be unable to determine, at the time payments are received, 

collections for the Highway Trust Fund or other trust funds that 

receive excise tax receipts. This is primarily because the accounting 

information needed to validate the taxpayer’s liability and record the 

payment to the proper trust fund is provided on the tax return, which 

is received months after the payment is submitted. Further, the 

information on the tax return pertains only to the amount of the tax 

liability, not to how to distribute the amount previously collected 

among the appropriate trust funds. IRS does not require taxpayers to 

submit information identifying the type of tax at the time of payment 

because it believes that imposing such a requirement would create an 

additional burden to taxpayers. In addition, IRS’s systems cannot 

presently capture and report such information routinely. IRS is working 

on systems improvements to accommodate this type of information. IRS 

will continue to be unable to timely report the specific amount of 

revenue it actually collects for these large revenue sources until it 

has the systems capability to record, and requires taxpayers to 

provide, this information. This condition also makes the federal 

government rely on a complex, multistep process to distribute excise 

taxes to the recipient trust funds that continues to be susceptible to 

error.



During fiscal year 2002, IRS continued to lack a cost accounting system

(1) capable of accurately and timely tracking and reporting the costs 

of IRS’s programs and projects to assist it in managing its costs and 

(2) meeting the JFMIP Systems Requirements for Managerial Cost 

Accounting.[Footnote 12] This condition also renders IRS unable to 

produce reliable cost-based performance information. IRS officials have 

indicated that IRS’s records contain information necessary to enable 

them to determine the cost of various activities, such as conducting 

investigations. However, this information is widely distributed among a 

variety of information systems, which are not linked and therefore 

cannot share data. This makes the accumulation of cost information time 

consuming, labor intensive, and not readily available as a tool to 

manage costs. For example, IRS has a variety of workload management 

systems that staff in different units use to track how their time is 

spent on specific tasks. However, these systems are not integrated with 

IRS’s general ledger or each other to allow IRS to readily identify and 

accumulate the total costs for time spent by all units involved in any 

specific activity. In addition, IRS’s workload management systems are 

not designed to track certain material forms of nonpersonnel costs by 

project and subproject, such as equipment depreciation, rent, and 

utilities.



Without a cost accounting system to centrally accumulate, organize, and 

timely report cost data in a format that meets management’s current 

needs, such information is not readily available for use by managers to 

aid in routinely managing costs and in decision making. Instead, IRS 

often finds it necessary to conduct special research efforts tailored 

to determine the cost of a specific task or project. In its Management 

Discussion and Analysis, IRS stated that the new cost management 

system, which includes a cost accounting module, is scheduled for 

deployment on October 1, 2003. IRS expects this system to provide and 

reliably report cost information that it can use to manage its 

operations.



As a result of these pervasive financial reporting weaknesses, IRS was 

compelled to expend far more time and effort to maintain its accounting 

records and generate financial management information than would 

otherwise have been necessary, and despite these monumental efforts, 

continued to lack current, reliable financial information available to 

assist in managing operations throughout fiscal year 2002. During 

fiscal year 2002, as part of its strategic planning process, IRS 

conducted a comprehensive assessment of its strategic priorities. A 

major goal of this exercise was to prioritize IRS’s programs relative 

to its mission in light of its available resources. IRS is using the 

outcome of this process as a basis for resource allocation decisions 

intended to reduce the difference between the aggregate amount of taxes 

assessed by federal tax laws in any given year and the amount that is 

paid voluntarily and timely (known as the tax gap). This initiative 

represents a major step forward in IRS’s efforts to ensure that it is 

utilizing its resources as efficiently and effectively as possible. 

Addressing the financial reporting deficiencies discussed above would 

enhance this process by providing sound, reliable, and timely 

information to assist in evaluating the impact of these decisions in 

terms of both the costs incurred and the benefits derived.



Unpaid Tax Assessments:



During fiscal year 2002, we continued to find serious internal control 

issues that affected IRS’s management of unpaid assessments. 

Specifically, we found (1) IRS continued to lack a subsidiary ledger 

for unpaid assessments that would allow it to produce timely and useful 

information with which to manage and report externallyand (2) errors 

and delays in recording taxpayer information, payments, and other 

activities that continued to hinder IRS’s ability to effectively manage 

its unpaid assessments.[Footnote 13]



IRS’s management of unpaid assessments is hindered by a lack of 

effective supporting systems. IRS lacks a detailed listing, or 

subsidiary ledger, that tracks and accumulates unpaid assessments and 

their status on an ongoing basis. As a result, IRS must rely on a 

costly, labor-intensive manual compensating process for external 

reporting. Specifically, to report balances for taxes receivable and 

other unpaid assessments in its financial statements and supplemental 

information, IRS must apply statistical sampling and projection 

techniques to data in its master files[Footnote 14] to estimate the 

balances at year end. While refinements were made to this process 

during fiscal year 2002, it continued to take several months to 

complete, required adjustments totaling tens of billions of dollars, 

and produced amounts that were only reliable as of the last day of the 

fiscal year. Consequently, this information is not useful for ongoing 

management decisions. In addition, the lack of a subsidiary ledger 

renders IRS unable to timely develop reliable financial and management 

reports and promptly identify and focus collection efforts on accounts 

most likely to prove collectible.



IRS’s management of unpaid assessments also continued to be hindered by 

inaccurate tax records. We continued to find errors and omissions in 

taxpayer records resulting from IRS’s failure to accurately and timely 

record information. As in prior years, the most prevalent errors we 

found involved IRS’s failure to record payments to all related 

taxpayers associated with unpaid payroll taxes.[Footnote 15] IRS’s 

current systems continued to be unable to automatically link each of 

the multiple assessments made for the one tax liability. Consequently, 

if the business or an officer pays some or all of the outstanding 

taxes, IRS’s systems are unable to automatically reflect the payment as 

a reduction in the related account or accounts. In reviewing unpaid 

payroll tax cases where one or more individuals were assessed a trust 

fund recovery penalty, we found 23 cases in which payments were not 

recorded in all related taxpayer accounts. We are 95 percent confident 

that the error rate in the population could be as high as 20 percent. 

IRS has recognized the seriousness of this issue and has attempted to 

compensate for the lack of an automated link between related accounts 

by manually inputting a code in each account that cross-references it 

to other related accounts. However, our work in fiscal year 2002 

indicates that this compensating control has not been fully effective: 

of the 23 cases with unrecorded payments, 21 had the manual cross-

references and in 9 of those cases, the unposted payments were made 

after the cross-references had been added to the accounts.



We found other errors in taxpayer accounts that were caused by IRS 

input errors. For example, in two different cases involving the estates 

of deceased taxpayers, IRS erroneously input the deceased taxpayer’s 

date of birth as the date of death. This input error caused the IRS 

system to automatically generate interest and penalties of almost $50 

million in one case and $1.8 million in another. IRS sent out tax 

notifications to both estates and, at the time of our testing, these 

amounts were recorded as valid unpaid tax assessments. Delays and 

errors in recording activity in taxpayer accounts complicate IRS’s 

efforts to derive a reliable balance for taxes receivable and other 

unpaid assessments for its financial statements and other accompanying 

information. Additionally, failure to record payments and other 

activity timely could result in a burden on taxpayers, including having 

enforcement actions taken against them for taxes they do not owe or 

that have already been paid.



We have reported on these issues in previous audits.[Footnote 16] IRS 

has acknowledged the seriousness of these issues and continues to take 

remedial steps to address their impact. For example, IRS has convened a 

task group to design an automated trust fund recovery penalty system 

that can properly cross-reference payments received and thus eliminate 

the opportunity for errors that plague the current manual process. 

However, the ultimate solution to many of these issues continues to be 

the successful modernization of IRS’s systems, which IRS acknowledges 

will take several years to complete.



Tax Revenue and Refunds:



During fiscal year 2002, we continued to find that IRS’s controls were 

not fully effective in maximizing the government’s ability to collect 

what is owed and in minimizing the risk of payment of improper refunds. 

IRS recognized this in its fiscal year 2002 Federal Managers’ Financial 

Integrity Act (FIA) assurance statement to the Treasury, in which it 

reported a material weakness in Earned Income Tax Credit (EITC) 

noncompliance. IRS’s taxpayer compliance programs identify billions of 

dollars of potentially underreported taxes and invalid EITCs each year. 

However, due in large part to perceived resource constraints, IRS 

selects only a portion of the questionable cases it identifies for 

follow-up investigation and action. In addition, IRS often does not 

initiate follow-up on the cases it selects until months after the 

related tax returns have been filed and any related refunds disbursed, 

affecting its chances of collecting amounts due on these cases. 

Consequently, the federal government is exposed to potentially 

significant losses from reduced revenue and disbursements of improper 

refunds.



The options available to IRS in its efforts to identify and pursue the 

correct amount of taxes owed and to ensure that only valid refunds are 

disbursed continue to be limited. For example, third-party information 

such as form 1099s[Footnote 17] that can corroborate the amount of 

income reported by taxpayers are not required to be filed until after 

the start of the tax filing season.[Footnote 18] Consequently, 

comparison of such information with tax return data is problematic 

because IRS does not have time to prepare the third-party data for 

matching prior to the receipt of individual tax returns. Additionally, 

while it processes hundreds of millions of tax returns each filing 

season, IRS must issue refunds within statutory time constraints or be 

subject to interest charges.[Footnote 19]



IRS has some preventive controls that help to reduce the magnitude of 

underreported taxes owed and improper refunds issued. For example, 

IRS’s Examination Branch is responsible for performing examinations on 

tax returns with potentially invalid EITC claims[Footnote 20] to 

determine the validity of the claim. When performed before refunds are 

disbursed, these examinations are an important control to prevent 

disbursement of improper refunds. However, these examinations are often 

performed after any related refunds are disbursed, which reduces their 

effectiveness as a preventive control. In February 2002, IRS estimated 

that of about 

$31.3 billion in EITC claims filed by taxpayers for tax year 1999, at 

least $8.5 billion (27 percent) should not have been paid.[Footnote 21] 

Of this amount, only $1.2 billion (14 percent) was either recovered or 

expected to be recovered through compliance efforts. The dollar amount 

of improper refunds disbursed related to these invalid EITCs is 

unknown. However, based on the fiscal year 2000 refund rate, which was 

about 84 percent,[Footnote 22] IRS may have disbursed about $7.1 

billion in EITC-related improper refunds in tax year 1999, of which 

about $6.1 billion (86 percent) may never be recovered. The full 

magnitude of improper refunds disbursed annually due to invalid EITCs 

is unknown.



Due to time and other constraints, IRS relies extensively on detective 

controls, such as automated matching of returns with third-party data 

such as W-2s (wage and tax statements) to identify for collection 

underreported taxes and improper refunds. However, these programs are 

not run until months after the returns have been filed. As a result, 

they are used too late to prevent improper refunds from being 

disbursed. In addition, although IRS’s matching program for individual 

tax returns identifies billions of dollars of potentially underreported 

taxes each year, IRS only follows up on a portion of these cases to 

determine how much tax is actually due and to pursue collection of 

those amounts. For example, for tax year 2000,[Footnote 23] IRS’s 

matching program for individuals identified 16.2 million individual tax 

returns with potential underreported taxes totaling $19.2 billion. IRS 

investigated 3 million (18.5 percent) of these returns accounting for 

about $9 billion (47 percent) of the total potential underreported 

taxes. There are factors that affect IRS’s ability to accelerate the 

timing of its automated matches, such as the limitations of its current 

automated systems and the timing of filing requirements for preparers 

of third-party documents, which are beyond IRS’s control. Nonetheless, 

the information from IRS’s automated matching program suggests that a 

substantial amount of additional revenue might be realized if 

additional resources were devoted to follow-up efforts. At present, 

billions of dollars in underreported taxes could remain uncollected and 

improper refunds could be disbursed. This, in turn, could further erode 

taxpayer confidence in the equity of the tax system and reduce 

compliance with the tax laws.



Property and Equipment:



In fiscal year 2001, we reported that material weaknesses in IRS’s 

property and equipment (P&E) systems and controls prevented it from 

having (1) current, reliable P&E information available on an ongoing 

basis and (2) reasonable assurance that its assets were properly 

safeguarded and used only in accordance with management 

policy.[Footnote 24] During fiscal year 2002, IRS continued efforts to 

compensate for these longstanding deficiencies in systems and controls 

over its P&E. Specifically, IRS implemented procedures to improve the 

(1) timeliness of recording P&E transactions in accounting records and 

(2) accuracy and reliability of its P&E inventory records. Nonetheless, 

fundamental deficiencies in IRS’s financial management system continued 

to exist, which precluded IRS from having ongoing information on its 

balance of P&E and assurance that its assets were properly safeguarded. 

However, through the use of compensating procedures, IRS was able to 

report a balance for P&E on its financial statements at September 30, 

2002, that was fairly stated in all material respects. IRS has reported 

a material weakness in its controls over P&E in its FIA assurance 

statement to Treasury every year since 1983.



As we previously reported, IRS does not have an integrated property 

management system that appropriately records P&E additions and 

disposals as they occur and links costs on the accounting records to 

property records. Instead, IRS expenses property purchases as they 

occur, and then later extracts the costs of property acquisitions from 

operating expenses and records adjustments to remove property purchases 

from expenses and capitalize them as P&E. Consequently, IRS does not 

have reliable P&E data available on an ongoing basis that it can use to 

make operational decisions related to the acquisition and use of P&E, 

and its property management system does not provide timely and reliable 

information to facilitate the preparation of financial statements.



In fiscal year 2002, IRS improved the timeliness of extracting and 

recording P&E financial information. Beginning in mid-fiscal year 2002, 

IRS was able to produce, with contractor assistance, P&E information 

within a few weeks after the end of the quarter. This is a significant 

improvement over fiscal year 2001, when reliable P&E information was 

not available until 3 months after the end of the fiscal year. Although 

IRS was able to produce P&E financial information on a more timely 

basis in fiscal year 2002, the fundamental deficiencies in its property 

management system remain. IRS did not properly record P&E transactions 

in P&E accounts as they occurred, and it was necessary for IRS to hire 

a contractor to extract, analyze, and compile the data needed to report 

a reliable P&E balance. In addition, IRS could not always link the 

property acquisitions eventually recorded on IRS’s accounting records 

to assets recorded on IRS’s property records. In transactions selected 

from IRS’s accounting records that we tested, some or all of the assets 

acquired could not be linked to inventory records.[Footnote 25] For 

example, one of the transactions we tested was for the purchase of 39 

desktop computers. IRS had recorded this transaction in the accounting 

records in November 2001 but had not recorded 38 of the 39 computers on 

the inventory records as of September 2002.



Accurate records are essential for maintaining control over P&E to 

ensure that assets are properly accounted for and safeguarded. In prior 

years, we reported that IRS’s procedures for recording P&E transactions 

in its inventory records were not effective in ensuring that 

acquisitions, disposals, and transfers were promptly and accurately 

recorded in its P&E inventory records. In fiscal year 2002, IRS made a 

concerted effort to improve procedures and practices used to account 

for its assets. Our testing indicates that IRS continued to make 

significant progress on this issue, but that nonetheless, transactions 

were not always promptly and accurately recorded. Specifically, we 

found that 22 of 220 P&E items, including computers and printers, 

selected at 22 sites could not be located at the time of our 

review.[Footnote 26] Based on our work, we estimate that 10 percent of 

the items in IRS’s P&E inventory records were erroneously included as 

assets.[Footnote 27] This year, however, we found that the majority of 

the errors we identified in our sample were attributable to a system 

limitation. Specifically, 16 of the 22 assets we could not locate had 

been disposed of, but the inventory records had not been updated to 

reflect these disposals due to a system problem that prevented 

personnel responsible for updating the inventory records for disposals 

from having access to the records. At the time of our testing, IRS was 

aware of the system problem and had identified 13 of the 16 disposed 

item records for review but had not yet corrected its inventory 

records. Despite these findings, we believe IRS is making clear 

progress in improving accountability over P&E. For example, in our 

fiscal year 2001 audit, we estimated that 12 percent of the items in 

IRS’s P&E inventory records were erroneously included as 

assets,[Footnote 28] and the reasons for the errors we identified last 

year were not primarily attributable to a single cause. Additionally, 

individual sites we tested showed significant improvement over previous 

years: at one location where we found that 5 of 10 assets we tested in 

fiscal year 2001 could not be located, all 10 assets we tested were 

accounted for in fiscal year 2002. While further improvements are 

needed, there has been notable progress made on this issue.



During our fiscal year 2001 audit, we found that IRS’s property 

management system did not capture information, such as licenser, 

contract period, and number of authorized users, essential to ensure 

that software and software licenses were controlled and utilized only 

in accordance with software license contracts. In fiscal year 2002, IRS 

initiated a process to identify and record software licenses and began 

developing an action plan that will set policies and procedures for 

review of and compliance with the terms of the licenses. However, as of 

the completion of our fieldwork, IRS had not completed this effort, and 

as a result continued to lack an inventory record system that captured 

information essential to ensure that software and software licenses 

were properly controlled and used only in accordance with license 

agreements.



Although we determined through detailed tests of transactions and 

analyses that IRS’s reported September 30, 2002, P&E balance was fairly 

stated, longstanding weaknesses in IRS’s property and accounting 

systems continue to affect IRS’s ability to account for its property 

and report a reliable P&E balance on an ongoing basis. These weaknesses 

will continue to exist until IRS has an integrated accounting and 

property system. In March 2005, IRS plans to acquire and install an 

asset management module to the integrated financial system. According 

to IRS, the system will be capable of recording P&E as assets when 

purchased and generating detailed records for P&E that reconcile to the 

financial records.



Computer Security:



IRS relies extensively on computer information systems to perform basic 

functions, such as processing tax returns and payments, maintaining 

sensitive taxpayer data, calculating interest and penalties, and 

generating refunds. Although IRS has corrected or mitigated many of the 

computer security weaknesses identified in our previous reports, much 

remains to be done to resolve the significant control weaknesses that 

continue to exist within IRS’s computing environment and to be able to 

promptly address new security threats and risks as they emerge. Such 

weaknesses can impair the agency’s ability to perform vital functions, 

and can increase the risk of unauthorized disclosure, modification, or 

destruction of taxpayer data.



IRS has continued to make progress improving computer security 

controls. For example, IRS has revised its information technology 

security policy and guidance, updated security standards for several of 

its computing systems and devices, and improved certain physical 

security controls at its data processing facilities. IRS is also 

consolidating several of its geographically dispersed Unix computer 

systems and centralizing responsibility for their operation and 

management, performing periodic internal control reviews of its 

computer-processing environments, and implementing an intrusion 

detection capability.



However, IRS continued to have serious weaknesses in fiscal year 2002 

with computer controls designed to protect computing resources such as 

networks, computer equipment, software programs, data, and facilities 

from unauthorized use, modification, loss, and disclosure. For example, 

IRS did not always effectively configure and implement computer systems 

in accordance with its computer security policies, monitor system 

configuration and implementation, and provide sufficient technical 

security-related training to key personnel. In addition, IRS has not 

taken sufficient steps to ensure that internal control deficiencies 

identified at one facility are considered and addressed at other 

facilities. The following examples illustrate the types of computer 

control weaknesses that affect IRS’s financial and tax processing 

systems.



* IRS did not adequately restrict electronic access rights and 

permissions on its servers, network devices, and mainframe computers. 

Inappropriate access to sensitive files and directories can enable an 

intruder or user to gain unauthorized access to computing resources.



* IRS did not sufficiently segregate system administration functions on 

its servers from those related to security administration and system 

backup operations, thereby increasing the risk that system 

administrators could perform unauthorized system activities without 

detection.



* IRS did not securely control network services or configure system 

software to minimize the risk of unauthorized access to and ensure the 

integrity of system programs, files, and data. At one location, for 

example, IRS did not secure its network against known vulnerabilities 

or minimize the operational impact of a potential failure in a critical 

network device.



* IRS did not sufficiently plan or test the activities required to 

restore certain critical business systems when unexpected events occur. 

Disaster recovery plans for some systems lacked essential information 

to facilitate recovery operations and were not fully tested.



* IRS did not effectively monitor key systems and network devices to 

identify unauthorized activities. Computer logs often did not record 

key security-related events and pertinent data. Security specialists 

also did not routinely or fully examine logs for unauthorized activity 

or usage trends.



Collectively, these problems indicate material weaknesses in IRS’s 

internal controls over information systems and data. These weaknesses 

decreased the reliability and increased the vulnerability of data 

processed by the systems. Until IRS can adequately mitigate these 

weaknesses, unauthorized individuals could gain access to critical 

hardware and software, and intentionally or inadvertently access, 

alter, or delete sensitive data or computer programs. Such individuals 

could also obtain personal taxpayer information and use it to commit 

financial crimes in the taxpayers’ names (identity fraud), such as 

establishing credit and incurring debt.



Reportable Conditions:



In addition to the material weaknesses discussed above, we identified 

two reportable conditions. These concern weaknesses in IRS’s internal 

controls over budgetary activity, which we have reported as a material 

weakness in prior years, and weaknesses in internal controls over tax 

receipts and taxpayer information, which we have reported as a 

reportable condition in prior years.[Footnote 29]



Budgetary Activity:



In prior years, we identified serious internal control deficiencies 

that prevented IRS from ensuring that its budgetary authority[Footnote 

30] was routinely accounted for, reported, and controlled. Over the 

past several years, IRS has made considerable progress in addressing 

internal control deficiencies related to budgetary activity. In fiscal 

year 2002, we noted further improvements in IRS’s controls and 

procedures that enhanced its ability to account for and report on the 

status of its budgetary resources. Specifically, IRS (1) improved its 

reviews of outstanding obligations and (2) performed more frequent 

analyses of certain general ledger accounts containing transactions 

incorrectly recorded as adjustments to prior years’ 

obligations.[Footnote 31] These further improvements allowed us to 

conclude that the remaining issues related to budgetary activity no 

longer constitute a material internal control weakness. However, IRS 

did not implement these improvements until after the first quarter of 

fiscal year 2002. Additionally, we continued to find that IRS recorded 

invalid transactions in its general ledger and instances in which IRS 

did not timely record obligations and expenditures.



Over the past several years, IRS has issued numerous policy memorandums 

and implemented procedures to deobligate funds[Footnote 32] no longer 

required for a specific purpose. IRS’s business units were required to 

review outstanding obligation reports on a quarterly basis and identify 

all obligations that were no longer active and thus would need to be 

deobligated. Beginning in the second quarter of fiscal year 2002, IRS 

improved its reviews of outstanding obligations by (1) providing 

specific guidelines to the business units that performed the reviews, 

(2) requiring the business units to perform monthly reviews, and (3) 

providing more relevant and timely information on the outstanding 

obligation reports to assist the business units in their reviews. IRS’s 

improvements to its reviews of outstanding obligations enabled it to 

identify on a more timely basis obligated funds that could be 

deobligated and made available for future or existing obligations, thus 

improving its management of budgetary resources.



IRS’s accounting system records all adjustments that affect a prior 

year’s appropriation, including those that do not affect the obligated 

amount, as adjustments to prior years’ obligations. Many of the 

activities recorded as adjustments to prior years’ obligations are 

related to changes in accounting codes, travel, and adjustments to 

doubtful accounts and are thus not valid adjustments to prior years’ 

obligations. For example, IRS records a change in an internal 

accounting code as a new obligation and erroneously adjusts the 

original obligation downward, thereby misstating its reported level of 

adjustments to obligations.



To identify valid adjustments to prior years’ obligations, IRS manually 

analyzes the adjustment activity recorded in its accounting system. IRS 

then uses the results of this analysis to record adjusting entries to 

the applicable general ledger accounts. For fiscal year 2002, this 

analysis resulted in IRS making correcting entries to remove $1.2 

billion of invalid transactions from the $1.4 billion balance of 

adjustments to prior year obligations in its general ledger. In prior 

years, IRS only performed this analysis at fiscal year end to prevent 

its financial statements from being misstated. This enabled the year-

end financial statements to be correct, but did not address the impact 

of these errors on interim internal and external reporting. Beginning 

in mid-fiscal year 2002, however, IRS began performing these procedures 

on a quarterly basis.



By increasing the frequency of its analysis of adjustment activity, IRS 

improved the reliability of budgetary information it submits to OMB on 

a quarterly basis through its SF133 Report on Budget Execution and 

Budgetary Resources.[Footnote 33] However, IRS’s compensating 

procedures only produce reliable adjustment balances for the specific 

date covered by the analysis. Thus, the existing deficiency in IRS’s 

accounting system with respect to recording adjustments to prior years’ 

obligations prevents IRS from having accurate and reliable information 

on budgetary resources and obligations on an ongoing basis. IRS plans 

to acquire and install, in fiscal year 2004, an integrated financial 

system with the capability to differentiate between activities that are 

and are not valid adjustments to prior years’ obligations.



In prior audits, we found instances in which IRS received goods and 

services during one fiscal year but did not record the applicable 

expenditure to reduce the undelivered orders balance in its accounting 

system until the following fiscal year. This resulted in IRS 

overstating its balance of undelivered orders and understating its 

accrued expenses. During fiscal year 2001, IRS developed a methodology 

to more reasonably accrue expenditures at year end and thus recognize 

the associated reduction in the balance of undelivered orders. By 

applying this methodology, IRS was able to report reliable amounts for 

undelivered orders and accrued expenses on its fiscal-year-end 

financial statements. However, IRS’s balances of undelivered orders, 

expenses, and capital expenditures were not accurate throughout fiscal 

year 2002 because of delays in recording expenditures. Specifically, in 

our testing of undelivered orders, we identified instances in which IRS 

took more than 30 days from the date it accepted the goods or services 

to record the applicable expenditure in its accounting system. For 

example, in one instance, IRS received telecommunication services that 

covered the month of November 2001, at a cost of $1.4 million. However, 

IRS did not record the associated expenditure in its accounting system 

until June 7, 2002--more than 6 months after the services were 

provided. Untimely recording of expenditures affects IRS’s ability to 

efficiently manage its budgetary resources by delaying the 

identification of obligated funds that (1) are insufficient to cover 

the expenditure or (2) exceed amounts owed and thus can be deobligated 

and made available for future or other existing obligations.



We also found that IRS continued to experience delays in recording 

obligations in its accounting system during fiscal year 2002. In our 

testing of undelivered orders, we found instances in which IRS took 

more than 30 days from the date the obligation document was established 

to record the obligated amount in its accounting system and instances 

in which IRS incurred costs prior to recording the obligation in its 

accounting system. For example, in one instance, IRS established an 

obligation on October 1, 2001, for armed security guard services 

totaling $366,000. However, IRS did not record the obligation in its 

accounting system until April 22, 2002--more than 6 months after the 

obligation was established. In another instance, IRS received office 

equipment on October 9, 2001, at a cost of $154,000. However, IRS did 

not generate the initial obligating document to establish the 

obligation of funds until March 18, 2002, and recorded the obligation 

in its accounting system on March 28, 2002--more than 5 months after 

the equipment was received.



Delays in recording obligations affect the reliability of IRS’s 

financial records used to track the status of its budgetary resources 

for day-to-day decision making. Until the obligation of funds is 

recorded, obligations reflected in IRS’s accounting system will be 

understated. Understatement of obligations could lead IRS management to 

believe that the agency has more funding than is actually available. 

Consequently, IRS management and staff might enter into obligations 

that exceed the budgetary authority made available by Congress.



Hard-Copy Tax Receipts and Taxpayer Information:



IRS manually processes tax receipts and taxpayer information at its 

service center campuses and field offices. In addition, commercial 

lockbox banks, operating under contract with Treasury’s Financial 

Management Service, process tax receipts and taxpayer information on 

behalf of IRS. During fiscal year 2002, IRS’s controls over cash, 

checks, and related hard-copy taxpayer data it received from taxpayers 

continued to be inadequate to sufficiently limit the risk of theft, 

loss, or misuse of such funds and data. Recognizing its responsibility 

to protect taxpayer information and receipts, IRS has taken action in 

the past several years to address a number of its internal control 

deficiencies. For example, to improve the safeguarding of taxpayer 

receipts and data, IRS began conducting periodic security reviews of 

receipt processing areas, implemented many of its new hiring and 

courier standards, and updated policies and procedures. In fiscal year 

2002, IRS issued the Lockbox Processing Guidelines to improve the 

safeguarding of taxpayer receipts and data at lockbox facilities. 

Nonetheless, internal control deficiencies remain, primarily because of 

inconsistencies in the establishment and implementation of, and 

compliance with, these policies at IRS service center campuses, field 

offices, and commercial lockbox banks.



We previously reported that IRS was hiring individuals and allowing 

them access to cash, checks, and other taxpayer data before it had 

received satisfactory results of their fingerprint checks.[Footnote 34] 

Since establishing a policy prohibiting new hires from entering on duty 

in any IRS offices until their fingerprint checks are completed, IRS 

has worked aggressively to enforce this policy and continued to make 

substantial progress in this area in fiscal year 2002. As a result, IRS 

has significantly reduced its exposure related to this issue.



We previously reported on weaknesses in internal controls to deter 

unauthorized access to receipt processing areas.[Footnote 35] In fiscal 

year 2002, we continued to find significant security access issues at 

field offices and lockbox banks, as well as at one of the two service 

center campuses we visited. For example, IRS policy requires that all 

perimeter doors be equipped with locks and alarms and that the doors 

must be locked and alarms set. At lockbox sites, we found one perimeter 

door unlocked, one without an alarm, and one where the alarm was not 

sufficiently audible. Guards also failed to respond when we activated 

the perimeter door alarms in two instances at a lockbox site and in one 

instance each at a field office and a service center campus. The 

building perimeter is the first line of defense in the effort to 

prevent unauthorized access to receipt processing areas. We also found 

other weaknesses in physical security at the service center campus, 

such as a door to a receipts-processing area with a broken lock that 

could be opened by an unauthorized individual, and a door with a cipher 

lock that we were able to open because it had not been properly closed. 

At field offices, we found that taxpayers visiting the taxpayer 

assistance centers to make tax payments or obtain assistance with tax 

questions could gain access to areas of the centers that are restricted 

to authorized IRS personnel handling tax receipts and taxpayer 

information. We further found that employees at IRS field offices had, 

or could have, access to certain areas where tax receipts and taxpayer 

information are handled, regardless of their need for access.



We continued to find other weaknesses and inconsistencies in controls 

over taxpayer receipts and taxpayer data at service center campuses, 

field offices, and lockboxes that have not been adequately addressed. 

For example, we continued to find receipts stored in open, unlocked 

containers, contrary to IRS policy. Another IRS policy limits personal 

belongings that each worker can bring into receipt processing areas to 

small items that can fit into a clear plastic bag, and specifically 

prohibits large items such as purses and backpacks in which taxpayer 

receipts could be concealed. However, we found that at one service 

center campus personal items were allowed in clear plastic bags of 

various sizes, with many of the bags containing so many items that not 

all of the items could be identified through the bag. In addition, at 

the same service center campus, we found that employees carried CD 

cases, newspapers, and magazines in the clear plastic bags--all objects 

in which taxpayer receipts could be easily concealed. At another 

service center campus, we noticed an employee leaving the processing 

area with a plastic bag that was not clear. At a field office, we found 

that employees were allowed to store personal belongings with taxpayer 

receipts and official receipt certificate vouchers in desk drawers or 

cabinets. Additionally, at four lockbox sites we visited, we were able 

to bring purses and fanny packs into processing areas, and at several 

lockbox sites we saw employees wearing bulky clothing or bring in 

personal belongings, such as gift bags and purses.



We previously reported that checks made payable to “IRS” could easily 

be altered and cashed and that returned refund checks were highly 

susceptible to theft.[Footnote 36] At field offices we visited during 

fiscal year 2002, we continued to find that checks were not overstamped 

with “United States Treasury,” and we continued to find instances at 

service center campuses, field offices, and lockbox sites where 

returned refund checks were not restrictively endorsed at the point of 

extraction.



We previously recommended that IRS develop policies and procedures to 

reconcile logs of payments found during final candling to the related 

receipts and documents.[Footnote 37] During fiscal year 2002, we 

continued to find that discovered items were not reconciled at both of 

the service center campuses we visited and at two lockbox sites. At 

service center campuses, we also found that discovered items were not 

immediately recorded and that personnel who had overlooked items during 

candling were not always identified.



IRS procedures require that emptied envelopes be candled twice, and the 

lockbox processing guidelines have this same requirement. Yet during 

fiscal year 2002, we found instances at both service center campuses 

and at lockbox sites where candling that should have been performed 

twice was performed only once. Furthermore, at one service center 

campus, we found that a single employee was performing final candling 

in a closed room, thereby increasing the possibility of theft or 

destruction of discovered remittances.[Footnote 38] Standards for 

Internal Control in the Federal Government requires agencies to 

establish physical controls to secure and safeguard vulnerable 

assets.[Footnote 39]



IRS has made an effort to address courier security weaknesses by 

adopting more stringent security standards for couriers who transport 

IRS’s daily deposits to depository institutions. However, IRS did not 

have effective controls in place to ensure that the contract 

requirements were enforced. In fiscal year 2002, we found that at one 

of the two IRS service center campuses we visited, IRS failed to assure 

itself that the courier service had met the insurance coverage 

requirements or that the courier service employees had passed the 

required limited background investigation. In fact, the courier service 

had failed to meet the insurance coverage requirements, and IRS had 

performed no limited background investigation of courier service 

employees. At a lockbox site, management of the site had authorized 

three couriers to start transporting daily deposits prior to receipt of 

their fingerprint check results.



Furthermore, we noted differing requirements for couriers depending on 

whether the couriers are operating at IRS’s own service center campuses 

or at contractor-operated lockbox banks, even though all couriers are 

entrusted with daily deposits. For example, at lockbox banks, pursuant 

to the Lockbox Processing Guidelines, couriers are only required to 

have a fingerprint check. Requirements also differed among the service 

center campuses: at the five service center campuses where couriers are 

under IRS-negotiated contracts, they are required to have a background 

investigation and a fingerprint check; at the other five service center 

campuses, the couriers operate under FMS-negotiated contracts and are 

not required to have either a background investigation or a fingerprint 

check.



These weaknesses increase IRS’s vulnerability to theft or loss and 

expose taxpayers to increased risk of losses from financial crimes 

committed by individuals who inappropriately gain access to 

confidential information entrusted to IRS. Thus, it is important that 

IRS continue to work to effectively address these matters because they 

are critical to IRS successfully meeting its customer service goals.



Compliance Issues:



Our tests of compliance with selected provisions of laws and 

regulations disclosed two areas of noncompliance that are reportable 

under U.S. generally accepted government auditing standards and OMB 

guidance. These relate to the release of federal tax liens against 

taxpayers’ property and the structure of installment agreements IRS 

enters into with taxpayers to satisfy the taxpayer’s outstanding tax 

liability. We also found that IRS’s financial management systems do not 

substantially comply with the requirements of FFMIA.



Release of Federal Tax Liens:



The Internal Revenue Code grants IRS the power to file a lien against 

the property of any taxpayer who neglects or refuses to pay all 

assessed federal taxes. The lien becomes effective when it is filed 

with a designated office, such as a courthouse in the county where the 

taxpayer’s property is located. The lien serves to protect the interest 

of the federal government and serves as a public notice to current and 

potential creditors of the government’s interest in the taxpayer’s 

property. For example, federal tax liens are disclosed in credit 

reports of individuals. Under section 6325 of the Internal Revenue 

Code, IRS is required to release a federal tax lien within 30 days 

after the date the tax liability is satisfied or has become legally 

unenforceable or the Secretary of the Treasury has accepted a bond for 

the assessed tax.



In previous audits, we found that IRS did not always release the 

applicable federal tax lien within 30 days of the tax liability being 

either paid off or abated as required by the Internal Revenue 

Code.[Footnote 40] We found that this condition continued to exist in 

fiscal year 2002. Specifically, in our testing of 59 tax cases with 

liens in which the taxpayers’ total outstanding tax liabilities were 

either paid off or abated during fiscal year 2002, we found 20 

instances in which IRS did not release the applicable federal tax lien 

within the 30-day statutory requirement. The time between satisfaction 

of the liability and release of the lien ranged from 46 to 1,263 days. 

For example, in one case we found that although the taxpayer satisfied 

the outstanding tax liability in April 2000, IRS did not formally 

release the lien against the taxpayer’s property until November of the 

following year--578 days later. Based on the results of our work, we 

estimate that for 34 percent of unpaid tax assessment cases where IRS 

had filed a tax lien that were resolved in fiscal year 2002, IRS did 

not release the lien within the 30-day requirement.[Footnote 41] The 

failure to promptly release tax liens could cause undue hardship and 

burden to taxpayers who are attempting to sell property or apply for 

commercial credit.



Structuring of Installment Agreements:



Section 6159 of the Internal Revenue Code authorizes IRS to enter into 

installment agreements with taxpayers to fully satisfy the taxpayer’s 

tax liability. While our fiscal year 2001 audit did not identify 

instances of material noncompliance in a statistical sample of 

installment agreements,[Footnote 42] audits for prior years showed that 

IRS had not always structured installment agreements to ensure that 

they would satisfy the taxpayer’s outstanding tax liability, including 

future interest accruals, before the statutory collection period for 

the tax liability expired.[Footnote 43]



During our fiscal year 2002 financial audit, we again found that 

installment agreements were not always structured to provide for full 

payment of the tax liability. Specifically, in our testing of 59 

installment agreements, we found 4 instances in which the terms of the 

installment agreements did not require full satisfaction of the tax 

liability. Based on the results of our work, we estimate that nearly 7 

percent of new installment agreements entered into during fiscal year 

2002 had payment terms that would not fully satisfy the tax liability 

within the statutory collection period.[Footnote 44] The presence of 

such cases in fiscal year 2002 indicates that IRS was not in compliance 

with section 6159 of the Internal Revenue Code.



Financial Management Systems’ Noncompliance with FFMIA:



In fiscal year 2002, we continued to find that IRS’s financial 

management systems did not substantially comply with the requirements 

of FFMIA. Specifically, IRS’s systems did not comply with Federal 

Financial Management Systems Requirements (FFMSR), federal accounting 

standards (U.S. generally accepted accounting principles), and the U.S. 

Government Standard General Ledger (SGL) at the transaction level. We 

found that IRS (1) cannot rely on information from its general ledger 

to prepare its financial statements, (2) does not have a general ledger 

that conforms to the SGL, (3) lacks a subsidiary ledger for its unpaid 

assessments, (4) lacks a reliable subsidiary ledger for its P&E, and 

(5) lacks an effective audit trail from its general ledger back to 

subsidiary detailed records and transaction source documents for 

material balances. Other material weaknesses we discussed earlier--

controls over unpaid assessments, federal tax revenue and refunds, P&E, 

and computer security--are also conditions indicating that IRS’s 

systems do not substantially comply with the requirements of FFMIA.



As a result, IRS’s financial management systems cannot produce 

auditable financial statements and related disclosures that conform 

with U.S. generally accepted accounting principles without substantial 

compensating processes and significant adjustments. These weaknesses 

also indicate that IRS’s systems cannot routinely accumulate and report 

the full cost of its activities. Since IRS’s systems do not comply with 

FFMSR, U.S. generally accepted accounting principles, and the SGL, they 

also do not comply with OMB Circular A-127, Financial Management 

Systems. In its FIA assurance statement to Treasury, IRS reported that 

its financial management systems did not substantially comply with the 

requirements of FFMIA in fiscal year 2002.



IRS has established a remediation plan to address the conditions 

affecting its systems’ ability to comply with the requirements of 

FFMIA. This plan outlines the actions to be taken to resolve these 

issues, designates resources to be devoted to implementing those 

actions, and specifies time frames for their completion. Due to the 

long-term nature of IRS’s systems modernization efforts, which IRS 

expects will resolve many of the most serious issues, many of the 

planned time frames exceed the 3-year resolution period specified in 

FFMIA. However, for these instances IRS has received a waiver from this 

requirement from OMB, as authorized by FFMIA.



[End of section]



Appendix II: Details on Audit Methodology:



To fulfill our responsibilities as the auditor of IRS’s financial 

statements, we did the following:



* Examined, on a test basis, evidence supporting the amounts and 

disclosures in the financial statements. This included testing selected 

statistical samples of unpaid assessment, revenue, refund, accounts 

payable, accrued expenses, payroll, nonpayroll, P&E, and undelivered 

order transactions. These statistical samples were selected primarily 

to substantiate balances and activities reported in IRS’s financial 

statements. Consequently, dollar errors or amounts can and have been 

statistically projected to the population of transactions from which 

they were selected. In testing these samples, certain attributes were 

identified that indicated either significant deficiencies in the design 

or operation of internal control or compliance with provisions of laws 

and regulations. These attributes, where applicable, can be and have 

been statistically projected to the appropriate populations.



* Assessed the accounting principles used and significant estimates 

made by management.



* Evaluated the overall presentation of the financial statements.



* Obtained an understanding of internal controls related to financial 

reporting (including safeguarding assets), compliance with laws and 

regulations (including the execution of transactions in accordance with 

budget authority), and performance measures reported in the 

Management’s Discussion and Analysis.



* Tested relevant internal controls over financial reporting (including 

safeguarding assets) and compliance, and evaluated the design and 

operating effectiveness of internal controls.



* Considered the process for evaluating and reporting on internal 

controls and financial management systems under FIA.



* Tested compliance with selected provisions of the following laws and 

regulations: Anti-Deficiency Act, as amended (31 U.S.C. §1341(a)(1) and 

31 U.S.C. §1517(a)); Agreements for payment of tax liability in 

installments (26 U.S.C. §6159); Purpose Statute (31 U.S.C. §1301); 

Release of lien or discharge of property (26 U.S.C. §6325); Interest on 

underpayment, nonpayment, or extensions of time for payment of tax (26 

U.S.C. §6601); Interest on overpayments (26 U.S.C. §6611); 

Determination of rate of interest (26 U.S.C. §6621); Failure to file 

tax return or to pay tax (26 U.S.C. §6651); Failure by individual to 

pay estimated income tax (26 U.S.C. §6654); Failure by corporation to 

pay estimated income tax (26 U.S.C. §6655); Prompt Payment Act (31 

U.S.C. §3902 (a), (b), and (f), and 31 U.S.C. §3904); Fair Labor 

Standards Act of 1938, as amended (29 U.S.C. §206); Civil Service 

Retirement Act of 1930, as amended (5 U.S.C. §§5332, 5343); Federal 

Employees’ Retirement System Act of 1986, as amended (5 U.S.C. §§8422 

and 8423); Social Security Act, as amended (26 U.S.C. §§3101 and 3121, 

and 42 U.S.C. §430); and Federal Employees Health Benefits Act of 1959, 

as amended (5 U.S.C. §§8905, 8906, and 8909).



* Tested whether IRS’s financial management systems substantially 

comply with the three FFMIA requirements.



[End of section]



Appendix III: Comments from the Internal Revenue

Service:



DEPARTMENT OF THE TREASURY:

INTERNAL REVENUE SERVICE WASHINGTON, D.C. 20224:



COMMISSIONER:



November 7, 2002:



Mr. David M. Walker, Comptroller General, U.S. General Accounting 
Office 

441 G Street, NW Washington, D.C. 20548:



Dear Mr. Walker:



Fiscal Year 2002 was a landmark year for Federal financial management 

at the IRS. We are pleased that your draft report titled, Financial 

Audit. IRS’ Fiscal Years 2002 and 2001 Financial Statements, so fairly 

presents both our progress and our remaining challenges. For the third 

consecutive year, we achieved an unqualified audit opinion for the 

annual financial statements. Doing so demonstrates to the public that 

we can properly and consistently account for approximately $2 trillion 

in revenue receipts, $281 billion in refunds, and $10 billion in 

appropriated funds.



We wish to recognize the GAO’s dedication and cooperation throughout 

this audit process. We appreciate the excellent counsel and support the 

auditors provided to us. As you noted in your report, in addition to 

maintaining our unqualified audit opinion, we met the significant 

challenge set by the Secretary of the Treasury of completing the FY 

2002 audit by November 15, 2002, six weeks after the end of the fiscal 

year and three and one half months earlier than last year. This was 

accomplished by making significant improvements in our financial 

management by reassessing and systematically changing how we process 

transactions, maintain financial records, and report financial results. 

Our success was also dependent upon the GAO’s agreement to test 

transactions and balances at interim periods rather than conducting all 

testing at year-end. We appreciate your acknowledgement of the great 

strides we made in FY 2002 and your willingness to work with us to 

adapt the audit process to the accelerated schedule.



During the fiscal year, we instituted a number of financial management 

reforms and improvements, which contributed to our ability to retain 

the clean opinion and meet the accelerated reporting dates. 

Specifically, we:



*Implemented procedures to improve the timeliness and accuracy of 

recording Property and Equipment (P&E) transactions in our accounting 

records *Capitalized property and equipment acquisitions at the end of 

each quarter:



*Recorded imputed financing costs regularly:



*Enhanced our accountability over budgetary activity by increasing the 

frequency of our analyses of outstanding obligations and other 

budgetary accounts:



*Improved our review of outstanding obligations and performed more 

frequent analyses of certain general ledger accounts:



*Established formal organizations within the revenue and administrative 

activities to develop and update financial management policies and 

procedures:



*Conducted a comprehensive assessment of our strategic initiatives to 

prioritize the programs relative to our mission and available 

resources:



*Began the design of an automated Trust Fund Recovery Penalty system 

that can properly cross-reference payments and eliminate the 

opportunity for errors *Revised our information technology security 

policy and guidance, updated security standards for several of our 

computing systems and devices, and improved certain physical security 

controls at our data processing facilities:



*Began conducting periodic security reviews of receipt processing 

areas, implemented many of our new hiring and courier standards, and 

updated relevant policies and procedures to safeguard taxpayer receipts 

and data:



*Issued Lockbox Processing Guidelines to improve the safeguarding of 

taxpayer receipts and data at lockbox facilities:



*Established a Peer Review Program to ensure adequacy and compliance 

with internal access control guidelines:



*Published guidance to all field offices to assure that a “controlled 

access environment” is implemented in every Taxpayer Assistance Center 

to the maximum extent possible within space and funding constraints:



To further improve financial management, we took specific actions in FY 

2002 to expedite the resolution of all IRS material weaknesses. The 

existing material weaknesses were reviewed by senior executives to 

identify the key issues requiring resolution. We determined and 

documented the actions necessary to resolve the issues. Where initial 

review indicated that long-term systems improvements were required, we 

reassessed to identify possible interim process solutions that would 

allow us to alleviate the materiality of the weakness while we waited 

for the long-term system fix. Expedited action plans were developed to 

resolve key issues for some material weaknesses and are being developed 

for three others. As a result, we reduced the number of material 

weaknesses from 14 to 9 and we plan to close at least three 

significantly earlier than previously planned. Work continues to 

expedite resolution of the others.



We also revised our Remediation Plans for Custodial and Administrative 

Financial Management Systems. We changed the format and content of the 

plans to better meet the requirements of the Federal Financial 

Management Improvement Act (FFMIA) of 1996. The Remediation Plans are 

now aligned with our Material Weakness Plans and our Business System 

Modernization Plans. We included more intermediate target dates to help 

ensure we stay on schedule for bringing our systems into FFMIA 

compliance.



As a result, these Remediation Plans are a better tool for effectively 

managing the remedial action process.



We must now focus on ensuring financial management practices are 

institutionalized and our new Integrated Financial System (IFS) is 

implemented. As we pursue these two primary initiatives, it is worth 

noting that system modernization efforts will address almost one-third 

of the currently open audit recommendations. We are also aggressively 

planning other short-term actions that will further improve the 

accuracy and timeliness of our financial management information. As 

examples, we plan to:



*Evaluate and determine ways to provide more precise revenue data and 

streamline the audit approach for unpaid assessments:



*Improve the timeliness of obligation transactions:



*Develop and implement a methodology to accrue non-payroll expenditures 

at least quarterly:



*Conduct reviews to assist offices in correctly implementing policies 

and procedures *Participate in each Treasury Financial Management 

Service review of commercial lockbox banks to assess compliance with 

Lockbox Processing Guidelines:



*Improve accountability over software licenses:



*Continue the automation of the Trust Fund Recovery Penalty process:



Though we are pleased with the balanced presentation of the progress, 

we continue to disagree with the GAO’s assertion that “IRS management 

and staff might enter into obligations that exceed the budgetary 

authority made available by Congress.” As we stated in our response to 

last year’s report, we clearly have the capability to prevent this from 

happening and have never exceeded our budget authority. Once again, we 

ask the GAO to consider modifying this specific conclusion.



We concur with GAO’s statement that fundamental deficiencies continue 

to exist in our property management system. We will reiterate our 

policy that all purchases of computer equipment must go through the 

Single Point Inventory Function first to be entered into the inventory 

database. During FY 2003, an interim process is being established to 

implement an electronic means of detecting computer equipment not in 

the inventory database. This should preclude the occurrence of 

situations similar to the one noted in your report concerning the 38 

desktop computers not recorded in IRS’ inventory records. Additionally, 

the GAO correctly identified disposal problems in this audit. We 

corrected the system problem identified in the report prior to the 

audit. However, there was not sufficient time after the certification 

activity ended and before the audit samples were extracted to correct 

the data. We provided the GAO with an exception report that listed the 

specific items. We will continue to refine the disposal process by 

providing Servicewide guidance on proper disposal procedures, ensuring 

that the property disposal database is properly updated, establishing a 

link to the procurement and financial systems, and tracking the 

deployment and usage of the site license via our automated processes. 

Full implementation and deployment of IFS will enable us to remedy all 

property-related issues.



In closing, I would like to restate the IRS’ commitment to continual 

improvement in financial management. That commitment permeates 

throughout the Service. We will continue the improvements made in the 

last few years as we develop and implement the fundamental long-term 

solutions needed to address the internal control weaknesses cited in 

your report. Both the GAO and the IRS recognize that it is only through 

implementation of the new integrated financial management system that 

we will be able to overcome the majority of the material weaknesses 

cited in your report. Our Chief Financial Officer will provide 

technical comments to Steve Sebastian under separate cover.



Sincerely,



Bob Wenzel

Acting Commissioner:



Signed by Bob Wenzel



[End of Section]



FOOTNOTES



[1] U.S. General Accounting Office, Financial Audit: IRS’s Fiscal Years 

2001 and 2000 Financial Statements, GAO-02-414 (Washington, D.C.: Feb. 

27, 2002).



[2] In accordance with OMB Bulletin 01-09, Form and Content of Agency 

Financial Statements, IRS prepared comparative Balance Sheets, 

Statements of Net Cost, and Statements of Custodial Activity as of and 

for the fiscal years ended September 30, 2002 and 2001. IRS prepared 

the Statements of Changes in Net Position, Budgetary Resources, and 

Financing for the fiscal year ended September 30, 2002, only.



[3] U.S. General Accounting Office, Financial Audit: Examination of 

IRS’ Fiscal Year 1992 Financial Statements, GAO/AIMD-93-2 (Washington, 

D.C.: June 30, 1993).



[4] In 2001, the Office of Management and Budget announced the 

executive branch’s intention to significantly accelerate agencies’ 

financial reporting timeline, requiring that by fiscal year 2004 they 

issue their financial statements by November 15. The Department of the 

Treasury established its own goal of issuing its fiscal year 2002 

audited financial statements by November 15, 2002. As a component 

entity of Treasury, IRS is subject to Treasury’s financial-reporting 

timeline.



[5] A material weakness is a condition that precludes the entity’s 

internal controls from providing reasonable assurance that material 

misstatements in the financial statements would be prevented or 

detected on a timely basis. Reportable conditions are matters coming to 

our attention that, in our judgment, should be communicated because 

they represent significant deficiencies in the design or operation of 

internal controls that could adversely affect IRS’s ability to meet the 

objectives described in this report.



[6] Prior to fiscal year 2001, we reported that IRS was not in 

compliance with section 6159 of the Internal Revenue Code, which 

authorizes IRS to enter into installment agreements with taxpayers to 

fully satisfy the taxpayer’s liability (see GAO-01-394). We did not 

identify any instances of material noncompliance with section 6159 

during fiscal year 2001 and therefore did not report it as an area of 

noncompliance, but we found instances of noncompliance with the section 

again in fiscal year 2002.



[7] U.S. General Accounting Office, Financial Audit: IRS’s Fiscal Year 

2001 and 2000 Financial Statements, GAO-02-414 (Washington, D.C.: Feb. 

27, 2002).



[8] GAO-02-414.



[9] The Joint Financial Management Improvement Program (JFMIP) is a 

cooperative undertaking of the Office of Management and Budget, the 

Department of the Treasury, the Office of Personnel Management, and GAO 

working in cooperation with each other and with operating agencies to 

improve financial management practices.



[10] IRS’s integrated financial system is planned to include the core 

financial system defined by JFMIP, including an SGL-compliant general 

ledger, accounts payable, accounts receivable, fund and cost 

management, budget formulation, and financial reporting.



[11] Suspense accounts are used to temporarily recognize certain 

transactions until sufficient information is available to determine 

their appropriate permanent account classification. As of September 30, 

2002, IRS recorded estimated nonpayroll expenses and in the process, 

reduced the suspense balance to an immaterial amount by analyzing its 

content and reclassifying most of it to the appropriate permanent 

accounts. However, IRS did not perform this process during the year.



[12] Joint Financial Management Improvement Program, Systems 

Requirements for Managerial Cost Accounting (Washington, D.C.: Feb. 

1998).



[13] Unpaid assessments consist of (1) taxes due from taxpayers for 

which IRS can support the existence of a receivable through taxpayer 

agreement or a favorable court ruling (federal taxes receivable), (2) 

compliance assessments where neither the taxpayer nor the court has 

affirmed that the amounts are owed, and (3) write-offs, which represent 

unpaid assessments for which IRS does not expect further collections 

due to factors such as the taxpayer’s death, bankruptcy, or insolvency. 

Of these three classifications of unpaid assessments, only federal 

taxes receivable are reported on the principal financial statements. As 

of September 30, 2002, IRS reported $20 billion (net of an allowance 

for doubtful accounts of $67 billion), $25 billion, and $137 billion in 

these three categories, respectively.



[14] IRS’s master file contains detailed records of taxpayer accounts. 

However, the master files do not contain all the details necessary to 

properly classify or estimate collectibility for unpaid assessment 

accounts.



[15] When a company does not pay the taxes it withholds from employees’ 

wages, such as Social Security or individual income tax withholdings, 

IRS has the authority to assess all responsible officers individually 

for the taxes withheld from employees. Although assessed to multiple 

parties, the liability need only be paid once. Thus, IRS may record 

assessments against each of several individuals for the employee-

withholding component of the payroll tax liability of a given business 

in an effort to collect the total tax liability of the business. The 

assessments made against business officers are known as trust fund 

recovery penalties. 



[16] GAO-02-414.



[17] IRS 1099 forms are used by third parties, such as financial 

institutions, to report taxpayers’ interest income, dividend 

distributions, and other miscellaneous income.



[18] The peak tax filing season primarily occurs from January 1 to 

April 15 of each year. 



[19] By statute, IRS must pay interest on refunds not paid within 45 

days of receipt or due date, whichever is later (26 U.S.C. §6611).



[20] Because it is a tax credit, an EITC claim always results in a 

reduction of the taxpayer’s calculated tax liability. However, 

depending on the taxpayer’s amount of taxes withheld, it may or may not 

result in a refund for a particular tax year. 



[21] Internal Revenue Service, Compliance Estimates for Earned Income 

Tax Credit Claimed on 1999 Returns (Washington, D.C.: Feb. 28, 2002). 



[22] We used the fiscal year 2000 refund rate because most of the tax 

year 1999 refunds were paid in fiscal year 2000.



[23] Individual tax returns are not due until April 15 of the following 

year (up to October 15 if extensions are filed), and the underreporter 

screening programs cannot be run until after the returns are filed. 

Consequently, tax year 2000 is the most recently completed tax year for 

which the cited data are available.



[24] GAO-02-414.



[25] Each transaction can involve multiple assets. 



[26] For our book-to-floor sample, we obtained a sample of P&E items 

with a two-stage cluster sample. In the first stage, we selected a 

sample of 22 buildings. In the second stage, we selected a sample of 10 

assets located at each of the 22 buildings from IRS’s asset records. 



[27] We are 95 percent confident that the error rate does not exceed 18 

percent.



[28] In our fiscal year 2001 audit, we were 95 percent confident that 

the error rate did not exceed 20 percent.



[29] GAO-02-414.



[30] Budgetary authority is the authority provided by law to enter into 

financial obligations that will result in immediate or future outlays 

involving federal government funds.



[31] An adjustment to a prior year’s obligation is recorded when the 

dollar amount previously recorded is affected by a subsequent event, 

such as a change in the price of goods or services.



[32] Deobligations are downward adjustments of previously recorded 

obligations. Deobligations can occur for a variety of reasons, such as 

if the actual expense was less than the amount obligated, a project or 

contract was cancelled, an initial obligation was determined to be 

invalid, or previously recorded estimates were reduced.



[33] OMB requires that each agency submit SF133s on a quarterly basis 

to report on each agency’s budget execution as well as the status of 

its budgetary resources.



[34] GAO-02-414.



[35] U.S. General Accounting Office, Internal Revenue Service: Progress 

Made, but Further Actions Needed to Improve Financial Management, GAO-

02-35 (Washington, D.C.: Oct. 19, 2001).



[36] U.S. General Accounting Office, Internal Revenue Service: 

Recommendations to Improve Financial and Operational Management, GAO-

01-42 (Washington, D.C.: Nov. 17, 2000).



[37] U.S. General Accounting Office, Internal Revenue Service: Status 

of Recommendations from Financial Audits and Related Financial 

Management Reports, GAO-02-848 (Washington, D.C.: July 30, 2002). 

Candling is a process that uses a light source to determine if any 

contents remain in the open envelopes before their destruction.



[38] Discovered remittances are cash or checks that were erroneously 

overlooked during the extraction process.



[39] U.S. General Accounting Office, Standards for Internal Control in 

the Federal Government, GAO/AIMD-00-21.3.1 (Washington, D.C.: Nov. 

1999).



[40] GAO-02-414.



[41] We are 95 percent confident that the error rate could be as high 

as 44 percent. In our fiscal year 2001 audit, we found five instances 

of noncompliance. At that time, we estimated that for 8 percent of 

unpaid tax assessment cases where IRS had filed a tax lien that were 

resolved in that fiscal year, IRS did not release the lien within the 

30-day requirement. We were 95 percent confident that the error rate 

could be as high as 19 percent.



[42] In last year’s audit, we found that based on a statistical sample 

of 59 installment agreements IRS entered into with taxpayers during 

fiscal year 2001, we were 95 percent confident that the rate of 

occurrence of installment agreements entered into during fiscal year 

2001 whose terms did not require full satisfaction of the tax liability 

did not exceed 5 percent. However, we also pointed out that this did 

not mean that all installment agreements IRS had entered into with 

taxpayers were structured to provide for full satisfaction of the tax 

liability.



[43] The statutory collection period for taxes is generally 10 years 

from the date of the tax assessment. However, this period can be 

extended by agreement between IRS and the taxpayer.



[44] We are 95 percent confident that the error rate could be as high 

as 15 percent.



GAO’s Mission:



The General Accounting Office, the investigative arm of Congress, 

exists to support Congress in meeting its constitutional 

responsibilities and to help improve the performance and accountability 

of the federal government for the American people. GAO examines the use 

of public funds; evaluates federal programs and policies; and provides 

analyses, recommendations, and other assistance to help Congress make 

informed oversight, policy, and funding decisions. GAO’s commitment to 

good government is reflected in its core values of accountability, 

integrity, and reliability.



Obtaining Copies of GAO Reports and Testimony:



The fastest and easiest way to obtain copies of GAO documents at no 

cost is through the Internet. GAO’s Web site ( www.gao.gov ) contains 

abstracts and full-text files of current reports and testimony and an 

expanding archive of older products. The Web site features a search 

engine to help you locate documents using key words and phrases. You 

can print these documents in their entirety, including charts and other 

graphics.



Each day, GAO issues a list of newly released reports, testimony, and 

correspondence. GAO posts this list, known as “Today’s Reports,” on its 

Web site daily. The list contains links to the full-text document 

files. To have GAO e-mail this list to you every afternoon, go to 

www.gao.gov and select “Subscribe to daily E-mail alert for newly 

released products” under the GAO Reports heading.



Order by Mail or Phone:



The first copy of each printed report is free. Additional copies are $2 

each. A check or money order should be made out to the Superintendent 

of Documents. GAO also accepts VISA and Mastercard. Orders for 100 or 

more copies mailed to a single address are discounted 25 percent. 

Orders should be sent to:



U.S. General Accounting Office



441 G Street NW,



Room LM Washington,



D.C. 20548:



To order by Phone: 	



	Voice: (202) 512-6000:



	TDD: (202) 512-2537:



	Fax: (202) 512-6061:



To Report Fraud, Waste, and Abuse in Federal Programs:



Contact:



Web site: www.gao.gov/fraudnet/fraudnet.htm E-mail: fraudnet@gao.gov



Automated answering system: (800) 424-5454 or (202) 512-7470:



Public Affairs:



Jeff Nelligan, managing director, NelliganJ@gao.gov (202) 512-4800 U.S.



General Accounting Office, 441 G Street NW, Room 7149 Washington, D.C.



20548: